Investors vs. Consumers: Misaligned Interests?David Bogoslaw
As the mortgage loan securitization fiasco has shown, business practices that generate the highest returns for investors are often at odds with the best interests of consumers. By now, most people are aware that one of the driving forces of the reckless availability of cheap credit to home buyers was the need to ensure an ongoing flow of mortgage-backed securities to ravenous and overly confident investors.
This misalignment of interests persists. Witness the recent success of investment banks in defeating legislation that would have allowed bankruptcy court judges to change the terms of underwater mortgages to help keep people in their homes rather than suffer foreclosure. To be fair, loan servicers' objections to so-called bankruptcy cramdowns are as much about concerns over legal exposure to investor lawsuits as refusal to settle for lower returns on pools of mortgages.
Socially responsible investing (SRI) managers and advisers have been at the forefront of efforts to get investors to focus more on sustainable practices that work to all stakeholders' advantage over the long term instead of just short-term returns. Much of the appeal of the SRI approach, besides addressing issues of responsible environmental practices and treatment of workers, lies in increasing awareness among investors about the misalignment of their interests with those of consumers.
Consumer Balance Sheets
For Reynders, McVeigh Capital Management in Boston, which follows an SRI model for the separately managed accounts it handles, the common ground between investors and consumers comes down to the idea of sustainability.
Although economists and policymakers keep focusing on the need for a recovery in home prices, "maybe the best thing for the housing market long-term and for people who bought houses responsibly is to keep a higher savings rate and to have the market stay muted for a longer time so their balance sheets can improve," says Chat Reynders, a principal at the firm.
"If house prices go up everywhere, it doesn't help you" as a consumer since you can't afford to buy a new home in the same market, says Richard Green, director and Lusk Chair in Real Estate at the Lusk Center for Real Estate at the University of Southern California. "The only way you can benefit is if you sold a house in California in 2006 and moved to Alabama." But while you would have cashed out, you would no longer be living where you wanted to live, he adds.
In reality, there's a lot of overlap between investors and consumers, since all investors are also consumers, and even instititional investors, such as employee pension plans, represent thousands of individual consumers. Some institutional investors, including the California Public Employees' Retirement System (CalPERS), have been giving a lot of thought to a more holistic and sustainable approach to investing for some time. The list of principles that the Aspen Institute published two years ago—aimed at getting companies and institutional investors to shift from a short-term focus to a long-term one when measuring value creation—was developed in cooperation with CalPERS and other groups concerned about business ethics.
For Judy Samuelson, executive director of the Aspen Institute's Business & Society program, it's a question of how to "extend the time horizons of investors and align money managers with the real endgame investors here who, in fact, are thinking long-term. [As an individual investor], I don't need alpha tomorrow. I need to be widely invested and make sure I have money in the bank when I retire."
While individual investors are mostly thinking about the long term, however, the problem is mutual fund managers are compensated based on very short-term performance, which explains much of the churn in ownership of equity shares, Samuelson says. That forces corporate executives to pay more attention to short-term growth instead of how to provide high-quality goods and services that stand the test of time.
CalPERS, along with TIAA-CREF and Britain's F&C Asset Management, supported resolutions this spring calling for three of the largest credit-card issuers to produce reports evaluating their credit-card marketing, lending, and collection practices, which are commonly deemed to be predatory, and the impact of these practices on borrowers, says Mark Regier, stewardship investing services manager at MMA Praxis Mutual Funds, the program agency of the Mennonite Church USA, which manages about $700 million in assets. MMA Praxis is one of a handful of church-related shareholder groups that filed these resolutions at six of the seven leading credit-card issuers.
Heat on Credit Cards
"This is the first time we've seen credit-card lending resolutions," says Eric Shostal, head of social and environmental policy at RiskMetrics Group (RMG), a provider of risk management and corporate governance services. "Several companies argued at the [Securities & Exchange Commission] that they would be able to omit them on ordinary business grounds but were turned down."
The credit-card resolutions came to a proxy vote at Bank of America (BAC), Citigroup (C), and JPMorgan Chase (JPM), where the preliminary votes in support of the resolutions were 33.4%, 28.4%, and 8.4%, respectively, of the votes cast, he says. Any vote of support above 10% gives the filers the right to resubmit the resolution the following year.
Two other proposals didn't come to a vote. One concerned predatory payday lending practices at Cash America and other payday lending institutions. The other involved compliance with the Eurodad Charter on Responsible Lending Practices adopted in January 2008 and developed by a consortium of nongovernmental organizations from 17 countries on the premise that the global financial crisis calls for new lending practices.
Question of Management
More and more, larger investors, "particularly those called universal investors, who own literally everything," are recognizing the damage to their overall returns by companies that externalize costs by passing them downstream instead of finding ways to manage them at the source, says Regier at MMA Praxis. The breadth of their portfolios allows them to see how the higher profits of one company that avoids environmental cleanup costs, for example, are offset by the detrimental effects that has on another company.
"They are seeing companies that ought to be better managed," says Regier. "In the process of finding a solution at company A, [management will] find a better way to make that product."
Closer alignment of investor and consumer interests is mostly about thinking of what will produce the most benefit in the long run. Although much of the urgent push for a shift to a more sustainable business model has targeted the financial services industry, shareholder activists such as MMA Praxis are starting to give careful thought to applying the model to other industries as well.
Health care, for example, is ripe for such an overhaul of priorities among stakeholders. In that industry, however, it's often harder to pinpoint the source of tension between investors and consumers, since the industry doesn't strictly adhere to free-market forces, according to Martin Bailey, a macroeconomist at the Brookings Institution. When you add to the equation the various forms of insurance most people have, responsibility for mismatched interests is due less to the profit motive of health-care providers than to inefficiencies in the system itself, he says.
"The problem with the current system is we give incentives for activity rather than for [taking good care of people's] health," says Bailey. While the two are partly linked, the current system seems to result in an excessive number of doctor visits and medical tests and the use of higher-priced drugs where lower-priced generics might work just as well, he says.
To improve the system, the incentives given to consumers and providers need to change, and that will require a lot of education of consumers, many of whom are resistant to the so-called socialized approach to medicine taken in Europe and Canada, says Bailey.
While the Interfaith Center on Corporate Responsibility (ICCR) has yet to draft any concrete resolutions directed at the health-care companies whose shares its members own, the organization does have a set of reform principles that Regier at MMA Praxis believes will help point toward solutions in the future.
Those principles grow out of such questions as whether it's better for health-care companies to make a lot of money off a limited number of very sick people or to look for business models that allow them to serve a broader population of healthier people with greater access to insurance, says Regier.
That issue has spurred such companies as Wal-Mart (WMT) to embrace the need for health-care reform, since the company sees a path toward better management of expenses that would allow it to trim costs associated with employee absenteeism and the adverse effects of poor health on work sites, says Regier.
"This is where I think the institutional investor role is so important. We have portfolios that we intend to be around 30 to 40 years from now," he says. That long horizon gives institutions an incentive to push for more sustainable business practices at the companies in which they invest. "As institutional investors, let's set our horizon a little further out," Regier says.
Ideally, there should be some confluence of interests between consumers and investors who want their companies to sell a quality product that meets legitimate consumer needs, that doesn't harm them, and that enhances their well-being and standard of living, says Robert Weissman, director of Economic Action, a not-for-profit organization that advocates for improved corporate accountability.
"At the same time, there is a core conflict: Investors have a simultaneous interest in price-gouging consumers, or selling them something they don't need or something of questionable quality," he says. "If those practices enhance the bottom line, generally investors applaud them."
The U.S. government is also taking a more proactive stance in trying to bring corporate, investor, and consumer interests into closer alignment, reversing a trend that for many years allowed corporations to define their relationship with consumers. Those efforts include a push for mortgage modifications that would protect service organizations from investor lawsuits and legislation that would give the Food & Drug Administration authority to approve follow-on biologic drugs—cheaper alternatives to brand-name drugs made from living tissues and microorganisms—and provide a cost-effective way to bring them to market that's also favorable to distributors and pharmacy benefit managers.
It's not only investors who may need to adjust the time horizon of their goals. From a different standpoint, allowing delinquent homeowners to modify their mortgages—whether within or outside the Chapter 13 bankruptcy process—may serve their short-term interests without helping them improve their financial behavior over the long run.
"I'm coming around to the idea that people need to make a really big down payment like 20% in order to buy a home," says Green at USC. "And to do that, we need to encourage the use of default savings mechanisms to spur a higher savings rate." Those mechanisms, when incorporated into 401(k) plans, have proven to result in higher savings than retirement plans that require employees to opt in to be enrolled, he says. "When companies structure a plan so that employees have to opt out if they don't want to be enrolled, people don't opt out."