We Need More Wall Street Prudence, but Could We Go Too Far?

John Bogle, founder of the highly respected, and one of the most stable and successful financial firms Vanguard, noted in The WSJ this week five problems Wall Street failed to recognize during the mortgage bubble period:

  • First, the folly of short-term speculation has replaced the wisdom of long-term investing as the star of capitalism.
  • Two, the financial sector became the driving force in the U.S. economy.
  • Three, innovation became the buzzword of the era. But innovation was dominated by complex new products, such as credit default swaps and collateralized debt obligations, designed to make money for Wall Street firms rather than for their clients.
  • Four, all of this speculative market activity and costly marketing activity seemed to lead institutional money managers to ignore the realities that drove the balance sheets and income statements of the companies held in their portfolios, a striking failure of professional security analysis.
  • Five, absent the check of their institutional owners, corporations pushed executive compensation to unprecedented heights.

Clearly these are all true. The question becomes, to what degree are these issues inherently wrong, or were they just misused, abused, or misunderstood?

For instance, obviously Wall Street is now dominated by a short-term outlook on financial gain, as opposed to the less lucrative long-term investment. But it doesn’t mean that short-term speculation is inherently bad though, it just must come in moderation.

And sure the financial sector is driving the economy, but that brought about rapid growth. If Wall Street had been more prudent, we could have had the growth in more stable form.

The same analysis would apply to the remaining three issues. And I don’t think Mr. Bogle would disagree with me. But he would say to lean towards the side of caution. It is a strategy he employed his whole life and it has made him very successful.

I wrote about Mr. Bogle back in September here featuring an interview in which he offers more analysis of the crisis and response.