The Wealth Gap
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(daily performance is updated after the close, early blog posts typically show the previous days performance)
"I’m not a fan of MMT — not at all,
We don’t need to get into danger zones,
and we don’t know precisely where they are.”
― Warren Buffett, democrat
I read an article recently about the growing divide between the rich and everyone else. The author made the same argument that I've read in many of these articles, essentially that the rich have too much money and the solution is to distribute it more equitably. This premise has always seemed overly simplistic and impossible to execute in the U.S. This redistribution idea also doesn't seem to provide a long term, generational model for success.
I'm reminded of a diseased lawn, where in some areas the lawn grows really green, is overly thick and thrives, while in other areas the lawn struggles just to survive. So to solve this problem the gardener regularly cuts the thick green areas way back and sprinkles it over the barren areas; and for a while everything looks okay. The gardener keeps up this practice and after a while notices that the areas he cut way back are no longer producing the thick green lawn that he needs to sprinkle over the barren areas; in fact the whole lawn is beginning to die off.
I accept that the wealth gap exists, I'm fully on board with helping everyone have all the resources they need and have access to opportunities that enable them to grow their own wealth as much or as little as they choose; note that, "as much as each individual chooses" for themselves and their family. What I don't accept is the premise that all wealthy people are evil, or that the only way they could possibly have achieved their success was by taking from those in greater need. Bad actors in every group exist. I prefer to look to macro economic indicators and the systems of wealth distribution that we have to see what went wrong and if there might be some answers in the data. Let's dig a little deeper into the soil.
Initial Public Offerings (IPOs)
In a 2017 Speech SEC Commissioner Michael Piwowar was discussing the decline in Initial Public Offerings, in particular the massive decline in small companies coming public. Piwowar stated that, "The beneficial uses to which that capital may be put are even more pronounced for small companies because they tend to be more innovative than large companies and they account for a substantial percentage of the jobs created every year."
What I found most interesting about his comments were that in the 1980's and 1990's 60% of IPOs were small cap companies raising less than $30 million dollars. These companies were significant job creators and included such small cap IPOs as Apple, Cisco and Genentech and many other household names.
About twenty years ago, we used to have an average of 457 IPOs per year. That average has fallen by 50%, which means publicly listed stocks in the U.S. declined by 50% from 1996 to 2016. The U.S doesn't have enough publicly listed companies or enough companies filing to come public. Is this just a U.S problem? Yes, other developed countries experienced a 50% increase in IPOs over the same time period; and the type of IPOs have changed too: “Small-cap IPOs” (< $50M revenue) have declined significantly over this same 20-year period. Since 2000 the number of IPOs is down to about 135. This year 220-230 IPOs are expected to come to the market, a big increase over the last 20 years, but not yet up to the old averages. The biggest concern, will there be enough liquidity in the market to support all the mega IPOs on the way.
Small companies are the biggest job creators over time. Fewer small cap IPOs, fewer jobs, fewer shares going to fewer people, eventually leads to less wealth distribution. It's a chain reaction. Besides fewer jobs, when companies hold off going public longer (Uber, LYFT, Pinterest, Palentir, and others) they become “quasi-IPO” in the private markets. Private markets are where people with wealth can invest in start up companies, like Lyft and one day hope to see the company go public so that they can exit the investment and allow it to trade freely in the public markets. For any investor this type of private equity investment is hugely risky and often takes 10 years to realize a return, if there is any return at all. But when these companies stay private longer most of the profits to be made on the new company are only going to private market investors. Because they stayed private longer, the big initial growth phase was only captured by the private investors so that when the companies do come public their valuations are enormous, making them less affordable by average retail investors. Lyft was founded in 2012 and when it goes public tomorrow will price shares at $72/share or more and the bulk of those shares will go to institutional allotments. The average retail investor who gets a hold of a few shares will be the mechanism that drives share prices up in the short term, and most likely takes the losses as well when the stock prices decline.
What's This Got To Do with the Wealth Gap?
The average investor, who relies on growth to diversify risk, fund retirement obligations, buy a house, put kids through college and so on, are being left out. Over 20 or so years, the people being left out has grown and will continue to grow because those who are allowed to invest in private equity funds (there's a law that protects you from this) are able to earn bigger and bigger returns while everyone else is left to earn what their own two hands can produce. Being invested means you're an owner and participate in the growth and wealth of a company without having to actual perform any work to achieve that wealth.
I'm not screaming "Unfair"! I'm looking at the problem like that diseased lawn and thinking, we need to dig deeper into the soil and fix the source of the problem so that everyone has an opportunity to grow their own treasure as big as they want and we reduce the sprinkling to only those who desperately need our collective help.
How Did This Happen?
The simplistic answer again is that a bunch of greedy rich people got together and figured out a way to screw the rest of us; it's not that simplistic. I think there's a more reasoned answer; well intentioned people passed laws and regulations that were meant to protect us all and maintain stability in our public markets. The unintended consequences of all that regulation are what we have today. Here's my short list of possible contributors:
Regulatory compliance to offer publicly traded shares is expensive
The 2002 introduction of the Sarbanes-Oxley Act increased compliance cost significantly, especially on small IPOs
Dollars spent on regulatory compliance are unavailable to spend on wages, R&D and capital investment
Lack of R&D investment (U.S ranks #10 for R&D investment relative to GDP ) reduces growth, reduces hiring, reduces wages, reduces productivity, ultimately keeping companies smaller and unable to go to the public markets for capital because they can't amortize the compliance cost
Availability of new sources of capital from Crowd-sourcing
Regulation A provides an alternative to a traditional IPO
Consolidation in investment banking and brokerage services has left fewer underwriters for small IPOs
Low interest rates make debt financing a cheaper alternative
Decimalization and Regulation NMS changed the economics of market making for small company stocks. The biggest impact is that fewer market makers are willing to organize a market for small stocks post-IPO.
Jumpstart Our Business Startups ("JOBS") Act in 2012 also made it more likely that companies will stay private for a longer period of time, particularly the changes made to Section 12(g). We all thought the JOBS Act was going to help, its actually widened the gap and nobody is changing it.
How Do we Fix It?
That's a big task, it took us 20 year to get here, we won't fix the problem over night, and we won'