The Battle for the Soul of Capitalism
Wednesday, February 22, 2006; 12:00 PM
In the new book "The Battle For the Soul of Capitalism," author John Bogle writes about the failures and recent abuse of the American financial system. He focuses on how the system got off course and suggests what can be done to bring ethics and integrity back to the industry.
Bogle was online Feb. 22 at Noon ET to discuss the misuse of corporate management for personal gains and how to get the nation's business industry back on course.
For more than 50 years, Bogle, the founder and former chief executive officer of Vanguard mutual funds, has been a passionate advocator for the small investor. In 2004, Time magazine named him one of the most influential people in the world, and in 1999, Fortune magazine named him one of the four investment giants of the twentieth century.
A transcript follows.
Editor's Note : Vanugard administers 401(k) and pension benefit programs for Washingtonpost.Newsweek Interactive and The Washington Post Co.
Valley Forge, Pa.: Former Reagan aid Bruce Bartlett described the current Administration as being unable to make the distinction between being pro-free markets and pro-business. Of course massive handouts to corporations and quid pro quo deals on regulations will have a way of deadening belief in the marketplace and dulling the responsiveness of the economy to new ideas and new products. Then again, it's awful tough to wean individual sectors like the airlines, pharmaceuticals, financial services, auto makers, and on and on, from feeding at the trough. What's the solution?
John C. Bogle: There is no easy solution to the issues you describe but I think we ought to make a distinction between industries that are deeply troubled from a financial standpoint -- certainly the autos and the airlines -- and industries that are awash in profitability, most notably the financial services business. The fact of the matter is that the cost of our financial services industry comes to something like $400 billion dollars per year, a dead weight loss on the returns that investors can achieve. We need a federal government commission to study the way our financial services system is working -- I believe it is working badly -- and we also need more educated investors. There are good long term low-priced mutual funds -- my favorite is a total stock market index fund -- and bad short term highly priced mutual funds. If investors would get themselves educated, and invest in the former -- taking their money out of the latter -- we would see some automatic improvements in the system, and see them fairly quickly.
Rockville, Md.: One issue I have is with 401(k) plans. On the surface, they seem like a great idea. The problem that I see is with the invisible fees that investors have but generally do not realize they have. My husband and I worked for many years at several different banks which had their employees' 401ks in mutual funds that they ran. My belief is that the banks bulked up the fees that were never reported to employees and that are pretty difficult to determine. I think it almost made whatever matching funds they gave employees pointless. Not that I have a problem with mutual fund companies being paid to manage investments, but the fees should be revealed to investors so that they can make informed decisions. Even if you get the 401k's annual report, the fee information is not at all clear.
At the Washington Post personal finance conference a few years ago I asked Arthur Levitt about this. But apparently this is not an SEC problem, but rather a Dept. of Labor problem. Do you have any suggestions about how this issue should be addressed?
John C. Bogle: You are absolutely right. There are too many conflicts of interest involved when banks, for example, are using their own -- normally rather high-priced mutual funds in their 401k plans. My own view is that our corporations have let us down -- indeed let their own employees down by not making absolutely certain that all costs of fund management are disclosed. I'm not just talking about the expense ratio, but also the hidden transaction costs that funds incur in portfolio turnover, amounts paid to consultants, out of pocket fees, and even additional costs. The level of costs that most 401k participants are so high as to badly erode the retirement funds they can possibly accumulate.
Houston, Tezxas: Thanks for your career and honesty, Mr. Bogle.
Your book argues in favor of shareholder democracy. But shareholders did not squeak about the robbery until the Enron-like collapses (I'm in Houston watching the trial now) hurt them in their wallets. I'm not certain shareholders can be counted on to keep the game honest if the crooks provide returns above inflation and steal the rest.
When Washington relaxed financial regulations (Democrat & Republican), it really opened the doors to conflicts of interest between brokers and investment bankers. Shouldn't Washington (not just Eliot Spitzer) be a much more active participant beyond Sarbanes?
John C. Bogle: To answer the last part of your question first, yes I believe Washington should be a more active participant focusing on the issue of why corporate shareholders and mutual fund shareholders are not given fair treatment by corporate management and mututal fund management. We need to develop a national standard of fiduciary duty to ensure that these agents, if you will, are adequately representing the principles -- pension beneficiaries and mutual fund shareholders -- whom they are duty bound to serve.
Boston, Mass.: Mr. Bogle,
What do you think of DFA and DFA-affiliated advisory firms? They allege to be the cats meow, but I understand their minimums are large, their affiliates' fees can be quite high, and that their funds cannot be purchased other than through an adviser. Thank you.
John C. Bogle: I have a great deal of respect for the DFA organization. However, I am not sure their cats will actually meow in the future. First it's very difficult for any particular segment of the stock market to sustain superior performance. The watch word for our financial markets is, "reversion to the mean" i.e. what goes up must come down, and it's true more often than you can imagine. Second while the returns the DFA publishes are accurate returns for their funds, those who invest in their funds are paying an extra 1% per year to do so significantly reducing capital accumulations over time.
Miami, Florida: I know that you will be speaking during a Boglehead Reunion in Las Vegas in May. What will be the topic of your speech?
John C. Bogle: It's wonderful to hear from the King of the Bogleheads! I hope you're feeling better and on the way to a complete recovery. I haven't decided on a final title for my reunion speech but I expect to talk about "bringing reality back to investing" looking not only at stock market returns but then reducing those returns by the cost investors incur i.e. advisory fees, operating expenses, marketing fees, sales loads, hidden transaction costs, out of pocket fees, taxes, and the cost of living over time. Believe me, the returns we read about in the industry sales literature vastly diminish when we move from the theoretical world of market indexes to the real world of actually investing.
Longview, Wash.: How much of an investor's fixed income allocation should be in TIPS?
John C. Bogle: It's simply not possible to generalize about the proportion of fixed income investments in TIPS. For investors deeply concerned about possible high inflation in the future, the TIPS should be a relatively larger proportion, and vice versa. Speaking for myself -- a person who is getting a little bit older! -- I have about 10% of my bond position in TIPS reflecting some concern about inflation but also interested in getting a small risk premium on corporate bonds that basically don't have TIPS protection. Perhaps, between the 10-25% is a reasonable rule of thumb.
Alexandria, Va.: Mr. Bogle, I have read in several publications that American Capitalism s, in effect, a Ponzi scheme which is economically unsustainable over the long term. It is a fact that the United States, with 5 percent of the earth's population, consumes 30 percent of global resources used each year. Our economic system is, at its core, unfair, unethical and unsustainable. I would love for you to prove these facts wrong, but something tells me that questions such as mine won't make it past your screeners.
John C. Bogle: I am not into screening questions. A responsible question -- and yours is a responsible question -- deserves a responsible answer. No, capitalism is not a Ponzi scheme. Capitalism is a scheme of free markets and, as I point out in my new book, of trusting and of being trusted. But our capitalistic scheme in the latter years of the 20th century seems to have lost its way. We've had a "pathalogical change" from traditional owners capitalism where most of the rewards have gone to those who make the investments and assume the risks to a new -- and deeply flawed -- system of managers capitalism where the managers of our corporations our investment system, and our mutual funds are simply take too large a share of the returns generated by our corporations and mutual funds leaving the last line investors -- pension beneficiaries and mutual fund owners -- at the bottom of the food chain. That is what has to be fixed.
San Francisco, Calif.: Are ETF's that index really a good alternative to index mutual funds, or just another warmed over product?
John C. Bogle: I have to give you a complicated answer. A total stock market ETF bought and held for an investment life time and operated at minimal cost is a perfectly good alternative -- maybe even a hair better -- to a standard total stock market index fund. So spiders and vipers, bought and held are fine. The problems with ETFs are two: 1. Even these total market funds are turned over at a frenetic pace by investors, trading something like $10 billion dollars every day -- a 20% daily turnover, or 5,000% per year. 2. The overwhelming number of ETFs are narrow speciality funds, specific foreign countries, specific industries, and the like, also traded like stocks. I think this latter group of ETFs are a better way to speculate than speculating in individual stocks. But I believe -- deeply and profoundly -- that speculation is a loser's game. I look at ETFs then, as I might look at a shotgun, wonderful for hunting, and equally wonderful for suicide. Handle with care!
Cortez, Colo.: I have seen a couple of discussions on C-Span (one was Milton Friedman) that we should not be concerned with the deficit because it is a small percantage of the GDP.
Do you have or can you recommend a book understandable to the average person that supports this theory? I am over 65 and trying not to retire or take "entitlement" funds. It would be nice to relax and enjoy what is left of my life without feeling as though I am destroying my grandchildrens' futures.
John C. Bogle: There is no easy answer to your question. Right now the deficit is a much larger portion of our GDP than is traditional, easy enough to calculate but only if we add back the costs for example of Iraq and Afghanistan and ignore the expiration of the Bush tax cuts later on. Just as in corporate America, there is a lot of "financial engineering" in Washington DC that' seriously obfuscates the risks we are running in the national deficit. It may well be true that deficits don't matter in the short-run, but I can assure you that they matter a great deal in the long-run. I'm not currently into economic textbooks, but my grandchildren tell me that the book by Greg Mankiew (sp?), former head of the white house council of economic advisors is a model of intelligence and clarity. Why not try that one.
Arlington, Va.: Mr. Bogle, Trying to find an ethical Capitalist is like looking for virgins in a brothel...the two simply don't exist. Can't we just agree that in business, the ends justify the means, and that any profit is good profit?
John C. Bogle: Without getting into brothels (no pun intended!), there are ethical capitalists the problem is that there aren't enough of them. In my new book I mention that it is not "just a few bad apples" that have been evident in our corporations, our investment bankers and our mutual funds, but so many that one has to concede that the barrel itself needs some work.
New York, N.Y.: As a new investor of 64 years, I'm sure impressed with vanguard. But choosing between a tax managed stock fund and the total stock market index is confusing, (for a taxable account.) They Seem very similar. In future will tax managed accounts include more types of funds, or are they now at their most useful level? There are many more index funds than tax managed fund, it seems.
John C. Bogle: You are right, there probably won't be much long run difference between our tax managed growth and income fund and our S & P 500 index fund. The former fund simply is much more reluctant to realize capital gains and prepared to accept small deviations from the index return (although there have been almost no deviations so far) and was originally structured with a redemption fee for short-term holders so that we could assure that we wouldn't be faced with large redemptions that would have forced us to sell stocks and realize gains. I happen to use our regular index funds in my retirement plan and our tax managed funds in my personal account.
Lakewood, Colo.: How does the better course of business practices to be gotten back to differ from today? Isn't a corporate society of public, private and nonprofit governance more efficient than a civic society? Absent avarice & speculation, how would you motivate the U.S. economic engine?
John C. Bogle: I believe that the behavior of too many of our corporations investment bankers and fund managers has jeopardized some of the trust that investors have had. It's not the economic engine that we need to focus on, but the need to make sure that our investors receive their fair share of the returns that that great economic system produces.
Philadelphia, Pa.: I was in an Ivy League business school in the 1970s. I recall being the only person in one class who felt that American businesses operating in foreign countries should follow the business laws of the countries within which they operate even if no American laws were broken by breaking the foreign law. I felt this was not only a moral question but also one that shows we respect the cultures of the people with whom we do business. This is just one example of what I found to be a rampant problem among my classmates. What I observed among my classmates was a cut-throat drive for personal success at nearly any cost. I can verify the tales that many college students have heard as being correct: library readings for classes were often missing (this was the days before the Internet), cheating was rampant and indeed widely boasted, and I learned never to work in a group. The object of learning groups was to stab others in the back in order to lower the class average. From all this, I did learn one valuable lesson: never hire anyone from my class to work for me.
Over time, as I watched and read about many of my classmates in the news taken away from their jobs in handcuffs, I was not in the least bit surprised. The question I have always wondered though is, if I could tell within minutes that I would never want these greedy cheaters working for me, how did they get hired and kept at these brokerage houses and businesses? Do many businesses themselves actually seek out cheating greedy people? Or do they worm their way into these businesses, in which case I feel sorry for the businesses when they find the personal spending accounts of these employees inflated and the business deals they made turned out to be ethically questionable.
Is there a business culture among some companies that attracts these people? If so, shouldn't there be a means for this culture to recognize when mistakes are made and can then to respond to correct itself and its own behavior? Did businesses never learn to look for warning signs and self-correct their own problems?
John C. Bogle: I was born in an earlier generation and, as a group, my classmates at Blair Academy and Princeton University were as ethical, straightforward, and integrity laden as you could possibly imagine -- perhaps not a 100% (we never get to a 100%) -- but the overwhelming majority. I've been in business a long, long time and I simply cannot imagine seeking out cheating, greedy people. Sure there are some companies at the margins of our society that probably do that and I think we all have the responsiblity as consumers and as investors to avoid them like the plague. If we do, they won't last very long. Doing what's right is the only possible formula for long-term -- I emphasize long term -- business success.
Laurel, Md.: If a corporation's excess of various forms (e.g. excessive CEO pay) affects its stock performance, can't the managers of large mutual funds, with their large research teams, find out about the waste and either sell the stock or avoid buying it?
If so, isn't there a sort of 'ripple' effect with other investors observing what Fidelity and Vanguard do and following suit?
If so, doesn't that make the stock price of a wasteful company decline considerably?
If so, don't the guilty executives and their enablers (boards of directors who approve excessive compensation packages) lose a lot of money in their personal holdings?
If so, isn't that a wonderful punishment or deterrent to corporate excess?
Does the above have anything to do with what you call the soul of capitalism?
John C. Bogle: The relationship between executive CEO pay, stock performance is tenuous and not easily unscrambled, just one of myriad factors that affect the price of a stock. I believe that the mutual fund industry's biggest shortcoming is too much focus on the momentary price of a stock -- an illusion -- and too little focus on the intrinsic value of the corporation -- the ultimate reality. I'm comforted by the fact that Warren Buffett feels the same way.
Providence, R.I.: After reading "Common Sense About Mutual Funds", and observing all of the overpaid/overpriced corporate ineptitude, is there any way that mutual fund investors through their mutual fund holdings in a corporation, affect the business practices, similar to the effect of large shareholders?
John C. Bogle: Among my greatest disappointments about the mutual fund industry -- in addition to excessive costs and excessive focus on the short-term -- is that fund managers have been passive participants in corporate governance. Mutual funds own 28% of all the stock in America, yet their voice on governance issues has been only the sound of silence. I've tried to get mutual funds that focus on long-term investing together to wield a "big stick" in governance but to no avail. But I haven't given up trying!
Casablanca, Morocco: Because Islam forbids corruption, thief and treason in managing goods and services of a corporation or a community, what do you think of inserting as rules of conduct, the ethics of the economic values of this noble and universal religion?
John C. Bogle: I'm not an expert on Islam, but I think there are lots of noble religions whose basic principles could stand considerably more observation in the world of business.
Bill, Denver, Colo.: In my view, the fulcrum of failure came for today's managers at the time they could award themselves excessive stock options. This encouraged top management to fraudulently distort the results reported to the public, thus accommodating their personal economic goals rather than the long term goals of their shareholders.
Personal greed has become a board-accepted, pervasive characteristic of today's top management.
Do you agree?
John C. Bogle: I agree with your first paragraph as it applies to too many of today's managers. I think we all ought to be careful about too much generalization on this issue, even as I confess to painting with a pretty broad brush myself!
Evanston, Ill.: Why not work on replacing capitalism with something fairer and more efficient? American University economist Robin Hahnel has many sound suggestions.
John C. Bogle: While I haven't read economist Hahnel's work, replacing capitalism would be at the very bottom of my list of priorities -- to be considered only after everything else had been tried. Improving our capitalistic system however, is at the top of my list and is of course the major theme of _The Battle for the Soul of Capitalism_.
Redondo Beach, Calif.: Can you provide a succinct MORAL defense of Capitalism? Why is it morally good? Capital is usually defended on grounds that it works better than socialism. Can you defend it, on moral grounds?
John C. Bogle: I think it's fairly easy to provide a moral defense of capitalism. It has been -- over the last 200 years -- the underlying basis for enormous increases in productivity and human welfare and rising living standards, particularly in the United States, and in the industrialized nations but in fact, in most parts of the world. Yes, I'd be the first to agree that capitalism bestows its blessings unevenly. But that wouldn't persuade me to think it was a good idea to do away with those blessings in their entirety. That said, there is lots of work to be done to make capitalism work better, and to broaden its blessings far more widely not only in America, but all over the globe.
Collinsville, Va.: The word "soul" suggests the presence of humaneness, compassion, and caring. Isn't "soul" an oxymoron when applied to capitalism?
John C. Bogle: You are not the first person to suggest that the use of "soul" in my book title is a bit pretentious. Perhaps so. But even so (you'll find this in the book) Thomas Aquinas defined the human soul as the core of our being, and the power that brings our characteristics into unity so the soul of capitalism -- in its own temporal world as contrasted to the spiritual world of human beings -- is what defines the core of the system and the factors that unify to produce the wonderful world that we are blessed to live in.
Laurel, Md.: About how much in percentage terms did a typical 401(k) investor lose from the well-known corporate scandals of recent years (MCI, Enron, and the mutual fund improprieties)?
John C. Bogle: I hesitate to comment on "the typical" 401k investor. Heavily laden with company stock, 401k participants were pretty much wiped out at MCI and Enron, while the mutual fund scandals -- while disgraceful and shocking -- had a fairly modest financial dimension. However, the fund scandals shined the spotlight on the fact that mutual fund managers were putting their interests ahead of the fund shareholders who trusted them, which had much more substantial consequences in the form of excessive fees and the promotion -- as the market moved into the stratosphere -- of technology funds and new economy funds which were soon to collapse.
Tampa, Fla.: The opponents of Sarbanes-Oxley are guilty of either total ignorance or willful blindness. They claim SOX inhibits business and costs too much. Everyone in the accounting industry (including myself; I'm a CPA) knows the Big 8-6-5-4 under priced audits as a loss leader. The increased audit fees about with CEO cheerleaders complain are finally being priced at market levels. Sure, there's a fair amount of overkill, but that is a lot better than the under kill of past years. And accounting systems are most expensive in th early years; their costs drop sharply after implementing them is finished. Even now, the average publicly-traded company still spends less on audit and SOX fees than on CEO pay. We can start worrying when the reverse comes true. How do you feel about this?
Those who oppose SOX say the shareholders can discipline errant management. As an Enron employee said to Ken Lay when Lay said Enron at $90 was a great buy, are they smoking crack? Shareholders do not control the board of directors and have no power over their companies, thanks to management-friendly laws of states like Delaware and Nevada. Shareholders cannot nominate directors and cannot nominate officers. Shareholders can't even know what the companies they own pay the CEO. Now how are shareholders to make and enforce any decisions over management?
Perhaps you could compare and contrast corporate elections in the US today with elections in the former USSR. Any striking similarities come to mind?
Finally, the feds, in conjunction with the EU, should bust up the Big 4 into the Big 8. I understand Richard Breeden, the overseer of KPMG, has publicly stated this in the past. I agree with Breeden totally. How do you feel about this?
John C. Bogle: I happen to be a believer that SOX was a necessary, indeed long overdue, law. I was chairman of the Instinet audit committee during the early years of SOX and, yes, it was expensive and to some degree cumbersome but it was also long overdue. I have seen very few negative comments about SOX except on section 404 on financial controls and I believe it would be useful for the PCOAB to have substantive discussions with its critics, and not to get rid of section 404, but to make it more manageable for smaller companies. Recently in the news there's been a proposal to eliminate 404 for smaller companies, which I think would be a tragic overreaction.
Brooklyn, N.Y.: Don't you think that many CEOs are grossly overpaid? Enormous salaries and egos to go with it! The gap between what they make and their employees make is way too great. How many more employees could be put on the payroll if they took less? How could anyone ever justify Mr. Grasso's salary? It is time for institutional shareholders to take a more active role on this issue.
John C. Bogle: Yes. And amen!
Washington, D.C.: Are there specific reforms that could be made to the system to make it better? Or are the kinds of changes you describe able to be brought about primarily through the effects of many individuals all changing their behaviors - a "grass roots" kind of reform? Is it top-down or bottom-up?
John C. Bogle: A simple answer: it's both. We need to reorganize our entire system of retirement plan investing and to develop federal standards of fiduciary duty for pension trustees and fund managers. These require "top down" intervention. But we also need investors to look after their own economic interests, a bottom up approach to our problems that is well within our individual power to undertake. I discuss both of these approaches in considerable depth in "The Battle . . ".
Albuquerque, N.M.: A response to the hypothetical......
Q: What will make you, a retired professional of comfortable means re-invest in corporate America?
A: I will need clear, consistent and persistent evidence that corporate leaders are actually earning their income with clear and consistent evidence that corporate boards and CEOs no longer collude to filch investors' hard earned money.
Mr. Bogle: for the next decade, my money stays in real estate, treasuries and buried in my back yard! I suspect I am not alone. Since 2000, this has clearly been a sound financial strategy; at least for me.
John C. Bogle: First of all let me assure you that I'm not retired although I confess that I've accumulated comfortable means during my long career. Corporate leaders surely have their problems, I believe that most CEOs are doing their best to hew to the ethical line. The problem is that that line has gotten blurred and that our moral standard seems to be "if everybody else is doing it, it's okay". That's not good enough for me. I believe that during the next decade that investing in stocks is likely to provide slightly higher returns than investing in bonds -- perhaps 6 1/2 % per year vs. 4 1/2% -- and that premium, if realized, will compound to create substantial additional assets. But we live in a very risky world and investors should not get "carried away" with excessive allocations to equities, or for that matter, real estate. As always asset allocation and low cost and broad diversification will be essential in earning one's fair share of whatever returns our financial markets are generous enough to bestow upon us.
Thank you Mr. Bogle for joining us today for this online discussion. To continue a discussion on ethics in corporate America, the authors of the new book "Pump and Dump: The Rancid Rules of the New Economy," are online now. To read or ask a question, click
Editor's Note: washingtonpost.com moderators retain editorial control over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. washingtonpost.com is not responsible for any content posted by third parties.