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The Dysfunctional Pension Financed Wall Street Monopoly Of Modern Finance

Pensions & Endowments today are mostly not investing through negotiated agreement with enterprise directly. Or rather, it is more technically correct to say that Pensions & Endowments are investing by negotiated agreement with only one kind of enterprise. That is, enterprises for paid professional speculation with Other People’s Money.

This is an industry that calls itself increasingly the Asset Management industry, populated by professionals who call themselves increasingly Asset Managers. They call the superfiduciary stewards of society’s superfunds with whom they contract almost exclusively, Asset Owners, whose job is to hire the best Asset Managers they can, to speculate with the Other People’s Money, for a fee, but without any guarantee of sufficient cash flows through which our superfiduciaries can discharge their superfiduciary duties, to their beneficiaries, across the generations, and to all of society, also across the generations.

It is an industry that is failing their clients, and all of us.

This failure began in 1973.

1973 is the year in which the Uniform Management of Institutional Funds Act was passed into law by some 43 states. It is now the law in all 50 states.

The Uniform Management of Institutional Funds Act was promulgated by the National Commission on Uniform State Laws during its Annual Meeting in August of 1972.

The National Commission on Uniform State Laws is a voluntary lawyer group organized and operated as a public service for the purpose of studying state by state differences in various laws that affect enterprises doing business in different states and people living in or moving between different states. Their purpose is to identify idiosyncrasies in state laws that impose burdens on people and business living and working in different states, without any clearly identifiable reason why one state’s laws should be different than another state’s laws, in this particular way. The Commission writes a set of uniform laws that it recommends all states adopt, so that state laws will not vary in idiosyncratic, but not truly meaningful ways, from state to state. Uniform laws are model laws that states can adopt, or not, as their legislatures may choose. The Uniform Laws Commission, as it is sometimes called, has not authority to actually make laws in any state or other jurisdiction. It’s function is purely expert advisory, in the interest of business and personal efficiency across state lines.

There is, for example a Uniform Commercial Code that was promulgated by the Uniform Laws Commission that has been adopted by 49 of the 50 states (Louisiana only excluded, preferring to remain with the Napoleonic Code, as they do in so many ways in Louisiana). It standardizes the main principles of contract law across the states, and provides a larger body of precedent for interpretation, since different states now all apply the same legal principles to the enforceability of contracts within their boundaries.

Many, if not most, of the laws that have been standardized by the Uniform Laws Commission (with voluntary opt-in by the various states) evolved out of what is known as the common law, or the history of decisions made by judges to resolve disputes in court cases going back in time, sometimes to the English courts. This is known as presidential law, or court law. There is a rule within this law, called stare decisis, which holds that once a court has established a precedent for what the law is in a particular matter, all other courts must follow that first court’s ruling, in order that they law may evolve to fit changing circumstances, but also provide some measure of predictability. Within the different states, each states courts have evolved their own precedents, that sometimes represent variation in the common law between the states that are mostly accidents of history. In some cases, also, legislation gets enacted into law in different states that reflect the idiosyncrasies of different legislators and their constituencies. Many of these accidental and stylistic difference in state laws hinder working and living in different states, without really advancing any particular policy choice made by one state that is purposefully different than another state.

Before 1972, the law of fiduciary duty, which governs the rights and responsibilities of people entrusted with discretionary control over another person’s money or other property, was determined under common law, on a state by state basis, much going back all the way to the English common law, and before that to French aristocratic law.

The reason is that the law of fiduciary duty originated in Medieval France, at the time of the Crusades, when an entitled nobleman heading off to fight in a Crusade, would entrust his titles and estates to a trusted friend, who choose to remain home, and no go crusading. A law evolved imposing on the person entrusted with another person’s titles and estates a duty of loyalty to the entrusting person. This duty required the entrusted person to hold the titles and look after the estates during the continuation of the trust with the best interests of the entrusting party in mind, and to return the entrusted titles and estates to the entrusting person, when they returned, and asked for them back.

This practice of transfers in trust, and the fiduciary duties that were created when one accepted such a transfer, passed with the Norman invasion of England into English practice, becoming part of the English common law, that forms the root of American common law.

It also found another use, for endowing church institutions, mostly monasteries, with lands, frequently tied to their providing education (and babysitting) to the children of the nobility granting such endowments. The lands were granted in trust, to revert to the grantor, if the Church ceased to use them for properly Church-like purposes.

As free enterprise, first in its commercial and later in its industrial incarnations, evolved out of the aristocratic estate economies, the fiduciary trust form of transfer was adapted to meet the new need to provide income to widows and orphans. In the estate economies, such provisions were not really needed, because all persons living on the estate had a claim for necessaries on the aristocracy that was charged under the prevailing social contract with stewardship of those estates, and of all the people living on them. As merchants left the estates to set up businesses and homes in the cities, to engage in trade and commerce, their claim for sustenance on the aristocracy remained behind them, on the estates. When they went to the city, they had to fend for themselves. That meant providing for their wives and children, and parents and other members of their extended family.

Wives and children, in these days, were not allowed to own property or enter into commercial agreements that could be held binding upon them in courts of law. Upon the untimely death of a husband and patriarch, widows and orphans would face destitution, if provision had not been made for them beforehand. The fiduciary trust form of ownership proved a popular way to make such a provision. Property would be entrusted to a trustee, with instructions to provide an income to the widow, until her death, and orphans, until they reached majority, or otherwise “came of age” to inherit outright, as provided in the indenture of trust.

These personal or family trusts often transferred money in trust, sometimes along with residential real estate, but less often income producing properties. In this way, the nature of fiduciary duties became less physical and more financial, less about good husbandry and more about prudent investment and transparent accounting.

The standard of financial fiduciary prudence oscillated for many centuries between two different measures: one is what might be called a Permitted Investments standard, (also known as the Legal List); the other was more of an reasonable prudence standard, i.e. a trustee must deal with entrusted property in the same way that a reasonably prudent person would deal with their own property and investments.

Both standards were developed in recognition that people dealing with other people’s money, where they might share in a benefit, but will not suffer from a loss, don’t always assess risk in the same way we do when dealing with our own money, where we will enjoy the benefit, but will also suffer the loss.

The Permitted Investment standard concludes that the risk of loss of caution associated with being invested with discretionary control over someone else’s money is, essentially, unmanageable. The law must restrict the choices a fiduciary can make, to ensure that only choices that do not carry undue risk can even be considered. These were generally limited to loans made on interest, against only the most reliable borrowers: governments, and estates, that is, loans secured by real estate. Over time, the Legal List evolved to include: government bonds; high grade corporate bonds; real estate mortgages; and real estate owned.

The Ordinary Prudence standard takes a more forgiving view of the risk of bad judgement in the context of a fiduciary trust, holding that any investment can be permitted if it is reasonably prudent under the circumstances, that is, if a hypothetical person of reasonable business experience and success would consider it prudent to make an investment for their own account, using their own money, at their own risk, then a fiduciary can be considered also to be prudent making such an investment using other people’s money entrusted to their good judgement.

However, whether following the Permitted Investment standard or the Ordinary Prudence standard, the law of fiduciary duty has alway held, and still does hold, even after 1973, that it is never permitted for a fiduciary to speculate with the other people’s money entrusted to their good judgement. Speculation is forbidden by law. No exceptions.

Except that, in 1972, the National Commission on Uniform State Laws formed the view that buying and selling stocks on a diversified portfolio basis, applying the principles of what is sometimes called Modern Portfolio Theory, can take the speculation out of speculating on Growth in the future selling price derived from expectations for future growth in the net present value, or NPV, of expected future cash flows flowing through a corporate bureaucracy.

And by the end of 1973, some 43 states had agreed.

This decision was based on a Report prepared by two lawyers, Messers Carey and Bright, at the request of Ford Foundation, in which Messrs Carey and Bright correctly concluded that the law of fiduciary duty only requires prudence, and that current practice widely followed by many people of ordinary business prudence was to buy and sell stocks over the Exchanges, using their own personal funds, for their own personal accounts, on a diversified portfolio basis. Since reasonable people of ordinary prudence traded stocks through diversified portfolios, Messrs. Carey and Bright argued that fiduciaries, like Ford Foundation, should also be considered to be acting prudently as fiduciaries, if they bought and sold shares over the Exchanges on a diversified portfolio basis.

It’s not easy holding Wall Street accountable for not getting it right.

That’s a problem.

It’s a problem because beginning in 1973, Wall Street has been taking over our entire global financial system, including government, both as investor and, increasingly, as regulator.

We know that is a problem because we have lived through something like it before. At least twice.

The first time was The Gilded Age, when Wall Street took over investing by insurance companies, fueling a speculative asset pricing boom that went bust in the Panics of 1897 and 1907, almost bankrupting the US Treasury, and requiring Teddy Roosevelt to ride in and break up the trusts, while state legislatures made it illegal for insurance companies to speculate on Wall Street with policyholder’s premiums.

The second time was The Roaring Twenties, when Wall Street took over investing of banking deposits, fueling another speculative asset pricing boom on Wall Street the wen bust in the Crash of ’29 and the Great Depression, requiring FDR to regulate both commercial and investment banking, while creating worker pensions and social safety nets.

Today, it is happening again. This time with pensions.

Forty years ago, almost everything pensions are doing today as stewards of society’s shared savings was against the law.