Economy by Lisa Scherzer (Author Archive) Bogle: American Capitalism Is Doomed AT 76 YEARS OLD, John Bogle, the founder of mutual-fund firm Vanguard, describes himself as an idealist. But you wouldn't know it from the first few pages of "The Battle for the Soul of Capitalism," which might give readers the notion that he has transformed into a gloom-and-doom cynic. Throughout his new book, Bogle paints a dire picture of the financial system, starting with a frightening comparison between 21st-century America and the fall of the Roman Empire. Perhaps it's a stretch to suggest that the U.S. is at risk of an epic decline. After all, vibrant and transformative companies like Google (GOOG: 521.53, -5.31, -1.00%), XM Satellite Radio (XMSR), eBay (EBAY: 31.15, -0.01, -0.03%) and Craigslist have cropped up in just the past few years. But Bogle isn't seduced. He offers a stinging indictment of corporate excess â and a Cassandra-like warning to individual investors. He invokes ancient history to remind us that "no nation can take its greatness for granted." Bogle, creator of the first index fund, pleads with investors to pay attention to what's happening with their money â or risk losing it to corporate managers with dubious motivations. For years, says Bogle, the U.S. had a system in which capital was the property of owners. Those who bore the risk reaped the rewards. That system, which he calls the ownership society, has been transformed in the past 50 years into the so-called agency society. Now investors swallow the risk while managers collect more than their fair share of the rewards. Along with that has come the era of phony accounting, stock-option mania and inflated executive compensation. A similar transformation has taken place in the mutual-fund world. Bogle frowns on the trend of fund managers flipping stocks to juice their returns â and running up transaction costs in the process. Such activity isn't in the long-term interest of shareholders. And when fund companies then charge investors excessive fees, it chips away at overall returns â undermining the entire investing process. "The ownership society is dead," says Bogle, who still keeps an office at Vanguard's Valley Forge, Pa., headquarters even though he long ago gave up the roles of chairman and chief executive. "And the agency society isn't working, so the task â and it's a huge, huge task â is to develop a fiduciary society that honors trustees." How to do that? Bogle advocates federal legislation that requires fund directors to serve solely the interests of fund shareholders, an endeavor that will bring about what he calls shareholder democracy. SmartMoney.com spoke with Bogle about what's wrong with investing in America and how to fix it. SmartMoney.com: How has capitalism veered in the wrong direction? John Bogle: What I tried to do in the book I don't think has been done before. All these systems are interlinked: the systems of corporate America, investment America and mutual fund America. They intersect to put the shareholder in the back seat. He ought to be up front, in the driver's seat.... Capitalism has changed into a new system, which is not a good system. It's a managers' system. The rewards have to go to the people who assume the risk; that's conventional capitalism. It's been taken over, most notably in mutual fund America. By far too large a share of rewards has gone to the managers. There are lots of reasons for that, but the main reason is that we don't really have an ownership society. It's gone, and it's not coming back. Fifty years ago individual investors directly owned 91% of all stock. In 1985 the balance changed and institutions owned more than 50% of all stock. Now 68% of all stock is held by institutions, and only 32% is held by individuals. SM: Why the shift? JB: It's because of a single principle, which is as old as the Talmud, and that's diversification. Most people do not have the capacity to diversify on their own. They do it through mutual funds. They're doing the right thing, but the system isn't working. We're becoming an agency society, where agents aren't representing the principals. They're representing themselves. I quote Adam Smith in the book: We can't expect people to look after other people's money with the same care they look after their own money. Interests are conflicted. SM: Explain the rent-a-stock industry vs. own-a-stock industry you talk about in the book. JB: In 1950, when I started in this business, there was an average six-year holding period for stocks [by a mutual fund]. In the last 10 years turnover [has increased to] 100% annually. It can easily be called a rent-a-stock industry. You know [former Treasury Secretary] Larry Summers' statement: No one has ever washed a rental car. Why would you take the trouble? We aren't owners. SM: Why is the increasing concentration of stock ownership such an insidious development? JB: The problem is that we have profound conflicts of interest as agents. Money managers â nearly all of them â are managing both mutual funds and pension funds. So there's not much of a distinction out there from an investment standpoint. The 100 largest institutions own about 58% of all corporate U.S. stocks. That's an amazing concentration. They're managing 401(k) plans and pension plans. They don't want to lose their clients. The managers don't want to offend their clients; and they don't want to offend two types of clients â actual and potential. They don't want to offend anybody.