When it comes to thinking through many of the fundamental problems embedded in financial services today, I think it may be useful to ask a rather simple and direct question: Why are so many people around the world suddenly so obese? Seriously. Why are people fat? That, quite simply, is the question I think we would learn a lot from asking... and then applying the answers to finance. To prove it, let me take you through my logic as to why I think this is the case.
Dealers: It struck me recently that companies that sell food products have similar businesses, in terms of incentives and motives, as those that sell financial products. For example, dig this:
For a long time, the most profitable food companies were those that had figured out ways to mass-produce and sell food. I’m talking here about homogenized, packaged, branded and widely distributed foodstuffs; ‘processed foods.’ What about selling fresh fruits, vegetables, grains and meats, you ask? Not so much. They’re expensive and don’t travel well. Processed “foods” have been augmented, changed and reconstituted in ways that make them durable and consumable by the masses. As such, the local and idiosyncratic features that one might expect and even hope to get from food (‘terroir’) ... were gone. Many thought this was a good thing, as these methods ensured food security. Moreover, most of this food was often engineered in labs to taste good. What few realized, however, was how bad much of this food would become for our society’s overall health.
In a similar vein, for a long time the most profitable finance companies were those that had figured out how to mass produce and sell homogenous, packaged, branded and widely distributed products. As with the food industry, these products were often abstractions of ‘real assets’. They were tranched and stripped of any local or idiosyncratic characteristics and sold onto central clearinghouses with the help of rating agencies and a whole host of intermediaries. Financial theory told us that this deconstruction and repackaging was a good thing, as it facilitated diversification and allowed for the mass distribution of finance. Top-down models, heuristics and black boxes accelerated things, leaving local knowledge and idiosyncrasy by the wayside. These products were engineered to provide investors with something that seemed to satisfy their risk and return objectives in a very palatable and easy way. In the end, however, finance (which used to be a highly personal and tailored industry) became depersonalized and, I’d argue, misguided.
Addicts: Following on from the above, it also struck me that the consumers of food and finance have similar types of limitations and constraints that end up working against their own interest. Peep this:
When it comes to food, most individuals lack the knowledge or will power to make healthy choices. We have come to know that mass-produced foods are really quite bad for us. But many of us still eat the junk. Why? It’s cheap and easy; short-term ease trumps long-term malaise. Moreover, there’s a general lack of transparency about what is actually being fed and consumed, let alone how these ingredients can create sickness over the long run (e.g., trans fats).
When it comes to finance, most investors (both individual and institutional asset owners) lack the detailed knowledge of the financial services industry to make smart decisions about where to consume financial advice and products. Many investors are attracted by the ease of buying a mass-produced product or giving a mandate to a mega-fund that purports to offer a “return,” but few truly understand the underlying fees, costs, risks and incentives being accepted either explicitly or implicitly. It’s the lack of transparency of this industry that ultimately drives much of its sickness.
Externalities: The people who sell mass-produced food or financial products aren’t being forced to price the long-term costs to society from their industries. In fact, quite the contrary — they’re actually being incentivized to prioritize short-term profits over long-term health and sustainability.
When it comes to processed food, most of the big companies aren’t being asked to share in the medical bills that they are undoubtedly responsible for creating. In fact, the government has actually taken steps to make the key processed food inputs (such as corn and soy) cheaper! Think about this insanity; big subsidies keep the corn and soy ingredients costs down, which makes it even less ‘appetizing’ for consumers to open their pocket books to pay for healthier treats. (By the way, you gotta laugh when ‘free market’ folks complain about a soda tax — sodas are already artificially cheap thanks to government’s corn subsidies, which means that a tax on soda could be a way of removing the distortionary influence that government is already creating...)
When it comes to finance, the people who sell products rarely pay for the havoc they create. Nor are they held accountable for the short-term rent seeking that they drive towards and the host of misaligned incentives that generates among portfolio companies and assets. In fact, as we learned in 2008/09, the government will ultimately step in and save the financial sector from itself. While this was perhaps understandable given the scale of the crisis, the moral hazard this creates for the entire industry is astounding.
Keep It Real: Given the parallels between food and finance, is it possible that we can apply some of the lessons we’ve learned making people healthier (see Whole Foods) to make finance healthier too ( e.g. Whole Finance)? Well, here’s an attempt:
The obesity epidemic in the United States is a function of cheap, unhealthy food. But is that food really cheap? We are spending far more than we used to on healthcare treating obese people. Wouldn’t it be cheaper to keep everybody eating good food than to pay for cost of healthcare provision to the 33% of our population that is becoming obese? If we priced medical costs into fast food, how much would that burger and fries cost, really?
Similarly, the models and products that purport to render finance cheaper, easier, better, and efficient represent, in my view, some of the most costly “products” in our society. Intermediaries use opacity to structure products that serve to enrich themselves. They’ve lost sight of who they serve; the real economy. It’s egregious.
So, what to do? In the same way many people have started to prioritize healthy foods, in part represented by the wild success of Whole Foods Markets, I think retail and institutional investors should move away from the overly processed and engineered products and mandates and instead focus on getting access to real assets. Is this hard to do? Yes. It is hard to cook food from scratch. It’s also hard to source, screen, diligence, negotiate, close and manage an asset. But it’s part of creating a “healthy” portfolio. So figure it out.
I would never suggest that people should do it all themselves; that they cook each and every one of their meals in house. No. I do think though that it’s the process of cooking that educates you about ingredients and balanced meals. This education is then carried with you into a grocery store or restaurant. It takes education at the level of the consumer to force the producers to make something that is actually healthy; the demand side can force the supply side to deliver what it wants. In other words we have to create a real interest in healthy food / finance before the market will really start to deliver.
Anyway, when it comes to finance, I think people need to ‘get in the kitchen and cook’. And that’s why I do what I do. I’m trying to help the big pensions and sovereign funds of the world better negotiate and better understand what they’re eating. My hope is that they’ll come to see that much of it’s unhealthy... and that it doesn’t have to be.
