When Investment News asked John Bogle, Vanguard's founder and the father of indexing, about my "Indexing into the Ditch" thesis (that indexing is one of the root causes of the financial crisis) he said: it “is nuts! Last time I looked, index funds accounted for about 0.4% of all stock trading ... Just perhaps the other 99.6% might bear a teeny-weeny bit of the responsibility.”
Let me first respond to Mr. Bogle's points in order.
The thesis "is nuts! "I must admit I smiled at the ad hominum implication that my thesis was "nuts" and not worth listening to; I remembered that Bernie Ebbers called me the "idiot Washington analyst" because my research was the first to charge that WorldCom's business simply did not add up.
- Most objective people would not consider it nuts to try and find as many of the different contributing causes of last fall's financial crisis as possible -- wherever that investigation may lead.
- Ultimately, it won't be Mr. Bogle's spin that will matter, but what the Financial Crisis Inquiry Commission, Congress, the Administration and regulators conclude after a full vetting of the facts. When all is said and done in cleaning up after last fall's financial crisis, I believe there will be many that conclude like I have that:
- "Market bubbles and crashes will continue to destroy the economy, jobs, and people's financial security as long as our regulatory and tax policies condone and encourage mass index speculation."
Indexing's only .4% of trades: This is a clever attempt at misdirection. Readers of my piece/thesis know that I spotlighted ETF's, daily traded index derivatives, which can create a large, distorting, market momentum effect. That's because they happen completely predictably right before the end of every trading day so that other un-recorded speculators can draft behind the formally recorded index/ETF speculators.
- My point is that it is less the exact amount of index trading that is the problem and more the concentrated timing and nature of the trading because it increases the ability to manipulate the market. Moreover, index funds and ETFs have spawned huge amounts of closet indexing or mass "me too" momentum-chasing trades that conveniently escape Mr. Bogle's misleading .4% "statistic."
- The .4% line of argument is also deceptive in that it ignores the speculative role of ETF's, the daily-traded index derivatives that Mr. Bogle himself has derided as speculation, just like I have in my argument.
- It is ironic that Mr. Bogle maintains that his indexing uber alles approach, bears no responsibility for the index derivative offspring, ETFs, that Mr. Bogle's indexing movement largely fathered.
"Others might bear a teeny-weeny bit of the responsibility." Mr. Bogle's sarcasm is a classic straw man argument.
- The title of my "Indexing into the Ditch -- Financial Crisis Root Causes -- Part I" made clear that there are other additional parts to my Financial Crisis Root Causes research series.
- Moreover, in my piece I never argued that indexing was the sole or only cause of the Financial Crisis. I described it as "a major reason" and "a major root cause" not the reason or the root cause.
Apparently, Mr. Bogle does not want people to consider the common sense factual basis of my "Indexing into the Ditch" thesis.
- "The monster flaw in index theory is the core assumption that indexing is benign and has no ill-effect on companies, markets, the economy, or the financial system." I then laid out why:
- "Indexing is destabilizing.
- "Indexing undermines capital formation and market efficiency."
- "Indexing is speculation."
- "Indexing hyper-stresses the financial system."
Next let me pose some important questions I would like to ask Mr. Bogle, if he is open to looking at the big picture and indexing's part of the big financial picture.
- Since index funds derive their value from an underlying collection of companies or other assets, aren't index funds essentially a derivative sold to average consumers?
- Could indexing derivatives ever cause market externalities or unintended consequences? If so what are they?
- Does a rapidly-growing, trillion-dollar-plus financial derivative system, that algorithmically-indexes the broader capital markets system, pose any systemic risk to the broader capital markets system of allocating capital on merit? If not, why do some derivative systems affect the broader market and others do not?
- At what share point of market adoption does an index essentially become the market it indexes?
- At what percent of market adoption does indexing on the basis of a relative algorithm and not economics or company fundamentals have an affect (positive or negative) on the economy or companies' fundamentals?
- Is there anything wrong with a large segment of society expecting to game the financial system and get something for basically nothing?
- Is indexing, or passive investing, at core a parasitic relationship that depends on a healthy, willing and active managed market host in order to survive and thrive?
- Should public companies be forced to sell their stock publicly to regulated public entities that clearly do not care at all about their solvency, fundamentals, track record, or future... or their employees or pension-holders for that matter?
- Should derivatives that are destructive to capital formation, market efficiency, financial system stability and economic growth, enjoy favorable regulatory, tax, or Federal retirement treatment?