I am a student of money, thrilled to live in (as they say) interesting times. What passes for wisdom on Wall Street reeks of promotional zest. Money so thoroughly corrupts the judgment of man that wealth and knowledge are often confused, prudence and excitement compete for the same dollars, and truth is such a rarely glimpsed commodity that when it rises up to bless the world with insight, it is mocked and crucified as an imposter by the high priests of Wall Street whose power and fortunes are derived from skimming millions and millions off the billions of thousands. The inhabitants of the cathedrals of finance cannot afford to let truth interrupt the rather profitable status quo.
But I am about to tell the unvarnished God-awful heart wrenching truth about my friends at Wall and Broad because I can do no other thing. As Martin Luther said, “to go against conscience is neither right nor safe. Here I stand, I can do no other, so help me God.” Or, in the vernacular of risk takers everywhere, let the chips fall where they may.
Money flows. Like music, it can be creative and fruitful and result in goodness and peace. More often, it is discordant and artless and commercial and crass. It may be innocent, such as when a child empties his piggy bank to buy a game for a friend or sings a lullaby to help his little brother sleep. But more often money is a harsh clanging sound as harried and desperate people chase it through the tender tundra of relationships and integrity, sometimes failing and sometimes succeeding but always leaving an ugly pain in their wake.
I like money to make sense. I am frugal. Most would say cheap. Watching Wall Street rob its clients blind not only upsets my sense of right and wrong, it strikes me as wasteful. Imprudent. Inefficient. It is an out of tune piano that spoils the listener’s ability to enjoy any music at all. What makes it criminal is that the world has changed to give investors the ability to take control of their own financial affairs. They can’t all become little Warren Buffetts, but neither must they remain tied to the financial service behemoths who have been taking advantage of them year after year. Times have changed. Financial technology has advanced the cause and all investors need to do is plug in the electric guitar and leave the dark ages behind. Rock and roll.
Technology is the application of science (new knowledge) to commercial or industrial applications. Technology is responsible for yesterday's top choice becoming obsolete. Technology is not limited to the field of computers or medicine. Financial inventions, new technology applied to the area of finance, have revolutionized how we save money and invest for the future, although we rarely think of it in these terms.
For instance, when inflation ravaged savings account returns during the late 1970's, banks paying very low rates of interest on certificates of deposit competed with each other by giving away prizes, known as savings premiums. Instead of giving away bigger returns, they gave away toasters, clocks, 8-track players and other gadgets. These premiums were fun to have, but cash is better. At that time, however, federal regulations put a ceiling on what banks could pay depositors, so giving depositors more cash wasn't an option.
At the time, the OPEC oil embargo prompted inflation and interest rates to move higher. Elderly savers, living on interest from bank savings accounts, fell further and further behind each year as prices increased faster than their interest income. As inflation increased, unregulated money market mutual funds began paying higher and higher interest rates to investors. The funds invested in short-term certificates of deposit and commercial paper whose interest rates weren’t capped and they became a popular escape from the low yielding bank products. Although money market funds had been in existence for decades prior to this point in time, up to this point few investors used them or were familiar with them. Most investors still invested in individual securities. The concept of investing in a fund along with other investors and leaving the day-to-day fund management to professionals at a fund management company was foreign to most people.
But money market funds seemed pretty safe, and gradually these funds' higher yields began attracting investors. More knowledgeable savers, and eventually the investing masses, withdrew money from local banks and savings & loan institutions and deposited it instead into money market funds. Individual investors learned how to take more control over their own personal investing program.
Eventually banks did respond, of course. They pressured regulators to lift the interest-rate caps which had prevented them from offering competitive rates. They stopped offering investors blenders and mixers, and started offering more competitive yields. But it was too late. The cork was out of the bottle and the upstart mutual fund genie had escaped. What was once a poorly understood niche product, the super safe mutual fund designed to be a higher yielding alternative to a government guaranteed bank account, has subsequently evolved into a financial leviathan.
Now, nearly thirty-five years later, money still flows out of banks and into mutual funds. Banks continue to lose market share. The banking industry is consolidating and bankers are struggling to understand this not-so-new mutual fund competitor. In 1996 Pittsburgh's blue blood Mellon Bank purchased Dreyfus Corporation, the mutual fund giant whose money market funds once dominated the mutual fund landscape. Since the Glass-Steagal Act that separated commercial and investment banking was repealed in 1999, banks have acquired and ruined many mutual fund companies. What began as a heresy of sorts due to an advance in financial technology in the 1970's has become very mainstream indeed.
Next post: The Fund Supermarket Innovation
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
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