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Shifting to an Age of Smaller Profits: Bogle


If investors have learned one thing from the financial crisis, it is that, eventually, level heads and long-term investing will prevail. In that spirit, sister publication Investment Dealers' Digest recently spoke with a man known for having one of the most level heads in the industry, John Bogle, founder of Vanguard Investments, about what he sees for mutual funds and other investment firms in the years ahead.

IDD: How do you think the credit crisis will play out?

Bogle: The market can't bail itself out of this mess. Wall Street has a lot to answer for to Main Street, and yet Main Street, which is really where the tax base is, is going to have to bail out Wall Street for Wall Street's errors. And that is, of course, a tragedy-an economic tragedy. But I am persuaded because I respect people like Larry Summers. I certainly respect Ben Bernanke. I am not so sure about Hank Paulson. I suppose I respect him in a way, but his issue is that he is an investment banker. So it should come as no surprise to anybody that he looks at these things from an investment banker's perspective. How else can he look at them?

It [the bailout] has to happen. I think it is too bad it has to happen, but I think we ought to get ready for building a better financial system, which means building a smaller financial system because what is going on on Wall Street is a casino and our croupier has raked too much off of the table before we get paid.

IDD: When you say our financial system gets smaller, what do you mean by that?

Bogle: Revenues will be less for a whole bunch of reasons. First, they are never going to be allowed-with the government being part owners of them-to have 35-to-1 leverage.

Number two, we're going to have better disclosure about what is on that balance sheet. When you think about it, if you are leveraged 35 to 1 and all your assets are Treasury bills, I don't see that as much of a problem. The problem is that none of them are Treasury bills. They are toxic mortgages, and we need much better disclosure of that.

The third thing is that they are going to have to be content with less revenues.

IDD: You like the idea of keeping things simple in business and investments; what do you think about the credit default swaps market?

Bogle: It's a modern-day version of quantitative insanity-a completely obvious example of the way that speculation has over run financial investment in our financial markets.

An easy way to look at it is this. Suppose you have a house and you insure it against fire for $200,000. Now, suppose that you have 130 neighbors, 65 of whom are betting that it will burn down and 65 of whom are betting that it won't. And, that's approximately the ratio we have got here. It's supposed to be about $2 trillion debt instruments covered by CDS and $62 [trillion] or $65 trillion of credit default swaps. Half of them are in one side and half of them are in the other.

So, you could say, "Well, what's the matter with having your neighbors insuring or betting your house will burn down or betting it won't burn down?"

What's the matter is you have to keep a close eye out for arsonists. So, we have arsonists out there playing the CDS market, to sink your firm, make money for themselves and their hedge funds. They want those premiums to go way up. Playing games like that-we don't know how much because the market is totally opaque and volume is not recorded-these are the things that have to change.

IDD: Your observation that the stock market is a giant distraction to people is interesting.

Bogle: It is a giant distraction to the business of investing. And the word "business" was not lightly chosen. Investing is owning businesses and hanging on to them so they can earn a return on your capital.

IDD: Does this idea run counter to playing the CDS market short term?

Bogle: Absolutely.

IDD: In your recent book, "Enough: True Measures of Money, Business, and Life" (Wiley, 2008), you trace the history of the introduction of futures and options on stocks. Yet, they seem like another toy to tinker with, taking away from the true essence of buying into a business and its future.

Bogle: When you buy an option or a future, you are making a bet on the future price of the stock or the derivative or the index.