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Toward Nonprofit Financial Services

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Bankers are not popular right now. I have friends who have taken to calling them "banksters," a term that apparently dates back to the Great Depression and now gets almost 300,000 hits on Google. Even a con man on the British TV series Hustle suggested that the collective noun for bankers be "wunch," as in "a wunch of bankers."

Why all the outrage? After all, isn't it only capitalistic for a small group of people to accumulate great wealth by mismanaging other people's money?

Modern finance, of course, is largely anti-capitalistic. There are many reasons for this, but a big one is what economists call agency costs, or the costs of making sure that people to whom you give money do what you want with it. The result is that modern financial-services companies are essentially sophisticated ways to profit from market failures, not from markets that do their job.

There are many solutions worth investigating, but one thing that might help would be a cultural shift toward nonprofit financial services. To understand what this means, consider that a for-profit company is ordinarily one that earns profits for its shareholders. A bank, or a mutual-fund company, exists primarily to earn profits for a separate group of people than the depositors or customers who have given them money.

This is a fine model for many kinds of commerce. It would be hard to run a nationwide clothing store, for example, by letting customers rather than shareholders be the ultimate beneficiaries. Customers come and go, don't have any particular stake in overseeing management, and wouldn't be willing to front operational costs. They just want to go in and buy a sweater.

Some kinds of financial-services companies, though, have a group of customers who can serve all the roles of modern shareholders. There seems to be little reason that an annuity insurer or mutual-fund company can't be responsible, ultimately, to its customers -- to those who have put their savings and retirement accounts in the hands of the company. Unlike clothing-store customers, holders of mutual funds have an ongoing financial stake in the company's success, and the company already has some fiduciary duties to them.

If this seems like a crazy model for a capitalistic country, consider that some of the most successful, lowest-fee financial companies are already "nonprofit" in the sense that I mean it. Companies like TIAA-CREF and Vanguard, popular choices for retirement accounts at universities, are owned by their own funds, so they don't exist to make profits for a separate group of people. I have no interest in promoting these particular companies, but it bears noting that their investment returns, service, and fees are all at least in line with their for-profit competitors -- and in many cases noticeably better. In fact, most academic colleagues that I talk to don't know that these companies are any different from Fidelity, AIG, or anyone else.

They should. It would be a good thing if we became more sensitive to the distinction between bank and credit union, customer-owned and shareholder-owned investment company, mutual insurance and non-mutual insurance.

Indeed, we may even want to consider how laws and regulations can promote such "mutual" arrangements and discourage their opposite. Fortunately, Americans don't seem to be as afraid of regulations as they recently have been -- no longer as interested in naive generalities about the perfection of markets. But even for those who are, it's worth mentioning that a mutual-fund company, with regulated duties both to shareholders and to customers, already faces essentially an arbitrary split of responsibility to those two competing groups. There isn't really a "market" to save here -- not in the shares of mutual-fund companies, at least.

There are important social and political reasons, too, to try to align investment companies with their fund-holders rather than a smaller group of shareholders. These companies control huge amounts of money, and therefore end up with significant influence, even if indirectly. Retirement accounts are crucial for most Americans, but they serve as one way that huge piles of money are concentrated, with too few people paying attention to retirees' interests. A mutual-fund company owned by its own fund-holders has one more reason to look out for those fund-holders' interests. That motivation might not be enough to keep bankers and financial managers perfectly honest and accountable in all cases, but it's a start.