In his new book Enough (John Wiley & Sons, 2009), Vanguard founder and low-cost investing pioneer John Bogle directly attacks the financial services industry for extracting far more value than it creates. The book also tackles the whole philosophy/culture of accumulation, and calls for greater professionalism, stewardship and leadership.
The book starts with a charming story. At a party given by a billionaire in 2007, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch-22 over its whole history. Heller responds: “Yes, but I have something he will never have… enough!”
Bogle claims that the U.S. economy has been distorted by the disproportionate role played by finance. In 2006 the financial sector alone earned $215 billion of the $711 billion net profit of all the companies in the S&P 500 stock index. That’s 30% of the total – 35% if we include the earnings of financial affiliates of large industrial companies like General Electric.
He admits that no systematic study has been done of how much of the returns of investors have been consumed by the financial services industry, but attempts some estimates. Intermediation costs data are from Bogle Financial Markets Research Center estimates based on data from the Securities Industry and Financial Markets Association, Lipper Analytical Services, and Empirical Research Associates. Bogle recognizes “the fragility of these data” and urges “a thorough and independent economic analysis of the costs and benefits of our financial system.”
Over the past 50 years, the nominal return of stocks has averaged 11% per year. Bogle estimates that it costs individuals at least 2% per year to own stocks – brokerage commissions, management fees, sales loads, advisory fees, the costs of all that advertising, lawyers’ fees and so on. Income and capital gains taxes cost at least 1.5% per year. And inflation has averaged 4.1% a year over the past 50 years. That leaves a relatively paltry 3.4% real return.
In 2007 the direct costs of the mutual fund system – largely management fees and operating and marketing expenses – totaled more than $100 billion. Funds are also paying tens of billions of dollars in transaction fees to brokerage firms and investment bankers, and indirectly, to their lawyers and all those other facilitators. Fund investors are also paying another estimated $10 billion of fees each year to financial advisors.
But that $110 blln is only the start. There’s another $380 billion in additional investment banking and brokerage costs. Fees to managers of hedge funds and pension funds, to bank trust department and financial advisers and for legal and accounting fees cost another $130 billion. The total of all such costs, by Bogle’s estimate, is $620 billion.
These are annual costs – and they are growing. If present trends continue, aggregrate intermediation costs would come to a “staggering $6 trillion” over the next decade. That compares to the $15 trillion total value of the U.S. stock market and $30 trillion value of the U.S. bond market.
