Drilling Deep to Discover the Fault at the Foundation of Our Financial System

Here, we use the word “fault” in its geological sense. In geology, a fault is a physical line of separation between two subsurface rock masses that causes earthquakes at the surface, when the rock masses slip in relation to each other.

In finance, we use this word “fault” metaphorically, to describe a misalignment of purpose between two different financial systems, causing the economic equivalent of earthquakes when those systems slip in relation to each other. It’s also known as a crash. Or a crisis. Or a boom that goes bust.

Two different financial systems?, you ask, quizzically.

Yes. Two different financial systems.

Conventional thinking conceives the financial system as one big system for doing mysterious things with money — itself a most mysterious thing.

What if conventional thinking isn’t quite right?

What if the financial system isn’t just one big system? What if the financial system is, in fact, a system of six decision-making subsystems, that each works by aggregating the savings of society for a specific purpose and deploying those aggregations in a compatible way, to pay the costs of organizing enterprises for doing work that adds to the wealth of choices people can make for how we want to take the world about us as we find it, and change it to be more a way we want it to be?

Isn’t that, in truth, what the economy is really all about? Isn’t this phenomenon we call “the economy” is really just a giant network of intellectual and interpersonal connections between people for doing work and sharing wealth through enterprise and exchange?

It starts with enterprise, and enterprising individuals who see changes taking place in the world about us that are creating both a need and an opportunity to co-creatively and collaboratively evolve adaptations to those changes.

When enterprise needs money, finance provides it.

Finance is how society decides which enterprise for organizing evolutionary adaptations to change can, should and will be made to happen.

Today, finance operates trhough six different decision-making subsystems, each of which aggregates savings for a specific purpose and deploys those aggregations to sponsor enterprise in an aligned way. They are:

  1. the Social Power of Family & Friends;
  2. the Moral Authority of Church & Charity;
  3. the Public Acts of Taxing & Spending;
  4. the Counting and Accounting of Money & Payments;
  5. the Future Valuation of Securities Trading; and
  6. the Current Cash Flows of Superfiduciary Collaboration.

Each of these decision-making subsystems is fit for its own proper purpose. Each can be the right choice for financing enterprise of the right kind, at the right time. Many times, multiple systems can be employed to finance the same enterprise at different times, or to contribute in different ways to the financing of the same enterprise at the same time.

The need and the opportunity is to make sure the use of each system is properly aligned with the purpose that system is designed to achieve.

Here, we discover a problem with the way things financial are currently being done in the world today. The problem is that we are using the Securities Trading system to deploy savings aggregated by the Superfiduciary system. This is creating a “fault” at the foundation of finance.

This fault at the foundation is causing the entire system to be unstable at its surface. The symptoms of this deep fault include persistant bad behavior by financial actors that is rewarded by a system that has become dystopian. Also, equity asset pricing booms that go bust with increasing frequency, and increasingly catastrophic consequences, for individuals and for us all.

People tend to think that booms are good, and busts are bad, but a boom is just a bust that has not happened yet. If we have a boom, a bust will follow, as surely as night follws the day. We cannot have booms without also having busts. They are a package deal.

If we want to avoid the busts, we have to stop creating booms. Both are exaggerations of the normal ebb and flow of change and co-creative, collaborative evolutionary adaptation to change that is the real pulse beat of prosperity, and the true story of human history.

Exaggerations are bad. Normal ebbs and flows are good.

So how do we stop the ebb-and-flow from being exaggerated into booms-that-go-bust?

We have to drill down beneath the surface of bad behavior, to see how credit bubbles are formed by equity asset price inflation that is a consequence of committing superfiduciary funds to securities trading.

What are superfiduciary funds? you ask.

Good question. Superfiduciary funds are pensions mostly. They are the largest. Also, we have university endowments and endowed foundations that share with each other and with pensions these three characteristics making the superfiduciaries.

  1. First, is that they are all stewards of very large aggregations of other people’s money. Some pension funds, especially, are enormous in their own right. Also, taken together, as a market demographic, these superfiduciaries are the largest, and therefor the most important actors in the equity sector of our financial system today.
  2. Second, these enormous aggregations of other people’s money are entrusted to the good judgement of these stewards for a purpose. Pension funds exist to deliver income security in retriement to their plan participants. University endowments exist to support the activities of the endowed university. Endowed foundations exist to pursue the mission of public good for which they were formed.
  3. Third, these funds are all evergreen, in the sense that they are automatically self-renewing and endlessly ongoing. They have not endpoint.

In combination, these three characteristics give this demographic super duties, super fiduciary duties. They have super financial fiduciaries duties under a charter of public trust that is so large, so purposeful and so ongoing that they become also super fiduciaries for all of us, whether or not we fall within the technical limits of those charters. This is because the choices they make, and the actions they take, as super financial fiduciaries under a governing chater of public trust have impacts on the economy and society that resonate and reverberate well beyond what we lawyers call “the four corners” of that trust.

Superfiduciaries savings are aggregated from society for the purpose of generating adequate cash flows, forever, so that those superfiduciaries can write the checks they have to write — to retirees, to universities and to mission-aligned activities- today, and every day, across and endlessly evergreen suceession of days.

In the case of securities trading, aggregations are deployed to finance growth in future valuation.

These two, evergreen cash flow and perpetual growth in future valuation, are not the same thing. They do not fit well together. Experience is proving that when superfiduciary funds are committed to securities trading, neither the superfiduciary system nor the securities trading system work the way they are supposed to, with adverse consequences for banking and the entire financial system, for enteprise and the entire economy, and for society and all the diverse individuals who make up society.

Why is that?

The reason is this. Securities trading is designed for individuals. Individuals are not evergreen. We are time-limited. Neither are we purposeful. We are, opportunistic, each of us doing the best we can for ourselves and those we care for and care about, under the circumstances as they prevail from time to time, and change over time. Nor are we large. Even the wealthiest of individuals is not rich enough to upset the financial system by the investment decisions that they make.

Securities trading is designed for small, opportunistic, time-limited individuals. It works by breaking up large enterprise into small shares that can be bought in relatively small lots as opportunity allows and held for a time, before being sold to other individuals, who also buy in small lots, as opportunity allows, and hold for a time, until it becomes their time to sell. And so on, ad infinitum.

As individuals, as a general rule, we buy secuities when we have savings we do not need to spend for a while, hold those securities while we do not need the money to spend on something else. Like college for the kids, a dream vacation for ourselves, a second home or a new business venture of our own. We sell when we do need the money back. Along the way, we may do some selective trading, to rebalance our portfolio, but mostly, we buy to hold.

This is the purpose that securities trading is designed to fit.

It is not a purpose that superfiduciaries pursue. Superfiduciaries, as we have seen, are large. Many are larger than most enterprises, and a small “club” of superfiduciaries can aggregate more than enough superfiduciary funds to finance, directly, enterprise of any authentic size.

As an aside, this question of “authentic size” for enterprise arises only because we have exaggerated the scale of business, artificially, through the mismatch of superfiduciary funds and the securities trading system — another form of boom that will eventually go bust, through bankruptcies of spectacular scale.

Back to our main point. There is this is the super power that superfiduciaries have with which to pursue their super duties. They have size. They have purpose. They have endurance. They do not have to speculate. They can negotiate.

What happens when superfiduciaries do speculate in securities?

Unlike individuals, superfiduciaries do not buy when they have money. They always have money. They do not sell when they need that money back, to spend on other things. They never need that money back. Instead, they need always to be invested in enterprise that generates the cash flows they need to write the checks they have to write, today and every day, across an evergreen, never ending succession of days.

I repeat the above point repeatedly, because it is critically important to seeing the purpose of superfiduciaries, and the fundamental failure of purpose of superfiduciaries trading in securities. Yet my own personal experience has shown that it is diffiult — much, much more diffiult than it needs to be — for many people to wrap their minds around this simple fact that superfiduciaries are all about generating adequate cash flows, forever. And securities trading is not.

By the logic of securities trading, superfiduciaries should be the ultimate buy -and-hold investors, buying and never selling, except to harvest small profits to meet their current cash flow needs, and perhaps to rebalance their portfolio from time to time.

But what happens to the securities trading markets when this much money buys and does not sell?

Those markets will freeze up. Liquidity will be lost. Individuals who want to buy may have a hard time finding something they can buy, because so much of the market would be held by superfiduciaries who are not selling. Indivuals who need to sell, may have a hard time finding someone to sell too, since superfiduciaries who do so much of the buying already hold the shares they bought before, may not be ready to add more.

Liquidity is why markets exist. A certain sale, at an uncertain price. That is the fundamental value proposition of the securities trading markets. If superfiduciaries lock up large percentages of the securities traded on the markets in positions they hold and do not sell, then the markets cannot function well.

No, superfiduciaries in securities must be made to trade. And when they trade, they only reason they can be trading is speculation on short-term movements in the market clearing price for the securities they are trading.

Who are they trading with? Mostly with each other. Sometimes with themselves (through different trading professionals).

What are they trading for? To beat the market.

But how can they beat the market, when for all intents and purposes, they are the market?

When securities trading comes to be dominated by superfiduciaries, as they are today, liquidity becomes a problem. Either there is not enough, and the markets fail of their essential purpose. Or there is too, much, and the markets fail of their essential purpose.

The answer is obvious to anyone willing to see the situation for what it truly is. Take superfiduciary funds out of the securities trading markets, and invest them instead in enterprise, directly, sharing in current cash flows, currently, to generate cash flows adequate to their fiduciary needs, forever.

That cannot happen all at once, of course. That would trigger a catastrophe.

It can be done more gradually, in increments, over time. A managed transition, managed by superfiduciaries as stewards of our financial future that is also our physical future.

A managed transtion towards evergreen.