The Financial Food Chain

By Michael Kinsley

Recently I received a brochure in the mail from Fidelity Investments, the giant financial company, inviting me to sign up for something called "Portfolio Advisory Services." For an annual fee of 1%, "a dedicated account executive" will invest my money for me, spreading it among Fidelity's dozens of "equity, bond and short-term mutual funds." My "portfolio" will be "personally tailored," of course, but basically the program promises what we all want: "preservation of assets as well as ... growth and income." This is known as a "wraparound account." It is one of the newer products invented by the financial-services industry, whose explosive growth is traced in Joseph Nocera's new book, A Piece of the Action: How the Middle Class Joined the Money Class. Words like product and industry are intended to give "financial services" the smell of a factory, where real things are made.

It may be worth 1% to have a Fidelity expert guide me through the financial maze created by Fidelity and its rivals. Nevertheless, the wraparound account is a reductio ad absurdum. "Put Fidelity's Renowned Investment Management Expertise to Work For You," blares the brochure. That is what I thought I was doing when I invested in a Fidelity mutual fund. Now I'm told I must pay someone to tell me which mutual fund I should buy. Then I pay the mutual-fund managers to put me into the right stocks and bonds.

But most big companies are glorified mutual funds themselves these days, shuffling parts as if they were stock portfolios. Like middle-class "financial services," corporate "mergers and acquisitions" are a permanent feature of American capitalism. Any pretense that they advanced some particular theory of corporate efficiency -- that small companies are better than large ones, or vice versa; that owner management is better than wide public ownership, or vice versa; that conglomerates are better than single- industry firms, or vice versa -- is now passe. Firms simply unite and divide like amoebas.

So, after I pay the "portfolio adviser" to choose my mutual funds and the mutual-fund manager to choose my stocks and bonds, I pay the top corporate executives to buy and sell the right divisions -- and pay the investment bankers to tell them how to do it. Eventually, way down there somewhere, I maybe pay someone to make and sell a product. I wouldn't know.

Now consider this financial-services food chain from the other end. The limited-liability corporation evolved in the 19th century as a way for businesses to raise large sums of money and for investors to get the benefit of professional management. It became a brilliant device for directing capital to where it could be used most efficiently. The key was the separation of ownership and management. But were they ever supposed to get this separated? Count the layers of management. There's the management of the actual business, as a 19th century capitalist might have recognized it. Then there's the management of the corporate shell. Then there are the investment bankers, putting companies in and out of "play." Then there are the mutual-fund managers, buying and selling company shares. And now there are wraparound account managers, buying and selling mutual funds.

A similar layering effect happens in the pension-fund corner of the financial world. Workers entrust their savings to trustees, who hire professional managers, who allot their assets among professional-inves tment firms, so that the investment firms can in turn allot them among various stocks and bonds. And there's a whole subindustry of pension-fund consultants who get paid to tell the managers which investment firms to allot their assets among.

Each link in the financial-services food chain may make sense, but the whole chain raises two questions. First, are we weakening the signals on which the invisible hand of capitalism relies? How many layers of decision makers are there between my decision to save a dollar and someone else's decision to put that dollar to practical use? Each layer is like a relay station along an old, predigital telephone line: it propels the message but also slightly distorts it. Cumulatively, the small distortions can add up to a lot of noise in the system.

Second, American capitalism has just gone through a tumultuous corporate restructuring, in which layers of middle management were stripped away. The result was supposed to be a leaner, more efficient economy. But is it possible that much of this middle-management fat has simply been moved from within the corporations to the "financial services" world? By the time we've paid all the financial advisers and investment bankers who stand between us and the actual productive use of our money, a large chunk has been taken out of our total return.

Well, that's capitalism's problem. I have problems of my own. Like which financial-service company's wraparound account should I sign up for? Clearly, what's needed is a "product" that will invest your money in different wraparound accounts. That would be worth another percent or so off the top, wouldn't you say?