Skip to comments.Financial Entrepreneurship vs. Product Entrepreneurship
Posted on 07/28/2007 11:02:42 AM PDT by Clintonfatigued
America is the greatest entrepreneurial nation in the world. But there are really two kinds of entrepreneurs here -- product entrepreneurs and financial entrepreneurs -- and only one of them truly builds the economy. Product entrepreneurs find new ways of satisfying customers. Financial entrepreneurs find new ways of ... well, making money off money.
Problem is, financial entrepreneurship is becoming more and more dominant in the economy. Thirty years ago, finance was the handmaiden of American industry. Now industry is run by finance. For every budding Steve Jobs or Bill Gates there are now thousands of aspiring private equity or hedge fund managers. That's because this is where the big bucks are. Which means, it's where some of our most talented young people are going.
The problem isn't just the brain drain. Itâs what the brains are being used for. Competition in the real economy generates better products. But competition in the financial economy is often a zero-sum contest. For every investor or speculator who wins, thereâs another who loses. Capital markets may be more efficient, but the added efficiencies are often minuscule â beating the competition to a profitable investment by a tenth of a second, or coming up with ever fancier derivatives, collateralized loan obligations, mortgage-backed securities. The results are ever more complicated, harder to value, and probably fragile when the markets turn downward.
Financial entrepreneurship is also forcing managers in the real economy to become ever more short-sighted, glued to the quarterly reports. Private equity moguls say theyâre freeing corporations from the quarterlies but the deals they do weigh down companies with so much debt they have to focus on short-term cash flow to survive. Often they have to cut long-term investment -- research, employee development, and basic innovations -- in order to pump up profits
(Excerpt) Read more at politicalinsider.com ...
While I was skeptical of the author of this article, it turned out to have some merit. The end of the article was memorable:
“America needs more product entrepreneurship and less financial gamesmanship.”
America does need more production instead of paper. Eventually the paper disappears
True about investing...it is a zero sum game. Someone has to lose in order for someone to gain in the world of investing. A lot of people LOST this week
Cant believe this came from Robert “Fourth” Reich...surprised a popular socialist would be keen on this
“WhatÃÂÃÂ¢s the answer? At the very least, stop giving tax financial entrepreneurs huge tax advantages over product entrepreneurs. Treat their compensation as income, not capital gains. And tax their partnerships that go public at the same rate public corporations are taxed.”
I have hard time believing that the statistical number of new organizations of the financial economy exceeds the number of new organizations of the real economy. The lists are full of new “product” organizations seeking capital.
They have lives of 2 to 4 years. And the US system works nicely to capitalize these companies with a varying terms of debt and equity. Mezzanine, angel investors, venture capital, banks and others.
In fact it is one of the best in the world. And Reich wants to lump the arbitrage of private equity in with all financial backers to tax them all.
The entire venture capital community could not have existed 50 years ago, and today is responsible for a substantial number of new US jobs. Money market accounts did not exist until recently. The invention of the ‘sweep account’, an idea that was awarded a patent, greatly increased the amount of funds that institutions had available for lending or investing elsewhere. The fact that well over 50% of US households hold stocks is a direct consequence of financial innovation.
The creation of wealth is never a zero-sum game. If this was true, then from where did our prosperity come? No, in a free market with voluntary participants, a transaction takes place only where both parties expect to gain from it. To claim otherwise is just populist drivel.
I think I like your response better than the article.
Well, sort of.
The fact that there are now more mutual funds in existence than companies traded on U.S. stock exchanges is also a direct consequence of financial innovation that may not be such a good thing.
"stop giving tax financial entrepreneurs huge tax advantages over product entrepreneurs. Treat their compensation as income, not capital gains."
In other words, he's carrying water for the House Democrats in their attempt to effect a tax increase on these so-called "financial entrepreneurs" (for example, hedge fund managers) by reclassifying as ordinary income some things they are now able to treat as capital gains.
I'm not sure I understand all the implications of this tax law change well enough to have an informed opinion. Just be aware that Reich wrote this article not because he gives a rat's patoota about American enterprise, but rather because his Democrat overlords want to raise taxes on someone!
Why not? Mutual funds hold shares in common for the fundholders in proportion. They must distribute both dividends and capital gains. They represent a basket of stocks, typically hundreds of different companies. How in the world can this be bad, especially with the great ocean of information, analysis, comparison, disclosure and rankings of these funds, most of which is available for free on the web. Indeed, it seems that Google and Yahoo are in a race to see who can offer more information for free. Even Morningstar offers a free trial subscription.
People who have money to invest can easily compare funds. Yes, you can pick a bad fund, but then again, some people park their savings at banks that offer downright pitiful rates of return.
Yes, there are a lot of funds. There are even quite a few funds that are set up just like the S & P 500 index, which you can buy via a stock account via the listed symbol SPY for a flat commission and no fees. The only difference between these funds would be the fee structure. Yet not everyone, for whatever reason, chooses the fund with the lowest fees. Why they do so, is not for anyone else to judge.
When people ask me about investing, if they have less than $10,000, I always tell them to select two or three mutual funds in different areas of the world economy, and then to review their holdings every few months to validate their holdings, or to replace a laggard with a better fund.
Mutual funds are one of the greatest financial innovations in modern times.
The mutual funds themselves are not the problem, but the fact that there are so many of them -- more funds than publicly-traded companies, in fact -- is an indication that the underlying fundamentals of the individual companies have become less important than the combinations and permutations of weighting within these mutual funds.
Two funds with identical stock holdings can perform in markedly different manners, depending on how the weightings of the various stocks differ between the two funds. Yes, these funds are managed by people who probably know a lot about the individual companies . . . but very few of the individual investors in these funds really do.
Further on this point, consider one of the finest fund managers of all time, Peter Lynch and the Fidelity Magellan Fund he ran for a number of years. This is a delightful example of economist Joseph Schumpeter’s “creative destruction”. Lynch did such a good job, that so many people invested in his fund, that it got too big for the portfolio management skills he had. Consequently, fund performance dropped, people moved their money to other managers who had better performance and Lynch himself resigned from being manager. I thank Peter for making money for me for several years.
But this example proves my advice is correct: that people must never just buy and hold a mutual fund. A manager has certain strengths and weaknesses. When a given market and economic environment play towards those strengths, the manager can excel at picking stocks, but it is difficult indeed to keep an above-average track record over long periods of time. So, people who hold mutual funds must periodically review their holdings in light of the universe of other funds, and not hesitate to trade out of poor performing funds.
But, again, this is all a good thing. There may be, say, 100 funds that cover Medical, and 100 fund managers. This competition is not a bad thing, but gives the buyers of mutual funds in this area the ability to select the best manager. Weak mangers will get culled by market forces. Strong mangagers will be rewarded.
If there is any problem, it is found in the forces that tend to reduce the number of different share offerings. One factor is over-regulation such as the recent Sarbanes-Oxley, a body of regulations so costly that no government agency would volunteer to follow. As a result, companies are listing in London or Hong Kong rather than on the NASD or NYSE. To get listed on the London’s AIM, a company only needs to find a broker who will sponsor the listing. For those small companies working towards a listing, why should they put up with the burden of SOX when they don’t have to? If you are a non-US firm, why put up with keeping a set of books in accordance with your country’s financial regulation and another set in US Dollars according to US accounting regulation? It is just silly.