Scott Shepard: Investment-House Collusion Suffocates Market Signals

In the below commentary published at RealClearMarkets, Free Enterprise Project Director Scott Shepard wants to know:

What shall we call a combination by three giant investment houses to use other people’s assets to force behaviors that reduce the productivity of all large American corporations in a way that masks the free-market information that these moves are wildly unproductive?

Hint: It certainly isn’t capitalism.

Even occasional readers of these pages will be aware by now that American capitalism is suffering attack from giant investment-house magnates who would prefer to replace the invisible hand of free markets with the marshal’s baton of their own direction. Such replacement would destroy – and is destroying – the genius of the market and of capitalism generally, with disastrous effects for American and world commerce and the human lope toward the broad, sunlit uplands of ever-increasing happiness and prosperity.

Scott Shepard

In order to see this, join me in a thought experiment, one whose correlation with reality you can for yourself judge.

Imagine that American investment is dominated by three huge investment houses – operations that collect other people’s money to invest for them. Then imagine that these three investment houses are the two biggest investors in one another, respectively, such that they in practice function as a single, giant Borg. Also imagine that the Borg collectively is the biggest shareholder of most American corporations by a very, very long chalk.

Now posit that the chief executives of these companies have used the power of the investments that they have placed for other people – power that really belongs to the ultimate investors and beneficiaries of those investments, not to them – to force all of the major public corporations of the United States to do those chief executives’ collective bidding, rather than to respond to market stimuli and feedback. Assume that we know this because the chief executive of one of the Borg components, BorgRegent, who fancies himself the fairest marshal of them all, has spent years bragging about it.

Isn’t it clear that every intervention by the Borg will result in a subtraction from the knowledge that freely functioning markets generate? Such markets, for instance, have long since established, as common sense also establishes, that the best way to prosper as a company is to hire the people who will be best at the jobs for which they’re hired, and not on any other basis? In other words, the only competent hiring plan is one of hiring purely on the basis of merit.

Everyone knows this, and in a freely functioning market without the Borg, those companies that hired on any other basis would rapidly see the consequences in falling productivity, revenue, profit and share price. The market and its signaling function – the primary value of free markets other than the, you know, freedom itself – will swiftly correct the misimpression that hiring on any other basis is a good idea.

But now posit that the Borg gets involved and forces companies to hire on the basis of considerations that are irrelevant to success, such as skin color, sex and sexual orientation. Imagine that they require companies to pretend that research that proves no such thing demonstrates – contra markets – that hiring on these bases magically increases productivity and corporate value. And then posit that the Borg uses the power of other peoples’ money to force essentially all large companies to do this.

The effect will be to destroy the signaling function of the market. If everyone is forced to do an unproductive thing, then the market won’t be able to indicate that it’s unproductive. But this won’t mean that it is productive; rather, it will mean that it is vastly unproductive, because the whole market is engaged in the unproductive thing – but that the Borg has made sure that the evidence of unproductivity is hidden.

In fact, it would seem pretty clear that the whole purpose of the Borg forcing something so unproductive – and so malign – on all companies at the same time would exactly be to hide how unproductive it is. The Borg is specifically acting to break the information effect of the market.

Similarly, imagine that the Borg has required these companies to abandon cheap, reliable energy to embrace expensive, unreliable energy – which, incidentally, is no cleaner than the reliable and affordable stuff. Energy is a central cost of any modern business. Any business that voluntarily gave up the good stuff to go for the expensive and spotty alternative would soon find itself out of business, as it should, and this information would inform other companies not to do the same thing.

But here, again, the Borg’s forcing everyone to adopt the same terrible decision at the same time masks that market-information process. Again, that seems to be the specific purpose of the Borg: to defeat the market.

Now, what shall we call a combination by three giant investment houses to use other people’s assets to force behaviors that reduce the productivity of all large American corporations in a way that masks the free-market information that these moves are wildly unproductive? It’s certain that this combination to force unproductivity while hiding that effect will make things more expensive for consumers and decrease their general welfare.

If only I could remember the name for such things.

Scott Shepard is a fellow at the National Center for Public Policy Research and Director of its Free Enterprise Project. This first appeared at RealClearMarkets.