Financially Engineering the Right Economy
Do we have the right economy?
a new conversation at the vanguard of public discourse
made possible by innovations in fiduciary finance
and the innovation of fiduciary activism
Prudent Stewards of Social Trusts for socially provisioning the social safety nets of Workforce Pensions and Civil Society Endowments
exercising their capacity
to use the technologies of spreadsheet math, desktop publishing and digital communication to negotiate agreements on
equity paybacks to a fiduciary cost of money, plus opportunistic upside, for Actuarial Complaince as to income ongoing into a secure future
from enterprise cash flows prioritized by contract for
suitability of the technology under the circumstances then prevaling
longevity of the enterprise under the circumstances then previaling, and
fairness in how the business does business, under the circumstances then prevailing, across all six vectors of fairness in business
fairness to suppliers (Fair Trade)
fairness to communities, of place and of interest (Fair Engagement)
fairness to Nature, Society and the Future (Fair Reckoning)
fairness to workers, and in the workplace (Fair Working)
fairness to customers and competitors (Fair Dealing) and
fairness to the savers whose savings are the ultimate and original source of the money made to flow into the enterprise by its financiers (Fair Sharing)
for Fiduciary Faithfulness as to safety ongoing into a dignified future
derived from their character of
vast size
programmatic purpose
forever time
true to their legally constituted aims
to investment money
for income as well as safety
to assure
income security in a dignified future, for evergreen populations of current and future retired workers, in the case of pensions, and for Mission, in the case of endowments
accountable to the common sense of what makes sense under the circumstances then prevailing of reasonable people familiar with such matters of capacity, character, aims and circumstances
If we look for answers to the question, Do we have the right economy?, the way we are today, through the lens of Asset Ownership and the financialization of fiduciary money through capital markets capture of control over the tens of trillions in society's shared savings aggregated, collectively, worldwide, into social trusts for socially provisioning the social safety nets of Workforce Pensions and Civil Society Endowments, we fall into a rabbit hole of linguistic legerdemain that transforms "the economy" into transaction volumes measured in prices paid in money and "right" into growth, so that our question becomes,
How do we grow transaction volumes as the magic formula for living better?
The qualities of "right" that are nuanced and subtle, and human, get reduced to the quantities of price that are cold, mathematical and inhuman.
The economy becomes a monstrosty.
The fix for this is simple: de-financialize fiduciary money.
Turn off the noise about maximizing extraction spewing out of the capital markets through oh so many channels, so we can take out the law books, instead, and go back to the text to remind ourselves of the rules by which money is made to flow from us, as individuals, who are learners and earners and spenders and savers and investors, into financing for enterprise to form the businesses that form the technologies that form the choices that form the economy that forms society that forms our future.
One set of these rules are the rules of the capital markets.
Another set of these rules are the rules of forever money.
These are not the same rules.
We have forgotten that. We need to re-mind ourselves of it.
Forever money is fiduciary. The capital markets are not.
A simple distinction never to be forgotten, if we want to be financing the right economy.
The capital markets are created by design to mediate the tensions between us, as individuals, who need liquidity in increments when we make investments - to accommodate our idiosyncrasies in timing and amount, and our opportunism in objective - and the need of enterprise for longevity at scale in their financings.
Enterprise is a physical coming-together of people who share knowledge of the same technology - as knowledge about how the world about us works, and how we can take the world about us as we find it, and change it to become more a way we choose to make it - to work together collaboratively co-creating a surplus of artifacts of that knowledge in abundance for sharing with others - for their use in forming their own personal and private worlds for living their own best lives under the circumstances then prevailing, out of the artificial world that we all make for ourselves in which to live together, out of the world of Nature into which we all are born - in exchange for a price paid in money, or other value.
Enterprise needs money to do its work, as legal instruments for effecting transactions between people who are separated by distances of time, place and social connection, that is also the social energy for directing the insights and initiative of individuals towards some activities, and away from others.
When enterprise needs money, Finance provides it.
Finance is the institutions of agency, authority and accountability through which society aggregates money set aside by others, for a purpose, for a time, and allocates those aggregations as investment in financings for enterprise to form the businesses that form the technologies that form the choices that form the economy that forms society that forms our future, where investment is making money flow into enterprise for its use in doing its work, for a time, at a cost and on terms.
Finance collects the cost charged to enterprise, and shares those costs with us, as savers.
There are six different rules of agency, authority and accountability in Finance today, giving us six different kinds of money.
1. Private Money is set aside by families and their friends to provide for the family and its friends, that gets aggregated through Family & Friends (Family Offices) and allocated through patronage for IMPACT, where impact is whatever the family and its friends feel is good for the family and its friends.
2. Civic Money is set aside by various people to provide for others, that gets aggregated through Church & Philanthropy and allocated as grants for MISSION.
3. Public Money is set aside by force of law (in theory, laws that are enacted through processes of representative self-government in which we have a voice) to provide for public health, public safety and the public's wellbeing that gets aggregated through Taxing & Spending (Government), and allocated through subsidies for POLICY.
4. Working Money is set aside for safekeeping and future transacting, that gets aggregated through Banking & Insurance, and allocated through the monetization of PROPERTY.
5. Mad Money is set aside for putting money to work making more money, idiosyncratically and opportunistically, that gets aggregated through Exchanges & Funds (the Capital Markets) and allocated through securitization for individual participation in enterprise financing at SCALE.
6. Fiduciary Money is set aside to programmatically provide certainty against certain of life's future financial uncertainties, that gets aggregated into social trusts for Workforce Pensions and Civil Society Endowments and allocated through negotiation for SUFFICIENCY to the longevity of the Pension or Endowment.
Pensions & Endowments, as prudent stewards of social trusts that control vast sums of money aggregated for a programmatic purpose across a future time horizon that is endlesssly receding into forever, don't need liquidity in increments in their investments, like we do, as individuals.
They do need longevity at scale. They need constant and consistent cash flows, at rates specified by the actuaries who design the mutual aid society that is a pension trust for provisioning a pension promise (or the equivalent for endowments), regularly and repetitively flowing into the trust, sufficient, according to the actuaries, to support payouts from the trust, of contractually calculated payments to contractually qualified recipients, at contractually specified intervals, to evergreen populations of currently retired workers, "every month, forever" (or equivalent payouts of grants for mission by endowments), while the money aggregated into the trust remains always invested in financings for enterprise to generate the required cash flows.
Pensions & Endowments need to generate cash flows through their investments in financing for enterprise.
Entetprise generates cash flows with the proceeds of its financings.
These two are the same.
The most efficient way to flow fiduciary money aggregated into social trusts for Pensions & Endowments, that is controlled by the trustees of those trusts, as investment in financing for enterprise is through agreements for sharing in enterprise cash flows, directly.
The capital markets do not do that.
Instead, the capital markets create a legal agreement for the ownership of the enterprise, usually a corporation, and securitize that agreement into large numbers of legally equal, commodity shares of ownership that can be bought and sold in various increments, at varying points in time, between buyers and sellers as market participants, at market clearing prices that increase over time as the cash flows generated by the enterprise(s) owned by the corporation are retained and reinvested to increase the scale at which the enterprise does business (or the number of enterprises that are owned by that corporation). (We are talking here only about equity financings arranged through the capital markets, as stock, or stock-alternatives. The capital markets also securitize loan agreements, as bonds, and bond-alternatives, as debt financing for enterprise. Debt trades on volatility, where equity trades on growth. We are limiting our focus here to equity that trades on growth).
This is fine for us, as individuals. We don't have the scale to buy a direct share in cash flows at the scale of enterprise, or the constancy over time to hold such shares for as long as the enterprise needs the equity.
For Pensions & Endowments, that do have both the scale and the constancy over time, it is inefficient, and disruptive, bending the arc of caring for the fiduciary stewards of these social trusts away from their aims, and towards their assets, and the selling price for those assets, and the profit that can be extracted from that price, without considering the consequences of that extraction, on enterprise, on workers, on society, or on Nature.
So why is our common sense agreeing that it makes sense for the fiduciary stewards of social trusts to self-identify as Asset Owners Allocating Assets Across Asset Classes, and within classes selecting Asset Managers who are peer-benchmarked by Consultants for excellence in maximizing the highest possible purely pecuniary profit extraction from other market participants, workers, society, the economy and Nature through price-taking in the public, or financially engineered value creation in the private, alternative, capital markets, solely in the financial best interests of capital markets professionals, in reliance on the axiomatic assertion that what is best for the capital markets will also always be best for all of us?
Why do we accept that axiom, without question, in defiance of pervasive and persistent lived experience that it is simple not true?
At least part of the answer must be that prior to 1983, there really was no practical alternative to the capital markets for putting money at the scale of social trusts into enterprise as equity.
Before 1972, the legal answer had been the New York Rule of the Legal List that limited social trust fiduciaries to investing like bankers, making loans at interest, but further restricting them to loans made to governments, high credit quality corporations or real estate.
In 1972, the New York Rule of the Legal List was replaced by the Massachusetts Rule of the Prudent Person, largely in reliance on new learning about how prices move in the stock markets, and how diversification across industries and over time can inoculate portfolios of shares against the vagaries of market clearing prices on individual issues, returning a blended return on an overall portfolio basis that mimics the growth in the stock market overall. This was, and still is, known as Modern Portfolio Theory.
At that time, this was accepted as a prudent way to manage volatility in share prices, consistent with the fiduciary duties of social trusts, and quickly became the accepted practice that it is today.
What was missed at the time, and is still not being properly recognized by lawyers and the law, is this:
markets that are dominated by individuals buying and selling with our own money, at our own risk, driven by our own idiosyncratic and opportunistic motivations that are shaped primarily by our own life experiences - buying when we have some money, and selling when we need that money back, to spend on something big: college for the kids, a dream vacation, a new home, or a second home, a business of our own, money to live on in our retirement, etc. - and modulated by our own personal moral values, move differently than
markets dominated by market professionals buying and selling professionally, with money sourced from social trusts that have no life experience, but always need to be invested, earning money through those investments to fund their institutional obligations, to a pension promise or an endowments mission.
Where individuals move the markets to the stately pace of buy-and-hold, professionals churn the markets to outperform other professionals - and increase their own Assets Under Management (AUM), and fees and profits they can earn by managing those AUM - by maximizing the highest possible purely pecuniary profit extraction, at the hurried pace of buy low to sell high, that episodically accelerates into a feeding frenzy of buy high to sell higher.
Now we know that this is a problem. But we still don't know what to do about.
The key to this solution, however, can be found in the variation on the theme of price-taking in the public markets, that we know today as Private Equity, and the financial engineering of what is marketed as "value creation".
Before 1983, the kind of financial engineering that has become common practice in Private Equity today was not practically possible, because that engineering involves modeling expectations for enterprise cash flows out into a variable future over an extended period of years, and revising those models in real time as new insights are acquired about how money will flow through the business, and for how long, through study and experience.
In 1983, Mitch Kapor released his Lotus 1?2?3 suite of software programs running in MS-DOS on IBM-PCs, giving us the technologies of spreadsheet math and desktop publishing that along with parallel innovations in digital communication do give us the practical power to model expectations for future enterprise cash flows, and revise those models "on the fly" in real time.
Lawyers for our social trusts did not appreciate the significance of these innovations for the investment choices that their fiduciary clients could make, and the consequences to the application of the law of fiduciary prudence and loyalty on the choices their fiduciary clients should and must make.
But capital markets professionals did not miss the trick. What started out as corporate raiders doing hostile takeovers financed with junk bonds, evolved through an alphabet soup of so-called financial innovations to securitize consumer debt (home mortgages as MBSs and CMOs; credit cards, auto loans/leases, student debt etc, as ABSs) to become what we know today as the value creation through financial engineering of Private Equity.
None of this could have happened without social trusts. None of it can continue without social trusts.
But social trusts can only continue if we evolve beyond it, upgrading financial engineering from value creation for profit extraction (from enterprise, and workers, and society and Nature and our shared future) to negotiated agreement on equity paybacks to an actuarial/fiduciary cost of money, plus opportunistic upside, from socially beneficial enterprise cash flows prioritized by contract for suitability of the technology, longevity of the enterprise and fairness in how the business does business, under the circumstances then prevailing.
Pension and Endowments investing as Asset Ownership effectively cuts off fiduciary accountability to our common sense, replacing our sense of what makes sense with the specialized expertise of capital markets professionals at knowing what to buy, and when to sell, to maximize profit extraction.
It also disconnects fiduciary stewardship from Actuarial Compliance and Fiduciary Faithfulness.
The innovation in fiduciary finance of financial engineering upgraded from value creation for profit extraction to negotiated agreement on socially beneficial cash flows creates a new space for reconnecting fiduciary stewardship with common sense as the innovation of fiduciary activism and a new conversation at the vanguard of public discourse about where fiduciary money can and should be going to finance the right economy for living the quality of life we all want to be living, under the circumstances then prevailing.