Economics of Wealth Management

Brooke Harrington in her book “Capital Without Borders” argues that wealth management is less about interest rates and capital gains, it's rather about tax avoidance, tax evasion, and dodging national law. I will summarize her thesis in 3 points: 1) The history of wealth management in the form of trustees. 2) The trusting process of wealth management in making assets ownerless, thus lawless. 3) Sovereignty, colonialism, and the politics of wealth management. Lastly, I will hit upon her policy advice of regulating the wealth managers, rather than the wealthy.

The history of wealth management

Harrington argues that the demand for wealth management was born during the crusades. A system was created where nobleman could transfer their assets to trustees. Feudal rulers sent noblemen to wage war in the east. Noblemen feared for their land, business, and assets to be seized or violently taken over by other noblemen, while they were fighting in foreign lands. Laws at the time prohibited children and women to legally take over assets. Thus, they signed over assets to men they trusted, and which had a good standing in society, preventing anyone from messing with them and their assets. Additionally, there were heavy feudal inheritance taxes. If the nobleman died in his crusading adventure the family would have to pay huge amounts to the ruler. A game of “hot potato” was played with their assets constantly trying to reassign assets in order not to pay taxes and to avoid outside aggression. Harrington argues that the intention of today’s wealth management and wealth managers is not different. The noblemen from then are today’s super-rich, and the medieval trustees are today’s wealth managers.

The process of today’s wealth management

While the intent of wealth managers stayed the same, the techniques changed drastically. Remember, the wealth manager intends to avoid rule of law, taxes, and foreign aggression (seizing of assets) for the rich person’s assets. The best way to do that is to hide it away, untraceable and ownerless. If individuals cannot be associated with their assets then governments cannot tax these assets, they can be spent in any way (even against national laws), and they cannot be seized (by divorce proceedings, or legal pledges).

Trust in wealth management

This is a dangerous game for the rich. There is a trade-off here: Making assets ownerless gives you the freedom described above (taxfree, law-free, unseizable). But, making assets ownerless runs into the risk of you not being able to access your assets (cause they technically don’t belong to anyone). This is where the super-rich has to trust the wealth manager. He (ca. 70% white male) is tasked with building a structure of companies, SPVs, holdings, foundations, (etc..) that cannot be traced back to the rich but can be accessed through a path that only the wealth manager knows. This gives the wealth manager immense power over the assets. So how can the wealth managers be trusted with hiding away all this money?

Extra Legal Costs in wealth management

Trust is difficult when sovereign laws are not applicable. Thus, extra-legal costs must be put into place. Wealth managers have to be part of the super-rich for the super-rich to exert pressure on the wealth manager and their family. Their kids have to go to the same schools, their wives have to go to the same Yoga retreats, family holidays have to be made in the most expensive places. If the wealth manager cheats, his family will be ostracized, they will lose their whole social environment. This is an extra-legal cost that can be imposed on only those who are part of the super-rich. (I have previously argued that trust outside of the legal realm can only be established with societal extra-legal costs.) To ensure this form of extra-legal costs the super-rich are willing to pay for the high standard of living via high commissions.

Example

To summarize: Imagine you’d have a treasure that you don’t want anyone to know about. You don’t know where to hide it. You need someone to bury it for you. Should an insider or an outsider bury it? If the outsider cheats you have no way of getting to him. You can’t sue him cause you don’t want anyone to know about the treasure. On the other hand, an insider (a friend) can be punished by weakening his social standings and reputation. You create an incentive scheme in which the insider is better off hiding away money repeatedly from you and your super-rich friends, rather than cheating you at any point.

The politics of wealth management

Assuming that the trust of hiding money is established, the question of how to do it is still unanswered. Once every two years, there is a scandal evolving a small island state, offshore companies, and tax havens. How did it come to that? Harrington argues that this phenomenon can be explained by two things: 1) The treaty of Westphalia. 2) Colonialism.

1)The 1648 peace of Westphalia was the starting point for the international law of state sovereignty. This meant that nations are free to choose their own laws and are also free not to persecute people on the basis of other nations’ laws. This creates an incentive for small nations to allow deregulation in the banking sector. There is an arbitrage game between these nations. The one with the least questions about the business, and the one with the smallest taxes, gets all the wealth management money. In this game, the Nash equilibrium is always “no questions and no taxes”.

2) A contributing factor to small islands nation incentivizing these tax havens is their colonial past. Once a colonial territory they were a) forced to partake in grand capitalist plans, b) be self-sustaining and profitable. The current attempt by the European Union or the United States to pressure these Island States are crushed by the argument of capitalist self-sufficiency once praised by the colonial powers.

Conclusion:

Brooke Harrington set out to study wealth managers as a sociologist, by training to become a wealth manager. She argues that, if nations want to crack down on hiding money, one should regulate wealth managers. There are three parties involved in the process: 1. The rich, 2. The wealth managers, 3. Small deregulated nations. Going after the rich is hard, going after nations is against international law, so wealth managers are left. Here the US and EU could find an incentive system where wealth managers are encouraged to place assets on their soil with less regulation and less tax. This would be an argument against increasing taxes for the rich.

There is very little data on wealth management since the endeavor aims to safely hide money. This is a great example of where qualitative sociological studies make sense.