WHO CONTROLS GLOBAL CAPITAL?

Executive Summary

Global financial assets lost $50 trillion in value in the credit freeze/global recession – http://www.morssglobalfinance.com/no-predictions-just-data/. They have made back $28 trillion. Where do the assets come from and how are they being invested?

The financial world has changed dramatically in the last two decades. A new industry of investment managers has emerged. It controls vast pools of funds collected by banks, pension funds, insurance companies, and mutual funds. Associated with this, new strategies and instruments to buy and sell risk have evolved into a giant financial industry of its own. This article describes these new financial industries – quantitatively and qualitatively – and explores their impact on global capital flows. It provides qualitative and quantitative road maps of the global financial industry.

Prologue

For the last 40 years, I have spent most of my time working in developing countries, first as a staffer at the International Monetary Fund and later as a consultant and private investor. I have always been interested in global power.

In “The New Global Players: How They Compete and Collaborate”, I presented my conception on what the post Cold War global power structure would be.[1] The essential point was that nation-states no longer ruled the world alone but had been joined by multinational corporations, international organizations, and special interest groups (SIGs)[2] as global powers.

The power structure outlined in that 1991 article has stood up well. And my interest has increasingly focused on global power and finance. In 1998, a conference was held on multinational organizations that resulted in a book edited by Alfred Chandler and Bruce Mazlish[3] in which I co-authored an article on global finance[4] and another article on global elites[5].

I concluded at that time that real global power and finance were closely aligned and poorly understood. I hoped to develop “road maps” of global finance: who were the major players and what did they do? My findings are presented below.

I. But First: A Brief Historical Review

In order to understand today’s financial structure, it is useful to briefly review the changes in global financial structures and institutions that have occurred since men lived in caves. Cave living was significant, because launched one of the two major “product lines” of the financial industry – insurance/risk adjustment. Living in caves reduced the risks associated with weather and attacks by dangerous animals.

When men lived in caves, there was no trade because there were no “production surpluses” to trade. Initially, all trade was one good for another, or “barter”. Money or “a medium of exchange” came along later in recognition that barter was often inconvenient. Precious metals served as the first form of money. From there, we evolved to gold coins, then paper money and coins with little intrinsic value, to plastic (credit cards).

Banks grew up as vehicles to transfer unspent monies (savings) to investors. These transfers were critical in early times to allow shippers to “stock up” prior to voyages taking six months or more. Commercial banks served as the first institutional vehicle to effectively mobilize significant amounts of saving for investments.

The financial world has changed dramatically in the last two decades. An entirely new industry has emerged. It controls vast pools of funds collected by banks, brokers, mutual funds, wealth managers, pension funds and insurance companies. Associated with these “collectors”, a new industry of consultants has grown up to advise on how these funds should be invested.

This new financial industry is described below from three distinct viewpoints, an “institutional” one that traces savings through institutions to invesments, a “borrowing roadmap that illustrates who borrows and what happens to the debt, and as a “risk adjustment process”.

II. The Three Roadmaps

a. The Institutional Roadmap – Who are the Financial Players? How Does It Work? 

In essence, here is how the global finance industry works. Income is earned; collectors pass it to intermediaries who in turn select investors who choose the vehicles.

Income Recipients►Collectors►Intermediaries►Investors►Vehicles

More details are given in the following table.

The Global Road Map of Finance – Institutional Investments

Income

Finance

Recipients Collectors Intermediaries Investors Vehicles
Individuals Banks Collectors Collectors Direct
    Commercial Banks
Institutions     Savings Banks Consultants Intermediaries Stocks
    For-Profit     Credit Unions     Direct (via Brokers)
    Financial Investment Banks Others     Mutual Funds
    Non-Profit Stock Brokers    Hedge Funds
Risk Adjusters    Private Equity Banks
Governments Mutual Funds    Venture Capital     Checking
    Savings
Wealth Managers     CDs
Insurance Secondary
    Life Markets
    Casualty
Pensions
    Private
    State/Local
    Federal

The “Income Recipients”, “Collectors”, “Intermediaries”, “Investors”, and “Investment Vehicles”are the key players in the new global financial industry. Individuals have funds for investment after paying for consumption and taxes out of income. Institutions may have investment funds. If governments run surpluses, they also have funds for investments. “Collectors” are good at marketing: convincing individuals and institutions to give them their money to invest. They aggressively pursue income recipients for their funds. They give the impression that they will invest your funds. But often they do not – their expertise is in getting funds, and they often find others to invest these monies, the “Intermediaries”. In recent years, this has spawned an entirely new Industry – that include the “Consultants” and “Risk Adjusters”. These advisors tell the collectors both how to structure their investments and which investment managers to use.

A Caveat

 In one sense, the financial industry is like the fast food business: you start with a hamburger, taco, pizza or some other specialty food. But from there, you broaden into

other food lines to get more customers. So too with the financial industry: you start as bankers, insurers, brokers, mutual funds, and then move laterally into other financial areas in hopes of becoming the “supermarket of finance”. This blurs some of the dividing lines in the road map.

b. The Borrowing Road Map

The current economic crisis had its genesis in sub-prime mortgages. What happened can be best understood by looking at the global road map of borrowing.

 The Global Road Map of Finance – Borrowing

     

Borrowing

Borrowers

Lenders

Guarantors

Vehicles

Individuals

Banks

Banks

Mortgages

Institutions

Mortgage

Insurance

Credit Cards

    For-Profit

Companies

Companies

    Financial

Other

    Non-Profit

Countries

Government

Loans

Agencies

Governments

 c. The Risk Adjustment View

 It is also possible to understand the financial industry as a mechanism to adjust the risk profile of assets. Virtually every financial transaction involves a risk adjustment of one sort or another. For example, when you deposit cash in a bank, your risk profile changes in that your cash becomes a bit more physically secure but at the same time, your ability to use that money becomes dependent on the financial well-being of the bank.

The financial industry can be seen as the emergence of firms that change the risk of investors. A “risk adjuster” can be defined as one who changes the risk profile of any investment. The best-known forms of risk brokerage are insurance and pensions. In these cases, the client pays a commission to the insurance companies and pension funds to reduce risk. There are other institutions that buy risk. For example, some hedge funds pay risk-adjusters to provide them with high-risk packages.

Derivatives have become a well-known financial term. A financial “derivative” is nothing more that an existing agreement or contract converted to a new contract with a different risk profile. For example, suppose Lufthansa enters into an agreement to buy Boeing jets for delivery in five years. Lufthansa will budget the payment in EURs, but Boeing will want payment in U.S. dollars, and the exchange rate between these currencies will change in five years. Lufthansa can pay some institution a fee to guarantee today’s exchange rate. The institution would write Lufthansa a derivative contract stating that Lufthansa’s EUR payment will be converted to U.S. dollars at today’s exchange rate. The exchange rate fluctuation risk would thereby be removed from Lufthansa.

Another example of the expansion of risk adjustment are the secondary markets for mortgages. These were initially created by government bank regulators to reduce the risks banks face as a result of interest rate changes. Banks used to make most of their money on the difference in interest rates they pay on deposits and the interest rate they can get on loans – the spread. If they make a 30-year loan at today’s lending rate and interest rates rise, their spread will fall. The secondary markets allow them to sell their new mortgages off and make money on a commission they make on writing up the initial mortgage. This removes the interest rate change risk for banks.

The Global Road Map of Finance – Risk Adjustment

    Risk Risk Adjustment
Clients Risk Adjusters Vehicles
Individuals Weather Mutual Caves
Funds  
Institutions Animals Cages
    For-Profit Insurance
    Financial Health Companies Insurance
    Non-Profit    Life
Property    Casualty Mutual
Governments Funds
Economic Pension
Fluctuations Funds ETFs
   Interest
   Rates Hedge Options
Funds
  Exchange Hedges
  Rates Commercial
Banks Swaps
   Stock
   Prices Government Derivatives
Agencies  
Leverage
Investment
Banks

 Adjustable rate mortgages is another example of a risk adjustment vehicle. The Federal regulators introduced them to protect banks from the risks of interest rate changes. There has been a dramatic increase in risk adjustment activities over the last 15 years to a point that risk adjustment is now the largest industry in the world. Much of this activity has taken place to manage the risk associated with stock market investments, foreign exchange or interest rates changes. Only $3 trillion in currency trading is needed to finance the world’s imports and exports of goods and services annually. There is $1.3 trillion in currency trading daily, with much of this involving risk brokering. By the end of 2004, the Bank for International Settlements estimated that derivative contracts outstanding were $248 trillion. By contrast, the combined value of bonds, equities and bank assets for North America, Japan, and European Common Market countries was only $68 trillion.

We now turn back to a more detailed examination of the institutional road map.

III. The Institutional View In Detail

 a. Income Recipients

Who are the income recipients, and what are their income sources?

Income Recipients Income Sources
Individuals     Wages
    Interest
    Dividends
    Capital gains
Institutions
    For-Profit
        Insurance Companies     Premiums
        Other Financial     Fees, various
        Other Non Financial
        Other
    Non-Profit
        Pensions     Pension contributions
        Other non-profit     Various
    Government     Taxes, fees
Rest of World     Various

We only have detailed Income Recipient information on the United States which is presented below.[6] The first table provides details on individuals’ annual investments for the last few years. They deposit money in banks and mutual funds. Note that on a net basis, individuals have been selling stocks they have bought directly (through brokers). They also put money in their pension funds and pay fees to insurance companies.

US: Significant Financial Activities of Individuals*

(bil. US dollars)

Item

2004

2005

2006

2007

Personal Income

9,727

10,301

10,983

11,659

Assets: Increase in –

  Bank Deposits

409

337

472

427

  Mutual Funds

160

274

402

536

  Corporate Equities, Directly Held

-269

-467

-761

-989

  Corporate and Foreign Bonds

44

-25

194

66

  Government Securities and Loans

144

-11

-97

247

  Life Insurance Fees

33

16

66

27

  Pension Fund Payments

288

238

198

124

Liabilities: Increase in –
  Mortgages

940

1,029

988

655

  Consumer Credit

115

95

104

132

* These data include a small amount for non-profit organizations.

The second table on individuals provides data on their total assets and liabilities at the end of 2005. Their largest asset holding is their real estate, followed by their pension fund assets and bank deposits. Even though they have been net liquidators of stocks held directly, they still own more stocks directly than they do through mutual funds. Their liabilities are also noteworthy. They had $41 trillion in mortgage debt and almost $10 trillion in credit (mostly credit card) debt.

US: Significant Balance Sheet Items of Individuals

(billions of US dollars)

Assets

2007 

Real Estate

80,862

Pension Fund Reserves

51,079

Mutual Funds

24,984

Bank Deposits

28,443

Proprietors’ Investment in Unincorporated Business

30,896

Corporate Equities, Directly Held

23,377

Consumer Durable Goods

15,907

Government Securities

8,238

Life Insurance Reserves

4,769

Liabilities
Home Mortgages

41,150

Consumer Credit

9,882

Like individuals, businesses earn income that can be invested. Again, we only have detailed data on US businesses.

US: Significant Non-Financial Business Activities

(in billions of US dollars)

Description

2003

2004

2005

2006

Income before Taxes

1,714

2,283

2,886

3,145

Assets: Increase in –
  Bank Deposits

329

173

352

-97

  Mutual Funds

-60

62

108

203

Liabilities: Increase in –

304

751

925

1,398

  Corporate Equity Issues

139

296

233

178

  Loans

166

455

692

1,220

 

US: Non-Financial Business

Significant Balance Sheet Items

(in billions of US dollars)

Description

2006

Assets

31,077

Bank Deposits

2,949

Mutual funds

1,442

Direct Investment

2,327

Liabilities

32,955

Bonds

6,423

Loans

5,163

Mortages

6,537

Corporate Equity

14,646

Most governments have debt, so any government surpluses are used to paydown their debts. However, there is a small number of governments who continually run large surpluses (mostly because of energy exports). Some of these countries have set up government investment funds (called sovereign funds). The largest sovereign funds are listed in the following table. Not included in this table are foreign government institutions (mostly Central Banks) that are buying up US government debt to keep the value of the US dollar from following futher. By the end of 2007, these financial institutions owned $773 billion, or 15.4% of all US Treasury debt.[7]

Sovereign Funds 

Amount

Year

Fund

Fund

(in bil. US$)

Established

Per Capita

UAE: Abu Dhabi Investment Authority

875

1976

194,617

Singapore: GIC

330

1981

76,283

Singapore: Tamasek

159

1974

36,801

Singapore: Total

489

113,084

Norway: Government Pension Fund – Global

380

1996

81,341

Saudi Arabia: various

300

na

12,209

Kuwait: Reserve Fund for Future Generations

250

1953

93,041

China: China Investment Corporation

200

2007

152

Hong Kong:: Monetary Authority

140

1998

20,056

Russia

127

2003

873

Libya: Oil Reserve Fund

50

2005

8,282

Qatar: Qatar Investment Authority

50

2005

61,501

Algeria: Fond de Regulation des Recettes

43

2000

1,278

US: Alaska Permanent Fund Corporation

38

1976

56,712

Brunei: Brunei Investment Authority

30

1983

80,214

Other

44

Total

3,505

   of which oil and gas related

2,103

Source: “Asset-backed insecurity”, The Economist, January 19,2008 and various articles by Stephen Jen of Morgan Stanley.

Jen estimates that by 2015, sovereign funds will have grown to $12 trillion. He also believes that by then, sovereign funds from the non-oil exporters will be equivalent to those of the oil exporters.

b. Collectors

In the last 30 years, commercial banks have lost their monopoly position as the repository for individual and institutional funds. Today, pension funds, insurance companies, mutual funds, securities dealers have joined commercial banks as the primary

“collectors” of global savings. Who are the leading Collectors, and how do they market themselves? The leading U.S. collectors are presented in the following table.

Assets of U.S. Financial “Collectors”

(US$ billions, end of year)

Sector

2006

Banks

Commercial banking

10,204

Savings institutions

1,714

Credit unions

719

     Total

12,637

Stock Brokers

2,742

Mutual Funds

9,700

Pensions

Private pension funds

5,558

State and local govt. retirement funds

2,979

Federal govt. retirement funds

1,142

     Total

9,679

Insurance

Life insurance companies

4,708

All other insurers

1,365

     Total

6,074

Source: Board of Governors, Federal Reserve System

Insurance companies take in fees and pay out when events they are insuring against actually occur. In this process of collecting fees, the insurance companies have amassed large asset pools estimated to be $14 trillion globally. These assets will continue to grow as insurance services expand in developing countries.

Like insurance, the pension fund industry has grown dramatically in recent years, and its growth is likely to continue. Funds are accumulated as money is withdrawn regularly from salaries. Today, global pension fund assets exceed $13 trillion.

The more publicly accessible stock markets for trading the shares of public companies have blossomed not only in the West, but increasingly in emerging economies. Today, the global value of stock markets exceeds $23 trillion. Until the 1980s, stock brokers/securities firms served as the primary agents for the buying and selling of stocks. In recent years, brokers have become less important as the popularity of mutual funds has increased. U.S. mutual fund investments exceed $7 trillion, suggesting that their investments are approximately 50% of U.S. stock exchange assets. There are about 8,000 companies with listings on the three major U.S. stock exchanges. Remarkably, there are more than 21,000 mutual funds buying and selling those stocks.

The large money pools generated by these institutions have to be invested. Many of the organizations collecting these funds view themselves as marketers and prefer to pay others to invest their money. So they also pay a rapidly growing cadre of advisers to tell them which financial managers to use. The financial management business is highly competitive, and success is often measured by quarterly to six-month rates of returns.

Vehicles

2003

2004

2005

2006

2007

Other Finance

11,338

10,833

12,547

14,305

16,471

Mutual funds

4,135

3,638

4,654

5,436

6,049

Issuers of asset-backed securities

1,732

1,945

2,158

2,574

3,264

Security brokers and dealers

1,466

1,335

1,613

1,845

2,127

Money market mutual funds

2,241

2,224

2,016

1,880

2,007

Real estate investment trusts

76

102

136

253

330

Exchange-traded funds

83

102

151

226

296

Closed-end funds

140

151

206

246

271

Banking

8,121

8,679

9,291

10,210

11,110

Commercial banking

6,829

7,329

7,825

8,560

9,320

Savings institutions

1,291

1,350

1,466

1,650

1,789

Pension/Retirement Finds

7,115

6,502

7,823

8,511

8,896

Private pension funds

4,048

3,677

4,520

4,915

5,120

State and local government employee retirement funds

2,207

1,931

2,344

2,572

2,702

Federal government retirement funds

860

894

959

1,024

1,075

Insurance

4,085

4,275

4,833

5,293

5,595

Life insurance companies

3,225

3,335

3,773

4,130

4,351

Property-casualty insurance companies

860

940

1,060

1,162

1,244

Government

4,665

4,948

5,344

5,501

5,581

Government-sponsored enterprises

2,309

2,549

2,794

2,883

2,819

State and local governments

1,748

1,800

1,908

2,015

2,168

Federal government

607

599

641

602

593

 

c. Intermediaries

 In short, extremely large pools of money are being invested by these new financial managers. These managers are not well known (this is in part because the “collectors” do not want clients to know they get others to invest their money). The investors of these large money pools, the new investment managers, are the primary drivers of global investments. The collectors use advisors to help them with their investment decisions. Partly, this is to insure they are in compliance with Federal laws – Congress recently enacted a new pension law that runs more than 900 pages. There is also the need to choose investment managers, and many of the consultants have developed rating criteria for the managers. The following table lists the top 20 consultants as measured by global institutional tax-exempt assets.

Largest Global Consultants, 2005

($ millions)

Consultant

Assets

Russell Investment Group*

$1,726,790

Watson Wyatt Investment

$1,500,000

Cambridge Associates

$925,000

Callan Associates

$900,000

R.V. Kuhns & Associates

$782,851

Ennis Knupp + Associates

$737,000

Strategic Investment Solutions

$706,145

Mercer Investment Consulting**

$668,907

Pension Consulting Alliance

$625,576

Wilshire Associates

$620,000

Hewitt Associates

$495,000

CRA RogersCasey

$325,000

Richards & Tierney

$306,082

API Asset Performance

$300,000

Evaluation Associates

$265,000

Rocaton Investment Advisors

$250,000

Independent Fiduciary

$205,967

New England Pension

$205,000

Angeles Investment Advisors

$194,000

Summit Strategies Group

$110,000

d. Investors

Typically, a collector will either develop an in-house investment capability or hire one or more outside investment firms to invest their funds. This chapter will discuss the leading “Investment Managers”, how they market themselves and how they choose to invest the monies they manage. The following table list the ten largest investment managers globally ranked by institutional assets under management.

Largest Global Asset Managers

  Manager Assets ($ millions)
State Street Global

$1,315,888

Barclays Global

$1,172,724

Fidelity Investments

$809,656

Mellon Financial

$551,204

AIG Global Investment

$494,622

Wellington Mgmt.

$469,259

Deutsche Asset Mgmt.

$454,757

JPMorgan Asset Mgmt.

$449,348

Northern Trust Global

$411,755

Vanguard Group

$398,751

Source: Pensions & Investments

Subsidiary industries have emerged to support the new financial world. The collectors need ratings to choose investment managers, so a group of investment manager performance raters has sprung up. So too, the investment managers need help in finding new money to manage. As a result, a group of firms has been created to assist investment managers to find new funds to invest.

The Frank Russell Company both manages money for institutions and offers a rating service on other financial management companies. Operating in more than 30 countries, it helps more than 600 international clients choose investment managers. Its clients manage $2.4 trillion, making it the largest firm of its type in the world.

Despite its size and influence, few people have heard of the Russell Company. The same can be said for Wellington Management (a firm managing about $470 billion), General Atlantic Partners (probably the largest venture capital company in the world with a portfolio in excess of $6 billion), and Stark Investments (one of the largest hedge funds in the world).


[1] Elliott R. Morss, “The New Global Players: How They Compete and Collaborate”, World Development, vol. 19, no. 1, pp. 55-64, 1991.

[2] SIGs are cause-driven groups where their cause is not primarily to make money. SIGs include NGO/civil society groups as well as more radical, dictatorial groups that use peaceful and violent means, such as terrorism, to achieve their objectives.

[3] Alfred D. Chandler and Bruce Mazlish, Leviathans: Multinational Corporations and the New Global History, Cambridge: Cambridge University Press, 2005

[4] Zhu Jia Ming and Elliott R. Morss, “The Financial Revolutions of the Twentieth Century”, published in Chandler and Mazlish, op.cit..

[5] Bruce Mazlish and Elliott R. Morss, “Is There A Global Elite”, published in Chandler and Mazlish, op. cit..

[6] The source of the US data in this and following tables comes from the Board of Governors of the Federal Reserve System’s “Flow of Funds” accounts.

[7] Board of Governors, Federal Reserve, Flow of Funds, Table L-209.

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