Authors explain what Wall Street does with your money

May 20, 2016 12:00 am • Last Updated: May 20, 2016 3:57 pm

Wall Street is about as popular in adult circles as broccoli on a 5-year-old’s dinner plate. In their new book, “What They Do With Your Money: How the Financial System Fails Us and How to Fix It,” authors Stephen David, Jon Lukomnik and David Pitt-Watson not only illustrate the inequities in current financial markets, but give individual investors practical advice on what to do about making a safer and saner investment climate.

“We are probing the inner workings of Wall Street. The system as it operates is flawed,” Davis says.

Davis and Lukomnik will be speaking at Congregation Beth Shalom Rodfe Zedek in Chester on May 22.

The mention of the words “Wall Street,” Lukomnik, maintains, inspires a sense of “free-floating rage,” even as people understand the importance of the financial system.

“Bernie got the rage right,” he says referring to the animating principle of candidate Sanders’ campaign, “but he doesn’t have the solution.”

Lukomnik thinks he and his co-authors have a far better answer for the problem: awareness.

“We don’t want to engender anger. We want to engender awareness. Free floating anger doesn’t help anything,” he says.

The authors believe investors need awareness on a wide variety of issues, from where mutual funds invest money to how mutual fund advisors are paid and how their funds are invested. Paying a fund manager 1.5 percent or 2 percent of earnings a year doesn’t sound like much, but over a lifetime, Davis pointed out, that can eat up as much as half of an investor’s retirement funds. And, he noted, there is little correlation between the management cost and the funds’ performances. The mutual funds with the lowest charges perform just as well as the firms that charge the highest compensation rates. In the Netherlands, where rates are far lower, an investor putting away the same amounts of money would end up with 50 percent more funds for retirement because of the far lower costs for the management of the money.

Lukomnik noted that the 2 percent charge has remained unchanged over decades.

“All kinds of things have advanced; we have computers; we landed on the moon, cars are more efficient, everything is more efficient but finance. We are still paying that 2 percent while business in the financial sector has more than quadrupled.” He pointed a finger at the ever-lengthening chain of middlemen involved in financial transactions as the culprit in keeping up costs.

Moreover, the amount managers charge clients often is not expressed clearly, using basis points rather than just providing the overall cost in a readily understood dollar amount or percentage. Clients looking at the basis points cannot comprehend what they are actually being charged.

“We should make fees explicit,” Lukomnik notes.

There are many other areas the authors see that are ripe for reform, including out-of-control CEO compensation and the kinds of companies mutual funds purchase. Investors often do no know what stocks their money is buying and are unaware of whether their investments support businesses that exploit workers or pollute the environment. These are moral issues of critical significance, Davis says, but also given the range of information now available on the Internet and social media, concerns that can materially affect the price of stocks.

Davis, a senior fellow in corporate governance at Harvard Law School, is a Madison resident. Lukomnik, executive director of the Investor responsibility Research Center, divides his time between Madison and New York City. Pitt-Watson, who lives in England, is executive fellow of finance at the London Business School. The three co-authored an earlier book, “The New Capitalists: How Citizens are Reshaping the Corporate Agenda.”

Working together and working long distance was not a challenge. Each had responsibility for writing a section of the book but, according to Davis, with suggestions and emendations by the time they were finished it was hard to tell who had written each chapter.

“We hope it is seamless,” he said. Lukomnik saw another advantage: “If you get stuck, if you have writer’s block, you can talk to one another.”

The authors also worked to ensure the book is understandable to laymen rather than only to economists.

“We tried to purge the book of financial lingo,” Davis says.

The goal is not simply to have shareholders understand but to encourage them to take a more active role in pressing money managers and corporations for the kind of reforms of corporate governance that benefit the investing public.

Lukomnik recalled trying to explain to his then-young children what corporate governance involved. They understood that his wife, a pediatrician, helped sick children. Corporate governance initially was far more difficult to explain. Finally, he told the youngsters a bit about capitalism. “Capitalism is the best system ever invented but it can be made better,” he explained.

Now when his wife leaves for work in the morning, he always says, “Make the kids feel better.” And she replies, “Make capitalism safe for the world.”