Capitalism in question

The jump in share prices in response to the de facto nationalization of Fannie and Freddie suggests the markets agree with your Marxist correspondent - that mortgage financing is a job better done by the state.
This episode, however, does more that merely corroborate the old jibe that, in a financial crisis, everyone’s a left-winger. It makes us ask: what’s the point of stock market capitalism?
The Treasury’s move is a recognition of the fact that governments can provide more and cheaper finance than the private sector.
But if the stock market is bad at providing finance - in the US, it has for years been a way for companies to give cash to investors rather than vice versa - what can it do?
It's not obvious that stock market ownership is suitable for industries vulnerable by virtue of their political sensitivity to changes in taxes or regulation. For example, the threat of a windfall tax on private utilities might depress investment. In this sense, nationalization might be more efficient than private ownership.
Nor does the stock market impose a discipline upon companies via the threat of takeover. Recent research confirms that inefficient firms are no more likely to be taken over than efficient firms.
With this discipline lacking, quoted firms are frequently badly managed. The experience of retailers confirms this. Whilst employee-owned firms such as John Lewis and Waitrose thrive, the shares of several quoted retailers have been falling for years: DSG, Debenhams, HMV for example. Which suggests, again, that markets are sceptical of the merits of stock market capitalism.
Academic research corroborates this. It shows that employee share ownership can raise productivity - which suggests that, at least within a certain range, outside ownership reduces it.
Of course, there’s a huge objection to all this - state-owned firms are hideously inefficient. But the reply to this was made by John Stuart Mill:

Government management is, indeed, proverbially jobbing, careless, and ineffective, but so likewise has generally been joint-stock management. (Principles of Political Economy, V.11.34)

Mill’s point was that the separation of ownership from control, whether in the public or private sector, is an enemy of good management; the fate of Fannie and Freddie corroborates this. Much of the success of the private equity business consists in recognizing this fact.
Now, of course, I’m not arguing here for nationalizing everything. The point is that we should ask a question: what is the most efficient form of ownership and control? The answer to this will vary from business to business. But could it be that, in many cases, the answer will not include external shareholders? 

Comments

[Neil]

In my experience, it always goes horribly wrong when a previously pretty-good company goes anywhere near the stock market.

I wonder how many people here actually work for a company with external shareholders? Not, I suspect, as many as you might first think.

[Phil]

An editor writes: I wish you'd knock the "closing rhetorical question" device on the head - it always makes me think of John Junor.

[Matthew]

What are stock markets good for? Providing some support for your theories?

"The jump in share prices in response to the de facto nationalization of Fannie and Freddie suggests the markets agree with your Marxist correspondent - that mortgage financing is a job better done by the state."

Does this really tell us that?

[Mike Woodhouse]

I suspect that the more closely aligned the objectives of the owners of the company are with those of the employees, the better.

So a sole trader is pretty much perfect - the better he operates his business, the more successful he'll be. But he can't, for example, build a nuclear power plant. Nor, in many areas of enterprise, can he scale.

Figuring out the means of building a network of aligned-objective small-to-medium businesses to deliver large-to-huge projects is an interesting puzzle.

Disclaimer: I work for a global bank with close to 100,000 employees. I own a vanishingly small piece of the action, too small to be well-aligned with the objectives of the business, even were I to really understand what they are, which I don't.

[Tom P]

Isn't a big part of the problem that the principal-agent divide doesn't just affect the company-shareholder relationship, but also the asset owner-asset manager one. In public companies the bulk of ownership is in the hands of fund managers who have no real motivation to act like 'owners' since what they actually get paid to do is generate good quarterly returns (leaving aside if this is possible or not).

I just about cling on to the idea that things could work a bit differently, and shareholder-company model could work more effectively, if we could address this problem. Though to be honest the changing nature of pension provision (DB to DC) is likely to result in more power shifting to fund managers and with accountability.

[Tom P]

"...and with LESS accountability"

[Sam]

The point is that we should ask a question: what is the most efficient form of ownership and control?

Well, that's an interesting question, certainly, but perhaps a more interesting question is to ask who are the "we" that should be asking?

[dearieme]

"Government management is, indeed, proverbially jobbing, careless, and ineffective" but he forgot to add, probably most important of all, that it is always a permanent monopoly.

[ad]

"This episode, however, does more that merely corroborate the old jibe that, in a financial crisis, everyone’s a left-winger."

Not sure about that. It might be more accurate to say that "at any time, everyone wants the government to give them someone elses money".

[chris strange]

The jump in share prices could also mean that people think that new opportunities for rent seeking have suddenly opened up, so long as they are part of an operation big enough to be able lobby the state for preferential treatment from its mortgage broker.

[Anonny Mouse]

I rather feel that the jump in stock price reflects the chance to make riskless money. After all, the government will get the mugs to pay for your risk. All it proves is that there should be more separation between mortgages and governments - let those who made the gamble pay the price. Yes, even if it is uncomfortable for a while.

[Alex]

"Recent research confirms that inefficient firms are no more likely to be taken over than efficient firms."

Well, yes:-) Who wants shares in an inefficient firm?

[Saver]

Since ISA's began I've been putting money into Nationwide each year. Why always Nationwide? Because they seem solid, and they're still a Building Society, and so my savings should be safe; they generally pay a good rate of interest; and it's (been made) much easier to just top up with the same organisation than start from scratch each year with a different organisation.

I have other things to do, and I want to keep it simple and easy.

Then I read that Nationwide may take over the Cheshire and the Derbyshire Building Societies, and I wonder whether those two small societies are in a bit of trouble, and the much larger Nationwide has agreed to step in before they get into real trouble.

Then I start to wonder whether Nationwide itself might not be quite as safe as I've always assumed.

So now for starters I'm going to check that I haven't gone over the £35K. I don't think I have, but I'm going to check.

After that, I'm going to think about whether I've got my cash savings sufficiently well spread. Probably not, as I've mainly stuck with Nationwide for simplicity and convenience.

I recount all this because of the:

"let those who made the gamble pay the price"

in the post above.

Like people who put their savings into Northern Rock, I wasn't making any gamble; I was prudently and responsibly putting aside some of my cash in what I was told was a completely safe place, with a modest rate of return.

If we carry on like this, people will go back to putting banknotes under their mattresses, or (in a minority of cases) buying gold and burying it in their gardens.

[Glenn]

In the US, there seems to be 2 big mortgage providers - fanny and freddy mae, and less competition in the market. If they have had poor lending practices, this puts the mortgage market at much worse risk.

In the UK - there is (or was) a very competitive market for mortgages. The risks are more spread, surely? and lending practices are not the same - e.g. Abbey had one of the loosest lending criteria in terms of income multiples.

The intervention in the US and UK are different. US bails out companies providing bulk of mortgage finance. UK bails out provider of small share of mortgage market. Big difference.

And there's still building societies and mutuals in the UK. Why not compare performance of mutuals against PLCs in the mortage market? recently I got the best mortage deal on the market - from an old fashioned mutual BS, and the fees were very low....!

[Anonny mouse]

"Like people who put their savings into Northern Rock, I wasn't making any gamble; I was prudently and responsibly putting aside some of my cash in what I was told was a completely safe place, with a modest rate of return."

Everything is a gamble. There are no certainties. It's harsh, yes, but there was nothing stopping you doing research into the Rock's finances. The gamble that you took is that you trusted an industry professional. Well, the uncomfortableness I alluded to before is that maybe it is time to rethink the person that you trust.

It's easy to say that the government should step in to save people who did not realise the risk to which they were exposed. But sadly this is the start of the government stepping in to save anything that should fail, in case it hurts someone undeserving. And the way that this road leads is towards state-wide bankruptcy, more restrictive laws and further impositions on liberty.

The current method of thinking, that there should be risk-free, guaranteed returns on any investment is really at the heart of the credit crunch. Such a thing does not exist, and a little background research on the Rock's financial footings would have revealed that it was running short of funds. The complacency that we have fallen into, as an economic society, is really the cause of the recent unpleasantness.

[CB]

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