Rule he would follow: 'Let the markets clear'

John C. Bogle is never one to mince words.

The current turmoil on Wall Street spawned by a financial system that - in his view - got too complicated and expensive gives the Vanguard Group founder plenty to talk about.

He does so from his perch at the Bogle Financial Markets Research Center on the mutual-fund company's campus in Malvern. The center was launched after he retired from Vanguard in 1999.

Bogle, considered a mutual-fund pioneer for his advocacy of index funds and low-cost investing, gives 40 to 50 speeches a year as part of his crusade to "reshape the financial system and the mutual-fund industry."

Question:

What do you think of the Fed's role in the Bear Stearns crisis?

Answer:

I think they did it because they had to do it. At least in their view, the consequences of not acting were much more adverse than the consequences of acting. . . .

I would say the basic rule I would follow is let the markets clear. That's almost always the best idea. . . . But they've interfered with a freely functioning market.

I'm not trying to say it's good or bad. I'm saying that they've gotten in the market system and interfered among a group of executives whose mantra is, "Keep the government out of our business." Strike that. Whose mantra was, "Keep the government out of our business."

. . . I find that philosophically disturbing. Anybody would.

. . . I'm pretty much willing to accept [the Fed officials'] conclusion . . . that they had to do it, and likely on the theory that the whole array of cards would all tumble.. . .

Q:

What do you think needs to be done, if anything, about this financial crisis?

A:

. . .I guess there are two issues. What do we think needs to be done in the instant crisis? And what do we think needs to be done to keep this from happening over and over again?

. . .In the instant crisis, I think we just have to fight our way through it. If . . . a Citibank or a Lehman is on the ropes, I guess the Fed will have to do it again. But somebody has to take into account the fact, this is not free stuff. This is adding to the government debt, in effect. . ..

We know that, according to Federal Reserve data, that investors took $5 trillion of equity out of their homes in the previous say, five or six years prior to last year and spent it. . . . They can't do that again. I don't know how much is left. But I think people are gonna be a lot wiser this time.

Q:

Are financial bubbles part and parcel of capitalism or can something be done to prevent them?

A:

Well I guess I'd quote Lord Keynes here, a great British economist: "When enterprise becomes a mere bubble on a whirlpool of speculation, the job of capitalism will be ill done."

Truer words than that were never spoken. And I would argue the job of capitalism is being ill done right now at this moment. And we will have to pay a price for that. There's no way around it.

Now, we can do a lot of things to make sure that this kind of a speculative bubble doesn't recur. We're always fighting the last war. . . .

Another one of the wisest people around is Henry Kaufman, Wall Street economist. . . . [He] says, we need financial entrepreneurship. We need innovation. But we also need stewardship and fiduciary duty and traditional investing.

. . .The trick is to get that balance right. And when innovation plays too big a role in the financial markets, it overwhelms . . . stewardship and fiduciary duty, which I think are conspicuous by their absence from our financial markets.

Q:

Who should perform those functions of stewardship and fiduciary duty?

A:

Well of course the modern mentality is the Adam Smith-ian way, that investors should just look after their own interests and the system will work.

That's not happening here. We don't have free competition. We don't have evenhanded information. [We] have what we call information asymmetry. The sellers have all these things, know a lot more than the buyers. . . .

It's capitalism gone awry. It's casino capitalism as it's been called. . . .

Q: Does any good come from financial innovation?

A:

. . . It must be obvious that every time you create one of these new products, the investor is . . . on balance the loser. Supposing you . . . separate a Treasury - let's call it a 10- year Treasury note - and divide it into its income component . . . and its principle value.

It's a perfectly good idea. Some people, they're more interested in the income. Some are willing to, you know, let the principle ride on changes in interest rates. . .. But the combined returns of those two investors separately do not equal the value of the unit itself because the croupier is in there.

. . . This is all to me, so simple. . . . We create innovation, and we create this staggering, unbelievable, large and expensive financial system which is at the root of these problems.

This quantitative side of the business . . . is where all the math majors from University of Chicago and MIT and God knows where else want to go. If we spent all that time analyzing the actual structure and risks of everything in the portfolio, then we might have avoided a good part of this. And then we have the rating agencies. They have this ghastly conflict of interest. . . . I think the rating agencies are facing a considerable era of change. When we have a rating agency here locally, Egan-Jones, who is the only rating agency I know of that does it right. The investors pay for their ratings, not the issuers. . . .

Q: How grave is the financial system's threat to the real economy?

A:

. . . I see too many things that suggest that confidence is waning, so I worry about the real economy.

If people have the money to spend, and they're not gonna spend it because they're worried about tomorrow, we have the same kind of economic problem, exactly the same kind of an economic problem as if they . . . don't have the money to spend.

. . . I think we're gonna have to go through a period of years to work all this out. And it could be fairly painful. It could be fairly painful, unfortunately, in this economy, for the people at the bottom of the economic pyramid. . . . And they were hardly the ones that were profiting a lot on the way up.

Q:

You mentioned earlier that you have this sense of society being ungoverned. . . . Can you talk about that?

A:

I happen to be one that believes that this society has to . . . bestow its benefits more evenly. . . . It really comes to shaping the society, I think, much more in a way that gives better education to the people at the bottom of the ladder. . . .

And it's exacerbated, I think greatly, by the incredible rewards that are taken by chief executive officers. . . . In other words, Wall Street subtracts value from our society. There can be no question about that. . . . And it's corruption of money in the system. . . . Give a congressman a certain amount of money and get a certain earmark - well, there's no quid pro quo, you put up $50,000 and get a benefit of a million. There are very few places you can get that kind of return on your capital.

Q:

Do you hear anything during the presidential campaign that you like?

A:

Not so much.