What They Do With Your Money What They Do With Your Money How the Financial System Fails Us and How to Fix It STEPHEN DAVIS JON LUKOMNIK DAVID PITT-WATSON Published with assistance from the Louis Stern Memorial Fund Copyright © 2016 by Stephen Davis, Jon Lukomnik, and David Pitt-Watson All rights reserved This book may not be reproduced, in whole or in part, including illustrations, in any form (beyond that copying permitted by Sections 107 and 108 of the U.S Copyright Law and except by reviewers for the public press), without written permission from the publishers Yale University Press books may be purchased in quantity for educational, business, or promotional use For information, please e-mail sales.press@yale.edu (U.S office) or sales@yaleup.co.uk (U.K office) Set in Minion type by Westchester Publishing Services Printed in the United States of America Library of Congress Control Number: 2015955527 ISBN 978-0-300-19441-8 (cloth : alk paper) A catalogue record for this book is available from the British Library This paper meets the requirements of ANSI/NISO Z39.48-1992 (Permanence of Paper) 10 Contents Acknowledgments Introduction: We the Capitalists ONE What’s the Financial System For? TWO Incentives Gone Wild THREE The Return of Ownership FOUR Not with My Money FIVE The New Geometry of Regulation SIX The Queen’s Question SEVEN People’s Pensions, Commonsense Banks EIGHT Capitalism: A Brief Owners’ Manual Notes Index Acknowledgments No book is the product solely of the authors We are indebted to the many thousands of people who work in the finance industry and try to the right thing for their customers and society while buffeted by conflicting interests They have been our inspiration In particular there are a number of people whose thinking and practice have contributed to the ideas in this book Any new insights we provide are built on their accumulated wisdom We cannot name them all, but here are some whose efforts have helped all of us to understand and reform the finance industry for the better Thanks go to Keith Ambachtsheer, Alissa Amico, David Anderson, Donna Anderson, Mats Andersson, Melsa Ararat, Phil Armstrong, Phillip Augur, the late Andre Baladi, Sir John Banham, David Beatty, Lucian Bebchuk, Marco Becht, Aaron Bernstein, Laura Berry, Kenneth Bertsch, Lary Bloom, Jack Bogle, Glenn Booraem, Peter J C Borgdorff, Amy Borrus, Erik Breen, Sally Bridgeland, Steve Brown, Maureen Bujno, Tim Bush, Peter Butler, Ann Byrne, the late Sir Adrian Cadbury, Anne Chapman, the late Jonathan Charkham, Douglas Chia, Peter Clapman, Paul ClementsHunt, Andrew Cohen, Francis Coleman, Tony Coles, Paul Coombes, Martijn Cremers, William Crist, Ken Daly, David Davis, Matthew de Ferrars, Sandy Easterbrook, Bob Eccles, Michelle Edkins, Ambassador Norm Eisen, Robin Ellison, Charles Elson, Luca Enriques, Fay Feeney, Rich Ferlauto, Peggy Foran, Tamar Frankel, Julian Franks, Mike Garland, Kayla Gillan, Harrison Goldin, Jeffrey Goldstein, the late Alastair Ross Goobey, Jeffrey Gordon, Gavin Grant, Sandra Guerra, Andrew Haldane, Paul Harrison, James Hawley, Scott Hirst, Hans Hirt, Catherine Howarth, Mostafa Hunter, Robert Jackson, Bess Joffe, Keith Johnson, Michael Johnson, Guy Jubb, Fianna Jurdant, Adam Kanzer, Erika Karp, John Kay, Con Keating, Matthew Kiernan, Jeff Kindler, Dan Konigsburg, Richard Koppes, Mike Krzus, Robert Kueppers, Paul Lee, Pierre-Henri Leroy, Suzanne Levine, Emily Lewis, Karina Litvack, Mindy Lubber, Mike Lubrano, Donald MacDonald, Hari Mann, Bob Massie, Michael McCauley, Greg McClymont, Bill McCracken, Alan McDougall, John McFall, Jane McQuillen, Jim McRitchie, Colin Melvin, Bob Meyers, Natasha Landell Mills, Ira Millstein, Nell Minow, Bob Monks, Peter Montagnon, Sir Mark Moody-Stuart, Susan Morgan, Roderick Munsters, Marcy Murningham, Lord Paul Myners, Bridget Neil, Stilpon Nestor, Saker Nusseibeh, Amy O’Brien, Matt Orsagh, Norman Ornstein, Barry Parr, William Patterson, Dan Pedrotty, John Plender, Julian Poulter, Mark Preisinger, Tracey Rembert, Iain Richards, Louise Rouse, Allie Rutherford, Sacha Sadan, Nichole Sandford, Kurt Schacht, Andrew Scott, Linda Scott, Joanne Segars, Uli Seibert, Ann Sheehan, Howard Sherman, Jim Shinn, Chris Sier, Anne Simpson, Anita Skipper, Tim Smith, Jeffrey Sonnenfeld, Nigel Stanley, Anne Stausboll, Christian Strenger, John Sullivan, David Swensen, Kenneth Sylvester, Henry Tapper, Jennifer Taub, Paul Taskier, Matthew Taylor, Sarah Teslik, Raj Thamotheram, Dario Trevisan, Mark van Clieaf, Jan van Eck, Alex van der Velden, Ed Waitzer, Kerrie Waring, Steve Waygood, Steve Webb, Andrew Weisman, Heidi Welsh, Kevin Wesbroom, Darrell West, Ralph Whitworth, John Wilcox, Eric Wollman, Simon Wong, Ann Yerger, and Beth Young We would also like to thank our spouses and children, our longtime agent, Gail Ross, and our patient and supportive editor, Bill Frucht, and his expert team at Yale University Press Finally, this book is dedicated to our parents Introduction We the Capitalists f you believe the advertisements, saving money over the long term weaves a reliable safety net, allowing us to retire comfortably, afford a house, or pay for extra care in the event of ill health Behind the hype, though, our financial system can subject that hard-earned capital to a perfect crime Undetected, a skein of routine practices can siphon savings from citizen nest eggs This book is about what “they”—the investment firms, banks, and pension plans—do with your money once it enters their world What happens can vary a lot from institution to institution and from country to country, and that in turn makes an enormous difference to our wealth and our welfare Consider a story of triplets At the age of twenty-five, ready to join the workforce full time, Beth moves to Atlanta, Georgia; Cathy heads to London; and Sarah makes a new home in Amsterdam, where financial institutions are different from those prevailing on Wall Street or in the City of London Each sister earns $60,000 per year, trying to balance the needs of today, such as how to feed the family, with those of tomorrow, such as how to afford retirement They intend to give up work at the same age, and they want the same income in retirement You would think that they would each have to set aside the same amount of savings every year Wrong Beth, who chose Atlanta, and Cathy, in London, will most likely pay 50 percent or more beyond what Amsterdam-based Sarah will have to spend to secure exactly the same retirement benefits at exactly the same age Either Beth and Cathy will have to scrimp for years to afford the retirement income they want, or they face a postwork income much less than Sarah’s.1 These huge variances in outcomes occur because small differences in annual charges compound over the years Here is how it would work From the age of twenty-five, Beth in Atlanta socks $6,000 annually into a commercial retirement savings plan selected by her employer Beth can get a percent return and so she could, in theory, have a savings pot of $725,000 when she retires at sixtyfive What she doesn’t factor in is fees The 1.5 percent that she is charged every year reduces her ultimate savings by more than $200,000, to $507,000.2 At sixty-five, when she retires, she has a difficult decision She needs to know she won’t run out of money if she lives for a long time On average, Beth might expect to live another twenty years, until she is eighty-five But Beth wants to be sure that she will still have an income even if she lives to ninety-five Assuming she will have to pay the same annual charge of 1.5 percent, Beth will be able to spend just $27,600 each year.3 Over in London, Cathy has discovered she has an ultimate pension pot of the same size: $507,000 In Britain, many people buy an annuity that will keep paying no matter how long they live But annuities are expensive and give low returns So Cathy might expect an annual payout of $31,000.4 In Amsterdam, though, Sarah has been enrolled into a giant, low-cost, nonprofit fund that will cover her for the rest of her life Annual charges are just 0.5 percent, so at age sixty-five she has a pension pot equivalent to $642,000 That gives her an annual payout of $49,400—far higher than either of her sisters’.5 Why the vast disparity? Rather than establish simple, commonsense, low-cost vehicles for I collective savings and retirement, such as the Dutch have, financial institutions and policymakers in the United States and United Kingdom have engineered a system that has transformed worker savings into a virtual ATM for the financial industry Complexity rules; one study tracked no fewer than sixteen different intermediaries escorting the citizen-shareowner’s money to an investment.6 Each can justify, on the basis of the complex system within which they operate, why their service is needed And each takes his or her slice of fees Agents pay other agents to advise us about investing in securities or mutual funds on which there is little evidence that anyone has better knowledge than anyone else Usually we aren’t told that the agent has been hired or how much they have cost us We think we’re hiring expertise, but what we are really buying—expensively—mostly is luck The most rigorous studies suggest that over more than a century, the financial system has plowed back any productivity gains to serve itself rather than us.7 But it’s worse than that The investment industrial complex not only charges us disproportionate fees It also fails to provide adequate ownership when it invests our money in public companies, leaving the entire business world vulnerable to periodic systemic shock The cash we hand to institutional investors such as pension, investment, and insurance companies has been used to purchase some 73 percent of shares in the world’s largest companies.8 That gives such collective investing bodies vast sway over corporate behavior around the globe But they each tuck bits of our retirement savings into stocks of thousands of companies to which the investment managers cannot possibly provide the kind of oversight we expect from owners, and whose names they may not even know We, the providers of capital, may have an interest in growing our savings for the long haul But the agents hunt rapid profits because that is what they are paid to Data are mixed about just how brief shareholding periods have really become Some alarmists point to high-frequency trading to suggest that investor “ownership” of a company is sometimes measured in milliseconds That approach converts stock exchanges into casinos rather than rational allocators of capital Other researchers argue that underlying time frames may still be measured in years.9 In any case, there is little dispute that many money managers trade in and out of stocks with scant attention to whether the companies they invest in are well managed, whether they contribute to climate change or corruption, or indeed whether they are poised to trigger a market meltdown Make no mistake: our financial system is one of the great achievements of modern times It is the means by which the money we save is placed at the disposal of companies and individuals who wish to use it to create new things in the economy: businesses, factories, homes, and other goods This process drives economic growth and prosperity The financial system helps create social mobility, rewarding talent and hard work Those of talent raise money to form their own companies, benefiting their customers, suppliers, and workers and enriching themselves Even the way we save for the long term is an extraordinary achievement We give our money to a retirement fund, which, in turn, gives it to a fund manager who invests in a company Despite temptations to so, the company normally does not defraud its investors, workers, and suppliers The laws and institutions, behaviors, and ethics that allow this and many other financial transactions to take place constitute one of the great social innovations of our era This book’s purpose is to show, though, that too often the financial system as it now exists in the United States, Britain, and elsewhere is built to fail, at least if success is defined as efficiently promoting our interests This makes little sense if you think about where today’s capital comes from Since the end of the Cold War, almost all of the countries of the world have come to accept and protect the merits of private over state ownership More of our private economy than ever has been handed over to “capitalists.” Who are these people? We might once have thought of the stereotype of rapacious, cigar-chomping tycoons—the robber barons of America’s Gilded Age Today, however, in most developed countries and increasingly in the emerging economies, the capitalists are us Citizens putting aside even small amounts in the bank or pension fund or for buying a home meet the dictionary’s definition: “one who has accumulated capital.” And the collective savings of hundreds of millions of citizens currently amount to a pool of some $85 trillion.10 We may not feel like capitalist moguls, but, collectively, we are The system should work for us But there is a catch to this new capitalism We are typically not the ones who manage our money We depend on “experts” such as financial advisors, brokers, mutual funds, and banks to invest our nest eggs with care so that they will deliver a reasonable return over time Evidence, however, points to a hard truth: the money we save is often not managed solely in our best interests Systemic conflicts benefit our financial agents That chronic fault produces a cascade of distortions that can cut deeply into our own returns while subtracting from the real economy Moreover, the siphoning is a perfect crime Think back to Beth, who after forty years winds up with a $218,000 hole in her savings Like most savers, she would typically never know of the pilfering She would instead see a “gain” of $267,000 (the $507,000 she has in her account minus the $240,000 she had invested) As one authoritative probe concluded, the fund industry is “purpose built for ambiguity and lack of accountability; a condition that favors the interests of everyone but the [saver].”11 Influential studies map other chronic effects on savings when we cede control of our capital Research has found that some mutual funds, apparently unchecked by their boards, often place “important business interests … in asset gathering ahead of their fiduciary duties” to savers.12 Some fund companies make investment decisions designed to help gain and retain corporate clients, even at a substantial financial penalty to the savers whose interests they are there to serve.13 Vanguard founder John C Bogle has calculated the titanic costs to investors when investment funds with permissive boards tolerate excessive buying and selling of securities with attendant fees and sales loads.14 Over twenty-five years ending in 2005, he suggests, fund companies reaped $500 billion in fees from overly complex products, while delivering returns to clients less than one third of the figure investors would have made had they put savings into a simple low-cost alternative A 2009 Aspen Institute report came to similar conclusions, finding that “funds engage in behavior that is inconsistent with their investors’ goals.”15 New York City revealed that “high fees and failures to hit performance benchmarks have cost the pension system some $2.5 billion in lost value” over the decade ended 2014.16 Even fund managers admit that the rapid trading behavior that characterizes today’s investment markets is counterproductive and subtracts value.17 In short, thanks to experts operating with different interests, citizen savers have seen a bonfire of their nest eggs This book contends the capitalist system needs accountability in order to render it safe to use over the long term We probe for symptoms of what has gone wrong and offer a diagnosis of causes and a prescription for treatment Fixing markets requires marrying twenty-first-century ways of empowering individuals to neglected principles such as common sense, ownership, and realeconomy economics It also requires confronting a fact of life: financial institutions today have powerful motivations, as rational as they are perverse, to oppose reforms that could restore trust to the system But capitalism, like political systems, must regularly be challenged by the citizens who live with it if it is to fulfill its purpose The cost of failing to challenge the financial system can be catastrophic on a grand scale Think of Hermes Equity Ownership Service, 89 Hermes Investment Management, 140 Hewitt Packard, merger with Compaq, 81–82, 247n48 Hewitt, Walter, 82 Hicks, John, 178 High-frequency trading, 29–30, 51–53, 64–65 ending favoritism for, 88, 223 ownership and, regulation of, 89 History, effect on economic performance, 167 Hodgson, Geoffrey, 262n51 Human motivation, behavior and, 182–83, 185–86 Hyundai Merchant Marine, 82 Icahn, Carl, 115 ICGN See International Corporate Governance Network (ICGN) IDEAS economics database, 156 Idiosyncratic risk, diversification and, 44–45 IEX, 88–89 IFC See International Finance Corporation (IFC) IMF (International Monetary Fund), 163–64 Impartiality, fiduciary duty and, 139 Incentives: executive compensation and, 72–73, 175–76, 245n29 for dishonesty, 144–45 for fiduciaries, 137 for finance industry, 30–31, 33–35, 60, 61, 188 fund management company, 77–78 institutional investors and performance, 112–13 interaction with social and institutional factors, 179–80 regulation and, 133 Income Data Services, 71 Indentures, 18 Index fund managers, stock selection and, 46 Index funds (tracker funds), 57 determination of, 45–46 Individual savings, collective pensions vs., 263n1 Indulgences, 23, 237n8 Information, access to relevant and unbiased, 141, 149–50 Institute for New Economic Thinking, 180, 189 Institutional design, regulation and, 146 Institutional investors: civil society organizations and behavior of, 119–20 corporate governance and, 98 fiduciary duty and, 11, 111–12 financial crisis and, governance and oversight of, 228 improving accountability and, 109–14 ownership and, 3–4, 249n3 reducing number of agents, 58–59 Institutions, 262n51 economic, 183–86 market, 170 political, 183–84 systemic regulation, 141–42 See also Financial institutions Insurance companies, 19, 22, 48 regulation of, 108 Insurance, pensions and, 201 Intermediaries, financial, 17, 19–22, 47, 74, 211–15 agency capitalism and, 74–80 fiduciary duty and, 139–40, 146 Intermediation, 211–12 International Corporate Governance Network (ICGN), 90, 113–14, 190, 205 International Finance Corporation (IFC), 73 International Swaps and Derivatives Association, 150 Internet trading, 51 See also High–frequency trading Investment: liability-driven, 54–56, 264n2 promoting culture of ownership in, 223–24 retirement as reason for, 241n39 Investment management: chain of agents in, 33 probabilities and performance, 35–38 Investment managers See Fund managers Investor coalitions, 89–90 Investor Forum, 89 Investors See Citizen investors/savers; Institutional investors IRRC Institute, 82–83 Jackson, Eric, 115 Jefferson, Thomas, 150 Jevons, Stanley, 260n13 JOBS Act (US), 11 Jobs, Steve, 182 Johnson, Keith, 137 Johnson, Michael, 105–6 Joint stock banks, 257n34 Jones, Tom, 76 Journals, demand for mathematical methodology, 189–90 JP Morgan Chase, 257n32 Kaplanis, E., 254n2 Kay Review, 138–40 Kay, John, 8, 32–33, 89, 138–39, 255n13 Kennedy, Edward, 108 “Key Standards for Sound Financial Systems” (Financial Stability Board), 150 Keynes, John Maynard, 164–65 King Pharmaceuticals, 81 KKR, 204 Knight, Frank, 236n33, 261n35 Knowledge Transfer Network, 53 Kodak, 44 Landes, David, 183, 185 Law Commission of the United Kingdom, 138 Law of supply and demand, 160–61 LDI See Liability-driven investing (LDI) Legislation on corporate governance, 9–10 Lehman Brothers, 25 Lemming standard, 137–38 Lenders, financial system as intermediator between borrowers and, 17, 19–22, 47, 74, 211–15 Leverage ratio, 215 Levitt, Arthur, 28 Liability-driven investing (LDI), 54–56, 264n2 Liar loans, 47 Libor, 257n32 Limited liability company, 21, 184–85, 237n7 Lincoln, Abraham, 157 LinkedIn, 116 Lipsey, Richard, 236n34 Lipton, Martin, Liquidity, 17 Liquidity crisis, 74 Llewellyn, Karl, 262n52 Loans, classification of risk, 129, 175, 212–13 Long-Term Capital Management, 38, 164, 260n20 Long-term growth, emphasizing, 223 Long-term investment, 148: evergreen direct investing, 87 tax policy encouraging, 92, 223–24 Longevity risk, 194–95 Loopholes, regulation and exploitation of, 130 Lorsch, Jay, MacDonald, Tim, 59, 87 Macey, Jon, 249n3 Macroeconomics, 179 Madoff, Bernard, 105 Mann, Harinder, 263n1, 266n28 Mao Tse Tung, 157 Marginal cost, 160 Marginal value, 160 Market capitalization, 45–46 Market discipline, 152–53, 258n46 Market economies, 142, 177, 181 regulation of, 125–28 Market institutions, 170 Markets: creating fiduciary behavior and, 152–53 regulation and, 125–28, 134 transaction costs and, 169–70 trust and, 178, 181 Marshall, Alfred, 177 Marx, Karl, 159 Mathematical modeling: atomized regulation and, 130 liability-driven investing and, 55–56 narrowness of, 153 overreliance on theoretical, 168–71 publishing economic research and, 189–90 recalibration of, 264n9 value at risk, 39–40 weakness of, 40–44 See also Economic modeling Max Planck Institute for Research on Collective Goods, 215 McRitchie, James, 116–17 Mercer, 122 Merrill Lynch, 44 Merton, Robert, 260n20 MFS Technologies, 82 Microeconomics, 179, 181–82 Millstein Center for Corporate Governance and Performance, 265n13 Millstein, Ira, Minow, Nell, 207 Mirvis, Theodore, Misalignment indicators, 104 Molinari, Claire, 112 Money managers, using collective action to allow focus on benefits for all, 89–90 “The Monkey Business Illusion” (video), 174 Monks, Bob, 62 Moral hazard, 73 Morality: economics and, 158 trade, 177 Morningstar, 34, 35, 36–37, 101, 122, 208, 225 Mortgages: chain of agents involved in, 31–32 subprime, 38, 40, 47 Murninghan, Marcy, 122 Mutual funds: agency capitalism and, 77–78 boards of, 205–6, 265n14 chain of agents in, 31 disclosure rules, 97 duration of holdings, 243n4, 258n41 failure to protect investors’ interests, 6–7 governance and performance of, 101–4, 224–25 grassroots campaigns influencing, 117 self-evaluation of, 110 votes on shareholder resolutions, 102 Mylan Laboratories, 81 Myopia, 66, 68 National Employment Savings Trust (NEST), 111, 206, 208 National governance code, 205, 265n13 Navalny, Alexei, 115–16 NEST See National Employment Savings Trust (NEST) Nestor, Stilpon, 43 Netherlands, 90, 111, 113 collective pension system in, 60, 197, 199, 209, 264n6 fund governance regulation in, 108–9 pension beneficiaries and investment returns, 265n20 New York Stock Exchange: average holding period of traded stock, 63 financial services as percent of, 16 high-frequency trading and, 88 New York Times (newspaper), 77, 88 Nippon, 18 Normal curve, 161–63, 260n18, 261n38 real world phenomena and, 172–73 Northern Rock, 245n31 Nusseibeh, Saker, 140 One-way market for financial assets, 240n31 Ontario Teachers’ Pension Plan, 59, 111 Opportunities, fiduciary duty and, 140 Organisation for Economic Co-operation and Development, 109 Outcomes, measuring success using, 132 Oversight: regulation and, 150–51 trust in government and, 141 Owner, use of term, 235n25 Ownership: agency capitalism and, 74–80 capitalism and, 62, 83–93, 243n2 changing conception of, 62–63 corporate governance and, 22 derivatives and, 80–83, 93 economic attention deficit hyperactivity disorder and loss of, 63–68 election of directors and, 78–79 exercised by financial agents, 230 for long-term investors, 87 individual investor’s use of technology and, 90–92 institutional investors and, 3–4, 249n3 portfolio management function and, 246n36 promoting culture of, in investment, 222–24 tax policy and, 92 Oxford University, 122 Passive investing, 45 Pax World, 77 Pay for performance, institutional investors and, 112–13 Payments system, banks and, 16–17, 20, 22, 211–12 Pension funds: collective, 197, 199, 209, 263n1, 264n3, 264n6, 266n28 commonsense, 194–96, 199–202 fees, 97–98, 195–96, 233n5 governance of, 100–101, 104–6, 107–9 investment strategy, 195, 196 People’s Pension, 202–11 portability of, 196 purpose of, 194 regulation of, 107–9, 251n22 shift from defined benefit to defined contribution plans, 99–100, 104–5 time frame and, 207 Webster and Wallace’s, 14, 199–202, 209 See also Retirement savings Pension Trustee Code of Conduct, 121 Pension trustees, 105–6, 108–9, 137–38, 140, 205, 207, 224–25, 229 People’s Pension, 202–11 cost of, 217 enrollment into, 208–9 feedback mechanisms, 207 fees, 204 governance and, 202–3, 205–6 investment interests of beneficiaries, 206–7 models for, 266n28 reform of financial institutions and, 226 transparency and, 203–4, 207–8 Performance: asset managers and, 48–50 defined, 149 encouraging through collective action, 57–58 executive compensation and, 68, 148–49 fees, 239n16 governance and, 100–104 institutional investors and incentives for, 112–13 investment management, 35–38 Performance metrics for executives, 68, 86–87 Perry Capital, 81 PFZW See Stichting Pensioenfonds Zorg en Welzijn (PFZW) PGGM, 77, 111 Philippon, Thomas, 26–28, 220 Philosophy, Politics and Economics (PPE), 190 Pitman, Brian, 213 Pitt, William, 158 Pitt-Watson, David, 263n1, 264n4, 264–65n11, 266n28 Plender, John, 259n5 Political economy, 142, 152 Political institutions, 183–84 Portfolio management: ownership and, 246n36 pension fund, 208–9 PPE (Philosophy, Politics and Economics), 190 Premium, 22 Price of goods, 160 Principles for Responsible Investment See United Nations Principles for Responsible Investment (UN PRI) Private goods, 170, 261n31 Private sector social responsibility, civil society organizations and, 120 Probability, investment management performance and, 35–38 Productivity: lack of, in finance industry, 26–28, 267n1 measurement of, 237–38n2 specialization and, 158–59 Property rights, 184 Prosperity: economics and, 166 forces underpinning, 180–82 “Protecting America’s Pension Act of 2002,” 108 ProxyDemocracy, 121 Prudence, 148, 258n35 Public goods, 170, 261n31 Purposeful economics, 188–92 “Push Your Parents” campaign, 122 Put options, 37 Putting People First (Clinton), 68 Railpen, 206 Rates of return on assets and investment, decline of, 67–68 RBS, 245n31 Real-world conditions, economics and, 12–13, 153, 164–65, 167–73, 179, 250n5 REC See Responsible Endowments Coalition (REC) Regulation: atomized, 128–31, 154 bank, 128–29, 175, 259n47 behavioral economics and, 143–45 contemporary approach to, 128–31 designing better, 145–51 financial crisis and, 124–25 fostering accountability and, 147–49 ossified behavior and, 131, 137 oversight and, 150–51 purpose of, 125–28 relation to financial institutions, 145 relevant and unbiased information and, 149–50 supporting fiduciary duty, 146–47, 152–53, 225–26 systemic (See Systemic regulation) transparency and, 146 Regulatory regimes, Basel rules, 152 Basel I, 125, 254n1 Basel II, 43 Basel III, 43, 125, 175, 254n1, 254n2 Rent seeking, 102–3 Research funding, for new economic thinking, 189 Reserves, bank, 213, 214–16 Responsibility: regulation and abdication of, 130–31 trust in government and, 141 See also Fiduciary duty Responsible Endowments Coalition (REC), 118, 122 Responsible Investing Academy, 140 Retirement Commission of South Carolina, 206 Retirement savings, 193–99, 201, 241n39 fees charged on, 1–3, 53 liability-driven investing and, 54–56 redirecting, 13–14 switch to defined contribution plans, 99–100, 197–99 See also Pension funds Revenue sharing, 31 Risk: categorization of loans and, 129, 175, 212–13 diversification and, 21–22, 44–45, 240–41n35, 242–43n57 fiduciary duty and, 140 financial industry and reduction of, 17 gaps in managing, 171–74 insurers and, 22 modeling, 12–13, 39–44, 161–65, 240n27 uncertainty and, 172, 261n35 Rock Center for Corporate Governance, Stanford University, 82–83 Rothschild, Victor, 17 Rotman School of Management, 100 Royal Society of the Arts, 243n57, 255n12 Rule of law, 184 Rumsfeld, Donald, 172 Russia, social media and demands for finance industry transparency in, 115–16 S&P 1500, 67 S&P 500, 45–46, 49, 51 Safety, banks and, 20, 22, 211, 212, 216 Sarbanes-Oxley Act (US), 10 Save Darfur Coalition, 120 Savers See Citizen investors/savers Schmidt, Breno, 102 Scholes, Myron, 260n20 Schwartz, Barry, 52 Scott, Andrew, 171 SEC (Securities and Exchange Commission), 52, 88, 91, 107, 204, 257n32, 265n14, 266n27 SHARE See Shareholder Association for Research and Education (SHARE) Share price, 66, 71, 148 ShareAction, 89, 111, 121, 225 Sharegate, 90–91 Shareholder activism, agency capitalism and, 76 Shareholder Association for Research and Education (SHARE), 121 Shareholder resolutions, mutual fund votes on, 102 Shareowners: board of directors and, 18 rollback of powers, 11 Short volatility strategies, 239n25 “The Short Long” (Haldane), 66 Short-term buying and selling, 150–51 Short-termism, 8, 10, 63–66, 68, 71, 148, 228 See also Economic attention deficit hyperactivity disorder Sier, Chris, 53–54 Silicon Valley, 70, 182 Simons, Dan, 174 Sinclair, Upton, 74 Smart beta, 241n36 Smith, Adam, 13, 161, 184, 259n6, 259n11 classical economics and, 157–59 on purpose of economics, 166, 192 on trading, 169 ownership and, 62 self-interest and, 180 specialization and, 30 trust and money management and, 33, 176 Social capital, 181 Social forces, economic forces and, 179–80 Social institutions, globalization and, 186–87 Social media: fostering accountability and, 114–19 scrutiny of funds and, 224–25 Social mobility, finance industry and, 4–5, 24 Socially responsible investors, 77 Soros, George, 189 Specialization: in finance industry, 30–33 productivity and, 158–59 reducing number of agents, 58–59 Stanford University, Rock Center for Corporate Governance, 82–83 State of Wisconsin Investment Board (SWIB), 59 Statement on Institutional Investor Responsibilities, 113–14 Stausboll, Anne, 110, 111–12 Stewart, Fiona, 103 Stichting Pensioenfonds Zorg en Welzijn (PFZW), 111, 206 Stock market crash (2013), 51 Stock options, executive compensation and, 69–71, 83–84 Stock price, 8, 50, 64, 67, 70–71, 72, 84–85, 146, 223 Stock, holding period of traded, 4, 63–65 Subprime mortgages, 38, 40, 47 Supervision, discouraging cheating via, 144 Supply, law of supply and demand, 160–61 “Sustainable Capitalism” (Generation Investment Management), 112–13 Sutherland, John, 215 Swaps, 93 SWIB See State of Wisconsin Investment Board (SWIB) Systemic regulation, 131–34 behavioral economics and, 143–45 enacting, 151–54 fiduciary legal system and, 135–41 institutions, 141–42 Systemic risk, diversification and, 45 Taleb, Nassim, 172 Taub, Jennifer, 102 Tax code: encouraging long-term investment through, 92, 223–24 executive compensation and, 69, 85 TD Ameritrade, 29 Technology, individual investors and use of, 90–92 TER See Total expense ratio (TER) The Theory of Moral Sentiments (Smith), 158 350.org, 118, 120 Time frame, pension funds and, 207 Tomorrow’s Investor-Pensions for the People (Pitt-Watson), 264–65n11 Total expense ratio (TER), 204, 233n2 Towers Watson, 122 Tracker funds (index funds), 45–46, 57 Trade morality, 177 Trading: de-emphasizing short-term, 87 holding period of traded stock, 4, 63–65 oversight of, 150–51 relationships between trading partners, 168–69 See also High-frequency trading Trading platforms, that protect investors, 88–89 Transaction costs, 127, 169–70, 255n4 Transparency: in governance, 97–100, 224 in People’s Pension, 203–4, 207–8 of financial institutions, 229–30 regarding fees, 53–54, 60 regulation requiring, 146 Trillium, 77 Triodos Bank, 111 TripAdvisor, 127 Trust, 256n14 finance industry and, 56, 187 financial system and, 176–77 globalization and, 186–87 in government, 141 markets and, 178, 181 Trustee boards, of pension funds, 105–6 Trustee Network, 121 Trustees, 105–6, 108–9, 137–38, 140, 205, 207, 224–25, 229 Twitter, 114, 115, 116 Uncertainty, risk and, 172, 261n35 Unequal treaties, 168–69 United Airlines, 114–15 United Kingdom: financial services as percent of economy, 16 index funds, 57 investor coalitions, 89 laws to protect shareholders, 152 switch to defined contribution plans, 197–98 trust in finance industry, 56 women on corporate boards, 247n45 United Nations Principles for Responsible Investment (UN PRI), 58, 90, 112, 117, 140, 207 UN Environment Program, Finance Initiative, 138 United States: defined benefit funds, 105 defined contribution plans, 100, 102 director elections, 79 disclosure rules, 97–98 fiduciary duty and brokers, 256n23 flash crash, 51–52 fund governance regulation, 107–8 index funds, 57 investor coalitions, 90 lack of corporate governance code, 205, 267n3 regulation in aftermath of financial crisis, 124 stock market crash (2013), 51 switch to defined contribution plans, 197–98 tax liability for executive pay, 69, 85 trust in finance industry, 56 women on corporate boards, 247n45 US Office of the Comptroller, 108 US Commodity Futures Trading Commission, 52 US Department of Labor, 60, 107, 139–40 University of Oxford, 190 University students, governance reform and, 121–22 Urwin, Roger, 206 Value at risk (VaR), 39–40 Values, economies and, 178 Van Clieaf, Mark, 68 van der Vondel, Joost, 262n49 Vanguard, 6, 139, 235n24 Volcker, Paul, 267n1 von Hayek, Friedrich, 165 Voting: derivatives and, 80, 82–83, 93 disclosure of, 93, 108, 120, 121, 140, 207 for directors, 78–79 fund managers and, 75–77 individual investors and, 91, 120, 223 Vulture investors, 248n50 Wall Street Journal (newspaper), 29, 52 Wallace, Robert, 14, 199–202, 209 Walras, Leon, 159–60 Walter, Elisse, 88 Warren, Elizabeth, 129, 130 Washington, George, 157 The Wealth of Nations (Smith), 158, 161 Webb, David, 115 Weber, Max, 167 Webster, Alexander, 14, 199–202, 209 Weisman, Andrew, 37, 38 White, William, 259n5 Williamson, Michael, 59 Williamson, Oliver, 262n52 Women, on corporate boards, 247n45 Wong, Simon, 104 World Bank, 73, 151 World Economic Forum, 103–4 World Federation of Exchanges, 64–65 WorldCom, 44 www.corpgov.net, 116–17 Yahoo!, 115 Yelp, 127 Yermo, Juan, 103 YouTube, 117, 174 Zheng He, 262n48 .. .What They Do With Your Money What They Do With Your Money How the Financial System Fails Us and How to Fix It STEPHEN DAVIS JON LUKOMNIK DAVID PITT-WATSON Published with assistance from the. .. system But capitalism, like political systems, must regularly be challenged by the citizens who live with it if it is to fulfill its purpose The cost of failing to challenge the financial system can... that there is no longer a line of sight between us, the providers of capital, and all of the agents That opacity allows those with expertise to use their knowledge to serve themselves without