The Market Is Broken: Thoughts on Big Investors and Lack of Oversight

In the financial markets, we have always had two important components: investors and regulators. Today, we are seeing governments as significant market participants that impact global markets. Sovereign wealth funds and public pension funds around the world are now among the largest owners of publicly traded stocks and bonds. China and Japan alone represent $5 trillion in public funds out of an estimated total $30 trillion of investments owned by 160 countries. No doubt these are investors of great size that can crowd out individual and institutional investors.

Enter Central Banks

In recent years, the largest and newest players are the central banks. Some say they wield both unprecedented and massive power, boasting unlimited resources because of their ability to print money. As investors, the major concern we have is that there is absolutely no supervision, accountability, or transparency when central bankers are buying equities and corporate bonds in the market place.

Ponzi Scheme Alert?

“The major central banks are no longer just the Banks of Last Resort. They are turning into Investors of First Resort.” This quote comes from Ed Yardeni, a respected economist and investment strategist. He goes on to say, “In the long run, it’s hard to imagine that having the central monetary planners buy corporate bonds and stocks with the money they print can end well. In effect, the central banks are turning into the world’s biggest hedge funds, financed by their own internal primary (money-printing) dealers and backstopped by the government--which can always borrow more from the central bank or force taxpayers to make good on this Ponzi scheme.”

Lack of Experience

To be a successful long-term investor, it takes discipline that is typically honed with experience. We looked at the credentials of ECB Chief Mario Draghi and Bank of Japan Governor Haruhiko Kuroda. Neither has had any investment experience. This is not surprising since most central bank heads are academics and bureaucrats. Draghi was a college professor at the University of Florence while Kuroda worked at various tax departments in the Japanese government as a bureaucrat after studying law as an undergraduate.

Big Bulls in the China Shop

Never in the history of the world have we seen the largest players being allowed to speak secretly, plot their actions together, and influence share prices in coordination. This certainly appears to be the case when central banks meet at G7 and G20 gatherings. They discuss market conditions and subsequently take coordinated action. Time and time again, these like-minded central banks have shown herd-like behavior by supporting equity markets and chasing yield, thus creating volatility and spikes in the financial markets. Investors and journalists scramble to find clues in what the central banks are saying. Markets move on the use of a specific word, or lack thereof. Statisticians chart FOMC statement word count!

The central banks’ foreign exchange reserves have grown to trillions in Yen, Euro, or Dollars at an unprecedented pace. As the world’s largest investors, they need to cope with competition, complexity, and trading inefficiencies due to their sheer size when accumulating stocks and bonds in the trillions. Central banks can say they’re responsible for ‘financial stability” when providing huge liquidity to the financial markets, but what happens if/when they take money out of markets in big pieces? And who is responsible for overseeing and regulating the world’s major governments in the financial markets in the future?

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"broken glass 2" by Nesster is licensed under CC BY 2.0

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About the Author: Andrew Wang

Andrew Wang


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