The Long View: Mark Higgins - Financial History Is More Relevant Than People Think

Key Concepts

Financial History as a Predictive Tool: The core argument is that understanding past financial events and human behaviors provides valuable insights for navigating current and future market conditions and policy decisions.
Hetty Green: A misunderstood but highly successful investor from the Gilded Age, often maligned for thriftiness which was actually a virtue.
Alexander Hamilton: A pivotal figure in US financial history, instrumental in repairing national debt, establishing the first central bank, and setting principles for debt management.
Central Bank Independence: The historical controversy and importance of a central bank operating free from political interference, with parallels to current debates.
Inflation Precedents: The significant inflation following World War I and the Great Influenza as a non-transitory event requiring aggressive monetary action, with lessons for post-COVID inflation.
Active vs. Passive Management: The historical difficulty for active managers to consistently beat market indexes, leading to the rise of passive investing.
Federal Debt and Reserve Currency: Concerns about unsustainable budget deficits and the potential erosion of the US dollar's status as a global reserve currency.
Shadow Banking: The risks associated with bank-like entities operating outside traditional regulatory oversight, as seen in the 2008 financial crisis.
Alternative Investments: The current over-allocation to asset classes like private equity and hedge funds, particularly the risks of marketing these to retail investors at the end of a cycle.
Private Credit Risks: The lack of fear and potential for high default rates in the private credit market, despite attractive yields.
Asset Bubbles: The identification of potential bubbly areas in the market and the specific concerns around private markets and evergreen funds using accounting "practical expedients."
Artificial Intelligence (AI) and Investment Analysis: The impact of AI on professions like investment analysis and the value of human dedication and hard work.
Investment Consulting Agency Conflicts: The inherent conflicts of interest in the investment consulting industry, leading to a focus on complex, high-fee products rather than simpler, lower-cost solutions.
Resilience of US Institutions: The historical evidence of the US overcoming significant challenges, leading to a more optimistic outlook on the nation's future.

Mark Higgins' "Investing in US Financial History" - A Detailed Summary

This summary delves into the key insights from Mark Higgins' book, "Investing in US Financial History: Understanding the Past to Forecast the Future," as discussed in the podcast. Higgins, a senior vice president at IFA Institutional and an editorial board member for the Museum of American Finance, emphasizes the critical role of historical financial understanding in contemporary investment and policy decisions.

Background and Involvement with the Museum of American Finance

Mark Higgins' engagement with financial history began with a paper on Hetty Green, whom he considers the best investor in US financial history. This paper, initially posted on SSRN, led to an invitation to write for Financial History Magazine. His continued contributions resulted in an appointment to the magazine's editorial board. He is also involved as a guest curator for the upcoming Museum of American Finance physical location in Boston, opening in July of the following year, where content from his book will be featured in an exhibit.

Hetty Green: A Misunderstood Investor

Higgins challenges the common perception of Hetty Green as the "Witch of Wall Street," arguing that the qualities she was maligned for were actually virtues. Her thriftiness, learned from the whaling industry (akin to venture capital with long waiting periods for returns), was a key to her success. He also highlights her significant, albeit quiet, charitable contributions, citing a follow-up article with Bethany Benson that uncovered Hetty Green's heir's will distributing her fortune to 63 charities.

The Genesis of Interest in Financial History

The catalyst for Higgins' deep dive into financial history was the March 2020 pandemic. Initially caught off guard by the global economic shutdown, he found that his extensive reading revealed historical parallels. He notes the striking similarity between the March 2020 panic and the July 1914 panic preceding World War I, where the global economy also shut down. Furthermore, he draws a parallel between the persistent inflation following the second wave of the Great Influenza (late 1918) and post-COVID inflation, emphasizing that it required aggressive monetary action and was not transitory. This realization underscored the importance of looking beyond short-term events to identify enduring patterns in human behavior and economic cycles.

The Significance of Alexander Hamilton

Alexander Hamilton is presented as a uniquely versatile and brilliant financial mind in US history. His most enduring contribution was repairing the US debt in 1790 by consolidating state and federal debts and modestly raising tariffs, thereby solidifying the nation's credit. He also established the first central bank in 1791, a precursor to the Federal Reserve (which is the third central bank). Hamilton's principles for debt management were crucial: debt should primarily be used for emergencies (like war) and paid back with budget surpluses once the danger subsides. Higgins notes that this practice was followed through World War II but ceased thereafter, leading to chronic deficits which are a recent anomaly, not a historical norm.

Central Bank Independence and Inflation

The controversy surrounding central banks in US history is attributed to a fear of centralized federal power, particularly after rebelling against Great Britain. Early banks also tended to benefit the merchant class more than farmers. Higgins emphasizes Alexander Hamilton's belief in central bank independence. He points to the Johnson and Nixon presidencies as periods where political pressure on the Federal Reserve contributed to spiraling inflation. He expresses concern about current threats to the Fed's independence, drawing parallels to Andrew Jackson's actions in dismantling the second Bank of the United States.

Higgins identifies two key Fed errors post-COVID inflation:

Underestimating Inflation: Failing to learn from the non-transitory inflation following WWI and the Great Influenza, which required aggressive action.
Premature Pivot: Pivoting away from tightening monetary policy too early, allowing inflation to persist. This, he argues, exacerbates civil discontent and increases political pressure on the Fed. He cites historical precedents like the "anguish of central banking" speech by Burns in 1979 and Alan Meltzer's work on inflation origins.

The Challenge of Going Against the Crowd: Charles Merrill Example

Charles Merrill, founder of Merrill Lynch, is used as an example of the difficulty in going against market sentiment. In 1928-1929, he believed stocks were overvalued but was ridiculed for his views. Higgins explains that outperforming the market requires being different from the crowd; otherwise, indexing and cost reduction are the logical approaches. The psychological cost of being wrong and facing ridicule is a significant deterrent, though Higgins believes there's no shame in learning from mistakes based on sound logic.

The Rise of Passive Management

Despite early evidence (dating back to the 1920s and 30s, and noted by Ben Graham in 1963) that active management struggled to beat market indexes, passive management took a long time to gain acceptance. This was due to incentives. In the Gilded Age, market manipulation through "stock pools" was common. The Securities Act of 1933 and the Securities Exchange Act of 1934 outlawed manipulation and insider trading, leading to the rise of security analysis as the primary method for active managers. This became the "last game in town" for Wall Street, even though studies, like an SEC study in 1940, showed most funds underperformed.

The Great Inflation and Money Printing Concerns

Higgins reiterates that the Federal Reserve's failure to contain money supply growth was the root cause of the Great Inflation (1960s-70s). He draws a strong parallel between the current environment and the early 1970s, citing significant spending on social programs and the Vietnam War, coupled with an overly accommodative Fed. He expresses concern that the Fed may be repeating past errors, despite having recent historical lessons.

Federal Debt and the Risk to the US Dollar

A major concern for Higgins is the unprecedented level of US federal debt, now exceeding World War II peak levels, despite the absence of a global crisis. He argues that the real anomaly is running deficits during peacetime. Historically, dominant reserve currencies have lost their status due to crises that bankrupted their issuing nations (e.g., Dutch losing to the British, British being bankrupted by World Wars leading to the dollar's rise). Higgins fears the US is eroding its borrowing capacity, leaving it vulnerable to unforeseen crises. He notes the increasing trend of countries "de-dollarizing" their reserve assets.

Shadow Banking and the 2008 Crisis

Shadow banks are defined as bank-like entities operating outside the Federal Reserve's purview. In 2008-2009, large entities, particularly investment banks, securitized mortgages. The problem arose from borrowing short-term and investing in long-term assets. When everyone demanded their money back simultaneously, these entities couldn't meet obligations. Unlike traditional banks, shadow banks lacked access to the Federal Reserve as a lender of last resort, leading to a run and the subsequent crisis.

Over-Allocation to Alternative Investments

Higgins is highly skeptical of the current market environment, particularly regarding alternative investments like hedge funds, private equity, and private credit. He traces the trend back to the early 1980s, when declining inflation and interest rates, coupled with rising equity valuations, fueled exceptional returns for these asset classes. The success of endowments like Yale's, under David Swensen, led to a widespread belief that simply allocating to alternatives would yield similar results.

He warns that trillions of dollars are now allocated to these asset classes, with clear signs of over-allocation, including dried-up distributions and a backlog of companies awaiting exit. The current push to market these to retail investors and 401(k) plans is a significant red flag, indicating the end of a cycle.

Private Credit Risks

Higgins points to a "lack of fear" in the private credit market as a primary warning sign, despite some recent jitters following bankruptcies like First Brands. He dismisses the narrative that private lending is still needed due to the aftermath of the 2008 crisis, noting that this was a legitimate gap 16 years ago but is no longer the case. He sees a herd instinct at play, where initial monster returns attract capital, leading to declining yields, underestimated risks, and eventual breakage. He estimates the default rate on private credit to be around 10%, suggesting that the focus on yield is blinding investors to the risks.

Asset Bubbles and Private Markets

Higgins identifies six phases of an asset bubble and expresses particular concern about private markets. He describes the practices of "evergreen funds" investing in private markets, often through secondary positions. These funds exploit an obscure 2009 accounting rule (practical expedient) that allows them to immediately mark up purchased secondary assets to their Net Asset Value (NAV), even if the purchase price was lower. This creates artificially high reported returns, which are then used to pay themselves incentive fees. He argues that these returns are likely not real, as investors are selling these assets for a reason, and the markups may never be realized. He cites a Wall Street Journal article on Hamilton Lane as an example of this practice.

AI and the CFA Charter

While acknowledging the impressive feat of ChatGPT passing the Level 3 CFA exam, Higgins doesn't see AI as an existential threat to investment analysts. He views the CFA charter as a signal of dedication and hard work, which retains its value. He ranks his own educational experiences, with independent research for his book being the most valuable, followed by the CFA and CFP, and then his MBA. He notes the inverse correlation between cost and value, with reading being the cheapest and most valuable.

Tariffs and Trade Policy

Higgins expresses relief that the Trump administration backed down from extremely high tariff levels and avoided a tit-for-tat trade war. He notes that while tariffs can be risky, the tit-for-tat response, which was a significant contributor to World War II and the rise of militarism in Japan, has not materialized. He acknowledges the historical parallels with the 1930s, where protectionist trade policies exacerbated the Great Depression.

Agency Conflicts in Investment Consulting

Higgins is critical of agency conflicts within the investment consulting industry. He explains that consultants, initially emerging in the 1970s to report on underperforming bank asset managers, have themselves become purveyors of complex, high-fee products. Despite evidence suggesting that simpler, lower-cost portfolios (like a 60/40 or 50/30/20 mix, excluding esoteric alternatives) lead to better aggregate results and are more behaviorally sound for investors, consultants often push for more complex allocations. He cites the case study of Nevada PERS, which outperformed peers significantly with lower fees by simplifying its portfolio, as evidence that consultants should be guiding institutions towards less complex, lower-cost options. He views the current trend of pushing alternatives into 401(k) plans as a concerning sign of consultants being wedded to business models that don't add aggregate value.

A More Confident Outlook on America's Future

Despite initial pessimism stemming from being "caught in the present," Higgins' three-and-a-half-year journey through US financial history has led him to a more confident outlook. By immersing himself in historical accounts, including newspapers from pivotal eras, he witnessed the severity of past challenges: the Great Depression (with average unemployment around 20% for a decade), World Wars, pandemics, and civil unrest. He concludes that the US has a remarkable resilience, with institutions and people that are stronger than often appreciated. While acknowledging ongoing problems like debt, monetary failures, and political divisiveness, he believes the nation's 230-year track record of overcoming adversity suggests it will continue to navigate future challenges.

Conclusion

Mark Higgins' book and discussion underscore the profound value of historical perspective in finance. By understanding the recurring patterns of human behavior, economic cycles, and policy decisions, investors and policymakers can make more informed choices. The narrative highlights the dangers of short-term thinking, the importance of sound principles established by figures like Hamilton, and the need for humility and a willingness to learn from past mistakes, particularly in an era of complex financial products and evolving economic landscapes.