Syntrinsic’s State of the Union

Posted by on 01/28/11 in America, Entrepreneurship, Global Politics, Government, Philanthropy

On Tuesday, President Obama presented his State of the Union address as required by the Constitution. Immediately following, Paul Ryan, Congressman from Wisconsin, offered the Republican response. We are reluctant to preempt either gentleman, and yet thought that this was a ripe opportunity to provide Syntrinsic’s first State of the Union commentary.

Syntrinsic’s State of the Union is informed by our daily work with good people across the political spectrum that are ethical, patriotic, intelligent, and of solid character. Syntrinsic is grounded in a very strong social agenda, though it is not a partisan one; thus, while our State of the Union may lack in standing ovations from 51% of America, we hope to compensate by referencing themes in 2011 relevant for all of us who care about the stewardship of our nation’s financial resources.

We have focused on one theme that is geopolitical, one national, one tied to the investment industry, and one tied to the nonprofit industry. Our last theme, we think, unites them all.

Geopolitical Theme: Beginning the Next Cold War
Much has been made in recent weeks of the rise of China’s military (e.g. stealth fighter), their increasing territoriality with their neighbors over control of the seas around China, and their desire to make the Yuan a global currency. Some pundits have attempted to position China and US in the beginning of a Cold War-like relationship, stirring up images of former Soviet-US tensions; however, this metaphor does not fit.

The US and China have developed a symbiotic relationship that never existed between the US and the USSR. The Soviets did not finance America’s government debt as China has, nor did American consumers finance the growth of the Soviet economy as we have and continue to do with China. While China and the US have become ever more interdependent, the US and the USSR largely lived in two isolated economic worlds, motivating each other, but doing everything they could to isolate and weaken the other.

We expect to see China continue to flex its growing muscles in the coming year, and yet also expect them to struggle to manage at least four major challenges that can destabilize a totalitarian regime: 1). A “hot” economy; 2). A demographic that includes far too many inadequately educated rural poor men; 3). Growing internal dissent around faith, corruption, government incompetence, and environmental devastation; and 4). Relations with North Korea, Japan, Taiwan, Myanmar, and India.

Will China overtake the US as the next global super power? Not yet. Will China and US relations deteriorate? Probably not. Will the US stop relying on Chinese products or China’s financing of our debt? No. Will the US compel China to become an advocate of human rights in North Korea, Africa, Myanmar, and elsewhere? No. Should we be wary of China? Of the people, no. Of the government, yes.

National Theme: Save our Cities (and States)
Closer to home, 2011 will be marked by the economic challenges of states, cities, and other municipal districts (e.g. schools, utilities, fire and police, airports, etc.). There will be budgets to cut, services to modify, pensions to renegotiate, and most likely employees to be terminated. Some municipal agencies will raise taxes to address the economic pressures, while others cut them with the same intention. Some unions will come to the table as constructive partners and some will do so as antagonists. Some citizens will understand the need to adjust expectations and others will rise up in anger. In some communities, business will partner with elected representatives to develop comprehensive solutions, while in other communities business will stand silently by.

While in most of America, we have moved away from citizen participation in local politics, the economic decisions that must be made may inspire renewed engagement. This is good. Just as the world has become more interdependent, our local communities have also become more closely woven into the web of broader economic and geopolitical forces. Former House Speaker Tip O’Neil liked to quip that “All politics is local,” and he was right. Were he with us today, he might well add that, “International has become local.” A rancher on the Eastern plains of Colorado is connected to one at the base of the Southern Andes in Chile and both are joined to the wheat farmer replanting a flooded field in central Pakistan.

Will our municipalities declare bankruptcy? Some, yes. Will they default on their bonds in greater frequency? Yes. Will pension contracts be renegotiated? Some, yes. Will it be enough? In most cases, no. It will just delay the inevitable for the next generation to address. Will America’s cities and states fall into perpetual decline? No. Many cities and states will need to reposition and make tough choices, but most Americans are resilient, loyal and have a strong sense of place. Cities and states will need to reinvent, but remember, we have done that before several times (e.g. New York City, Chicago, San Francisco, Atlanta, etc.)

Investment Industry Theme: Fiduciary Standard
Imagine if doctors were having a national debate as to whether they needed to put the health care needs of the patient before their own financial gain. Imagine if engineers were arguing in a public forum about whether bridges needed to be built for safe transport or simply to meet the business needs of the engineering firm. What if states were trying to decide whether teachers should strive to serve students before serving themselves?

We believe that were any of these debates going on, the nation would be riveted and strong feelings and extensive news coverage would abound. Yet such a debate is going on right now within the investment industry and even most investment professionals are not even watching from the sidelines. Yet this will be one of the most important decisions impacting the investment industry and its customers in the last 70 years.

In the initial drafts of what became the Dodd-Frank Act, language was proposed that would compel all broker-dealer representatives to meet the same fiduciary care that is required of Investment Advisers per the 1940 Investment Adviser Act. Per the 1940 Act, Advisers must provide loyalty and care to their clients first and foremost, disclose how they are compensated, disclose all conflicts of interest, and act in good faith. Rather than being a rules-based guideline, the fiduciary standard is intended as a principles-based guideline; thus, financial professionals would be expected to meet the spirit—not just the letter—of the guidelines.

Both Dodd (Chris Dodd, Senator from Connecticut) and Frank (Barney Frank, Congressman from Massachusetts), quickly struck the requirement for a fiduciary standard from the Act. Instead they required that the SEC study the situation and make a recommendation. On January 21, the SEC released their study to Congress. Now Congress, the SEC, FINRA (the self-regulating body of the broker-dealers), and lobbyists from the broker dealer, insurance, and banking community, financial planning advocacy groups, money management firms, and others are teeing up for negotiations.

Will Congress compel all financial professionals to meet the fiduciary standards defined by the 1940 Act? No. There’s too much money made under the current arrangement that consumers would not pay if they knew. Will Congress create a single, watered-down standard for everyone despite the SEC’s recommendation otherwise? Possibly. Again, there is much money at stake and great pressure to weaken, not strengthen, fiduciary standards. Will investors experience a more transparent investment industry designed to put their needs first? No. We continue to believe that the only thing that will materially change the structure of the investment industry is a change in consumer demand.

Nonprofit Industry Theme: Impact
The nonprofit industry feeds the hungry, houses the homeless, cares for the sick and abandoned, preserves history and protects the environment, cultivates the arts, and otherwise serves the faith, psychological, and educational needs of society. It helps make us a civil society, provides a safety net, and enables the many aspects of life that do not have short-term profit motive or potential.

Economic pressures in 2011 will continue to challenge nonprofit agencies to become even more efficient, better demonstrate their impact, and forge ever stronger relationships with those that provide financial sustenance, whether through contributions, reimbursements, or other revenue streams. Thus, like in other aspects of society, we can expect to see quality rise to the top. Nonprofits that are extremely well governed, well-managed, and sustainably resourced will continue to thrive. Those that have weak boards, ineffective staff or unsustainable revenue streams will go away, be absorbed, or, merge with peers. That’s okay.

In 2011, we will see continued interest in the expansion of social impact investment structures that raise capital to meet social needs in more creative ways. The line between nonprofit and forprofit will blur as social entrepreneurs move back and forth between legal structures and business strategies to strive to meet their social objectives. That, too, is good.

Will Congress look for ways to tax nonprofits on endowments, hard assets, or other aspects of their business? Yes. When revenues are tight and spending is high, expect Congress to consider everything, including taxing aspects of nonprofit business. That said, we think actually implementing such taxes will be politically difficult and thus unlikely. Will Congress reduce the tax deductibility of charitable donations as the Obama administration has proposed? See answer above. Same pressures to do it, same pressures not to. Will nonprofit organizations go out of business in 2011? Yes. Will the service demands on nonprofits increase? Yes. Will nonprofits be able to meet those increased demands? Some yes. Some will thrive in this environment as they will be able to demonstrate their value at a time when value is important.

Unifying Theme: Entrepreneurship
We hear again and again that people are concerned that America has lost its competitive edge, that we have become complacent, that we are Rome in decline, a shadow of our former greatness, no longer relevant or vital or even interesting. We would share the concern except that America has voiced that level of self-critical anxiety ever since the generation that took over leadership from the first revolutionaries in the 1790s. We believe firmly that America’s obsessive fear of becoming irrelevant keeps us hungry and motivated and relevant.

Once the housing/banking/credit crisis hit the fall of 2008, many Americans felt that the devastation was an indication that our most fundamental structures had failed. Anti-capitalists and anti-globalists reveled in a sort of schadenfreude (def.—“pleasure in someone else’s misfortune”) that the great exploiter had crashed and burned. Clearly government had not protected us from our excesses and perhaps even contributed to them. Many of our banks were unable to manage their own businesses and were taking us all down with them. Our heavy industry was shot, as was the housing industry which made everyone so rich for the previous 20 years.

We see it otherwise. America’s greatness is in its fundamental structure, not our temporal management (or mismanagement) of it. America’s constitution (small “c”) is based on rule of law, the free flow of capital and investment, a healthy civil society, human rights, and the opportunity to launch something, fail, and try again. We are imperfect in all of these endeavors and yet these factors exist in America as they rarely have in any other place or at any other time in human history. Few immigrants leave their homes and families and risk their lives to come here just to receive Social Security and Medicare. People around the globe still see America as a place where the lowliest among us can forge a life of value and meaning, can raise a family, can pray, and can become what one wishes. For that, people will give up and risk a great deal.

Is America perfect? No. Is America fundamentally broken? No. Are America’s partisan politics particularly bad now? Not by a long shot. We’ve improved tremendously over the past 235 years. Is the spirit of the American people broken? No. Can one start a company in America? Yes. Is capital available? Yes, for the right business plan and with enough tenacity. Will it be government spending that turns around the economy? On the margins. Government spending is a tax on the economy (today or tomorrow), so ultimately it is a zero sum impact. Will it be private enterprise that turns around the economy? Yes, as it ultimately is in every recession throughout history and across societies.

As we enter 2011, we have never been more confident, more excited, or more inspired by those among us who seek to make an impact in creating a more humane, secure, innovative, and loving world. Our Union has been rocked hard these past several years; yet, we possess the fundamental structures and thoughtfully engaged citizenry necessary to move from strength to strength. And so we will.