Episode 378: Learning from Market History

Episode Summary

Executive Summary: The episode features Mark Higgins arguing that financial history is essential for understanding markets, central banking, debt, and bubbles. He warns that U.S. debt capacity is eroding, but his strongest critique targets private markets: he says private equity, private credit, venture capital, and evergreen funds are attracting too much capital, using flawed valuation and fee structures, and will likely disappoint retail and institutional investors alike. He advocates indexing, humility, and skepticism toward financial innovation marketed as diversification.

Main Topics: Why financial history matters (Priority: 5/5): Higgins argues that studying long-run financial history helps investors recognize that most market events are not unprecedented and can be emotionally and strategically navigated using historical analogs. Alexander Hamilton and the U.S. financial system (Priority: 5/5): The conversation highlights Hamilton’s role in creating U.S. credit, central banking, and fiscal capacity, which Higgins views as foundational to American growth and national stability. U.S. debt, fiscal capacity, and reserve currency risk (Priority: 5/5): Higgins warns that chronic deficits and rising debt have reduced the U.S. ability to respond to future crises and could eventually weaken global influence if reserve-currency credibility erodes. Central banking, regulation, and financial crises (Priority: 4/5): He explains that central banks stabilize currencies and act as lenders of last resort; when absent, banking panics, contagion, and depressions were much more severe in U.S. history. Private markets as a modern bubble candidate (Priority: 5/5): Higgins is highly skeptical of private equity, private credit, and venture capital, arguing that too much capital has entered these markets, future returns are being bid down, and industry incentives suppress skepticism. Evergreen funds and NAV markups (Priority: 5/5): He criticizes evergreen fund structures for buying secondary interests and marking them up to NAV immediately, creating paper gains, incentive fees, and a structural need for ever-larger secondary flows. Indexing, governance, and institutional behavior (Priority: 4/5): Higgins says indexing is the sensible default because most investors cannot beat the market, and institutions using active or alternatives-heavy approaches are often driven by peer effects, consultants, and governance instability.

Key Arguments: Most market turmoil feels unprecedented only because people do not look back far enough; historical analogs can calm investors and improve judgment. The U.S. financial system was a major driver of national success because it enabled credit allocation to innovators who lacked capital. Alexander Hamilton understood that stable public credit was necessary for nation-building and wartime resilience. Chronic deficits are historically abnormal and dangerous because they reduce the nation’s ability to respond to future emergencies. The U.S. could lose reserve-currency status over time, with consequences similar to the Dutch and British experiences of declining global influence. Central banks reduce the frequency and severity of panics by stabilizing currency and providing lender-of-last-resort support. Unregulated or weakly regulated banking systems tend to overissue claims, become fragile, and suffer contagious failures. Private markets resemble a modern bubble because capital is flooding in despite weak skepticism and poor long-run expectations. Incentives across consultants, pension staff, and managers encourage complexity and asset gathering rather than honest assessment of expected returns. Modern portfolio theory is often abused to justify alternatives by assigning optimistic return and correlation assumptions that can move capital on imprecise inputs. Evergreen funds exploit accounting rules by marking secondary purchases up to NAV, creating immediate paper returns and fee extraction without true economic realization. Indexing is not just cheaper; it also reduces governance turnover risk and the odds of firing good managers or hiring bad ones at the wrong time.

Data Points: Episode number: 378 - Rational Reminder episode featuring Mark Higgins. Hamilton’s original bank charter: 1791 - First U.S. central bank chartered after Hamilton’s financial programs. Hamilton quote year: 1795 - Quote on public and private credit as the invigorating principle of the country. First bank charter duration: 20-year charter - Hamilton’s first bank was granted a 20-year charter that Congress did not renew. Period without a central bank after First Bank: about 5 years - Mid-1810s gap between the First and Second Banks of the United States. Period without a central bank after Second Bank: about 80 years - Long gap before the Federal Reserve was established. Panic of 1837 defaults: 8 states and 1 territory - Florida was a territory at the time; defaults occurred during severe depression conditions. Secondary market volume in 2009: $10 billion - Approximate size of secondary transactions when practical-expedient NAV marking was less significant. Secondary market volume last year: about $160 billion - Modern scale of secondary transactions referenced in the evergreen fund critique. Expected secondary market volume: about $200 billion - Projected growth in secondary transactions. Venture capital lobbying change: 1979 - National Venture Capital Association successfully pushed to loosen prudent-man-rule concerns. Yale Endowment strategy publication: 2000 - David Swenson’s Pioneering Portfolio Management helped popularize alternatives. Retail-style cost load cited for older funds: ~5% per year - Higgins compared current evergreen/private fund costs with investment company fees from the 1920s and 1930s. Typical private equity incentive fee: 2 and 20 - Referenced as part of total cost stack in evergreen/private market vehicles. Estimated all-in evergreen fund cost: 5% or 6% - Management fee, incentive fee, custody, and underlying fund costs combined. Institutional assets Higgins references: almost 100 million - He said his institutional assets were around this level, while also noting more high-net-worth business. Governance turnover risk: about every 5 years - Average replacement cycle for investment committee members cited as a reason indexing hedges governance instability. Outperformance reference: 90–95% of peers - Nevada PERS and Steve Edmondson example used to illustrate long-run benefits of indexing.

Pivotal Quotes: "There’s almost nothing that happens in financial markets that is unprecedented. It just seems that way because nobody looks back far enough." — Mark Higgins: Explaining the value of studying financial history after the COVID shock. "It’s my duty to exhibit things as they are, not as they ought to be." — Mark Higgins: Citing Alexander Hamilton as his professional ideal for truth-telling and analysis. "If you’re going to be like everybody else, the only sensible thing to do is to index." — Mark Higgins: On institutional behavior, peer effects, and why indexing is the rational default when not pursuing a genuine edge.

Implications: Listeners should expect history to rhyme more than repeat, and to be wary of narratives selling alternatives, crypto, or new fund structures as innovation. The episode argues for skepticism, low-cost indexing, and attention to incentives over marketing.