Stewardship of Money and Water

Matt Prescott shares with us in this post a list of the requested rate hikes from "the most polluting water companies in the UK".

Considering the high costs of poor performance of essential services by for-profit operators creates a useful space for considering alternatives to the Markets vs. Government, private vs. public, price vs. policy

"cultural framework that we’re trapped in" and "can’t seem to get out of" (American filmmaker Adam McKay).

The question to be explored is,

What costs are those increases funding?

Every enterprise has to manage the tensions for fairness across six vectors of cash flow:

1. fairness to suppliers (Fair Trade);
2. fairness to communities (Fair Engagement);
3. fairness to Nature and Society (Fair Reckoning );
4. fairness to workers (Fair Working);
5. fairness to customers and competitors (Fair Dealing);
6. fairness to the savers whose savings are the original and ultimate source of the money supplied to the enterprise by its financiers (Fair Sharing).

Forever businesses like water companies are natural and legal monopolies. They have captive customers and no competitors. We cannot look to market forces to enforce fairness in such businesses.

Regulation is usually perceived as the only alternative.

In this case, regulation is failing because it is not effective at policing the financiers for fairness. This is because financing is coming through Private Ownership Equity in the capital markets. And the Capital Markets have an insatiable appetite for extracting as much profit as they can.

A better solution is to mandate the movement out of Private Ownership Equity and into Social Stewardship Equity using equity payback to a fiduciary cost of money.

The capital markets are an ecosystem of finance that is built around securitization as its core technology. Securitization is a legal process of dividing large scale, long-dated financing agreements into large numbers of small, incrementally liquid, commodity shares of ownership that are issued for trading between buyers and sellers as market participants in anticipation of future movements in market clearing prices for those shares in markets for maintaining market clearing prices for those shares.

The essential feature of these share price trading markets is liquidity. A seller must always be able to sell. A buyer must alway be able to buy.

These markets maintain liquidity through volatility and growth in share prices that create opportunities for buyers to buy low in order to sell high when they become sellers, extracting a profit from each trade that works out well. Not all do. That is not essential to markets maintaining liquidity. It is sufficient that it works out well often enough to keep new buyers buying so that existing sellers can sell, frequently, if not always, at a profit. Sometimes at very large profits!

These markets are purpose-built to supply money to enterprise for its use, for a purpose, for a time, at a cost and on terms, either as debt (borrowing) or equity (ownership) by mediating through market price volatility and growth the tensions between individuals as buyers and sellers, who are usually small, relative to the financing needs of enterprise, opportunistic in the profits they are seeking, and idiosyncratic in their holding periods, and enterprise as issuers that need money at scale for long periods of time.

Investment bankers negotiate large scale, long-dated financing agreements with enterprise (debt as bonds, equity as stock), securitize those agreements into large numbers of incrementally liquid commodity shares of ownership, and distribute (resell) those shares to market participants in public exchange or private fund markets.

Market participants buy in whatever increments they choose, and hold before selling for as long as they choose, each idiosyncratically driven by their own personal motivations, at market clearing prices in markets that set prices by matching supply and demand from buyers and sellers.

The enterprise does not participate in, consent to, or even know about, these market trades between market participants. They operate legally only as counterparties to the large-scale, long-dated debt or equity financing they are legally a party to.

Except for this one thing. They have an obligation to support volatility and growth in market clearing prices that the markets need to deliver the liquidity that market participants need as a necessary pre-condition to their participation.

This obligation is not legal. It cannot be enforced in courts of law.

It is more of a social contract that is enforced through practical means: people lose their jobs.

This is how the capital markets are purpose-built to work, driven by the stately rhythm of buy-and-hold by individuals as market participants trading with our own savings, for our own account, in pursuit of our own opportunistic and idiosyncratic purposes, regulated by our own personal moral compass that helps to shape our own individual choices about what shares to buy, and when to sell, that also effectively regulates the conduct of business by issuers in the markets, through their social contracts for supporting market liquify through volatility and growth in their share prices.

That was how the markets did work before 1972 (except on at least two earlier periods when they did not work that way: the Gilded Age and the Roaring Twenties - but that's a story for a later article).

Before 1972, the Lore of the New York Rule for interpreting the fiduciary duties of the trustees of social trusts for the social purposes of socially provisioning the social safety nets of Workplace Pensions and Civil Society Endowments as forever promises to private persons, directly, that are also a social good for all of us, consequently, generally constrained the deployment of fiduciary money aggregated into these social trusts to the Legal List of loans to governments or secured by mortgages on real estate. Participation in the capital markets was widely seen as fundamentally speculative, and therefor not fiduciary.

That changed in 1972, when the Uniform Management of Institutional Funds centered the Massachusetts Rule of the Prudent Person as articulated in 1830, in the context of a private trust for private purposes, by Samuel Putnam writing for the Massachusetts Supreme Judicial Court, writing:

"All that can be required of a trustee to invest is that [they] shall conduct [themself] faithfully and exercise a sound discretion. [They are] to observe how [humans] of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested." (Harvard College and Massachusetts General Hospital vs Francis Amory, 26 Mass. 446. Massachusetts Supreme Judicial Court, March 1830)

A new Lore was quickly developed by capital markets professionals replacing the Prudent Person with the Prudent Investor as the litmus test of fiduciary care (prudence) and caring (loyalty), shifting the focus of fiduciary practice away from:

"the “financial integrity” of their [social trust]", Thole vs US Bank, US Supreme Court, 2020, Justice Sotomayor dissenting)

to

increasing profits for Wall Street (US Senator Bernie Sanders)

as

...the investment professionals...basically pushed out the attorneys from interpreting fiduciary duty (Keith Johnson)

A profusion of fiduciary money poured into the capital markets, pushing individuals to the periphery, and fueling a proliferation of so-called financial innovations as the technologies of securitization were applied to various forms of corporate and consumer debt and equity- giving us a bewildering array of acronyms for exotic financial "products": LBOs, MBOs, Junk Bonds, CMOs, MBSs, ABSs, commercial paper, venture capital, private equity, interest rate and foreign exchange derivatives and hedge funds, and others, all designed specifically for sale to Pensions & Endowments, through their professional portfolio managers:

A raider who has to get support from millions of dispersed individual stockholders soon runs out of time and money. (Peter Drucker, Reckoning with the Pension Fund Revolution, https://hbr.org/1991/03/reckoning-with-the-pension-fund-revolution)

Institutional investors morphed into Asset Owners Allocating Assets across Asset Classes, and within Asset Classes selecting Asset Managers peer benchmarked for maximizing purely pecuniary risk-adjusted returns on investment solely in the best financial interest of the beneficiaries, as the special pleading for the special interests of capital markets professionals in seizing and holding monopoly control over this fiduciary money, and through their monopoly control over fiduciary money, exercising monopoly control over how money gets supplied to enterprise to shape the technologies that shape the choices that shape the economy that shapes society and our shared future, making us all dance to the tune of the Markets and their insatiable demand for Growth in share prices.

Following from this market capture of fiduciary money was a call to privatize a wide range of enterprises that had previously been placed into governmental ownership and control in the public interest.

This included, in the UK, the privatization of municipal water services in England and Wales that had previously been operated by the national government.

This experiment with private ownership of what are essentially public utilities is becoming a spectacular failure, most dramatically in the financial implosion of Thames Water Company after decades of financial engineering by Private Equity Funds funded by Pension Funds.

One should never let a good crisis go to waste.

The spectacular failure of pension-funded Private Equity Ownership of water companies in England and Wales that is unfolding in real time before us today is an opportune moment to question the prudence and loyalty of pension investing in Private Equity, specifically, and in Private Ownership Equity for financing Growth through Creative Destruction in the Capital Markets, more generally.

What is the alternative?

That's the first objection that gets raised in response to such questioning of the fiduciary prudence of the Prudent Investor (where "investor" is specially defined to mean a market participant in the public Exchange and private alternative Funds markets for trading in shares in anticipation of future movements in market clearing prices).

Let's meet that objection by answering the question.

The alternative is restating the law of fiduciary duty for Pensions & Endowments to mandate the movement out of Private Ownership Equity and into Social Stewardship Equity deploying aggregations of society's shared savings held in social trusts to supply money to enterprise for its use, for a time, for a purpose, at a cost and on terms, through negotiated agreement on equity payback to an actuarial/fiduciary cost of money, plus opportunistic upside, from enterprise cash flows prioritized by contract for:

• suitability of the technology to the changing times;
• longevity of the social contract between the enterprise and popular choice in the commercial markets; and
• fairness across all six vectors of enterprise cash flow (as detailed above).

This innovative new financing technology of equity payback financing for enterprise, directly, is adapted from the proven reliable equity payback method in common use for supplying equity in Real Estate and in US tax credit partnerships for Affordable Housing, Renewable Energy and other public policy favored (and taxpayer subsidized) commercial activities.

It gives us a way of looking at enterprise design that opens up new possibilities for popular engagement - and accountability to a fully informed common sense - in answering our opening question of

What are the cost the requested increases will be funding?

By looking at each of the six vectors of enterprise cash flow identified for negotiated agreement in Social Stewardship Equity financing, we can discuss which increases are required to deliver necessary and desired levels of service and longevity, and which, maybe, are not.

By looking at the water business through this framework, we can see clearly just how important sources of financing are to the overall cash flows that flow through the enterprise, and we can, after some quiet contemplation and reflection, begin to see that financing as Speculation on future selling prices for Private Ownership Equity is a bad fit for forever businesses like water companies. Such financing quickly becomes extractive, and even extortionate, distorting of the priorities within the enterprise, impairing quality of life for those who rely on these enterprises for water quality, reliability and affordability.

The better alternative - the Untaken Safe Alternative - is forever financing through negotiation of Social Stewardship Equity with Pensions & Endowments, directly.