"There was a dream that was Rome. You could only whisper it. Anything more than a whisper and it would vanish, it was so fragile." Marcus Aurelius, Gladiator
This article is a bit of a departure from our usual commentary on recent market activities. I focus on companies in managing funds for my clients, but the markets in which those companies operate have become extremely important in recent years. Own a Greek bank? Sorry. Own a Canadian bank? Congratulations, you're at the top of the performance charts for the past 5 years. Macroeconomic events have imposed themselves on the once insular world of equity investing in a major way. However, investable markets have always had at their core a freedom from corruption (sorry Russia) and regulatory over-reach. As we wade through the onslaught of earnings releases in the coming weeks, and deal with the repercussions of an impending Spanish "restructuring", I thought it would be good to step back and look at the "rules" under which the various companies we may invest in operate. Warning: I was a History major in college.
The United States government was modeled after that of the Roman Republic. The Roman republican form of government consisted of three branches – a Senate, an Assembly, and a Consul (President). The Romans had 2 Consuls in order to prevent any one person from accumulating too much power, but otherwise our system in the US is very similar to that of the Roman Republic. While there are numerous and complex reasons for the fall of the Roman Empire, a very simple version of the story would be that the government got too large, religion came to dominate politics and government, politicians became decadent, leading bureaucracy to get out of hand, which led to ever higher taxes being imposed on businesses, which in turn begat corruption and a flight of intellectual capital (those that could move their businesses did) out of Rome and into the territories. The "fall" in 476 was just the closing act of a long decline.
A recent article I wrote discussed how the main threat to the US economy is too much regulation. From Dodd-Frank to the mandatory purchase of health insurance, from insane licensing requirements to be a hairstylist to the Consumer Product Safety Improvement Act of July 2008 that required third-party certification that toys didn't contain lead or phthalates (according to this article, "each component of a toy, such as zippers, buttons, and paint, must be tested separately. Retailers must also ensure that their entire inventory is certified. Toymakers and retailers who violate the law face fines of tens of thousands of dollars."), over-regulation is threatening to drive the US down the path taken by Rome into decline.
For an easy compare and contrast about the dangers of over-regulation versus letting people make individual decisions to get things done, read this excellent article from the April 14th Wall Street Journal, page A13, about the large difference in the recoveries from the tornadoes of last year that destroyed Joplin, Missouri and Tuscaloosa, Alabama. The article clearly illustrates the power of individual initiative versus the inaction and sclerosis that clogs the arteries of the economy as a result of central-planning and regulation. Tuscaloosa decided to centrally plan everything related to rebuilding its city – as a result, less than half of affected businesses in Tuscaloosa have reopened, versus 8 out of 10 in Joplin. Tuscaloosa's recovery plan is 128 pages long and was written by outside consultants. Joplin's is 21 pages long, made property rights a priority and relied heavily on business input and a citizen's advisory group. Joplin relaxed regulations and reduced licensing lead times in order to speed the recovery. Joplin is now nearly rebuilt. Tuscaloosa hasn't even really gotten started.
The paternalistic approach taken by Tuscaloosa is unfortunately endemic in government in recent years. Government run by professional politicians, instead of regular citizens who serve their term and then return to their communities, breeds a poor form of democracy. Professional, career politicians see every problem as something to be solved by more government – to a hammer, everything is a nail. These politicians create more laws, which require more bureaucracy to enforce them, in a downward spiral of rules and regulations.
"I don't pretend to be a man of the people. But I do try to be a man for the people." Gracchus, Gladiator
This is even more of a problem in Europe than in the US. In Europe, career regulators and government workers assume, as a given, that bigger is better, that bigger is safer, that more rules somehow mean that bad things won't happen. But ask yourself this: when you think of dynamic, forward looking organizations, ones that really "get it", places that inspire confidence and make others want to emulate them, do you think of a regulatory agency? Did the European Commission Competition Committee ("Making Markets Work Better" – no really, that's their slogan) pop into your head? Mine neither. And yet investors are required to rely on ratings from ratings agencies and regulators in determining the safety of investments. People that have never worked in a particular job or even industry are given special status as those that determine what is risky and what is not, what levels of leverage are ok and which are not, and get to determine what investors can and cannot do, without regard to the realities of the actual investment risks and merits. For a recent egregious example, see this Financial Times article on the new EU and Swiss regulations for hedge funds. Not only does it impose reporting requirements (understandable for funds of a certain size), but now they will also tell private businesses how much they can pay their owners and employees. Switzerland is even now requiring that any fund that takes money from a Swiss investor must have a permanent employee in the country. Finma, the national regulator, states that the rule changes "aim to raise quality in asset management…and strengthen investor protection." Implied in this is that a bigger fund is a safer fund. AIG (AIG) was one of the biggest insurance companies in the world when it needed to be rescued. Bank of America (BAC) was the largest US bank when it got bailed out. The list goes on and on. And yet implicit in these new rules is that bigger is better and safer. Nothing could be further from the truth. Too big to fail is now government policy.
Relatively speaking, the US looks really good. The recent JOBS Act reduces impediments to small and mid-sized firms raising capital. This simple move, combined with the EU's ever increasing regulatory burden, will help the US retain its lead as the best place to start and grow new innovative businesses. China and Russia are too corrupt, the EU is too stifled by regulation, Africa and South America, while full of potential, generally do not yet have the infrastructure and rule of law necessary to sustain strong entrepreneurial economies. Australia and Canada are similar or superior to the US in some ways (strong resource utilization for example), but simply have small populations, relatively speaking. So while the ever-expanding US legal system is a real danger (read this article for a scary look at our reality – it is about the erosion of Mens Rea legal protections at the same time that there has been a dramatic increase in federal criminal laws. Among other things, its states "Back in 1790, the first federal criminal law passed by Congress listed fewer than 20 federal crimes. Today there are an estimated 4,500 crimes in federal statutes, plus thousands more embedded in federal regulations, many of which have been added to the penal code since the 1970s.)
"It's a dream, a frightful dream... life is..." Commodus, Gladiator
Europe is farther along this dangerous path than the U.S. is, and by a large margin, but it doesn't mean that our relatively less bad position means that we should become complacent to the dangers of over-regulation and too much bureaucracy. David Kotok wrote a great essay on this topic recently – the full article can be found here. He described the issue well, so I will quote it liberally:
"I invite you to read the last few sentences of the below article from The Lessons of History, by Will and Ariel Durant. It is about how the destruction of the Roman Empire through the taxation channel made people 'slaves,' in other words how serfdom emerged. This is my number one fear for Italy, but I guess France is making the same mistakes, just starting from a lower debt level. You can also find an online version of the book, thanks to Google.
"Rome had its socialist interlude under Diocletian. Faced with increasing poverty and restlessness among the masses, and with the imminent danger of barbarian invasion, he issued in A.D. 301 an edictum de pretiis, which denounced monopolists for keeping goods from the market to raise prices, and set maximum prices and wages for all important articles and services. Extensive public works were undertaken to put the unemployed to work, and food was distributed gratis, or at reduced prices, to the poor. The government – which already owned most mines, quarries, and salt deposits – brought nearly all major industries and guilds under detailed control. 'In every large town,' we are told, 'the state became a powerful employer, standing head and shoulders above the private industrialists, who were in any case crushed by taxation.' When businessmen predicted ruin, Diocletian explained that the barbarians were at the gate, and that individual liberty had to be shelved until collective liberty could be made secure. The socialism of Diocletian was a war economy, made possible by fear of foreign attack. Other factors equal, internal liberty varies inversely with external danger.
"The task of controlling men in economic detail proved too much for Diocletian's expanding, expensive, and corrupt bureaucracy. To support this officialdom – the army, the courts, public works, and the dole – taxation rose to such heights that people lost the incentive to work or earn, and an erosive contest began between lawyers finding devices to evade taxes and lawyers formulating laws to prevent evasion. Thousands of Romans, to escape the tax gatherer, fled over the frontiers to seek refuge among the barbarians. Seeking to check this elusive mobility and to facilitate regulation and taxation, the government issued decrees binding the peasant to his field and the worker to his shop until all their debts and taxes had been paid. In this and other ways medieval serfdom began."
For now, the Roman Republic (ah, United States.) lives on and remains the best place to live and invest. Let's hope we can avoid the fate of our forefathers in democracy and instead build a lasting, strong republic.