SOME FINANCIAL CRISES PASS QUICKLY... But this crisis is different. Millions of Americans are seriously asking whether they can continue to entrust their retirement and their kids’ education to such a rickety financial system. They want to put their money to work in the enterprises they know and care about. They want to invest in their own schools, hospitals, factories, and homes. For the first time in generations, they are thinking about how to invest locally.
The financial experts running Wall Street insist this is silly. Local businesses— connected to a particular place and owned by geographically proximate members—are unreliable, the backwater of the old economy, not the places where serious investors should place their money. But what truly has become ridiculous is continuing to pour hard-earned dollars into global businesses and stock market casinos that increasingly bear no relationship to our own prosperity. Real prosperity must begin at home.
The $15 Trillion Shift
America’s investment system-- what many call "Wall Street"-- is broken. Even though roughly half the jobs and the output in the economy come from local small business, almost all our investment dollars go into big corporations on Wall Street. The overall wealth of the country is more than $150 trillion. Some of this wealth is held in the form of land, buildings, and machinery and is considered “illiquid”—not very easy to convert into dollars.
The most liquid assets held by households and nonprofits are stocks, bonds, mutual funds, pension funds, and life insurance funds, and at the end of 2010 these totaled about $30 trillion. To put this number in perspective, all the production in the United States each year—the gross domestic product (GDP)—currently totals about $15 trillion. So Americans have double their GDP in long-term savings. Not even 1 percent of these savings touches local small business.
Were local businesses uncompetitive, unprofitable, and obsolete for the U.S. economy, this gap would be understandable. But as we will see, local businesses are actually more profitable than larger corporations—and their competitiveness is impressive despite decades of inattention from policymakers and economic developers. This investment gap represents a huge market failure. It means that Americans are systematically over investing in Wall Street and underinvesting in Main Street. Were this $30 trillion allocated efficiently, at least $15 trillion would move into locally owned small businesses.
Imagine the kinds of new businesses and economic revitalization that would be possible with a $15 trillion shift. To put this number in perspective, it represents twenty times more money than all the funding the federal government allocated in the first national stimulus program of 2009–2010. It represents about $50,000 for every American man, woman, and child. For even a small town of five thousand, this shift would make $250 million available for starting or expanding local business. For a suburban town of fifty thousand, it would mean $2.5 billion more of capital. For a metro area of half a million, $25 billion more would be available.
What stands in the way of this shift is obsolete institutions and laws that make local investment extremely difficult and expensive. Securities laws have enacted a system of investment apartheid, with “accredited investors” (representing 2 percent of the population) being able to invest in any business they wish and unaccredited investors (98 percent of the population) being told to get lost. Accredited investors earn more than $300,000 household income or have more than $1 million in assets, excluding their primary residence.
Besides ensuring full employment for attorneys, securities law can claim one stunning achievement: It has managed to keep small investors away from small businesses. 98 percent of the American public cannot invest in more than half of the economy.
This exclusion is especially remarkable given overwhelming evidence local businesses are the most important sources of new income, wealth, and jobs for communities. At a time when official U.S. unemployment is at its highest levels since the Great Depression, the sluggishness with which either political party has sought to fix this problem by reforming securities law and promoting local investment is stunning.
Most Americans don’t invest in individual companies. They place small percentages of their paychecks into their individual retirement accounts (IRAs) and 401(k) accounts. But for any person who wishes to put this money into a portfolio of local businesses, the market failure is just as bad.
There is not a single mutual fund or investment broker in the country that gives people the opportunity to invest in a portfolio of local businesses. The curious soul who presses her financial advisor for some local-investment options is told, condescendingly, that these small businesses are too risky and their profits too insignificant to bother with, even though there’s compelling evidence, as we’ll see, that they are less risky and more profitable than the Fortune 500.
What about the socially responsible investment (SRI) movement? Aren’t more and more Americans telling their investment brokers to screen their funds so that they are no longer investing in cigarettes, nuclear weapons, or a toxic dump? In fact, SRI, despite great intentions, is simply about removing the most offensive global businesses from one’s portfolio (rather than proactively investing in promising, small, local businesses).
When I set up my very first IRA in the mid-1980s, I chose Pax World for exactly this reason. It never dawned on me that despite the screens I was still investing in lots of reprehensible companies. For many years, highly rated companies on SRI lists included Walmart, Home Depot, and Starbucks—the Death Stars for local retailers, hardware stores, and coffeehouses.
Many SRI investors pumped up portfolios with U.S. federal government bonds, which might cause the morally attentive investor to worry that they were unintentionally propping up their least favorite federal boondoggle. Municipal bonds were also common, even though many of these were financing the corporate attraction and retention policies that were wrecking local businesses. The possibility of investing directly in local businesses was not even on the table.
Our current investment system has failed local companies, and all but requires that we invest in global, publicly traded corporations. And it all but forces a successful local entrepreneur looking for more capital—whether it’s to grow the company, to cash out and retire, or to move on and start another venture—to go public or sell out to a big nonlocal company.
Elizabeth Ü, a rising star in the local-investment field observes, “For those companies that would prefer to stay small or stay in their communities,what kinds of financing models can we create that will serve their needs? Today, we run the risk of matching up our best entrepreneurs with investors who don’t necessarily share their values."
From Wall Street to Vall Street
Another approach to investment can be found in rural Sweden. Exasperated by mainstream financial institutions that had been sucking up the savings of businesses and residents for investments thousands of miles away, a group organized some simple ways to invest in small local businesses, focused on food production. Everyone in the region can now invest in sheep, their sheds, their grazing land, and machinery for processing their wool and meat. People can buy shares of these assets and then trade them with one another. Because "a vallen" in Swedish refers to land used in sheep grazing, the locals joke this is their Vall Street.
The truth is that every community in America can create their own Wall Street through investing money in local enterprises they know and trust. These innovations involve things that are simple and transparent, which means that the risks can be easily evaluated and the chances of fraud can be minimized.
What's more, we need our own “Vall Streets” to correct a market failure that exists not only in the United States but throughout the world. Even though the majority of the Earth’s nearly seven billion inhabitants live at or near poverty levels, their national governments—irrespective of size, wealth, and politics—have historically focused their economic-development investments on big business.
A global consensus is emerging, however, that a key to ending poverty in the most distressed corners of the planet is to seed and spread small and microenterprises. Traditional public-sector improvements in education, health, and other quality-of-life factors can only be sustained in communities generating their own wealth, and this is only possible in communities rich in entrepreneurs.
The foundation for entrepreneurship is ownership. In The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, Hernando de Soto demonstrates the importance of legal reforms to clear ownership title to land and capital so that entrepreneurs can put these economic inputs to productive use. Muhammad Yunus won the Nobel Peace Prize for his efforts to bring microentrepreneurs into the financial mainstream through microcredit and micro-ownership. New web tools like Prosper.com and Kiva.org are enabling almost any lender to find even the smallest and most unconventional loan opportunities. Yet thus far these innovations have facilitated a global democratic revolution not around ownership, but around debt.
Debt can be a helpful tool for entrepreneurs, but it also can be counterproductive and imprisoning. Microentrepreneurs around the world now have IOUs from unscrupulous lenders who are charging usurious interest rates. The same predicament confronts Americans who were pressured by fly-by-night financial institutions into taking on more credit card debt and larger mortgages than they really could afford. Ditto for millions of residents of Greece, Portugal, Italy, and other countries in trouble, where debtors now have little hope of paying back their debts.
What’s now needed across the planet is microequity and other forms of local investing that shatter the monopoly of the world’s financial elite. De Soto’s conclusion that the historically miserable state of the law in Latin America has crippled small businesses is equally true in developed countries like ours. Indeed, the need for overhauling investment laws and practices worldwide could not be more urgent.
The Earth is now beset by a growing number of crises. Reasonable people can disagree about their causes and solutions, but there’s little disagreement about the mounting dangers: The climate is changing. Once plentiful supplies of cheap petroleum are running out. Species are disappearing at an accelerating pace. Fish stocks in the world’s oceans are being exhausted. Farmland and prime topsoil are fast disappearing. Weapons of mass destruction are spreading into more hands. The freer global movement of goods and services means the freer global movement of germs, migrants, and terrorism. All of these dangers will intensify as the number of people placing demands on the world’s resources grows, as expected, to eight billion people by 2025.
What can we do about a world that is slipping into an epoch of unprecedented instability? To a growing number of people, the answer is to go local: Make my community more resilient and help other communities globally do the same. William Rees defines resilience as “the capacity of a system to withstand disturbance while still retaining its fundamental structure, function, and internal feedbacks.” The more communities can feed, house, educate, transport, and care for themselves, the more they can manufacture their own goods and provide their own services, and the less vulnerable they will be to the coming financial challenges. This presents new opportunities to create and expand local businesses to meet local needs. And seizing these opportunities requires new local-investment tools that rechannel our savings into priorities at home.
About a decade ago, I teamed up with a dozen other people sharing these views—entrepreneurs, investors, policy analysts, and big-picture thinkers—to form the Business Alliance for Local Living Economies (BALLE), promoting the idea that economic power should reside locally. The term local living economy ties together two intellectual strands. The first concerns localism, expounded in such early works as E. F. Schumacher’s Small Is Beautiful (1973) and Jane Jacobs’s Cities and the Wealth of Nations (1985), as well as my own books, Going Local (1998) and The Small-Mart Revolution (2006), which made the case that local ownership of business and community self-reliance are key requirements for prosperous local economies.
The second is from the writings of David Korten on the importance of a “living economy” rooted in smaller, more accountable businesses. In recent years, many in the BALLE community have come to understand the critical importance of local investment, and how new practices, tools, and institutions can and should be used to achieve what we call a living rate of return—a return that’s real, honest, dependable, and modest, yet big enough to enable a prudent family to secure reasonable income security before and after retirement and to bestow a decent upbringing and education for its children.
The Journey Ahead
Americans are beginning to create their own Vall Streets to earn a living rate of return. Determined, ordinary people are exploiting exceptions, loopholes, or quirks in securities law to invest locally. There are ripe areas for legal reforms that could greatly speed up local investing—and stimulate a dying economy—without costing the taxpaying public a penny. While mostly from the United States, the examples here also suggest some investment tools and strategies that people living in other countries might deploy for revitalizing their own local businesses.
Here are ten points to consider in the journey ahead:
1. We must understand the financial risks of continuing to invest as we have been. The returns Wall Street has historically achieved are not the 8 to 12 percent its enthusiasts claim (and mass media fails to question) but rather 3 to 5 percent. Unless Americans change their investment habits—and fast—millions will be shocked to find themselves retiring in abject poverty.
2. The case for investing in local business is compelling. Evidence and research in economic development shows that the most prosperous communities follow three rules: They maximize the percentage of their workforce in locally owned businesses. They increase local self-reliance through the production of local goods and services, knowing that many of these businesses will grow into regional and global powerhouses. And they identify and replicate local business models with high labor and environmental standards. For this kind of economic development to succeed, the critical challenge is to channel local capital into increasingly profitable and competitive local businesses.
3. A sector of the U.S. economy that can comply with securities laws most easily are cooperatives. There are some thirty thousand cooperatives in the country owned by workers, producers, or consumers. They are involved in everything from housing, groceries, and credit to utilities, telecommunications, and insurance. There are creative ways cooperatives are borrowing from their members and reinvesting their members’ capital in other local businesses.
4. Keenly aware that local banks and credit unions are much better at investing in local business than are global banks, millions of Americans have recently moved their money. Others have entered partnerships with their local depositories to create special certificates of deposit (CDs) to collateralize targeted small-business loans. We also see how municipal bonds (“slow munis”) and state-owned banks like North Dakota’s can catalyze more local business lending.
5. Anti-poverty investing is a form of community development, which has been one of the principal sources of local-investment innovation since the 1960s. Funded largely by government agencies, foundations, do-good banks, and philanthropists, the activities in this field include community-development corporations, microenterprise lending, community-development venture capital funds, and state-financed job funds. These initiatives, once dismissed as charitable aberrations, are increasingly being seen as a lucrative market niche for creative local investors.
6. There are remarkable options available to accredited investors. For example, at a holding company in the Pacific Northwest, Upstream 21, investors can support an evolving network of local businesses. Local-investment “angels” in the small town of Fairfield, Iowa, are funding so many start-ups it’s called Silicorn Valley.
7. There are creative investment strategies local businesses have deployed to avoid or reduce the costs of securities law compliance. Some businesses like Awaken Café in Oakland are pre-selling coffee to raise money for a new store. Others are tapping into crowdfunding donations and “micropatronage” through websites like Kickstarter and IndieGoGo. A community organization, LION, in Port Townsend, Washington, builds relationships among local investors and entrepreneurs. My partners at Cutting Edge Capital are lowering the costs of direct public offerings through simple, fill-in-the-blanks forms.
8. The Holy Grail for local investing are “Local Exchanges,” Internet-based spaces where anyone in a community can freely trade local securities. Once operating, these exchanges will allow the creation of diversified local portfolios, local mutual funds, and local pension funds. Mission Markets is prepared right now to deploy such exchanges with state and local partners. Low-budget, grassroots approaches to local stock markets are happening Pennsylvania and California.
9. Local investors can start pooling together to diversify their risks. Several models exist of revolving loan funds that are supporting local business and there are now exciting possibilities for creating local mutual funds, local pension funds, and local business-development companies (pools of small businesses). At the No Small Potatoes Investment Club in Maine ordinary people can make loans to local food businesses.
10. Superior returns come from investing in one’s own bank, home, energy efficiency, and other personal needs. For many Americans, perhaps even most, these opportunities are so big and compelling that they might never need to think about their IRAs or retirement funds again. Finally, anyone, even an unaccredited investor, can take control over his or her investment life through a self-directed IRA.
The Journey Ahead II
This movement is not about how to get rich quick. At best, it’s about how not to get poorer by continuing to hand over hard-earned cash to the bandits of Wall Street. Readers should be mindful that local-investment tools described here are works in progress. None is a panacea. And even the best tools are only as good as their craftsman. The success—or failure—of the first local stock exchange, for example, may or may not say anything significant about likely performance of its successors.
I encourage you to treat all numbers relating to investment with skepticism, especially various claimed rates of return. Mainstream investment practitioners have developed numerous tricks for exaggerating their performance, and it has taken years to put in place reliable metrics to hold them even remotely accountable. It will be many more years before we really understand how well local-investment tools work, in what circumstances, and with what risks.
The era of individuals, families, and communities depending exclusively on Wall Street is over. We are seeing the beginnings of a fundamentally new approach to investing and managing our wealth. Because local businesses in the United States have been severely undercapitalized and many are highly profitable, some of the early pioneers could hit the jackpot. As more and more of us see backyard investment opportunities that are working and thriving, others will follow. What might first appear to be a trickle of funds going into local business could soon burst into a torrent.
What will happen when the first, say, trillion dollars of the unaccredited public’s money moves from Wall Street to Vall Street? Obviously, this will benefit many local businesses. But what happens when a trillion dollars is withdrawn from the New York Stock Exchange and the NASDAQ? Fortune 500 companies, long kept superficially healthy through automatic pension fund investments, will see the prices of their shares plummet and their assets shrink. More mainstream investors will worry and look to local alternatives, which will depress prices on the stock exchanges still further. This capital flight could occur with dramatic speed and result in the largest and most monumental shift of money in human history.
As the titans of Wall Street begin to tumble, gullible government officials will be pushed to bail these companies out, as they did with big banks. I sincerely hope the temptation is resisted. Globalization, extolled over the past generation as the future of mankind, is out, and localization is in. It’s time to let the financial dinosaurs go extinct and let the new era of Local Small Business flourish.
The following excerpt is from Local Dollars, Local Sense by Michael Shuman (Chelsea Green Publishing, 2012) and is reprinted here with permission of the publisher.