Make Capitalism Compete

My wife brought a Wall Street Journal opinion piece to my attention.  It’s about why the younger generation is rejecting capitalism.  There were plenty of disturbing things about the recent presidential election.  One of the most disturbing to me was the people who followed Bernie Sanders.  Many of his followers followed him because of his plainspoken words, and the fact that he railed against things he saw in our society.  But, there were plenty of others that followed him because of his economic stance.  If you believe Bernie’s economic theory will work, you are sadly mistaken.

Bernie is a socialist.

Time and time again the data shows socialism never works and always fails.  For a modern day example, look at Venezuela.     The ugly strife there is a direct result of poor government policy and socialism.  The countries behind the Iron Curtain are another example.  Argentina is another example. Cuba is another example.  Spare me pointing out China.  We don’t really have good data on China.  If you look at their environment, it is atrocious.  Their finance numbers look sketchy too.  That’s what happens when there are no private property rights.

No matter where socialism is tried it fails.  Margaret Thatcher joked that “socialism fails when you run out of other people’s money.”  Milton Friedman said if centralized planners were in charge of the Sahara in five years they would run out of sand.  Except, the effects of socialism on individual people isn’t funny.

Here is a piece from the WSJ opinion that was very interesting to me:

Jack Stephens, used to say, “A great idea never fails for lack of capital, because capital will always find it.” Sadly, I’m not sure that’s true today.

For proof, we need look no further than the growth of private equity, a direct result of the limitations placed on the public markets. Yes, private equity should be an option both for those seeking money and for those who wish to invest it. But we cannot ignore that private equity is a vehicle that excludes most investors. The result: Access to capital and the benefits of capitalism have been concentrated among too small a group, restricting opportunity on both sides. The very individuals and businesses the government purports to help have virtually no chance to participate in and benefit from the creation of great companies.

This is why I am a huge fan of crowdfunding, ICO’s and any other innovative way that democratizes and makes capital markets more transparent.  Make capital compete.  I am a big fan of the democratization of capital and flat, non-hierarchial transparent markets.  It’s one reason I am so interested in the blockchain.  It’s another reason that I truly love investing in B2B Fin Tech because there are so many places a transparent market can efficiently do things that aren’t being done today and raise the standards of living for everyone.

An ancillary reason that PE and VC have a very high rate of return is that there is a lack of competition for capital.  Entrepreneurs only have so many choices.  That drives returns because when there is a lack of competition, either valuation goes down, or the amount of equity an entrepreneur has to sell off goes up.

I think that there are PE/VC firms that add a lot of value and assume a lot of risks.  That also drives returns and competition for capital isn’t a part of that equation.

In the US today, we talk about the “free market system” but our markets are not truly free.  There are all kinds of rules, regulations, subsidies and taxes which screw up the “free” part of the free market system. Elon Musk has left Trump’s Advisory Committee but I bet he wouldn’t walk away from all the subsidies he receives.  Bob Iger also left, but I bet he wouldn’t refuse all the different tax breaks and subsidies Disney takes advantage of.  Subsidies and price floors pollute free markets.  The corn market seems like a free market until you look at all the regulations around corn combined with price floors and crop subsidies.  The stock market certainly isn’t a “free market”.  Sarbanes-Oxley, Dodd-Frank, and the alphabet soup of government and non-government regulators make sure that it isn’t.

I remember when I started Hyde Park Angels and people told me we could only take “accredited investors”.  I had never heard of it before.  Turns out, the IRS says who can invest in different things and who else can’t.  If you have or make enough money, you can join the exclusive club.  If you don’t, tough beans.  That really rubbed me the wrong way because I think people should be free to do whatever they want, as long as it’s legal, with their own hard earned money.  That’s the way it was when the country was founded.  The accredited investor requirement is an artificial price floor.  The limits on how many investors you can have in a private fund or private company is a price ceiling.

I also remember when I was on the board of CME.  I thought, “Hey, wouldn’t it be nice to trade futures on single stocks.  Wouldn’t that be an efficient way to manage risk.”  Turns out, it was illegal because of SEC regulations.  It’s not illegal because it is deceitful or bad business.  When they did bring in single stock futures the SEC re-regulated to kill them again.  The CBOE and other options exchanges didn’t want the competition.

Instead, our government has to create new legislation to get around all the old legislation and regulation it created.   The JOBS Act, prized by entrepreneurs, is another piece of new legislation to work around old legislation.  Regulation A+ is designed to get around the old laws that limit IPOs.  It seems stupid because all this legislation just invites lobbying which brings more money into the government.

Here is a letter from the June 1, 2017, Wall Street Journal:

Young companies are less reliant today on public markets. The number of private-equity firms has exploded and they, along with venture capital firms, are pouring money into new companies. Historically low interest rates have made borrowing attractive to startups. Robust private markets aren’t a cause for hand-wringing—though they do cut into Nasdaq’s bottom line. What’s more, today’s fewer IPOs are more stable and raise far more capital than those of the 1990s, as an EY report details. At the 1996 peak, 624 IPOs raised $38 billion; in 2014, when IPOs last spiked to 291, they raised $96 billion. The U.S. is still the preferred market for cross-border IPOs, and U.S. companies rarely list elsewhere. Let’s not forget that many of the IPOs of the 1990s weren’t sustainable; many flopped, harming investors and markets.

In short, there are many reasons for the drop in U.S. IPOs, but they are not necessarily bad, and red tape isn’t one of them.

KEN BERTSCH

Executive Director Council of Institutional Investors Washington

My response would be this.  First, it doesn’t matter if IPOs flopped, were sustainable, or anything else.  That’s a value

First, it doesn’t matter if IPOs flopped, were sustainable, or anything else.  That’s a value judgment not rooted in positive economics.  What matters is that companies were free to choose public markets as an option for fund raising and that investors put money into them in a free and transparent manner.  What happens next doesn’t matter.  Plenty of Dow 30 companies fail too.  Look at Kodak.

Second, if there was true competition for capital among PE, VC, public markets, and private individuals, companies would have a choice and their weighted actual cost of capital would decrease.  Having less competition benefits institutional investors because they have access and the public doesn’t.

You might think, “Hey Jeff doesn’t like institutional investors and sees no role for them.”  That would be wrong.  Many of them provide a valuable service.  If all markets for capital competed, it would actually be tougher for new VCC’s like myself to raise money.  Upstream at institutions, they also would have to improve their service because competition would drive them to do it.  Heaven forbid, everyone’s fees might come down!  The baseline of the rubric between S&P and US Treasury returns would be the measuring stick along with the absolute floor of cost/opportunity cost to decide where capital flows.

We’d all have to work harder to earn it and that’s better for markets, return, individuals and entrepreneurs.

I come from the trading floor which was the most hyper-competitive place I have ever seen and it shapes my world view. No one is bigger than the market.  Competition is great for markets because it forces everyone to up their game and service their customer better and more efficiently-driving the amount serviced up and prices down.  Because there are preferences and costs/opportunity costs, there is no proverbial race to the bottom.

That’s why the trend of the younger generation embracing socialism is very troubling indeed.  It’s pretty clear they don’t appreciate or understand free markets.  But, it’s also increasingly clear their elders don’t understand or appreciate them either.  If they do understand them, it’s even more sinister.