Strategic Insider – William Rees-Mogg – 8 November 2006
I do not think that Bill Gates is a “malefactor of great wealth”, to use Theodore Roosevelt’s phrase about the early American builders of trusts. For that matter, I do not think that John D. Rockefeller, Cornelius Vanderbilt or J.P. Morgan were malefactors; they were businessmen who made large fortunes, but also created a great deal of wealth. Most of that group, like the steel magnate Andrew Carnegie, or Rockefeller himself, were major philanthropists, as is Bill Gates. The world needs great entrepreneurs and would be poorer without them.
Nevertheless, the billionaires of the early twenty first century present certain problems, both financial and social. The financial problems are exemplified by the two new investment vehicles of the billionaire age, the hedge fund and the private equity fund. Both of these have grown up to meet the needs of hugely wealthy investors who can afford to take high risks.
It is true that there are some pension funds or charitable funds which have invested both in hedge funds and in private equity funds, and some of them have had very good returns. Yet both types of fund are now being criticised, on the grounds that they are under regulated and over leveraged.
Originally, hedge funds were designed to reduce investment risk by allowing the fund managers to balance long with short positions. Some hedge funds have always been run on this long-short principle, but they are a minority. Many hedge funds are highly leveraged speculative funds which go long most of the time. These have been very attractive to private billionaires, because they feel that they can afford to take higher risks than smaller or institutional investors. However, smaller investors would like to have the same yields. In the early years of the 1980s, there were only limited funds going into hedge funds, and managers like George Soros did prove to have exceptional skills. Now very large numbers of investors are putting their funds into the hands of managers who are on average less skilled. Hedge funds also compete for market opportunities.
The same process is occurring in private equities. They, too, proved to be very attractive to billionaire investors, who made them fashionable. In the 1980s they did not for the most part have the success of the best hedge funds. The relatively long lock-in periods put off many investors. Since then, however, the performance of the best funds has improved, and they are regarded as a normal and profitable investment for large scale investors. The best managers produce excellent results, but there is, as always, a large group of average managers, and there are always some who will be sub average.
As with hedge funds, there is concern about the lack of regulation of private equity funds. The latest development is that the Financial Services Authority in London has announced the intention of paying regular visits both to the private equity firms and to the banks which lend them money. The F.S.A. has even warned that the collapse of a large buy out is now “inevitable”. Given that some of these funds make their money out of increasing leverage to an inordinate level, this warning is likely to prove correct.
The leverage risk is an obvious matter for concern. The over leveraged Long Term Capital Management was the worst failure of a hedge fund to date, but the risk of speculative failure based on borrowed money is the classic risk of all finance.
No doubt there will be failures and no doubt there will be more regulation. It will not greatly affect the billionaires unless they are quite unusually reckless. Bill Gates has just invested in a $3.7 billion buy out of Four Seasons Hotels; his partners are Prince Alwaleed and the entrepreneur who developed Four Seasons, Isadore Sharp. It looks a neat deal, which will cost Mr. Gates not much more than $1 billion, which he can well afford out of a net worth of about $50 billion.
As an old-fashioned free market, Adam Smith, economic writer, this does not worry me. Bill Gates is an efficient capitalist. He is a good entrepreneur, a rational risk taker, a valuable saver and a shrewd investor. He helps to keep the global economic machine in good order.
However, he must sometimes feel lonely out there. Ordinary people are not embarrassed to meet ordinary businessmen. A businessman whose business has a turnover of $1 million is not in awe of another businessman whose turnover is $10 million. They sit at the same table. But the rest of us do not sit at the same table as Bill Gates, or indeed as Prince Alwaleed. We may meet them at a College reunion or at the Opera House, but we do not have the entry card to their club, because that entry card is $1 billion.
That is O.K. by me, and probably it is O.K. for them. But it does create a social gap. There are now a thousand or two of billionaires in the world, maybe more. In Marxist terms they are in danger of being “alienated” from society by their great wealth. We know from history that these social gaps can be the cause of resentment. This resentment is partly defused by democracy, but not wholly. In the societies where the billionaires are most often to be found, there are also the gaps of race. In North America there is the gap of wealth between the white majority and the large black and Hispanic minorities. In Europe, the major worry is about the Islamic immigrants.
Add to these problems the declining job opportunities of manufacturing industry and the divisions in our society look rather alarming. Before 1917, Russian society consisted – approximately speaking – of liberated serfs on the one hand and grand dukes on the other. The billionaires are useful people, which could not be said of the grand dukes, but they are to some extent isolated by their wealth. Another Teddie Roosevelt might make headway even in the United States; he might use their wealth as the basis for an appeal to social jealousy.
Strategic Insider – William Rees-Mogg – 8 November 2006