Allison's Ode to the Second Moment


Welcome to the 61st issue of Allison’s Ode to the Second Moment, a newsletter dedicated to making us more aware about risk, but this week argues some of the risks you’ve heard about are overrated.

Market Concentration

Some say it is the single worst thing about the modern economy. It may be responsible for all of our problems: inequality, toxic politics, and the downfall of Caesar salad. I am talking about increased market concentration. If you read The New York Times, The Economist, Bloomberg, or The Financial Times, you might believe that large firms are dominating the economy and causing all sorts of trouble we associate with monopoly power, squeezing workers and consumers, and we need to invoke some anti-trust stat.

There is evidence that markets are becoming more concentrated, especially at the national level. This might not be true at the local level though. Supposed you live in a small town and the local mom-and-pop general store is the only place you can buy stuff. Now that most mom-and-pop stores are out of business, there is probably a Walmart and a Walgreens.

Whether or not this is actually posing normal monopoly problems is an open question. Markets change and evolve, and so does the ideal market structure. It could be that a more globalized, tech-driven economy makes larger firms more productive. After all, more concentrated markets tend to be more productive.

Not only that, there is mixed evidence that market concentration is actually to blame for stagnating wages or higher prices. Actually, prices are lower for many consumer goods—which may be why people in small towns aren’t mourning their lost mom-and-pop stores and burning down Walmart or Amazon in effigy. It is also not clear concentration is actually hurting competition or innovation.

I am not saying monopolies are good things. I worry they pose more risks, we do have less diversification. We can end up with an economy more reliant on a few big firms, and that is worrying. But I am not so excited about trust-busting. Anti-trust is built to solve old-school monopoly problems, higher market ups and suppressed wages. If we have new monopoly problems, we need new monopoly solutions.

Too much diversification means more concentration?

You might think everyone can at least agree that we need more diversification. But Jack Bogle, of all people, is worried we may have too much of a good thing. He argues too much diversification resulted in too much concentration! Let that one sink in.

You see, we all believe in efficient markets these days and are investing in index funds, which means we are well diversified and pay low fees—which is great. But the problem is there are too few index fund providers, and they take up a large share of the market. There are many reasons for this market concentration, as economies of scale make sense given technology and how markets are structured. But Bogle is worried that once index funds make up more than 50% of the market, we’ve reached a tipping point where Vanguard calls the shots for too many corporations. He suggests a number of things to prevent this from happening, including limiting the number of companies in a single industry a fund can invest in. Or, less diversification to preserve more diversification. Bogle rejects that idea and instead advocates for a more robust fiduciary standard (sigh, why does everyone think this is the solution to everything when it is the solution to nothing?).

At the risk of sounding a little Chicago School, I just don’t understand how that tipping point can ever be reached. If markets become inefficient because there’s too much indexing, wouldn’t some active investors come along and make money off this?

Also, it is a big leap from 17% (current share of stocks owned by indexers) to 50%. I am all about indexing, but I accept its appeal is limited. Remember institutional investors? The people who manage pension funds and endowments need to claim they are getting higher returns than everyone else (whether they actually do is a different story). It is how they keep their jobs and they can only do this if they invest in actively managed funds. Institutional investors manage lots of money. Maybe someday all retail investors will index, but I am not convinced it will destroy markets.

It seems like Bogle wants to create a first-order cost to prevent a potential third-order problem.

Fed Speech

People are excited because Jay Powell said interest rates are just below neutral, as opposed to far below, I guess just and far are matters of a few weeks and even fewer basis points. Or people just believe what they want to believe when they think the fed funds rate is the single most important thing in the economy and a few basis points matter a lot.

What I found more interesting is that the Fed is now publishing a Financial Stability Report! Yup, the mandate meal now officially includes financial stability. Powell says interest rates aren’t the right tool for promoting financial stability. And we are still unclear on what macro-prudential policy means.

And yes, they are worried about leveraged loans, too, but not as much as Elizabeth Warren is.

In Other News:

  • The 4% rule is terrible, I agree, but this article still does not address asset risk, which is sort of worrying.

  • What happens to your saving plans when you plan on one child and then have twins?

  • When you don’t need to mark an asset to market, you might pay an illiquidity premium. I reckon this explains the success for private equity.

  • The University of Illinois insured against the risk that fewer Chinese students would want to enroll and pay tuition. That sounds like a systematic risk that would impact all universities in the U.S. and the UK. I am curious how that policy was priced. No wonder pension geek Jeff Brown was behind it.

  • It takes more than money to help low-income students thrive in college.

Until next time, Pension Geeks!