Et Tu, MSRB?
Defining ESG Disclosure in the Muni Market
The U.S. Securities and Exchange Commission (SEC) took up all the oxygen in the proverbial financial regulatory room two weeks ago with its proposal to mandate climate disclosure for publicly reporting companies. (I will have more to say about that in a future blog.) But what went almost unnoticed was a parallel foray into climate disclosure by another financial regulator, the Municipal Securities Rulemaking Board (MSRB), which earlier this year issued a request for information on environmental, social and governance (ESG) practices in the municipal bond market.
The Securities Industry and Financial Markets Association (SIFMA) and the American Securities Association (ASA), in both of which Baird is a member, filed comments letters with the MSRB that capture fairly comprehensively the issues raised by potential ESG disclosure regulation in the muni market. (SIFMA letter; ASA letter.)
Both the SEC's proposal and the MSRB's request raise the same critical and fundamental policy issue: What is the proper role of financial regulators when it comes to ESG disclosures? Do they have the legal authority to mandate ESG disclosures without explicit authority to do so delegated to them by Congress (which none of them have)?
In the muni market, the issue of prescriptive ESG disclosure is further complicated by a couple of additional factors.
First, it would be enormously difficult to implement in an effective manner. That's because there are an approximately 50,000 state and local government entities, not including many not-for-profit or other obligors, that raise capital by issuing municipal bonds (as opposed to about 4,000 public companies) and a staggering one million bonds outstanding. There are widely varying risks and exposure considerations between different types of governmental units and geographies. As the Government Finance Officers Association wrote in a letter to the SEC, "the notion of developing a uniform set of metrics to evaluate risks is so impractical as to be virtually impossible."
Then, consistent with our country's foundational principle of federalism, there's the historical reluctance of Congress to regulate the activities of states and their political subdivisions. As officials from 23 states contended in a comment letter to the MSRB, the request for information "thwarts Congress's decision to leave states free from bureaucratic securities supervision." "The MSRB needs to stay out of this area," Utah State Treasurer Marlo Oaks told The Bond Buyer.
The irony in this situation is that municipal bonds are the original socially responsible, green, ESG-focused securities. U.S. Treasury and IRS rules have long required tax-exempt municipal bonds to be issued for a public purpose. Municipal bonds finance parks and greenways, energy efficient improvements to schools and hospitals, mass transit development and water management systems, the environmental and social impacts of which are fairly obvious.
Clear, factual disclosures by state and local government borrowers as to how bond proceeds are going to be used and the impact they are going to have on real people living in real communities in the real world, are far more important to investors than adding ESG labels without clarity or consistency as to what they mean.
Death, Taxes and... Demographics
Benjamin Franklin is credited with saying, "In this world, nothing can be certain, except death and taxes." But savvy long-term investors know they can add demographics to the list.
With inflation annualizing at 7.9% (according to the Consumer Price Index), a 25 basis point increase in the Fed funds rate with six more likely on the way, the 10-year U.S. Treasury bond yielding roughly 2.4% and home mortgages rates over 4%, all eyes and ears are focused on the economic impact of a hike in interest rates. Yet two recent articles in The Economist suggest that the demographic trend of global aging is likely to keep a cap on interest rates over the longer term.
- How high will interest rates go? | The Economist
- Why the world is saving too much money for its own good | The Economist
My colleague Warren Pierson is Co-Chief Investment Officer at Baird Advisors, which manages $130 billion in bonds for institutional and individual investors. I asked for his take on the potential effect of U.S. age demographics on inflation. Here is what he had to say:
We believe/agree that aging populations and the associated increase in retiree savings will work to limit increases in interest rates around the world going forward. We think many strategists have continually underestimated/underappreciated the strength of these demographic trends. Retirees tend to save more and spend less and we believe that is part of the reason why the Fed's extraordinary stimulative policies over the last decade-plus did not produce the inflation that so many were eagerly anticipating. Instead of being lent and spent and greatly stimulating the economy, much of the easy money was simply invested and the only inflation that resulted (until recently) was in financial assets.
The COVID fiscal stimulus changed that as dollars were given directly to many individuals that had immediate needs who spent it, giving a big boost to our economy and creating demand-led inflation. While strong demand led to much of the inflation we are seeing now, a lot of the price increases (goods and labor) are more related to supply disruptions. While it is taking longer than expected to right many of these disruptions, we do believe market forces will correct them over time and inflation will eventually settle in much closer to the Fed's desired target of 2+%.
Another demographic consideration is the aging population's effect on the labor pool. Some estimates suggest that about 60,000 baby boomers are currently retiring each day in America. While that number might not be precisely accurate, the trend is clearly happening.
The chart below shows how the percentage of our population that is over 65 has grown and will continue to grow for the next decade plus. The lower panel also shows that our country's population overall is barely growing.
As a result, our labor force is barely growing (see top of chart below). Combining the growth in our labor force with productivity (bottom panel below) is another way of defining how fast our economy can grow.
Add these two estimates together and you get a long-term growth potential of about 2% – hardly inflationary. This is a major tenet of our thesis that interest rates will stay lower longer than many people think.
Many contend that the current environment feels a lot like the late '70s and early '80s. While we agree there are similarities in government policies, look at the difference in the large growth of our labor force from the '50s to the '80s. Not only was our country's population growing, but we also had many women leave their traditional homemaker roles and join the work force. That huge growth in the work force and big gains in productivity fueled much stronger growth that in turn led to higher inflation. We don't believe our economy has that same long-term inflation-generating potential for the foreseeable future.
What is the takeaway?
In the short run, the volume of retiring Boomers is contributing to a current labor shortage that is putting upward pressure on wages. Baird's take is that this increase in wages, which has been more focused on lower paying jobs, has been a very appropriate and much needed one-time adjustment or catch-up for workers whose wages have been largely stagnant for the past decade. We believe these wage gains will stick and hold. We also believe it is unlikely that such a large uptick will repeat. We feel the same about the price gains of many goods and services (e.g. cars, houses). That is, prices are not falling back, but also probably not advancing much further from current levels any time soon.
The evidence points to some significant differences between the cause of today's inflation and the factors at play in the 1970s, the period to which so many are drawing comparisons. The long-term effect of demographics is likely to be lower, not higher, interest rates.
The Investment Case for Diverse-Owned Managers
When it comes to aligning your investments with your values, Marcia Page holds a place in my personal Hall of Fame.
I met Marcia through serving together on the Board and Investment Committee of The Minneapolis Foundation. Marcia co-founded and now serves as Executive Chair of Värde Partners, an institutionally focused, $14 billion global alternatives investment firm. But for the past four years, she has been working to create and launch MPowered Capital, which targets private minority investments in asset managers with diverse ownership. Marcia has already invested $25 million of her personal capital in MPowered's first fund and will ultimately commit $75 million alongside limited partners (LPs). Baird is also an investor in MPowered.
I recently had the opportunity to talk to Marcia about the landscape for women and diverse professionals generally in asset management and across the financial services industry.
Here are excerpts from our conversation:
What was your motivation in creating, and in providing such significant personal financial support, for MPowered Capital?
Page: I have had the most amazing 30+ year investing career. When I stepped down from the Co-CIO and Co-CEO role at Värde Partners at the end of 2015, I was dismayed at how little progress the industry had made in recruiting and retaining more diverse talent on their investing teams. I started by researching and working on ways that investment organizations can attract, retain and promote a more diverse employee base as well as thinking about ways to influence the industry to accelerate change. About three years ago, it became clear to me that one way I could use my experience, resources and influence to effect change was to invest in and back diverse talent. The idea for MPowered Capital has been several years in the making, and I couldn't be more excited about the opportunity set and amazing talent we are underwriting today.
When you started Värde Partners, did you have an angel investor or financial sponsor that took a special interest in backing you as a woman?
Page: No, just personal savings from the three founding partners. I still have a copy of my first Värde paycheck – which took nearly three years to achieve!
Were there any gender-specific hurdles you faced in starting and growing Värde?
Page: Not in a material or overt way, perhaps aided by the fact that Värde's two other founding partners were men and that I was in a position to commit capital directly.
You talk about the fact that diverse managers have been "underrepresented and under-capitalized." Can you expand on that?
Page: Diverse talent accounts for just 10% of total investment management firms and managers a mere 1.4% of institutional assets under management in the U.S. asset management industry. According to a 2018 study by WillisTowersWatson, the number of female fund managers around the world has remained stagnant for two decades at around 14%. A combination of structural forces and unconscious bias have created a circular conundrum. Capital has accumulated amongst established firms. LPs tend to reinvest capital with existing managers and, as limited partnerships have grown in size, LPs are committing larger amounts to maintain their allocations. There is a desire to invest with "people like ourselves" – it's human nature. The lack of portfolio "fit" – meaning considerations like first time funds, constraints in size (too small) or length of track record (too short) inhibit investments in diverse managers. As a result of many factors, research has shown that women must outperform to achieve the same assets under management as men.
Why do women and other diverse talent need the kind of support MPowered Capital offers?
Page: The combination of alpha generation and lack of capital flows to diverse investing talent creates what we believe is one of the most inefficient markets for capital formation in existence today. Importantly, to be successful in the market, investors need a unique set of skills to address the specific issues that give rise to this opportunity set. First, investors have to approach opportunities with flexible capital solutions. MPowered has several investing strategies in its portfolio, each of which are designed to address specific capital pain points in this emergent manager landscape. Equally important, in our opinion, is MPowered's ability to provide strategic advice to accelerate firm building and fund formation. We believe the MPowered team, coupled with its affiliations and network of service providers, can help propel managers through the critical start-up and early fund formations phases of their organizations.
Baird Financial Corporation is a limited partner investor in MPowered Capital’s MPowered Access Fund I; Baird Capital is not affiliated with MPowered in any way.
Are We Really Facing a "Purgatory" of Low Returns?
One of the things I admire about famed "permabear" Jeremy Grantham and the asset management firm he founded, Grantham, Mayo, & Von Otterloo (GMO), is their commitment to putting forecasted future returns for different asset classes right out there in the public square, so to speak. Recently, Grantham made headlines with his latest call for a reversion to the mean from today's "superbubble" in financial assets, which he describes as the "most dangerous breadth of asset overpricing in financial history."
But what may be even more concerning is GMO's predictions for how capital markets will behave over the longer term.
Per GMO, only two of 11 asset classes will earn investors positive returns over the next seven years – both in emerging markets. Large-cap U.S. equities are expected to be the worst performers, with a return of -7.3%. U.S. bonds won't provide a safe haven, with an estimated decline of -4.1%. Even cash will lose the race against inflation, with a forecasted return of -1.1%.
Grantham and GMO have been famously wrong before. But if they’re even a little bit right, that would be very bad news for the modern global system of financial capitalism. So much of our daily lives and the organizations we belong to and rely on are leveraged to positive real returns on financial assets. Pension funds, for example, are designed around the premise of long term returns. Universities, schools, museums, hospitals, count on drawing on their endowments into perpetuity to supplement their earned income. Individual defined contribution accounts, now the primary retirement savings vehicle for most Americans, don't serve their purpose if investment returns don't outpace increases in the cost of living (including healthcare). The operating models underlying all of those assume positive real returns. And for the last decade, since the Great Financial Crisis, capital markets have delivered. Big time.
Last week's heightened market volatility further underscores the consensus concern that those recent returns haven't been driven as much by fundamental economic growth but instead by artificially low interest rates and easy access to capital (the result of accommodative monetary policy and stimulative fiscal policy,) which have in turn boosted valuation multiples to the point where they are "largely flashing red" (as my colleagues at Strategas wrote this week). Large-cap equities, as an example, are trading at more than 22x forward earnings, a level from which, historically, the next five years of nominal performance has averaged only 1.7%. As the Fed begins to raise interest rates and moves from buying bonds to shrinking its balance sheet, the proverbial music may be about to stop.
I take some solace from an article of GMO's former gurus, James Montier, wrote entitled "The Purgatory of Low Returns." In it, he bemoaned "This might just be the cruelest time to be an asset allocator. Normally we find ourselves in situations in which at least something is cheap... However, today we see something very different... today's opportunity set is characterized by almost everything being expensive... this is a direct effect of the quantitative easing policies being pursued by the Federal Reserve and their ilk around the world."
Does that sound like what we're hearing today? Well... the date of that article is 2013.
Since then, the MSCI U.S. index has delivered an annual rate of return of over 16%. More typically diversified investment portfolios have also delivered strong returns over that same time period, well above the 7% required to fund operating draws and grantmaking activities and preserve portfolio principal.
The consensus forecast may be for single digit equity returns this year, but as Strategas CEO Jason Trennert notes, "That doesn't actually happen all that often". Only three times in the past 13 years, in fact. Longer-term forecasts are even more suspect.
Short of trying to time the market, which is a fool's undertaking, the best defense against low future returns may just ultimately be banking the positive returns you've generated in the past – which have been plentiful – and counting on them, as individual investors and societally, to get us through the lean years we might be about to face.
Welcome to the Meta-DeFi-Crypto-Verse Economy
Mary lives on a five-acre farm near Seattle with her three horses, two cats and a flock of chickens. At the age of 41, she makes her living in the real world as a farrier, shoeing horses – for which she dropped out of the world of commercial finance, giving up careers on Wall Street and in fintech.
To supplement her equestrian income, Mary trades digital assets. She owns, for example, a non-fungible racehorse token that she enters in online races in the metaverse, a reality parallel to our own which has been described in the Wall Street Journal as "an extensive online world transcending individual tech platforms, where people exist in immersive, shared virtual spaces."
Tech companies, particularly Facebook, have hailed the metaverse as the next evolution of the internet, with CEO Mark Zuckerberg highlighting his intent to turn Facebook into "a metaverse company" on a recent investor call.
When her NFT horse wins, Mary gets paid in some form of digital currency, to be converted into fiat currencies, or redeployed into more online assets.
"I trade assets in the digital world to support my life here in the real world," she told me. "My goal is not to have to work in the real world at all."
Mary belongs to a growing legion of metaverse denizens for whom digital currencies and markets are just as relevant as the fiat currencies or the New York Stock Exchange.
In 2020, when COVID-19 shut down the economy in a rural province of the Philippines, a gaming entrepreneur named Gabby Dizon began lending our characters in a game called Axie Infinity. Members of his community used those characters to earn tokens in the game, which could then be exchanged for local currency. The game caught on quickly in the Philippines, where players can earn a multiple of the local minimum wage.
Thus began the phenomenon of "play-to-earn" and the creation of Yield Guild Games ("YGG"), with more than 1.5 million daily active users (an estimated half of whom are from emerging markets) having earned over $8 million by "combining NFTs, DeFi and gaming to deliver ... a new model of employment in the Metaverse."
Announcing $4.6 million investment in YGG, venture capitalists Andreessen Horowitz pointed to "a largely untapped economic opportunity in emerging markets to provide jobs by building a virtual economy in the digital world."
How far we have traveled in a short time from the world view of former Federal Reserve Chairman Alan Greenspan, who once said: "You really have to stretch your imagination to infer what the intrinsic value of Bitcoin is. I haven't been able to do it."
For the Greenspans of the world, blockchain technology, decentralized finance, non-fungible tokens and the economic activity they are making possible are as intellectually impenetrable as quantum physics. The headline of a recent issue of the Economist focused on decentralized financed borrowed aptly from Lewis Carroll's Alice in Wonderland: "Down the rabbit hole."
Critics have described it as "totally self-absorbed, all about providing different ways for people to speculate on cryptocurrencies." "A solution in search of a problem." "The financial services equivalent of self-driving cars that can do just about everything but stop at red lights." One commentator joked, in a recent column, "Maybe one day DeFi will find a real use."
Well... it already has.
On a wealth- and asset-weighted basis, the Greenspans of the world control most of the assets and operating companies supported by our financial system. But the future of finance belongs to the Marys and the Gabby Dizons, for whom the appeal of digital finance is precisely the fact that it exists outside or alongside the world of conventional finance and centralized institutions.
The potential benefits of this alternative system, according to the International Monetary Fund, lie in creating "more inclusive financial services." Or as the New York Times puts it, "Crypto finance gives people long excluded by traditional institutions the opportunity to engage in transactions quickly, cheaply and without judgement."
The biggest negative is that the system as it exists today is rife with outright criminal behavior: fraud, manipulation, abuse, money laundering.
Meta-DeFi-Crypto-Verse finance is clearly here to stay. And as YGG demonstrates, it even has potential to be a force for good. But to realize its full potential, it needs to integrate into the conventional financial, legal and regulatory infrastructure that undergirds financial capitalism.
"If it's going to have any relevance in five to 10 years," SEC Chairman Gary Gensler has said, "It's going to have to be within a public policy framework."
The challenge will be how to accomplish that without squashing energy and the torrent of innovation behind this latest iteration of alternative finance.
Baird does not currently recommend the purchase of cryptocurrencies, products that attempt to track cryptocurrencies or cryptocurrency custodians and won't until there are more secure and cost-effective ways to gain exposure to this asset class.
It's Coming... But When?
Living With Systemic Risk
In the climactic scene from the cult movie classic Big Trouble in Little China, the movie's hero, Jack Burton (played by Kurt Russell) knocks over the first in a long line of Buddha-esque porcelain statues in cursed Emperor David Lo Pan's throne room. Each statue tumbles into the one beside it, one after another, leaving the chamber littered with porcelain shards and Lo Pan's empire in a state of collapse.
It's an illustration of "systemic risk" – an antiseptic regulatory term that refers to hidden threats that could topple the global financial system because of what's known as the cascading effect: the finance equivalent of one statue falling into another. Recently, concerns over "contagion" from Chinese conglomerate Evergrande's solvency have rattled global markets and brought the specter of systemic risk to the forefront yet again.
With financial assets at historically high valuations and excesses popping up across the board, there is growing concern about where the cause of the next financial crisis might be hiding.
Fingers have been pointed at:
- Retail "meme" trading in stocks like GameStop.
- A default by the U.S. Treasury if the debt ceiling isn't raised.
- Negative interest rates.
- Bitcoin volatility.
- Swap contracts.
- The new "wild west" of decentralized finance, or DeFi.
- Money market funds (which precipitated the last crisis).
- Climate change exposure in the lending portfolios of banks and in muni bonds.
- Exchange-traded funds.
- The surge in private credit.
- Growth in margin lending and securities-based loans.
- Even index funds.
What makes any and all of these a potential catalyst is, ironically, the complexity and interconnectedness of the financial system that undergirds financial capitalism, the dominant socioeconomic system in the world. One of the wonders of the modern era, our global financial system is actually more subject to collapse than it was, say, a century ago.
On one hand, the regulatory infrastructure is far more advanced, battle-tested and sophisticated than it was after our last two major financial crises, the Great Depression and the Great Financial Crisis a decade ago.
But with complexity comes increased fragility, a point that Nassim Nicolas Taleb makes in his books The Black Swan and Antifragile. Simple systems are resilient. Complex systems are fragile. In today's interconnected global financial system, a shock anywhere in the financial system goes deeper, travels faster and affects other players around the world far more dramatically than ever before.
Any one individual or institutional statue toppling over isn't in and of itself a problem. A recent example of this of Archegos Capital, the family office run by Bill Hwang, which imploded due to leveraged long equity positions embedded in total return swaps.
Multiple financial institutions were dented by their exposure to Archegos losses, including Credit Suisse ($5.5 billion), Nomura ($2.9 billion), Morgan Stanley (nearly $1 billion) and UBS ($774 million). But none so seriously they risked falling over.
Archegos exposed one of the fundamental contributors to systemic risk – lack of transparency. Not one of Hwang's counterparties fully understood the size and concentration of the stock exposure he accumulated because disclosure rules for total return swaps had not yet become effective.
In the wake of the last financial crisis, Congress created a new regulatory oversight body, the Financial Stability Oversight Council (FSOC). Chaired by the U.S. Secretary of the Treasury, it includes the chair of the Federal Reserve, the Comptroller of the Currency (OCC), the Consumer Financial Protection Bureau (CFPB), SEC, FDIC, Commodity Futures Trading Commission, among others. Its job is to scan the landscape for vulnerabilities in both the regulated and unregulated (or shadow banking) sectors of the financial system and act to address them before any meltdowns occur.
The FSOC reported to President Biden last spring that "the financial system is in strong condition... financial risks are being mitigated by robust capital and liquidity levels in the banking system and healthy household balance sheets."
But there are several challenges with the FSOC's early warning system.
First, as Financial Times columnist Gillian Tett wrote recently, it is devilishly "hard to tell where pockets of excessive leverage lie." Second, even when risks are identified, opinions are often split on whether they are systemic in nature. On the one hand, if all the bitcoins outstanding lost all their value "its holders would lose hundreds of billions of dollars but that... fallout would be manageable," the Economist wrote recently. On the other, Tether stablecoins, another digital currency worth approximately $62 billion and only partially backed by commercial paper, are just about the size of the Reserve money market fund whose Lehman Brothers commercial holdings caused it to "break the buck" and precipitated the last financial crisis.
Finally, there is always a tradeoff between protecting against systemic risk and permitting the free flow of capital necessary to fuel economic activity. One analogy used by former Fed Chairman Alan Greenspan has stayed with me over the years. He likened financial regulation to building levees in coastal cities. The question is how high to build the dikes. High enough to protect against a 50-year flood? A 100-year flood? The higher the levee, the better the protection... but the more it costs. The same is true for financial regulation – only its cost comes in the form of reduced economic activity.
Improving disclosure is a relatively low-cost preventative measure. As former SEC Chairman Arthur Levitt declared, "The more you know, the less risk you take." But only up to a point. Taleb warns that "gains in our ability to model (and predict) the world may be dwarfed by the increases in its complexity – implying a greater and greater role for the unpredicted."
Put another way by Taleb: "Globalization has created this interlocking fragility, while... giving the appearance of stability." We must continue to balance regulation and risk to maintain the resilience and vitality of the global financial system.
Is the Fed Fueling Inequality?
In case you hadn't noticed (and chances are you haven't... with the warm summer weather, beach books have probably been at the top of most peoples' reading lists), a debate has been raging in the financial press about whether the Federal Reserve and its monetary policies have exacerbated societal inequality in the U.S.
The leading voice in the "Yes, it has," camp is Karen Petrou, who published a book earlier this year titled Engine of Inequality: The Fed and the Future of Wealth in America. She then followed up with a July op-ed in The New York Times, "Only the Rich Could Love This Economic Recovery."
On the other side of the argument is Martin Wolf, chief economics commentator at the Financial Times, whose recent op-ed entitled "Monetary policy is not the solution to inequality," riffed off a report by the Bank for International Settlements that concluded, "Monetary policy is neither the main cause of inequality nor a cause of it."
Petrou's argument, at its core, is that the Fed's decade-long, post-financial crisis, pandemic-times policy of keeping interest rates ultra-low (negative, in fact, when inflation is taken into account) has inflated the value of financial assets and real estate without stimulating broad economic growth.
Stocks and bonds are disproportionally owned by the wealthy. According to data from the Fed itself, in the U.S. 54% of equities are owned by the top 1%. And since the 2008 downturn (and the Fed's subsequent stimulus efforts), the increase in the value of financial assets has been 10 times the growth of GDP – which until recently had languished at levels not seen since the end of World War II. The well-being of most people outside the 1% is tied more to economic growth. The math, Petrou writes, is pretty simple: "When financial rates of return are above that of broader economic growth, inequality speeds up in a cumulative way."
As a result, Petrou said in a June Financial Times op-ed of her own, "The U.S. central bank has played a direct, if wholly unintended, role in driving income and wealth inequality to astonishing heights."
("Unintended" is an important word here. There is no indication the Fed is a knowingly malevolent actor. Fed Chairman Jerome Powell has spoken publicly about the Fed's commitment to principles of inclusion and diversity.)
There are a couple of other ways in which Fed policy affects rich people and disadvantaged populations inequitably. Those at the lower end of the wealth ladder tend to put what money they accumulate in savings accounts, where the interest they have received for the past decade has been close to zero in nominal terms, and negative in real terms. It's those at the upper end who tend to invest in higher-yielding assets.
Also, to the extent the Fed's easy money policies – low rates and aggressive bond buying, known as quantitative easing – end up spiking inflation, the effect will be more pronounced on the poor, who tend to spend a greater proportion of their income and wealth on consuming goods and services, which rise in price in inflationary environments.
"Inflation is already a painful tax on low, moderate and middle-income households," Petrou wrote in the Financial Times.
The counter argument essentially asks: What should the Fed have done differently in the wake of the two seismic shocks we suffered through in the past 10 years – the global financial crisis and the Covid-19 pandemic?
Martin Wolf put it this way in the Financial Times.
"It would have made no sense to adopt a deliberately more restrictive monetary policy solely in order to lower asset prices. This would have reduced activity and unemployment. That is the worst thing that could happen to people who are dependent on their wages for their livelihoods."
"How would the majority of people, who own almost no assets, be better off because billionaires were a bit poorer? It would be mad for central banks to cause slumps in order to lower asset prices."
I tend to agree with Wolf. But I worry that widening disparities in wealth and income could pressure political leaders to adopt fiscal (tax and spending) policies and impose regulations that slow growth and end up reducing overall well-being.
The White Hat/Black Hat debate over monetary policy is only one aspect of an ongoing conversation about whether (and if so, to what extent and in what ways) the financial system that powers our capitalist economy is an agent of, or a purveyor of, systemic inequality.
Related examples include claims by Emery University law professor Dorothy A. Brown in her book, The Whiteness of Wealth, that the tax system impoverishes Black Americans. Or by Destin Jenkins, University of Chicago assistant professor and author of The Bonds of Inequality, which claims the municipal bond market represents "infrastructural investment in whiteness" and that "the history of inequality in twentieth-century America is, in part, the history of municipal debt."
The debate over whether the financial system is driving inequality to new heights is, I believe, a distraction from what needs to be our singular focus: on shared prosperity and on how the financial system can help support that outcome.
Here we are again: The United States has once again hit the debt ceiling, and the government can no longer issue any new debt unless and until Congress acts to raise the ceiling.
A number of years ago I wrote an Op-Ed for The New York Times, excoriating Texas Senator Ted Cruz for reading Dr. Seuss's Green Eggs and Ham for 21 hours on the floor of the U.S. Senate holding the debt ceiling hostage to his unrelated cause du jour... rolling back Obamacare.
This fall, as the U.S. Treasury runs out of tricks to keep our federal fiscal machinery running, we will no doubt see Congress once again play chicken with our country's full faith credit.
As my colleague, Strategas' Dan Clifton recently wrote, "Republicans have little appetite to raise the debt ceiling... making it clear they are not willing to vote for a straight debt ceiling increase given the Democrats are moving $6 trillion of spending under the budget reconciliation process."
Warren Buffett has aptly termed the debt ceiling a "political weapon of mass destruction." A default by the United States on its outstanding public indebtedness would have incalculable consequences for the global financial system and would permanently impair the dollar's status as the world's reserve currency. Treasury Secretary Janet Yellen warned of "irreparable harm to the U.S. economy and the livelihoods of all Americans" if Congress does not act on the debt limit.
Yet, ironically, voting not to increase the debt ceiling is one of the few levers members of Congress have, be they Republicans or moderate Democrats, to prevent an equally serious act of fiscal irresponsibility – namely, spending another $4 trillion on childcare, eldercare, housing, education, paid leave, pre-Kindergarten programs, health insurance, nutrition and other social priorities. Which, if enacted, would come on top of the following spending bills:
- $550 billion in new spending in the much-discussed bipartisan infrastructure bill which was just passed by the Senate and is awaiting consideration by the House of Representatives.
- the $1.9 trillion American Rescue Plan passed earlier this year;
- the $2 trillion COVID-19 relief CARES Act and the $500 billion Paycheck Protection Program.
All of which piles onto outstanding debt (both that held by the public and intergovernmental holdings) of over $28 trillion. The United States now owes others more than 126% of its gross domestic product. 100% is considered the threshold for avoiding a "debt spiral."
What will it take before our elected officials recognize there is, in fact, a limit to what we as a society can afford to spend – and that we are way, way past that point? Are we even capable of navigating between the Scylla of default and the Charybdis of excessive spending?
In my 2012 book Stewardship, I wrote about the Great Financial crisis as a preview – a case study in what happens when we fail to live up to our stewardship responsibilities. I warned that similar stewardship failures were showing up in our failure to responsibly manage the finances of our country.
The sequel to that frightening film is playing out now. As I said in 2012, the consequences could well make the last financial crisis look like child's play.
Pressing On: From Marriage Equality to Financial Equality
June 26 isn't just any other early summer day – it's an historic day for LGBTQ equality.
It's the anniversary of numerous milestone moments in the gay rights movement. On June 26, 2003, the U.S. Supreme Court ruled on Lawrence v. Texas, voting to invalidate sodomy laws across the U.S. Ten years later, the Supreme Court overturned a key section of the Defense of Marriage Act (DOMA), a federal law that defined marriage as a union between one man and one woman.
And on June 26, 2015, the Court ruled on Obergefell v. Hodges – a landmark ruling that gave same-sex couples the right to marry in all U.S. states and made marriage equality the law of our land. Obergefell v. Hodges also removed some of the most significant of the inequities same-sex couples had historically faced – namely the inability to participate in the benefits available to married heterosexual couples, such as filing joint tax returns, access to a spouse's Social Security or health benefits, and gift and estate tax marital deductions, to name just a few.
The day symbolizes a lot for me and my family. I am a father and stepfather of two LGBTQ women. When my home state, Minnesota, proposed an amendment to make same-sex marriage unconstitutional in 2012, I campaigned publicly to encourage business leaders to oppose the amendment. It didn't pass. Remarkably, just a few months later, Minnesota legalized same-sex marriage.
Lately, a lot of attention and energy has been focused on the extent to which our financial system may or may not contribute to systemic racial inequality. Versions of this narrative are presented in several recently published books, including Karen Petrou's Engine of Inequality, Dorothy A. Brown's The Whiteness of Wealth, and Destin Jenkins' The Bonds of Inequality. All focus on the relationship between the financial system and economic inequality.
But in the same way financial inequality is all too real for all communities that exist outside mainstream culture – that continues to be true for the LGBTQ community.
In addition to complexities around retirement, estate and financial planning, the LGBTQ community faces its own particular share of financial headwinds. To name just a few: Numerous studies have found LGBTQ professionals face a pay gap in their careers, and the disparity can be especially wide for transgender individuals who transition at work – one study found female transgender workers saw their earnings drop by a third after their transition. When buying homes, LGBTQ individuals and families may face discrimination from agents or sellers – as well as being 73% more likely to be denied when applying for a mortgage. And nearly one-third of bisexual women and transgender individuals live in poverty.
That said, there is promising energy behind a push for financial equality for the LGBTQ community. In March, the Consumer Financial Protection Bureau issued a rule affirming it is illegal for lenders to discriminate on the basis of sexual orientation or gender identity. And the Call Me By My Name campaign is calling on U.S. financial institutions to increase support of the transgender and nonbinary communities by allowing consumers to select the name they'd like to be called by – and honoring that decision on each touchpoint, from the individual's bank card to statements to phone calls.
Important legislation is also in the works. In Congress, the House-passed Equality Act would amend existing civil rights laws to establish sexual orientation and gender identity as protected characteristics, as well as establish explicit nondiscrimination protections for LGBTQ people. It awaits action by the Senate.
While these advances are steps in the right direction, there is still more to do. We must continue to press for financial equality for the LGBTQ community and all communities that face financial roadblocks – and, working together, help to eliminate the challenges they face.
Here Come the ESG Boo Birds
Call it what you will – ESG, socially responsible, sustainable – values-based investing has become as polarizing as seemingly every other topic in American society.
On the one hand, the current administration seems intent on incorporating it into every nook and cranny of financial, monetary and regulatory policy. On the other, ESG "boo birds" have recently come out in force, pushing back on the rush to invest in investment strategies that stake a claim to being socially responsible.
A recent Wall Street Journal op-ed titled "Who Really Pays for ESG Investing?" claims, "If ESG investing truly maximized returns, fund managers wouldn't fake a commitment to it while quietly doing their job – investing in companies that focus on shareholder returns and profits."
A recently published study by Scientific Beta, "Honey I Shrunk the ESG Alpha," argues there is no positive ESG alpha and states, "ESG strategies perform like simple quality strategies mechanistically constructed from accounting ratios."
Blackrock's former sustainability investing CIO accused financial services firms in a USA Today op-ed of greenwashing in the name of profits.
Even my Baird colleague Jason Trennert at Strategas (et tu, Jason?), pointing to a 98% correlation between the risk/return profile of the leading ESG ETF and that of the S&P 500 Index (with almost identical sector weights), writes, "Products being sold to achieve these social goals are little different from the Broader Index itself, merely more expensive."
It's no surprise that as socially responsible investing enters adolescence here in the United States, it is coming under increased scrutiny and losing some of its youthful luster. Some of the criticism is deserved. This is yet another area where the financial services industry has taken a good idea and pushed it to commercial excess. There is a lack of consistency around metrics. Product sponsors have made unsupportable performance claims based on short-term one-year results post-COVID. Not to mention that the language of socially responsible investing is enough to confuse even experienced investors.
However, what underlies much of the criticism of ESG is a failure to acknowledge a sea change in what it means to be a fiduciary.
Fiduciary traditionalists believe that the sole responsibility of individuals, firms and committees managing and overseeing portfolios is investment return – more specifically, risk-adjusted returns over full market cycles. I can remember being chastised by committee elders on one of my first committee assignments 35 years ago for failing to hew to the investment management equivalent of Milton Friedman's pronouncement that the only responsibility of corporate executives is to grow shareholder value.
Friedman's shareholder-centric formulation has been since been replaced by the Business Roundtable's 2019 statement about stakeholder value, which declared that corporate executives are accountable to multiple consistencies – shareholders, yes, but also employees, customers and clients, suppliers and the communities in which they all live and work.
In the same way, the orthodox view of fiduciary duty is being replaced by a more holistic vision of what it means to be a fiduciary: one in which fiduciaries are responsible not just for investment returns, but for the overall well-being of the ultimate beneficiaries of the funds they are overseeing.
It doesn't do any good to beat one's benchmark or generate a superior Sharpe ratio if, in the process, the planet can't support life or social order devolves in the face of economic inequality.
Or, as an "Other Voices" column in Barron's recently suggested, it is penny-wise and pound-foolish to focus on portfolio diversification while ignoring "real-world root causes of systemic risk" that can't be diversified away but determine more than 75% of your return.
No less a traditionalist organization than the CFA Institute – known for ethical integrity and analytical rigor in support of the investment profession – has embraced "purposeful capitalism." The Institute's 2021 report, entitled "Future of Sustainability in Investment Management," embraces "a mindset change" that calls on investment organizations to "be proactive, rather than reactive, in helping solve the world's problems."
"Financial organizations must ... combine their financial views with some exposure to wider stakeholders," the report states, and must consider "total system-wide returns on capital."
Which, one might agree, is a dramatically broader mandate than mere investment returns alone – and one ESG boo birds may want to consider before decrying socially responsible investing strategies.
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