Monday, May 7, 2012

The Market Will Choose

Money, when it works right, drives the endlessly recurring cycle of earning, spending, saving and investing that is the engine of our prosperity.

Earning and spending, we all know, have to be in balance.  There is a lot of flex in the system that gives it robustness and resiliency, but there is a limit beyond which it cannot bend: if we spend too much that we have not yet earned, trouble will ensue. We cannot spend more than we earn.

Saving and investment also have to be in balance.  If we do not save, we cannot invest.  If we save, but do not invest, we leak energy out of the system.  Money has to flow.  If it stagnates, it dissipates.

Think of money like electricity.  It can never stop flowing.  We can store it for a little while, like we can store electricity in a battery, but even a battery only slows things down.  Always, the power leaks out, and over time, even if it is not used, the battery will go dead.  Money is similar.  We can store it as savings, but only for a time.  If it is not used, eventually it leaks away.

So money has to flow, from Earning to Spending, from Spending to Saving, from Saving to Investment.  To complete the circuit, Investment has to flow back into Earning.

Investment has to create new value, providing people with new choices that they need, want and otherwise would not have.  It is new choices that create new earnings.   Unless investment creates new choices, earning will slow, spending will curtail, savings will shrink and investment will dry up.  The system will either grind to a halt, or more likely, collapse under its own weight.

"New" can mean different things.  It can mean new instances of a choice we already know and like, but that has to be re-created after each time we use it (or after some number of repeated uses), because the artifacts of exchange are used up or wear out.  It can also mean new choices that empower us to do things we could not do before, or to do things in new and better ways: invention and innovation.  And, it can mean larger quantities of what we have already decided we know, like and what to have more of: growth and expansion.

All of these forms of new value creation require some level of investment to sustain them.  This is how the proper flow of money sustains our prosperity: by sustaining investment that supports earnings that empowers spending (for good living), saving, and investing.

History and experience have shown repeatedly that it is prudent to have some wealth stored up and held in reserve, as a buffer against the vagaries of life.

In addition, we need to spend less than we earn, so that we can invest in earning more.

In our system, we rely on commercial banks (and their variants: collectively, the Banking System) to provide the liquidity our economy needs to move wealth from earning to spending and into saving, but when it comes to moving savings into investment, and investment into new value creation, a number of choices are available.
  1. Commercial banks make business loans, and provide credit in other ways, mostly to facilitate reinvestment and the creation of value that is new in the sense of being a replenishment of what has gotten used up.
  2. Investment banks buy shares in companies which they then list for re-sale as commodities traded over the Exchange, mostly to facilitate investment and the creation of value that is new in the sense of being more of what we already know, like and what more of:  Growth through Economies of Scale.
  3. Institutions (Insurance, Endowments, Pensions and Annuities) form investment partnerships with special purpose Enterprise organized and operated to create value which may be new in the sense of continuing (competition for the Banks), new in the sense of growing (competition for the Exchanges) or new in the sense of innovative (more on this later).
  4. Governments assess taxes to fund projects that are determined to be required for the public good. but not capable of being funded by private means.  These frequently include projects that create value that is new in the sense of innovative.

The Banks, commercial and investment, in combination, are true marvels of human ingenuity when valued for their ability to provide liquidity.  And liquidity is good.  

Unfortunately, it is not enough. We also need sustainability.  Money has to move, but it has to move in the right direction.

Right now, too much money is caught in a short circuit.  The power, so to speak, is not getting to the load.  Too much money held as savings and intended for investment in the creation of new value and the generation of more earnings that will keep the cash flow flowing, and sustain the prosperity of our economy, is instead getting caught in an infinite loop of buying and selling financial assets as commodities traded for a price over the Exchange.  Rising share prices become a self-fulfilling prophecy, creating the illusion that new value is being created, when really all that is happening is that savings are piling up inside these assets.  The proof: earnings fall while share prices rise; an unsustainable dynamic.

For the source of this problem, and it's solution, we have to look to the same place.  And it is not Wall Street, as many would have us believe.  It is on Main Street.

In the 21st Century, new stewards have emerged as the keepers of our wealth.  Insurance. Endowments.  Pensions.  Annuities.  These programs are increasingly the vehicles we use to manage our savings and provide for our posterity.  To be sure, banks are still important, but we also have these other choices now that provide programmatic solutions for specific financial concerns, and these choices, for those concerns, we like better than banks.  Insurance gives us protection against the financial impact of catastrophic losses.  Endowments take care of those we care about, but who for whatever reason cannot effectively take care of themselves.  Pensions and annuities save up purchasing power that can be drawn down later, to fund our spending needs after we stop earning as we go.

Vast sums of money are entrusted to these institutions, and part of their charter of trust is to use our money to make more money.  We want them to invest for us.  And they want to be our investors.  This is all a good thing, an innovation and an adaptation that gives us a new and better economy in the 21st Century.

These institutional investors favor an architectural paradigm for putting Investment into Enterprise that works programmatically to create new earnings capacity in the economy, generally, and that will programmatically pay returns to investors that align well, programmatically, with the programmatic purpose of our Institutional Investment programs.

The paradigm is the partnership model that is the financing solution of choice for Institutional Real Estate, and also for Energy and Infrastructure Project Finance.

This is all good, as far as it goes, but here we encounter a problem that is also an opportunity.  We have not yet fully embraced the Institutional Investment Partnership as the architecture of choice for putting Investment into Enterprise beyond the large, but relatively narrow, domains of Real Estate and Government-sponsored/subsidized Project Finance.  For more general business finance, including both Growth and Innovation, the Institutional Investment Partnership is used not to make a direct investment in Enterprise, but to make a direct investment in the Exchanges.

This means that the principal advantages of the partnership architecture, and of direct alignment of interest between Enterprise and Investment along multiple points of shared value that balances liquidity with sustainability, are being lost to us.  Instead, we are seeing our savings get trapped inside the Exchanges, where the interests of all, Enterprise, Investment, Government, the general public, must be aligned with the interests of whatever will bring the next new buyer in to make the next trade.

We get lots of liquidity, but not so much sustainability.

In too many ways, Wall Street has become the Las Vegas of finance. Where casinos in Las Vegas run gaming tables, Wall Street runs trading desks. 

The High Rollers on Wall Street are Professional Asset Managers who organize partnerships with Institutional Investors.  These Managers place bets with their Investors’ money, charging a fee for placing the bets, and sharing in profits (but not the losses) if the bets pay off.

It didn't start out that way.  In the 19th Century, when Investment Banking as we now know it was just getting going, the Exchange-based architecture for bringing Investment into Enterprise was the height of innovation, using cutting edge technology of the day for information and communication to finance the innovative enterprises of the day on a scale that had never been achieved in the private sector before then.

The genius of this solution includes: the Dutch auction method for setting the price for securities listed for trading over the Exchange, the broker network for soliciting bids and asks; and the central clearinghouse for settling transactions between buyers and sellers separated from each other by distances of space and time.

Today, we have computers, the Internet, the World Wide Web, cells phones, email, texting, Social Media and all manner of information and communication technologies that connect us together, from remote locations, in real time, eliminating for all practical purposes the distances of space and time that once separated Enterprise from Investment, making a centralized, placed-based solution an inspired innovation.  And today, if and when physical proximity is necessary, we have air travel to cross the miles in minutes, easily and affordably.

We no longer need a centralized, place-based solution to make the connection indirectly that once could not be made directly.  

Yet, we still choose to.

That is not unusual.  It is hard to let go of what we know, and to move into something new and less familiar.  This is a common dynamic with every paradigm shift to innovation.  When large amounts of money are invested in keeping the old way of doing things the current way those things get done, the shift is even harder, because the resistance to change is so high.

Nonetheless we need to make the shift.  It should not be that hard.  We already have the new paradigm with need.  It is the Institutional Investment Partnership that is a proven, effective mechanism for bringing Investment into Enterprise directly, with interests aligned along multiple points of shared value that include both liquidity and sustainability, each in due measure.  This paradigm is already familiar to those we need to use it most, our Institutional Investors who have emerged as the new stewards of our private wealth.

All we need is the right catalyst.  We need to market to know there is a choice.  Once the market sees that choice, the market will choose, and we will make the move.


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