Rand and a Rand and a Rand we go...

A brief detour and then finally we start to talk passive...

Point of correction: In last week’s letter, I noted that the economist Robert Gordon had died. I was misinformed. Robert Gordon, the rockabilly singer, passed away in 2018. The economist, Robert J. Gordon, is alive and kicking despite being seven years older. My apologies, Professor!

“Over 90% of the systemic risk that exists in the system today is created by the fact that we have a Federal Reserve” — Yaron Brook

In the summer of 2022, I had the unenviable task of debating whether central banks should exist with Yaron Brook, the Chairman of the Board of the Ayn Rand Institute. As you might guess, I was in the affirmative. While I am no fan of central banking as it is currently administered, I am even less of a fan of a return to the 19th century when the whims of an individual, J.P. Morgan, could determine who failed and who succeeded with implications on a national scale. This does not mean I believe the government should be the primary determinant of who wins or who loses, but it does mean that the role of the government is non-negligible in financial markets.

Why unenviable? Because I am sympathetic to Yaron’s arguments. In a quick summation of Yaron’s arguments, “absolute power corrupts absolutely” is a truism. No matter how well-intentioned the creation of an institution is, over time, it will metastasize into an institution that protects what it was designed to protect from. And in the case of the Fed, this has given rise to an entity that protects large banks and players with systemic risk, leading me to agree with Yaron’s above sentiment (“90%…”) even as I disagree with the magnitude and the origin. The CFA institute defines systemic risk as:

“Systemic risk refers to the risk of a breakdown of an entire system rather than simply the failure of individual parts. In a financial context, it denotes the risk of a cascading failure in the financial sector, caused by linkages within the financial system, resulting in a severe economic downturn.”

With this definition, it’s obvious that systemic risk must be dominated by the institutions that underlie the financial system. The Fed must sit front and center. But then the CFA can’t help itself and allows an “oh so obvious” solution:

“A key question for policymakers is how to limit the build-up of systemic risk and contain economic crises events when they do happen. Reducing the likelihood and severity of future financial crises can be ensured by a coordinated global effort to monitor market trends and bubbles, and to end government bailouts for failing financial institutions.”

“A coordinated global effort to monitor market trends and bubbles” — coordinated by whom??? Who enforces the rules when they are broken? Who determines when they are broken? And what’s this “ensure” nonsense? Who’s providing this guarantee, the CFA Institute?

Let’s imagine a private sector entity regulation. A group of banks decides to form a self-regulatory organization that monitors bank solvency. How do we enforce that banks comply? The only possible approach under Yaron’s philosophy is that banks voluntarily agree to limit dealings with entities that are not members of the self-regulatory organization and do not “pass the solvency test.” How does the organization punish failure to comply? While certainly there could be voluntary fines, there would be no mechanism to enforce payment, and the only possible ultimate punishment is ejection from the self-regulatory organization. In other words, “voluntary” restraint of trade.

How would this organization handle failure, which would be immediate upon the ejection of the entity as much more limited business opportunities exist and which, by definition, has to consist of defaults on claims owed to other participants in the system? There would obviously be a mechanism to transfer these liabilities at distressed prices to entities within the network, facilitating consolidation by the largest, strongest players. Excellent so far. Now play the game forward. New entrants to the market require inclusion in the network, but this is against the interests of the existing players, so it is discouraged. Failures drive consolidation. Rinse, repeat… and we’re left with the inevitable oligopoly.

Now it gets interesting… because what happens when one of the oligopolists fails? It can be due to completely unforeseeable and ridiculous reasons — a meteor strikes the headquarters on the same day that a foreign state-sponsored terrorist organization targets the bank for a massive cyber-hack and a coordinated group of clown-face wearing criminals steals the bank vault contents? Absurd? Of course. But so was the prospect of a nationwide decline in home prices until 2008… and now in 2023 it becomes a “well of course home prices should decline.” The answer is we either allow the system to fail, i.e. 1907, or we allow the system to consolidate further in a “bailout” by the remaining banks where the equity is largely wiped out while the claims to other entities within the system are honored to the extent the system will bear. Why the clarification “to the extent the system will bear”? Because if losses are high enough (and a coordinated meteor/terrorist/clown attack seems likely to generate previously unimaginable losses), the loss on claims within the system will push the system to fail the voluntary solvency test. So obviously, the voluntary solvency test will be changed. Spot the pattern?

The private sector is no less fallible than the government, as Alan Greenspan famously discovered in 2008. In fact, we know that “the government” is nothing more than an association — “We the people” — operating under a more or less coercive agreement. As John Adams’ put it in his 1795 Novanglus letters:

But, however it may sound, I say we are not a part of the British empire; because the British government is not an empire. The governments of France, Spain, &c. are not empires, but monarchies, supposed to be governed by fixed fundamental laws, though not really. The British government is still less entitled to the style of an empire. It is a limited monarchy. If Aristotle, Livy, and Harrington knew what a republic was, the British constitution is much more like a republic than an empire. They define a republic to be a government of laws, and not of men. If this definition be just, the British constitution is nothing more nor less than a republic, in which the king is first magistrate. This office being hereditary, and being possessed of such ample and splendid prerogatives, is no objection to the government’s being a republic, as long as it is bound by fixed laws, which the people have a voice in making, and a right to defend.

The objective of the founders of the United States was not to overthrow “government”, it was to clearly establish the priority of a government of laws, not of men. Or as Winston Churchill put it in more modern terms:

“Many forms of Government have been tried, and will be tried in this world of sin and woe. No one pretends that democracy is perfect or all-wise. Indeed it has been said that democracy is the worst form of Government except for all those other forms that have been tried from time to time.…” Winston S Churchill, 11 November 1947

The objection to the role of government in antitrust flows from the attempt to uniquely paint the government as capricious. From the Ayn Rand institute in 2002, commenting on the Microsoft antitrust trial:

“In the nightmarish world of antitrust law, any and no action can be pronounced illegal. There are and can be no definite, objective principles specified in the law-and as a result a businessman has no way to determine, before he acts, whether his action is legal or not. In practice, this means that businessmen are at the mercy of the government.” — Onkhar Ghait, The Ayn Rand Institute

Let’s rephrase that:

“In practice, this means that businessmen are at the mercy of we, the people.” Maybe it’s just me, but this seems less bad.

This brings us back to Rand. I thoroughly enjoyed a rewatch of her 1959 interview with Mike Wallace following her publication of Atlas Shrugged:

The discomfort of Mr. Wallace at Ayn’s emphasis on the role of “self-interest” is tangible. And often, Objectivism is portrayed as an exclusive focus on unqualified self-interest. But this is not at all what Ayn Rand believed. As she put it:

“His highest moral purpose is the achievement of his own happiness and that he must not force other people nor accept their right to force him”

Which does not seem at all at odds with the teachings of traditional religion:

“So in everything, do to others what you would have them do to you, for this sums up the Law and the Prophets.” Matthew 7:12

Ayn goes further:

“A morality not based on faith, but on reason and morality which can be improved by means of logic. My morality is based on man’s life as the standard of value and since man’s mind is his basic means of survival, I hope that if man wants to live on Earth and to live as a human being he has to hold reason as an absolute”

The Objectivist often emphasizes the second part of this: “if man wants to live on Earth and to live as a human being he has to hold reason as an absolute,” but that emphasis is voluntary. If we instead focus on the bolded “morality based on man’s life as the standard of value,” the meaning resonates with Ayn’s adopted country’s Declaration of Independence:

"We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”

There is no shocking conflict here, nor any statement that government is the source of all problems. Rand’s complaint is with a coercive majority, exactly what the Constitution was designed to protect against with the institution of a Republic and a system of checks and balances, rather than a direct democracy. Should the interests of the business people be protected? Of course. The Constitution clearly lays this out in the Fifth Amendment's takings clause:

“nor shall private property be taken for public use without just compensation.”

There is no prohibition of taking; there is a prohibition of taking without “just compensation.” Small government activists have legitimate complaints about “uncompensated takings” in the form of regulatory restrictions, often taking on absurd characteristics. The most recent Doomberg piece on the Nuclear Regulatory Commission might be the single best illustration of these absurdities. I encourage you to visit the home page of the NRC:

And just for the sake of argument, search the page for “Energy”… if you lack the energy, don’t worry… I did it for you:

But the universal litigiousness of our business community betrays another reality — there is no belief in any “justified” taking, nor is there much credit given for the innate innovation potential of our population. In my opinion, “we the people” can overcome almost any reasonable restrictions with a clear set of rules and a profit incentive.

To me, it is clear that complaints against antitrust enforcement are disingenuous. The Constitution itself consists of a “taking” of rights formerly belonging to the independent states (colonies), and without those takings, we found ourselves ungovernable, as we saw under the Articles of Confederation. In this framework, the Constitution specifically forbids monopolistic restrictions of trade by the former colonies:

“No State shall, without the Consent of the Congress, lay any Imposts or Duties on Imports or Exports, except what may be absolutely necessary for executing its inspection Laws: and the net Produce of all Duties and Imposts, laid by any State on Imports or Exports, shall be for the Use of the Treasury of the United States; and all such Laws shall be subject to the Revision and Control of the Congress.” — Article 1, Section 10

To expect individual rights that restrict trade to be upheld is absurd if it has been restricted for the states.

On this point, the Sherman Antitrust Act, and the subsequent Clayton Act, are quite clear:

“Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal. Every person who shall make any contract or engage in any combination or conspiracy hereby declared to be illegal shall be deemed guilty of a felony”

Can we force businesses to conduct trade with each other? As Ayn Rand says, “I should hope not.” But when business actions, supported by the government, unreasonably limit the ability of individuals to express their rights to pursue life, liberty and the pursuit of happiness, the government must step in. Who determines “unreasonable”? Well, we the people — in the form of a jury trial.

Resistance is Futile — You Will Be Assimilated

“You love people not for what you do for them nor what they do for you. You love them for their values, their virtues, which they have achieved in their own character.” — Ayn Rand

We should not need to love, or fear, any business any more than we should be required to love, or serve, any individual or group of individuals. And yet, there is fear of monopolies. I know it because I feel it daily in my interactions with investors. Adding to my media tours, I recently had the opportunity to interview Bob Pisani on his new book, “Shut Up and Keep Talking.” Unfortunately, I likely did not endear myself to Bob when I challenged him on his favorable view of John Bogle, a man almost universally loved. The entire interview was a lot of fun, and Bob was a great guest, but the audio can’t quite capture the look on Bob’s face when I told him that John Bogle was marketing to him:

But that’s exactly what Bogle did. He was a marketing genius. Did he create something original in the index fund? No, Wells Fargo did that first. Did he create something unusual in the mutual fund structure or the mutualized ownership of investment funds? No, insurance companies have been doing this for centuries. Did he choose to mutualize Vanguard for the benefit of shareholders? Only if you believe the hype. He chose to mutualize because it was the only path for him. From Eric Balchunas of Bloomberg:

“Anyway, long story short, what they decided and what Bogle came up with, was the idea to create a back-office company that would just do the boring stuff that Wellington didn't want to do. And they wanted to manage money; OK, fine, you do that. We'll keep you as investment advisor; we'll do all the back-office stuff; I'll run that company. And by the way, we'll make it mutually owned. That way, nobody thinks I'm trying to get out of here and put a bunch of money in my pocket. And so, that's how Vanguard was born as the sort of boring, mutually owned back-office company. And it was just a way to save his job in a way and appease all these different parties so they would be able to resolve this nasty, really unusual situation.”

To be fair, I want to reiterate that Bogle was a genius, and by nearly all accounts, a damn fine man. And I genuinely believe that he himself believed in the ideology he sold to Bob Pisani. But as I note, so does Cathie Wood at ARK Investments. And the Vanguard ideology is being increasingly put to nefarious purposes, leading to our generation's most important market power concentration story. But that will have to be a story to pick up next week.

In the meantime, I hope you enjoy the other Robert Gordon. As always, comments appreciated!