Sense on Cents

Is our nation trending away from the principles of capitalism which built the foundation upon which we rest? Another healthcare whine? Nope. I am talking about the once proud pillars of capitalism centered on lower Manhattan, otherwise known as Wall Street.

Let me simplify the debate. What is capitalism? Are you willing to accept the definitions provided by my Investing primer, Investopedia?

What Does Capitalism Mean?
An economic system based on a free market, open competition, profit motive and private ownership of the means of production. Capitalism encourages private investment and business, compared to a government-controlled economy. Investors in these private companies (i.e. shareholders) also own the firms and are known as capitalists.

What does the Financial Times have to say about our financial system this morning?  The FT writes, Fat Fees, Few Banks:

When the number of participants in a market declines and fees rise, there is clearly a prima facie case for a competition investigation. Just such a situation obtains in the post-crisis investment banking market, and the Office of Fair Trading in the UK is right to think about examining it.

As with the wider banking market, the investment banking field has contracted thanks to the crisis. Two large players – Lehman and Bear Stearns – have disappeared, while others have been forced to contract. Fee levels are rising in some areas. The UK insurer Prudential is paying $1bn to underwrite its $20bn rights issue. A few years ago, underwriting fees were closer to 2 per cent than 5 per cent.

Any investigation must be broad in scope. It should examine how the sector maintains such high profitability – and hence rewards its employees so lavishly. The bankers argue that this is attributable to the excellence of their product. But since the meltdown, this claim is hard to sustain.

There is little price competition in investment banking. The large global firms charge similar amounts for underwriting and M&A services. Such discipline is only possible if the barriers to entry are high. Circumstantially, this seems to be the case. There have been few new entrants, and those there are have done so through acquisition.

The continuing concentration of business into ever fewer hands opens the door to substantial conflicts of interest. The “financial supermarket” model allows banks to advise companies, sell them financial products and also trade on their own account in those products also. It is not clear that the companies that buy investment banking services are sufficiently alive to the pitfalls of this. Chief executives of businesses appear more concerned about successful execution than price, and equate this with brand names. No one, they say, ever got fired for hiring Goldman Sachs.

Investment banking services are like a tax on stock market returns. During the boom it is estimated that they cut returns by about half a percentage point a year. This could actually increase because of the additional capital and liquidity burdens that are likely to be placed on the industry. Regulators acknowledge that these costs will be passed on to clients.

A competition review must therefore go hand in hand with regulatory reform. An OFT probe would at least be a start. If the time is not ripe now, when will it ever be?

Thus, if we accept the premise that capitalism is based upon free market, open competition, profit motive, and private ownership of the means of the production, then what did the FT just describe? Capitalism? I don’t think so.

The FT just laid out that our global financial system is now effectively an oligopoly which, in the spirit of equanimity, Investopedia defines as:

What Does Oligopoly Mean?
A situation in which a particular market is controlled by a small group of firms.

An oligopoly is much like a monopoly, in which only one company exerts control over most of a market. In an oligopoly, there are at least two firms controlling the market.

You can resign yourself and say, “It is what it is.” I will grant you that, and respond in kind that on Wall Street, “It isn’t what it isn’t,” and right now it isn’t capitalism.

What do you think?

LD

This entry was posted on Monday, March 22nd, 2010 at 1:53 PM and is filed under General, Wall Street. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.