The week of May 2: index funds and antitrust, as well as inflation, Hawaii’s pandemic, and more.
We’ve been hearing for a while that, under its “progressive” chairwoman, Lina Khan, the FTC’s enforcement activities are being ratcheted up. The agency has Big Tech and any other “big” that, uh, big government reckons is too big for “our” own good in its sights. That this is bad news for the economy, the consumer, and, at a time when technological supremacy will be vital in seeing off China’s challenge, for the nation’s security, doesn’t seem to bother the central planners now running competition policy. Dogma trumps prosperity. Theology trumps geopolitical reality.
Writing for the Wall Street Journal in July, Robert H. Bork Jr. noted how Khan’s FTC and the administration, more generally, was
executing a campaign to undo the consumer-welfare standard and replace it with a full-on effort to regulate pharmaceuticals, healthcare, agriculture, telecom, technology and manufacturing. Through a “sweeping” executive order signed Friday, Mr. Biden aims to empower the alphabet of federal agencies to use their authority to second-guess and undo business decisions that could “harm competition.” Should these agencies falter, the new White House Competition Council and Ms. Khan will be there to remind them who is boss.
Consumer-welfare standard?
Earlier in the [20th] century, Justice Louis Brandeis had denounced the “curse of bigness” against “small dealers and worthy men.” He thought the law should protect small firms against the predations of larger, more efficient ones. Justice William O. Douglas took up this cudgel in the 1960s and ’70s, thwacking businesses for being too successful. The conclusion of my father’s [Robert H Bork] work was the profound declaration that antitrust law shouldn’t try to decide who is “worthy” or to defend smaller or less efficient competitors. The sole aim of antitrust law is to protect consumers.
Fair enough. In fact, about the only justification for antitrust, at least for those who believe in free markets — a group that includes neither Khan nor Biden, nor, it seems, some Republicans — ought to be consumer welfare. And in the elder Bork’s view, famously set out in his book, The Antitrust Paradox (1978), consumer welfare was (to oversimplify) the underlying principle that made sense of our antitrust law. This was an idea that was taken up by the Supreme Court and one that has generally guided the operation of federal antitrust activity since then.
At its core, a competition policy that goes beyond that aim inserts the agencies of the state into the operation of the market on the grounds, essentially, that they know better, something that goes a long way to explaining the stance being taken by the current administration. This is about power, not the preservation of competition.
Too cynical? I don’t think so. But one test of what motivates these activist antitrust enforcers may be the attitude that they take with respect to the market position now enjoyed by large stock index funds. If you’re looking for market “concentration,” a focus of the administration’s wrath (however performative), index funds provide an almost perfect example.
David McLaughlin and Annie Massa, writing in Bloomberg/Business Week (in December 2020):
Since index funds became widely available in 1976, they’ve upended the business of money management and made investing for the masses easier and cheaper. They’ve also had an unexpected side effect: Because they’re so large, index fund families are among the top shareholders in many companies, including those that compete with one another. Despite this, funds’ share purchases get no review from antitrust regulators.
That could change under an initiative by the [Trump-era] U.S. Federal Trade Commission—possibly radically. Two proposals could result in investments by all the giant mutual fund families coming under scrutiny for the first time from both the FTC and the U.S. Department of Justice, which share antitrust enforcement. It’s the index funds that appear to be causing regulators the most heartburn. Just three companies—BlackRock, Vanguard Group, and State Street—manage about 80% of all indexed money, and together their portfolios own more than 20% of the typical S&P 500 company. The Vanguard Total Stock Market Index Fund just became the first stock fund to hit $1 trillion in assets.
Some antitrust enforcers and academics believe that common ownership—when one institutional investor is the largest holder of shares in companies in the same industry—is subtly tamping down the competitive forces that motivate companies to gain market share by innovating and lowering prices. In theory at least, an owner of rival companies would generally prefer they don’t compete forcefully, as doing so can eat into profits. For example, a 2018 study found that, when the same institutional investors are the largest shareholders in branded drug companies and generic drugmakers, the generic companies are less likely to offer cheaper versions of the brand-name makers’ drugs.
Perhaps there’s a there, there, but I have to say that I’d be surprised if large funds collude in that way, even more so, of course, when it comes to passive funds.
But read on to find this:
The bigger worry for fund companies is buried in a separate, pre-regulatory notice in which the FTC asks for public comment on whether mutual funds should lose their filing exemption because they engage in a broad range of activities that fall under the label “shareholder engagement.” These activities include communications from funds that nudge portfolio companies to hold the line on executive pay, lower carbon emissions, increase workforce and board diversity, and meet other goals they consider part of good corporate governance. Fund companies today point with pride to such efforts . . .
Mutual funds’ current antitrust-reporting shield, dating to 1978, was based on the idea that they bought shares solely for the purpose of investment and paid scant attention to how companies were managed. “The exemption is pretty narrow, and it’s hard to see [how] what the institutional investors are doing fits into the exemption,” Sayyed says. In one of its notices on the proposals, the FTC says a discussion about executive pay could turn into one about how performance should be measured, delving into the basic business decisions of a company.
The fund companies say engagements are just part of taking care of their clients’ money and dispute the possibility that their ownership is harming competition. Tara McDonnell, a spokeswoman for BlackRock Inc., says it’s still analyzing the proposals. “Our investment and stewardship activities are guided by our fiduciary obligations,” she says. A State Street Corp. spokeswoman says that index funds save investors money and that the proposals “could have a significant impact on index products and other types of investment funds and their investors without a clear benefit.”
That’s generally been true, up to now anyway. Index funds have lowered the cost of investing, and, thanks to their lower fees, passive funds typically outperform their actively managed counterparts. As a result, it’s hard to see how an attack on them on antitrust grounds could, at least until recently, be justified if consumer welfare is what counts. (There’s a separate discussion to be had on what these funds’ collective size might mean for the overall health of markets and the economy, but that’s for another time).
However, if each of the three largest index funds are beginning to vote their shares in ways influenced by ESG — the variant of “socially responsible” investing in which companies are measured by how they score against certain environmental, social, and governance measures — or the principles of stakeholder capitalism, then the consumer-welfare defense becomes harder to sustain. Given the sheer size of these funds, they could swing a shareholder vote, and given that both stakeholder theory and ESG could hit a company’s economic return, where, then, is the consumer welfare flowing from the concentration of voting power held in such passive funds’ hands? To be clear, if these funds end up voting in ways consistent with ESG or stakeholder theory, this is not likely to be the result of collusion but of groupthink, though the damage to the consumer will be the same.
It’s worth adding that this concentration is made all the more powerful by the dominance of just two proxy advisory firms, ISS and Glass Lewis, companies paid by many investment-management groups for their advice on how to vote their shares. While it’s certainly the case that these companies are well aware of the fact that ESG-style proposals are not in line with the objectives of all their clients (I recently wrote about one case in which ISS, quite properly, reflected this), there is an obvious danger that, over time, ESG/stakeholderism will become these businesses’ default recommendation. Needless to say, neither firm is oblivious to the moneymaking opportunities to be found in the ecosystem that has grown up around ESG, an ecosystem that looks more and more like a rent-seekers’ Eden.
Index-fund clout is beginning to attract some attention. To take one example, Marc Andreesen, the co-founder of Netscape (among other achievements), recently tweeted about how “the phenomenon of index funds, managing other people’s money, who say they lack the competence to pick stocks but possess the competence to redesign society, is under-studied.”
Andreesen later tweeted an extract from a 2018 article by Vanguard’s founder, Jack Bogle, the father of the index fund, in which he (Bogle) noted the growing weight of index funds within the market and made the sometimes overlooked point that their power could not be considered in isolation:
Even that penetration [17 percent at the time Bogle was writing] understates the role of mutual fund managers, as they also offer actively managed funds, and their combined assets amount to more than 35% of the shares of U.S. corporations.
Hullo, Larry Fink, chairman and CEO of BlackRock and evangelist of ESG and stakeholder capitalism!
After noting how difficult it was for new players to enter the index business (due mainly to economies of scale, and the incumbents’ rock-bottom pricing), Bogle listed some ways in which index funds could be reformed, some of which he liked, and some of which he did not. He rightly rejected the idea that index funds should be deprived of their vote, but supported
federal legislation making it clear that directors of index funds and other large money managers have a fiduciary duty to vote solely in the interest of the funds’ shareholders. While I believe that such a fiduciary duty is implicit today, making it explicit, with appropriate penalties for violations, would be a constructive step.
It would and, for avoidance of doubt, it should be made clear that the interests of the funds’ shareholders are, for these purposes, purely economic.
In a thoughtful paper for the Mercatus Center from 2000, Caleb Griffin went further still.
As he noted:
Another problematic feature of index funds’ approach to voting is that index funds vote nearly all shares under their control as a bloc. Ideally, funds would vote proportionately. This would give additional voice to investors in the minority, who otherwise (if they owned the shares directly rather than through an index fund) would have their votes be counted. Not only would such a step would ensure that voting decisions were better aligned with the preferences and priorities of ultimate investors, it would also mitigate the concentrated power of index funds by preventing a handful of fund managers from wielding the voting rights of millions of investors as a unified bloc.
Griffin went on to suggest three ways in which this problem could be alleviated (his preference would be a menu that incorporated all three). The first would be to implement pass-through voting instructions. The second would be to give investors the ability to delegate their voting authority to a third party. The third would be for index funds to survey their investors to assess their preferences and vote the shares under their control in accordance with those preferences. In the paper, Griffin explains in detail how this might work. It’s well worth a read.
Meanwhile, and to his credit, Fink has announced that BlackRock is “pursuing an initiative to use technology to give more of our clients the option to have a say in how proxy votes are cast at companies their money is invested in. We now offer this option to certain institutional clients, including pension funds that support 60 million people. We are working to expand that universe.” BlackRock, he added, is “committed to a future where every investor — even individual investors — can have the option to participate in the proxy voting process if they choose.”
That, as Fink noted, won’t be easy (especially, I imagine, in the case of index funds), but moving in this direction would be a welcome step.
Reforms on the lines proposed by Bogle and Griffin, and, if implemented the whole way down the ownership register, Fink, would go a long way to buttress the “consumer welfare” defense of the current index-fund market (to the extent that it still counts for something under the current regime). But with the partial exception of Fink’s initiative, such reforms have yet to see the light of day, leaving wide open the question of what an administration purportedly concerned by economic concentration is going to do about index funds.
Back in February, I touched on the same question:
We live in an age when the Left is increasingly focused on the supposed evils of business concentration, from the “big is bad” ideology of the new antitrust enforcers at the FTC to the attempts to blame inflation on Big Grocery, Big Oil, or any of the other “bigs” allegedly exploiting the beleaguered consumer. And yet the concentration of corporate ownership positions held by a relatively small number of massive investment funds, particularly (but not only) the indexers, has drawn comparatively little criticism from the same quarters. Perhaps their managers’ role in helping create our emerging corporatist state through an ever tighter embrace of “socially responsible” investment and larcenous stakeholder capitalism has acted as a shield of sorts.
An unworthy suspicion, doubtless, but then again (via the Wall Street Journal from last June):
While punishing businesses it doesn’t like, the Biden Administration is moving fast to ease regulation on those that advance its climate goals. Witness how Mr. Biden’s new Securities and Exchange Commission Chairman Gary Gensler is moving to roll back the regulation of proxy advisory firms.
The SEC announced this month that it will suspend enforcement of new rules issued under former Chairman Jay Clayton that subjected proxy advisory firms to the same anti-fraud rules as public companies and required them to disclose their business conflicts. Mr. Gensler has directed SEC staff to consider revising the rules . . .
Government pension funds and progressive activists have fiercely opposed the rules since proxy advisers augment their power over public companies. Now Mr. Gensler is giving the advisory firms a pass as he seeks to unwind the rules. Democrats think monopolies are fine if they serve their policy goals.
Say it ain’t so.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 65th episode David is joined this week by Jim Iuorio, managing director at TJM Institutional Services and 30-year veteran of markets, to talk about the economy, the Fed, the state of the labor markets, and most importantly, the fate of old-school restaurants. It is not an episode to miss.
The Capital Matters week that was . . .
Energy
Russia, for its part, has used a multipronged approach to ensure that its interests are embedded in Bulgarian public policy, including funding anti-fracking activism and courting Bulgarian political elites. The result is that Moscow’s influence has remained pronounced right up to the present, owing to, in the words of the German Marshall Fund’s Bradley Hanlon and Alexander Roberds, “Bulgaria’s lack of energy diversification, the Kremlin’s infiltration of Bulgarian politics, and the deep cultural and historical ties between the countries.” As with its efforts to bind Germany’s fate to continued fuel deliveries, Russia has used its energy resources as a means of leverage in Bulgarian affairs. “For Russia, energy has always been a means for the Kremlin to extend its geopolitical priorities and financial interests,” said former Bulgarian energy minister Traicho Traikov. “Enough people in Bulgaria owe favors to Russia so [this policy] is successful.” . . .
ESG
The Financial Times’s Camilla Hodgson asks whether there is “a clash between ESG considerations and overall investor priorities.”
Only within ESG world could that be anything other than a rhetorical question. Of course there is a clash. ESG (a variant of “socially responsible” investing under which prospective or actual portfolio companies are measured against a set of environmental, social and governance criteria) is (with the partial exception of governance issues) the antithesis of what most investing is supposed to be about, which is the generation of economic return . . .
Supply Chains
The solution to global supply-chain problems is not unplugging from the rest of the world. There are reasons to rethink some specific aspects of supply chains, especially in China, and businesses are very much in the process of doing so all on their own. But those who advocate a more general withdrawal from global markets as insurance against disruptions severely underestimate how much international interconnectedness affects nearly every product in nearly every industry. The Amish produce top-quality, made-in-America furniture with craftsmanship deeply rooted in their traditional way of life — and even they rely on global supply chains.
Innovation and Free Markets
Nick Austin at FreightWaves tells a great story about how a weather app used by truckers came to be. It’s a perfect example of how serendipity aligns with technical know-how in free markets and leads to the creation of valuable products that improve people’s lives.
The story is about an app called Drive Weather. It was created by a man named Paxton Calvanese. He’s an amateur pilot, and in 2014, he had a near-death experience due to a change in the weather while flying, Austin writes. He made it through unscathed but saw an opportunity to make things better for other pilots in the future . . .
Labor Relations
Post-pandemic, employees are coming up with every possible reason/excuse to avoid going back into the office.
Last week, a group of U.S.-based Apple employees called Apple Together issued an open letter to Apple CEO Tim Cook, protesting his plan to have them go back to the office for three days a week. They said such a move is “only driven by fear” of making the company more diverse and inclusive.
The letter stated, in part, that: “It will make Apple younger, whiter, more male-dominated, more neuro-normative, more able-bodied. In short, it will lead to privileges deciding who can work for Apple, not who’d be the best fit.” . . .
Inflation
When inflation began to pick up last year, Powell and other Fed officials initially wrote it off as transitory. It is hard to fault them for that. The price level had grown slowly over 2020, and so some catching up was in order. Moreover, by July, inflation in excess of what was required to achieve its 2 percent target appeared to be attributable to temporary supply disturbances.
Yet that position became harder and harder to justify over time. The price level — already well above the level consistent with the Fed’s target — grew 5.06 percent in October. Unemployment had fallen to 4.6 percent and, despite lingering supply disturbances, real output had largely recovered. The available data clearly suggested the economy was over-producing given its reduced potential. Still, the Fed was reluctant to recant and act . . .
Scapegoats are popular in modern politics. Consider America’s current experience with inflation. When President Biden took office, the consumer price index was 1.4 percent, year-over-year. Since his inauguration, that number has climbed to 8.5 percent.
The Biden administration has been reluctant to own the problem, recently turning Vladimir Putin into its own scapegoat with a misleading narrative about “Putin’s price hike.” To put things mildly, Putin is not a good actor on the global stage, but the Russian autocrat is not the primary cause of pain at the pump, in the grocery store, or anywhere in between. Not even close.
When the Fed turned on the money pump, it reassured us that inflation wouldn’t appear. Once it did, the oracles at the Fed told us that inflation would only be temporary. The Fed and its Keynesian camp-followers cast around for scapegoats — they have blamed Covid-19, supply-chain disruptions, high oil prices, corporations not wanting to pay their fair share of taxes, price gouging, and, now, Putin.
They blamed everything except the factor that was most responsible — the Fed’s own monetary policy, which financed the vast increase in government expenditures since March 2020. Of course, other factors did play a role, but the Fed’s boosters ignored the monetary elephant in the room . . .
The Pandemic
This calculus suggests that Hawaii overpaid somewhat to delay its contact with Covid. The implication is that people would leave Hawaii, especially in 2021 and 2022 when the state was locked down more than the U.S. average, because they would rather live a more normal life even if it meant facing a somewhat greater health risk from the virus. Alternatively, individuals who especially valued Hawaii’s approach (or just were looking for a tropical location for their remote work) could have moved there, enduring the 14-day quarantine for many months of added safety, especially in 2020 when the state was more like the rest of the country.
According to Census Bureau population data, between July 2019 and July 2020, Hawaii’s population increased more than it had in its history as a state. The next year, its population decreased the most while Americans moved to Florida, Idaho, and other states that offered more freedom.
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