WHO CONTROLS GLOBAL CAPITAL?

Road Maps of the Financial Industry

by Dr. Elliott R. Morss

 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).

 

 

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[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.