John Bogle’s Prescription for Restoring Faith in Financial Markets

Reading Assignment: Restoring Faith in Financial Markets

Here’s a quick summary of what Bogle wrote (in his own words):

The process of restoring the faith of investors must begin with a demand that the agent/owners of investment America stand up for the rights of their principals/beneficiaries. What we need is congressional action to establish a federal principle of fiduciary duty—encapsulated by the phrase “no man can serve two masters.”

This principle will require institutional managers (1) to act solely in the interests of their shareholders and beneficiaries; (2) to observe due diligence and professional standards in their investment practices; (3) to honor their responsibilities as owners by active participation in corporate governance; and (4) to eliminate conflicts of interests in their activities.

Together, these standards would require the giant financial institutions of investment America to behave as owners of corporate America, actively voting proxies in the interests of their principals; playing a role in dividend payouts and executive compensation as well as in mergers and acquisitions; limiting (or even eliminating) excessive stock options; and demanding the independence of directors from management (including the separation of the roles of chief executive and board chairman).

In addition, policy makers ought to be considering structural changes that would enhance the role of investors and diminish the role of speculators. For example, granting longer-term (say, two- to five-year holders of stock) extra voting rights and/or a higher dividend; a federal transfer tax on securities transactions; or a tax on short-term realized capital gains (say, shares held for less than six months), applicable to taxable as well as tax-exempt investors such as IRAs.

I’m not sure I like any of the suggestions in the last paragraph. Not all short-term transactions are speculative. What about rebalancing? If you have a stock that appreciates quickly, what’s wrong with selling some of it in order to rebalance your portfolio? I don’t think that should be penalized with a higher tax above and beyond what we currently pay.

I do agree with the four points he makes in the second paragraph. The question is: how do we make them do it?

7 thoughts on “John Bogle’s Prescription for Restoring Faith in Financial Markets”

  1. I like Bogle — he just seems to come across as a common-sense kind of person. Unfortunately some of the things he is discussing are problems that arose out of his own creation: namely the index fund. People own index funds now, not shares in a company.

    The index fund manager (Vanguard, Fidelity, Barclays, etc) makes all the shareholder votes, on your behalf, of the shares you indirectly hold in the index fund. Do the index fund managers vote they way you think they should?

    Unfortunately its just the nature of the beast. A solution could be to allow the index fund shareholders (ie; you and me) to have the ability to vote at shareholder meetings — if we chose to do so. Of course this would prohibitively increase costs and kill off the index fund industry — which is perhaps a good thing.

    We need to return back to the olden days when people actually ‘owned’ a part of companies — and voted for what they believe in.

    Index funds were great when they were started, but now that the vast majority of shares are owned in a few huge investment firms, I no longer believe that the typical index fund is such a good deal (or the stock market in general for that matter).

  2. It is the speculator that helps keep markets liquid. It is the speculator that takes the other side of the trade that allows farmers to know the price for their crop months in the future. It is the speculator that finds mis-pricing of securities and arbitrages them away.

    To claim that long term investors are somehow more virtuous, and deserving of preferred treatment, doesn’t hold.

  3. The process of restoring faith of investors must begin with a demand that every agent/owner of investment America that engaged in fraudulent activity turn themselves in now, because we will prosecute each and every one of them. There is nothing wrong with speculation, but intentionally selling worthless assets at inflated values, knowing they are nothing more than a pile of dog poop, will not be tolerated! What we need is congressional action to establish a reinstate mark to market, leverage limits and Glass Steagall–encapsulated by the phrase “Stop the looting; start the prosecuting!”

    This principle will require institutional managers (1) to stop lying; (2) to obey the law; (3) to go to jail; and (4) to not pass Go!


  4. In addition, policy makers ought to join their comrades in jail as well for their role in this crisis. For example, Greenspan and Bernanke for holding interest rates too low for too long; Paulson, for shoving a $700 billion dollar bill down our throats that was opposed by 300-to-1 by the citizens in order to prevent the “impending collapse” of the world as we know it; and Geithner, for acting according to the interests of Wall Street and his buddies as Goldman Sachs (oh, and not paying his taxes either).

    I am 100% sure these decisions would be beneficial for America and actually get us on a path to recovery. Yes, there will be pain and it will hurt, but the bust is a necessary correction to the inflated values of the boom.

    You should all agree with my points that I make in the above paragraphs. The question is: where are the handcuffs?

  5. The level of taxes typically proposed for these sorts of schemes are small. This is because the target of such taxes are not individual investors but institutions relying on high leverage ratios to extract tiny profit margins available in most short term investments. These levered strategies are purely speculative in that they generally do not reflect any fundamental of the investment, and even a very small tax, perhaps less than 1%, would be sufficient to render them unprofitable.

    As a long term investor I am more than willing to pay that penalty if it could be be demonstrated to me that the result would be significantly lower leverage ratios (and, consequently, lower volatility) in financial markets. It is now clear that the high leverage ratios used on Wall Street were a critical component of the 2008 financial crisis.

    More information:

  6. No matter what Congress or the banks do, it’s going to be a long, long time before the public will trust our financial industry again. Or at least until another generation of people pops up that are too young to remember everything that’s happened in the past 5-10 years.

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