Financial History 25th Anniversary Special Edition (104, Fall 2012) | Page 20
“The Future of Finance”
By John C. Bogle, Founder, The Vanguard Group
The future of finance will be different than
its recent past. The traditional and principal role of finance in our economic system and our society has been to allocate
investment to its highest and most profitable uses — the most promising existing
businesses and new businesses created by
In the recent era, however, the principal
role has become to facilitate speculation
in the financial markets. For example,
in recent years, finance has raised some
$250 billion annually in equity capital
for business, while the volume of stock
trading averaged $33 trillion — 0.8% for
investment and 99.2% for speculation. The
task is to bring these two models into a
sounder balance in the years ahead.
The major lesson of the past 25 years
is that the financial markets imprudently
magnify changes in the intrinsic values of
stocks as stock prices lose touch with economic reality. Moment-by-moment volatility engenders excessive trading, enriching financial firms even as it (relatively)
impoverishes investors. We need investors to understand Benjamin Graham’s
time honored maxim: In the short-run the
stock market is a voting machine; in the
long-run it is a weighing machine.
The role of leadership in finance is to
restore prudent investing to its traditional
dominant role in our society. This view is
almost universally shared by the “wise men”
of our era — the Volckers, the Buffetts, the
Donaldsons, the Whiteheads — of which
there are all too few. We must develop a
new generation of leaders imbued with the
idea of patient long-term investing, with
strong ethical values and with a clear understanding that the role of finance is to serve
not Wall Street, but Main Street — those
human beings out there who are trusting us
to invest soundly for their future well-being
and their financial independence.
“Have We Learned Our Lessons?”
By Henry Kaufman, President, Henry Kaufman & Company, Inc.
While we have experienced substantial
turmoil in the financial markets in recent
decades, it is nevertheless unclear whether
or not we have learned our lessons. One
of those important lessons is that financial institutions have an important dual
On the one hand, they serve as fiduciary
for the savings and investment process.
On the other hand, as private institutions,
they need to achieve a reasonable rate of
return on their capital. Unfortunately, balancing these two responsibilities has not
worked well in recent decades. Entrepreneurship has overcome the responsibility
of financial trusteeship. It is far from clear
whether the Dodd-Frank legislation will
allow financial institutions to move ahead
effectively and efficiently.
In the euphoria leading up to the recent
financial debacle, it was also forgotten that
good times breed the illusion of boundless
liquidity. Indeed, liquidity seemed to be
interpreted by many as the smooth and
quick access to borrowing rather than the
liquidity displayed on the asset side of the
Another related lesson that should have
been learned is that marketability is not
the same as liquidity. Liquidity is a characteristic of the markets where marketability
has to do with how easy it is to trade in a
particular security or class of securities.
Adding to this perception of liquidity has
been securitization, but this can give a
false impression of seamless marketability.
The fact still is that marketability varies
considerably over a financial cycle.
In these last few decades we also should
have learned that marking financial assets
18 FINANCIAL HISTORY | Fall 2012 | www.MoAF.org
to market is an imperfect process. The fact
is that the capacity to effectively mark to
market varies with market conditions.
When market conditions deteriorate and
liquidity seizes up, no one can readily
claim that the last quoted price in organized markets or quoted by dealers in
the over-the-counter market is the real
Finally, we should have learned that
modeling risk has great limitations. This
practice has become increasingly popular with the improvement in computer
technology. Unfortunately, many of these
models have relied importantly on historical statistical overlays. As Mark Train
once noted, history rhymes but does not
necessarily repeat itself.