Is Big Finance Too Big?

By Marc Ross posted 09-13-2023 20:01


Your humble blogger recently read John Coates's The Problem of 12 When a Few Financial Institutions Control Everything. after hearing the author speak on WBUR's weekday program On Point. It begs the question: has big finance gotten too big? The largest index fund complexes and private equity behemoths control swaths of the economy and exert political influence in ways both transparent and opaque. As Coates indicates in a footnote in the introduction, the number 12 is notional only, not a reference to twelve firms.

The phrase is a reference to an overconcentration of  a small number of players who have the power to influence disproportionately a nation's politics and economy. There exists a fundamental tension between big finance's ability to achieve economies of scale and constitutional limits on the political power that they wield. These outsized institutions grease the wheels of capitalism, enhancing quality of life through greater longevity and and increase wealth, yet also parse out gains unequally. A rising tide does not necessarily lift all boats.

Their rise to prominence has put such institutions in the sights of politicos looking to curb their power and influence that would undermine, in their view, the very bedrock of a democratic republic. Index funds have grown to the point of what appears to be an oligopoly, the few actors being able to exact change at public companies through concentrated share holdings that affords them voting power. Private equity, by contrast, has accumulated power over the economy through opaque control of a wide range of businesses. Themselves publicly traded (KKR, Carlyle, Blackstone, Apollo), these firms manage and restructure companies largely out of the public eye. Information on their holdings is not available to investors to a large extent, yet they have been quite facile in the recasting of their image from the '80s as predatory buy-out firms. The work of private equity firms affects legions of pensioners whose funds invest in private markets.

The largest index funds and private equity firms have used their power to change labor and tax laws and regulation in the context of increasing globalization and technological progress. The resultant mix of buyouts, takeovers and the ascent of institutional shareholder activism have made for a fissiparous geopolitical and economic environment. So what is to be done? Identifying the problem leads to more questions than answers. Policymakers have an unenviable task of reining in these actors' excesses while not stifling the many benefits to the economy. Any solution would be tentative, entailing disclosure, conflict-of-interest, regulation and anti-trust law.

For the typical investor and the advisor (CFA charterholder), awareness of these tensions and their impact on performance and disclosure is critical. What investors cannnor see may hurt them. The Problem of 12 is and will be a problem of long standing.