11

PREPARING FOR THE FUTURE

Saddle up! We are all pioneers venturing into unmapped territories. “It’s tough to make predictions,” Yogi Berra once said, “especially about the future.” But here’s one prediction I can make with confidence: Local investment opportunities will very soon become easier to find, evaluate, and transact. And some of them will become more lucrative. We are at the beginning of what historians might someday call the Great Local Investment Revolution.

Come On, What’s So Revolutionary about Money?

Everything!

By the time this book is published, US citizens probably will have invested nearly a billion dollars locally since 2016 through investment crowdfunding. That’s a tiny sliver of the $85 trillion dollars in financial assets Americans have, but it’s a start.

As more people in your community invest locally, more local businesses will get financed, more municipal infrastructure will be built, more of your neighbors will become homeowners, and more of those struggling with crushing debt will find a way out. As more investors begin to localize their portfolios, they will expand local income, wealth, and jobs, which in turn will enlarge the tax base, gin up public services, and improve the quality of local life. This could be the holy grail of economic development that so many communities have been searching for, far more reliable and cost-effective than giving away billions of dollars of “incentives” to attract and retain global businesses like Amazon.

There also will be losers. As competitive local businesses get more capital, big companies will experience a decapitalization—some dramatically so. What happens when the first trillion dollars moves from Wall Street to Main Street? As demand shifts, the price of Wall Street stocks will drop and the price of Main Street stocks will go up. As more mainstream investors start to notice that the smart money is moving into local business, they too will join in. So will investment advisors. This trend will accelerate until local businesses receive the 60–80 percent of available capital they deserve. And the shift could be stunningly swift.

Among the first major companies to decapitalize may be the “too big to fail” banks, investment houses, brokerages, and other institutions responsible for the crisis of 2008. Were it not for the massive government bailout in the years that followed—not just the $700-billion-dollar relief package that Congress passed in 2008, but the trillions more pumped into the economy by the Federal Reserve through “quantitative easement”—many of these financial behemoths would have gone extinct. If these companies continue to cater exclusively to global finance, their volume of business will steadily shrink. And their competitors at the local level—credit unions, local financial advisors, local investment funds—will multiply. The nation’s financial system will become more diverse, safe, and stable.

There are four pillars of the emerging local investment ecosystem:

• Issuing—Local businesses will be able to issue securities to grassroots investors more easily and inexpensively.
• Reselling—Local stock markets or other “intermediaries” will become available for the purchasers of local securities to resell them, whenever they want, locally. This will help prevent local investors from getting stuck holding worthless pieces of paper.
• Pooling—Local investment funds will become more widespread, making it easier for local investors to put their money into diversified pools of capital. Experienced managers running these pools will relieve local investors of the burden of evaluating all the companies, projects, or people they put their money into.
• Institutionalizing—Local mutual funds will be set up to help big institutional investors like hospitals, churches, and labor unions put their money into appropriate local investment funds and securities.

What is not widely appreciated, however, is how much each pillar depends on the others. Mutual funds will probably never become seriously interested in local investment until they can see many local investment pools operating with good track records. Local investment funds will never get very far until there are local exchanges or intermediaries where they can sell their securities from time to time. And local exchanges will never be formed until there is a critical mass of local investors looking to use them.

Right now, the local investment ecosystem is filled with a bunch of fragile seedlings. With the JOBS Act and state securities reforms, we have made it easier for local businesses to sell securities—but that’s about it. No state has created its own local stock market, though Michigan passed a symbolic law to explore the idea. About two dozen local investment funds across the country allow grassroots investors to participate. Nearly all of them take advantage of the exemption in the Investment Company Act for nonprofits. To really expand the number of these funds, we need new kinds of funds that take advantage of the more than a dozen other exemptions in the Act.¹

The home-run reform, which conservatives would surely rally around, can be summarized in one word: Federalism! We should allow states to experiment with new local investment frameworks and institutions. While federal laws permit states to frame their own laws about issuing local securities, they do not clearly give the states authority to create local stock markets or local investment funds. They should. States should become “laboratories of democracy” when it comes to investing. Congress might consider passing a very short law allowing this, but there’s no reason to wait: The SEC has all the authority it needs to issue a “no action letter” saying that whatever states do regarding their own investors and intrastate securities is their own business—period.

Once this very modest policy declaration occurs, US states will be happily surprised to find plenty of models around the world that they might adopt. In 1999, the Canadian province of Nova Scotia passed a law permitting grassroots groups to set up local investment funds inexpensively, and more than sixty funds have been created since. If the United States had as many funds per capita, we would have 21,000! It shows the importance of getting the law right. In the Canadian province of Alberta, with vast oil resources that make it the Texas of the north, co-ops are given special privileges to become investment funds to stimulate local economic development.

It’s harder to find examples around the world of local stock exchanges, except in our own history. In the late 1800s and early 1900s dozens of small stock exchanges scattered across the United States facilitated the buying and selling of shares of local companies. They were indispensable tools for regional economic development. We need to bring these exchanges back. Every state should have at least one virtual exchange where residents can find local companies. If I live in Montana, I should be able to sign up for the Big Sky Exchange, search for “organic food” companies, and quickly find fifty interesting places to park my money. Unlike today’s two principal exchanges operating in the United States, the New York Stock Exchange and the NASDAQ, these local exchanges might maintain higher standards of social responsibility and favor slower transactions that discourage speculation.

All this will take time. If you’re like me, however, you may be impatient. The gap between rich and poor is yawning. The legions of homeless on our streets are expanding. Traditional jobs are under threat from cheap labor abroad and robots at home. The climate is getting hotter, and water supplies are dwindling. We have got to act now.

What Can Be Done Immediately?

The faster law and policy change, the more local investment options you will have, and the more likely it is that you will find the right ones that fit with your needs for return, risk, and liquidity. We can accelerate this process by bringing down the costs of local investing. While there are a zillion things the federal government can do, I’m going to focus on where we have more influence—state and local governments.

The spread of Self-Directed IRAs and Solo 401ks can greatly increase the number of local investors and the amount of money they move from Wall Street to Main Street. DIY Accounts cost something—not a lot, but something—and like speed bumps, their fees slow down the local investment revolution. Suppose we could bring down those costs. Automation and competition are likely to do this anyway, and I predict that the cost of a Self-Directed IRA and Solo 401k will ultimately shrink to about $100–200 per year, maybe even less. But let’s go further and get rid of these costs altogether.

One way to do this effectively might be through a local investment tax credit. For every dollar you put into local investment, you might get some amount off on your taxes. Suppose you had a 5 percent state tax credit. If you reinvested $10,000 of your DIY Account into local business, you would get a $500 credit on your state income or property taxes—more than enough to cover your fees for a year. Better still, let’s apply the credit to the total amount of local investments you hold, so you can apply it year after year.

Tax credits exist in many states for a variety of purposes, but none are designed to facilitate local investing by unaccredited investors. A great example can be found just above the US border. The province of New Brunswick, which abuts the state of Maine, recently passed a tax credit to promote local investment. Residents there get fifty cents off every dollar they pay in provincial taxes. There’s no reason US states couldn’t pass a tax credit like New Brunswick’s. In fact, several state legislators are already drafting pieces of legislation to do this. How about yours?

What else should we ask policymakers to do? Let’s start with your city council. You might kindly request they consider the following:

• Create a local property tax credit for local investments.
• Move the city’s banking into a local bank or credit union, as the cities of Phoenix and Tucson have done. This boosts local financial institutions and keeps more money recirculating at home.
• Publish a list of every local investment opportunity on the city’s official website. This would be just for informational purposes, but it could help investors and businesses find one another for private deal-making.
• Encourage your city to issue municipal bonds for important local projects like expanding local renewable-energy capacity, and make it possible for grassroots investors to buy those bonds.
• Create a local land trust with both public and philanthropic funds that can buy up residential land for affordable housing and commercial land for affordable retail development. Allow grassroots investors to add capital as well.
• Share with businesses innovative structures that law firms like Jason Wiener’s are using to provide their employees with self-direction options.
• Start economic-development funds that are run by the city but capitalized by grassroots investors (this is an exemption in the Investment Company Act that has yet to be exploited). Such pools might focus on food startups or affordable housing. Or they might help early-stage entrepreneurs find funds to pay for otherwise steep zoning and licensing fees.
• Get the managers of the city’s public employee pension funds to start putting money into local investment options—perhaps through municipal bonds or land trust loans mentioned previously. They could provide their employees with DIY options.

Please don’t stop there. Get busy at your statehouse too. After your state legislators pass a local investment tax credit, you might ask them to try these ideas:

• State leaders should formally ask the Securities and Exchange Commission for the “no action letter” just discussed—that is, permission for creative financial entrepreneurs within the state to begin experimenting with local stock exchanges and local investment funds. Once that permission is granted, experiment away! Create a local stock market. Make it easy for local investment funds to get established. Create simple tests for knowledgeable residents who are not rich to qualify as accredited investors.
• Create a new state agency that evaluates local business securities and makes that information available to investors. Sooner or later, this will probably be done privately—as Moody’s or Standard & Poor’s do for big companies—but we need some early models to get things moving.
• Check what your state has done with crowdfunding. Is your state one of the dozen, like California or New York, that hasn’t legalized it yet? Even in states that do allow local crowdfunding, much more is possible. Raise the limits on the amount a company can raise ($10–20 million seems right) and the amount unaccredited investors presumptively can give (some states allow up to $10,000 per year). Sound the rams’ horns to break down the Jericho-like walls that keep grassroots money away from local businesses.
• States have impeded intrastate crowdfunding through their rules governing “community portals,” where local investors and businesses do transactions in a legally compliant way. The SEC now allows portals licensed under the JOBS Act to be run by anyone and these portals can charge a success fee, which pays the bills and allows them to be viable businesses. Oddly, the states don’t allow their portals to collect success fees right now, clinging to an old rule that only broker-dealers can do that. This is, frankly, little more than a protection racket for the broker-dealer profession that needs to be broken up. Until that happens, state crowdfunding platforms—unlike their national counterparts—will be left with unworkable business models.
• Here’s another no brainer: Legalize free speech. I’m serious. Securities law is filled with absurd limits on what companies can and cannot say to establish relationships with potential investors. These laws were conceived in an era when long-distance communication was mostly transacted by telegraphs and mail. The Internet has democratized the flow of information, and the time when little gnomes in securities departments can control that flow by issuing “permission slips” for sharing information, company by company, is over. Allow local companies and people to talk with one another about anything, any time. We’re all adults now. Fraudulent claims and misrepresentations would still be prohibited and actionable. But if you’re sharing truthful information about your business with potential investors, this is a wonderful relationship to be celebrated—not a problem to be squelched.
• Which brings me to another area for state policy: Education. States should provide grants to grassroots organizations that are prepared to teach residents how to become prudent, successful local investors. It’s stunning how few businesses and people actually know about emerging local investment options. The many tools that states have used to discourage smoking or drunk driving—billboards, bus-stop signs, conferences, curricula, social media—should be deployed to encourage local investing. We all need to spread the word, and state support can speed things up.

Advocating for policy change may be more than you signed up for. I know, I know, you just want to put your money in your life. But there’s a practical point here: The more you and others in your community can change the system—locally, statewide, and ultimately nationally—the better your returns will be. You can shape the system to make it easier for you to find, evaluate, and profit from local investments. Become your community’s expert on local investing, engage in modest advocacy, and all kinds of new possibilities may open up.

And for the Finance Entrepreneurs . . .

I began the book by noting that the local investment revolution, while grounded in well-founded public distrust of Wall Street, also provides the most visionary leaders in the financial industry with tremendous new business opportunities. To expand the services of local banks and credit unions with DIY Accounts. To deploy new investment funds and stock exchanges in your states. To provide grassroots investors with better tools to evaluate local securities. To integrate local securities into mutual funds. To bundle local securities in new ways, including local futures and derivatives (hopefully with greater transparency than their predecessors). To design new ways of diversifying portfolios with interesting combinations of large and small companies.

The most creative among you might see ways of improving economies of scale in the local investment industry. You might put together a national fund of local funds. Or design one platform for local stock exchanges and replicate it in all fifty states. Or create a network of local banks that share certain administrative functions, like a producer cooperative. Or launch a national consulting firm in the area of local finance. Or open a business school that specializes in teaching the skills required for cutting-edge financial institutions.

Some of your colleagues will dismiss local investing as a carnival sideshow irrelevant to the real economy of global businesses. That’s great news! It means that you are likely to come to this cutting-edge industry faster than your peers. And by the time they realize their mistake, you will be comfortably and profitably building the next century’s financial system.

For the Rest of Us . . .

Here’s a checklist I hope you will consider:

• Commit at least 1 percent of your life savings to local investment next year and to moving at least 1 percent more every year going forward.
• Join The Next Egg, where you will find hundreds of people like yourself asking and answering vexing questions about local investing. You also will find periodic commentaries from me on www.MichaelHShuman.com.
• Recruit a small group of friends, maybe five to ten, to join a group where you can share the many tasks needed for successful local investment. Together, you will collect ideas about local investment opportunities, evaluate them, commit funds, and compare notes on your progress. You might even consider converting your group into a formal investment club.
• Introduce your local, county, and state politicians to the action lists laid out earlier, and perhaps even give them a copy of this book (heck, my kids need the royalties for college). Better still, become a politician and make local investment reform your calling card.
• Challenge the financial experts in your community to figure out how they can join the local investment revolution and profit from it.

As you embark on this adventure, remember the immortal words of Sir Francis Bacon: “It would be an unsound fancy and self-contradictory to expect that things which have never yet been done can be done except by means which have never yet been tried.”