Monday, July 6, 2009

Socialism of Capitalism-Update on Australia Regulation #1

This post from November of last year on Australian regulation is still one of the most read posts on my blog, and rightfully so. I consider it one of my most thoughtful, original, and well researched. But in sharing this information with other professional peers, and the public, I have realized further truth that I believe is worth your time to read. I will focus posts on these thoughts over the coming weeks.

Watch the 2.5 minute Clarke and Dawe video, and pay close attention to the comments on how capital became available for subprime mortgages in the US. They talk of mortgage underwriters who don't lose money on subprimes, but get paid to create CDO's. The interviewer asks who would buy these "bag full of crap" loans.
The 'economist' explains, "They're fund managers Brian. They're paid to buy things. They don't make any money if they're not buying stuff."
The interviewer then asks, "But where do they get the money from?"
"They're fund managers Brian. People send them money. The money rolls in every hour Brian."

The pendulum of US capital markets has to some extent shifted away from democracy towards socialism. This is a natural (and not unprecedented) event. The majority of American, middle class, capital wealth is in retirement plans (401k, 403b, etc.). The majority of upper class capital wealth is trust funds, self-directed IRAs, or individual investments. The disparity here is that the upper class is unconstrained in relation to investment options. The middle and lower class has somewhere between 4 and 10 diversified investment options (usually mutual funds).

During a presentation a few months ago I asked a middle class group, "If you were given $1,000 today with the condition that you had to buy and hold one stock for a year with it, how many would buy GM?"
--Nobody, even though a good portion of these people worked for GM suppliers.

I then asked, "If given 100 shares of GM with the condition that you had to own a stock, but could change to another, how many would change?"
--About 95%.

I then asked a series of questions to find about 75% have money in a retirement plan with limited options, and are invested in the domestic stock option. They were as surprised as I was to realize the implications when I suggested that likely over half of those people own GM stock, but they don't want to. And if they want to own US stocks, they have no choice, but to own GM.

Irrespective of what the educated fund manager thinks is worthwhile to invest in, the majority of these people want to vote against GM, and have lost their voting right with most of their investment capital, unless they want to vote against the full market. And that is just the mistake that many of them make. They make wild allocation swings based on recent returns, constantly buying high and selling low.

This drift toward socialism of capital markets for the middle and lower class happened just prior to the Great Depression, where investment trusts (the predecessor to today's mutual fund) was the only reasonable means for the the middle class to invest in capital markets. There were very few of them, and there was no disclosure of actual holdings.

The most important consideration here is how much control do you have over where your capital is invested? And don't allow tax rules, or conventional understanding to limit your options. For example, some IRA custodians will allow you to own direct rental real estate inside an IRA.

For further research:
"The Great American Bubble Machine," article by Matt Taibbi, Rolling Stone, July 9, 2009
The World on Fire- researches and discusses the clash of governmental structure and economic structure, and how consensus understanding may be wrong.