The year 1982 rarely gets much attention in the lineup of magic years. Unlike 1968, 1941, or 1929, 1982 didn’t usher in any cultural revolutions or wars or economic cataclysms. In 1982, President Ronald Reagan was struggling through his second year in office, with his popularity sinking and the country wallowing in economic recession. The unemployment rate was creeping up to 10 percent, and more than twelve million Americans were out of work. Interest rates were at 14 percent, leading to widespread business closures and bank failures.
Nineteen eighty-two wasn’t the “morning in America” we would later associate with Reagan. It was more like the darkness before the dawn, with many economists and politicians doubting that Reagan’s promises of trickle-down economics and growth fueled by tax cuts and deregulation would ever materialize.
As Kevin Phillips, the political commentator and former Republican strategist, wrote in his book Wealth and Democracy, 1982 was grim for just about all income groups in every part of the country. “The Farm Belt was in trouble, and the Great Lakes industrial region was smarting under its new, dismissive nickname: the Rust Belt. By the end of the year, median family income had slipped back to its 1974–75 lows.”
New research, however, is shining a new light on 1982. Rather than being a year of false hopes, it may have been the crucible for America’s Second Gilded Age. It was a year that set in motion a series of political and economic changes that would create the greatest wave of prosperity in nearly a century.
It also marked the birth of high-beta wealth.
To understand these changes and to see how the rise in inequality is tied to the rise of high-beta wealth we first have to go back in history to the pre-1982 world of wealth.
For nearly thirty years after World War II, the American wealthy were a small, quiet, and financially conservative group. They were removed from the nation’s boisterous booms and busts and relatively restrained in their earning and spending. There was plenty of wealth created in America during the postwar years. But it didn’t pile up at the top the way it did after 1982. Wealth was more broadly shared, thanks to high taxes on the wealthy, strong unions, New Deal programs, protectionist trade policies, and the nation’s manufacturing power. America celebrated middle-class values and the “organization man.” Big, quasi-paternalistic companies held the real wealth and power in America, rather than the individual entrepreneur or corporate executive. From a wealth perspective, 1947 to 1982 was the sturdy bridge built by the working class, straddling the wealth peaks of the Roaring Twenties and the years after 1982.
The wealthy sat on the sidelines as the economy ebbed and flowed. During the consumer-led expansion of the 1950s and the “nifty fifty” stock craze of the 1960s—in which investors piled into fifty popular stocks—the incomes and wealth of the top 1 percent barely kept pace with the rest of the population’s. The average income of the bottom 90 percent of the population doubled between 1943 and 1980 in constant dollars, while the average income of the top 1 percent grew only 23 percent between 1943 and 1980, from $270,000 to $333,000.
The elite were equally restrained during downturns. During recessions in the 1960s and 1970s, the incomes of the top 1 percent fell less than the incomes for the rest of the country.
The pre-1982 rich, in other words, had a low beta, or low income-volatility compared to the rest of the country.
The population of rich people was also small. After the trauma of the Great Depression, which slashed the number of millionaires by more than 85 percent (and which we’ll examine later), the rich were more like the shining city on the hill rather than the teeming nation we would later know as Richistan. In 1955, only 276 people made $1 million or more, compared to 513 in 1929.
Most wealth came from one of two sources: oil and trust funds. By some estimates, inherited wealth accounted for more than half of all fortunes over $1 million during the postwar period. In 1982, half of the members of the Forbes 400 inherited their wealth, while many of the rest made their money from oil, timber, real estate, or other commodities that had benefited from years of high inflation. In that same year, there were only thirteen billionaires in America, compared to more than four hundred today.
The postwar years were so egalitarian that economists would later label them “the Great Compression,” since the gap between the rich and the rest actually shrank. It was also a period of anti-elitism in culture, when the rigid manners, moral code, and snobbery of old money were widely ridiculed. The rich were embarrassed to flaunt their wealth, or what little of it they had left after paying taxes (the top marginal tax rate was 90 percent after the war). Plus the family trusts had to be divided among squabbling heirs in Palm Beach, Newport, and Greenwich. Science Digest observed in 1948: “The old habits of smoking cigars wrapped in hundred-dollar bills, throwing banquets for dogs or giving $50,000 parties with automobiles as door prizes are out.”
During the culture wars of the 1960s, this reverse snobbery took on added intensity as the wealthy came under fire from the egalitarian, anti-establishment.
An article in the New York Times in 1982 quotes a defensive Rose Sachs, a commercial real estate baroness, saying the image of the leisure class as all leisure was insulting. “We have this terrible image that we play all the time,” she told the Times. “I went to three balls last night, and all of them were for charity.”
Nineteen eighty-two, however, would set the stage for an unprecedented party of wealth.
Throughout American history, large wealth booms have been created by the convergence of three forces: deregulation and pro-wealth government policies, technological innovation, and financial speculation. In 1982, the personal computer was the big emerging technology. Time magazine in 1982 named the computer its Man of the Year, noting that the growing popularity of the PC heralded a new age of bits and bytes. In 1980, companies such as IBM, Hewlett-Packard, and Apple sold 724,000 personal computers. By 1982, the number had more than quadrupled.
Time noted that “the enduring American love affairs with the automobile and the television set are now being transformed into a giddy passion for the personal computer. This passion is partly fad, partly a sense of how life could be made better, partly a gigantic sales campaign. Above all, it is the end result of a technological revolution that has been in the making for four decades and is now, quite literally, hitting home.”
The new technologies created massive personal wealth and allowed people and companies in almost every industry to spread their products over a wider market. As a result, the market winners had larger spoils. “The services of the best performers can be reproduced, or ‘cloned,’ at low additional cost,” wrote Robert H. Frank and Philip J. Cook in The Winner-Take-All Society. “More generally, whenever there are economies of scale in production or distribution, there is a natural tendency for one product, supplier or service to dominate the market. The battle is to determine which one it will be.”
Government policy also flipped in favor of the wealthy in 1982. In 1981, Ronald Reagan persuaded Congress to pass the Economic Recovery Tax Act, which lowered the top marginal tax rate from 70 to 50 percent and reduced other taxes on individuals and companies. Tax rates for non-wealthy Americans also dropped. Yet the biggest beneficiaries in dollar terms were the wealthy, who enjoyed one of the largest tax cuts in American history. In 1982, Congress passed the Garn–St. Germain Depository Institutions Act, which deregulated savings and loan associations and relaxed the constraints on home mortgages. The changes led to a surge in real estate lending and buying, and a boom in real estate values.
The Federal Reserve may have played a larger role in the wealth revolution of 1982 than either Reagan or Congress. The 1980–82 recession was widely blamed on Federal Reserve chairman Paul Volcker, whose interest-rate hikes tamed years of runaway inflation but also caused an economic crash. By the end of 1982, however, Volcker’s strategy started working, and interest rates and inflation both started to fall.
The combination of lower interest rates and financial deregulation unleashed a flood of money into the financial system. The total value of the Standard and Poor’s (S&P) 500 jumped from $863 million in 1981 to $1.2 trillion in 1983, adding more than $1.4 trillion in market wealth by the end of the 1980s.
As more and more companies began doling out stock as part of their executive compensation, top executives and corporate founders got a larger portion of their pay in stock. That linked more of their fortunes to the stock market and gave them a growing share of the more than $1 trillion in new market wealth during the 1980s. By 1989, the wealthiest 5 percent of Americans owned 73 percent of the individually held stocks (it is 82 percent today).
Lower interest rates also touched off a wave of deals. Debt became known as “leverage” and fueled a wave of deal making and buy-outs. In The Snowball, a biography of Warren Buffett, author Alice Schroeder described the period between 1982 and 1987 as a Renaissance in finance. “With debt now cheap, would-be buyers of a company could use the company’s soon-to-be gutted assets as collateral to finance its purchase—like getting a hundred percent mortgage on a house,” she wrote. “It cost no more to buy a huge company than to set up a lemonade stand. The merger boom had begun.”
The volume of shares traded on the New York Stock Exchange more than tripled between 1980 and 1990, fueled partly by the mass of Americans who were investing their retirement money in mutual funds and stocks. By the early 1990s, profits from finance, insurance, and real estate (known as FIRE) overtook profits from manufacturing—a complete reversal from 1980, when manufacturing profits were twice as much as the profits from FIRE.
By 1986, many of the country’s top one hundred earners were in finance. Michel David-Weill of Lazard Frères was making $125 million a year, while George Soros, who ran an exotic new form of financial vehicle called a hedge fund, made more than $90 million. Michael Milken, who had yet to be implicated in an insider-trading scandal, was making nearly $80 million.
It wasn’t just pure financiers who benefited from this new gusher of wealth. In addition to corporate executives, who were increasingly paid in stock and options, entrepreneurs and business owners cashed in by taking their companies public or selling them to competitors. There have always been entrepreneurs and privately owned companies in America. Yet the 1980s gave them a chance to trade in their respectable annual profits for one giant payday.
In addition to unleashing a gusher of financial wealth, 1982 also introduced a new era of asset bubbles. The amount of cash sloshing around the world swelled from retirement accounts, governments, and companies looking for short-term gains. Technology allowed investors to move billions with the click of a button, creating sudden capital stampedes.
Jeremy Grantham, the financial market guru who helps manage more than $100 billion in assets, has studied hundreds of asset bubbles over history and says that the past thirty years in America stand out for their frothiness.
“If you look at financial bubbles and financial markets, you see that the period until the 1970s was very flat, very boring, and then it steadily began to increase at an accelerating rate.”
The bubbles that preceded the dot-com bust of 2000 and the real estate and then the financial crisis of 2008 marked a new level in bubbliness, he says, and even bigger ones are on the way.
“It looks like maybe we’re heading in to what you might call a paradigm jump from 2007 onwards, into a period of a lot of bubbly activity, much more than normal,” he told me. “Selling all those financial services is hardly going to make the world a more stable place. Much more likely it will stir up activity. It is much better financially for Wall Street to have an unstable system than a stable system. If the S&P just grew at its long-term trend rate every year, everyone would die of boredom and the deals would dry up and it would be a different world. You wouldn’t have these great leaps and crashes. It’s turned into a circus, and the huge explosion in financial services since the 1980s has a lot to do with it.”
Grantham argues that there is a historical connection between bubbles and wealth booms. America’s largest bubble periods—the Gilded Age after the Civil War, the late 1920s, and the 2000s—also marked eras of peak wealth, suggesting that large concentrations of wealth may be both a cause and an effect of speculative frenzies.
“Speculative asset bubbles correspond to periods of highest inequality,” he said. “To me they are clearly interrelated. In the 1920s, you had this colossal increase in wealth associated with stock and speculation. In 2000, you had the creation of new companies where one minute it’s a gleam in someone’s eye and the next minute it’s worth billions of dollars.
“Wealth gets flashed around like an aphrodisiac. It encourages everyone to roll the dice and take risks and make millions.”
The aphrodisiac allure of wealth spilled into American culture, where television, movies, music, and magazines began to glorify the pursuit of wealth. After the economic doldrums of the 1970s and the recession of 1982, Americans yearned for a new national confidence and prosperity. The top network TV show in 1982 was Dallas, the series chronicling the oversize mansions, limos, diamonds, and family battles of the oil-rich Ewing family. The shows Falcon Crest and Dynasty, which also were popular, helped make a mass market for wealth voyeurism. The king of rich-people TV, Robin Leach and his Lifestyles of the Rich and Famous, followed soon after, famously wishing his audiences “champagne kisses and caviar dreams.”
Nineteen eighty-two also marked the launch of the first Forbes 400 list of richest Americans. The list recalled the fabled “Four Hundred,” the group of A-list New Yorkers from the nineteenth century. (The story goes that four hundred was the maximum number who could fit in society queen Caroline Astor’s ballroom, but alas, it’s just a canard.) Forbes magazine’s founder, B. C. Forbes, published a briefer, similar list in 1918, but it didn’t catch on at the time. The 1980s were ripe for such an undertaking, however. To make the 1982 list, which included thirteen American billionaires, the entrants were required to have $75 million or more (it’s over $1 billion now). The richest man in America in 1982 was Daniel Ludwig, a ninety-five-year-old shipping magnate who turned a small paddle steamer into the fifth-largest tanker fleet in the United States. Yet Ludwig was more the exception than the rule. Most of those on the Forbes list inherited their wealth or made it from oil. Texas had sixty-five residents on the 1982 list, by far the largest state contingent in the country.
With the collapse of the old codes of wealth—family pedigree, membership clubs, pet-like names such as “Bitsy”—spending became the new status marker. U.S. News and World Report declared, “Wealth is back in style. The old less-is-more, down-with-materialism atmosphere that achieved a high-art patina during the Carter years has been brushed aside by the new ruling class. A flaunt-it-if-you-have-it style is rippling in concentric circles across the land.”
The changes in government and the economy, combined with a wealth-cheering culture, reinvigorated the wealth divide in America. After seeing their share of national wealth decline since the Great Depression, the top 1 percent saw their share of both income and wealth suddenly start to rise. In 1981, the top 1 percent had 8 percent of the nation’s income; by 1990, they held 13 percent. In 1981, there were about 638,000 millionaires in America; by 1985, there were more than 800,000.
To see this transformation of the American rich from moderately wealthy makers of things to otherworldly rich beneficiaries of financial markets, consider the story of the Stern family.
In 1926, Max Stern, a young textile manufacturer in Germany, was nearly broke. Germany was suffering from hyperinflation and high unemployment. When the Stern family’s textile business closed, twenty-eight-year-old Max went looking for work.
He wanted to go to America, but he had no cash. When a childhood friend offered to repay a loan from Max with five thousand singing canaries, Max accepted. He boarded a steamship of the Hamburg American line bound for New York, getting a ticket in exchange for paying the freight charges on the canaries. He spent much of the journey in the cargo hold, feeding and caring for the birds.
Max arrived in a New York that was booming from Wall Street profits and the growth in autos and railroads. Max didn’t speak English and didn’t have any friends or relatives in the city. But within days, he sold all of canaries to the John Wanamaker department store in Manhattan. Max Stern, textile manager, was now in the bird business.
He set up an office in lower Manhattan and started traveling back and forth to Germany to bring back more birds. He sold them to R. H. Macy’s, Sears Roebuck, F. W. Woolworth, and other stores. By 1932, Max was the nation’s largest livestock importer. Since the customers who bought birds needed something to feed them, Max started selling bird seed. He created a new brand, called Hartz Mountain, named after one of his favorite mountain regions in Germany.
In 1959, Max’s twenty-one-year-old son, Leonard, took over the business. Leonard loved selling, and as a boy had done door-to-door sales. He graduated from New York University’s School of Commerce and earned his MBA while working as a clerk.
After joining his dad, Leonard expanded the business into other kinds of pet products, from Hartz Dog Pretzels (and their puppy version, called Pup-zels) to parakeet training recordings and rawhide bones. By the 1960s, Hartz flea collars, pet shampoos, and cat litters were also top sellers.
The pet food business was hugely successful. Industry pundits claimed that Max and Leonard Stern had done for pet supplies what Henry Ford had done for the auto industry. By the 1960s, the Stern family was doing so well that they had excess cash. Leonard looked around for a new business that could soak up capital but would require far fewer workers than the pet food business, which employed thousands.
“I wanted to find something that I could run that could handle more capital without creating a big organization,” he told me. He explored the Manhattan real estate market but decided it was already saturated. Leonard wanted to build his own venture from the ground up. While exploring the outskirts of New York City, he discovered a large plot of swampland and defunct pig farms in the New Jersey Meadowlands, six miles from downtown Manhattan. He bought more than twelve hundred acres and began developing warehouses and offices.
As Leonard’s fortunes grew from real estate and dog chews, his family also grew. Leonard’s two sons, Edward and Emanuel, began to work their way up the corporate ladder, and in the 1990s Emanuel started running the real estate division, while Edward took over the pet business.
By the end of the 1990s, the pet business had become less attractive. Hartz had gotten hit with a spate of antitrust lawsuits, claiming the company was strong-arming distributors and retailers into shutting out competitors. The suits were settled, and while Hartz never admitted to wrongdoing, it had to pay a $20,000 fine to the Federal Trade Commission.
The consumer landscape was also becoming less friendly. As retailers shifted from mom-and-pop stores to giant big-box retailers and nationwide drug chains, they had more leverage to drive down Hartz’s prices.
“We went from, like, forty-five-hundred customers down to about twenty,” he said. “That’s not a good prescription for large profits. But there was also a human element to it. Before, you would do all this product development and bring a great new product to the customer, and they would be very appreciative. But it changed and just became about data rather than personal touch. You’d bring in a new product and before you left it was being copied in Japan or China.”
The biggest problem was the family. Edward “Eddie” Stern grew up with a view of wealth that was different from his father’s and grandfather’s. For him, the best path to wealth was finance, not bird food or buildings. Eddie saw that in a world of fast-moving global capital, you didn’t have to make anything tangible to get rich. You merely had to make good bets—preferably with other people’s money.
“When I grew up,” Leonard said, “the kids I knew who had money had private family businesses. One kid’s parents owned a thirty-store drugstore chain; another kid’s family made picture frames; another kid’s family made suits. Those kinds of family businesses don’t exist anymore. For my son, for people now in their thirties and forties, they saw a whole different kind of wealth. He grew up, you know, where one friend’s dad was a partner at Goldman Sachs and another’s dad was at Credit Suisse. That’s where the money is now. That’s the opportunity. And, frankly, I don’t blame them. It becomes seductive when a college grad can get into one of these financial companies and make $300,000 a year.”
Eddie, in other words, wanted to join the ranks of those who make money from money. Leonard, by contrast, has a visceral dislike for bankers and Wall Street.
“I don’t invest in the stock market,” he says. “I dislike the stock market. I dislike bankers. I’ve always said, ‘There are people who grow tomatoes and people who trade them.’ For me, I like to grow the tomatoes.”
After some heated internal debate, according to family friends, the Sterns sold the pet business in 2000. Eddie devoted his time to managing the family’s investment portfolio, which grew by over $100 million after the pet business sale.
Eddie had already been trading on a small scale since 1998. But in 2000 he established a full-fledged hedge fund, called Canary Capital Partners, along with its management company, Canary Investment Management (named for the German birds that started it all). He also started taking in money from outside investors.
In two years, he had $400 million under management—more than the entire value of the pet business his family had built over two generations. In 2002, his assets grew to $730 million. He earned impressive returns. In 2000, when the S&P 500 fell 9 percent, Canary posted returns of nearly 50 percent. The next year, as the S&P fell further, Canary gained 29 percent.
Eddie charged his investors a fee of 1.5 percent of the funds under management as well as taking 25 percent of the profits, bringing in tens of millions a year for himself and a handful of employees. The only problem was that one of Canary’s main strategies—known as “market timing,” or quickly trading in and out of mutual funds—violated securities rules.
Eddie Stern faced illegal-trading charges by the New York State Attorney General in 2003. He settled the case for $40 million and, while not admitting to any wrongdoing, he agreed not to trade in mutual funds or manage any public investment funds for ten years.
Leonard, Eddie’s father, now runs his own philanthropy, the Stern Foundation. He donated $30 million to New York University in 1988 to help expand the business school, which was renamed the Leonard N. Stern School of Business. When I asked whether this new form of financial wealth—often revered by Stern students anxious to start work on Wall Street—is good or bad for the economy, Leonard paused before responding. “I can’t answer that question. In my generation, my peer group, we felt that to be entrepreneurs and to achieve the American dream, we had to make things. The next generation grew up incorporating different ideas of wealth and success. They start with the idea of a transaction.”
The Sterns have so far managed the move to transactional wealth without any major blowups, except for their brief run-in with the law. Yet by shifting their fortune from dog collars and bird seed to leveraged real estate and financial markets, the family is no longer rooted in the mass consumer market or broad economic growth. They are tied to asset bubbles, stocks, and fast-moving money flows.
The Sterns are part of what economists have called “The Great Financialization”—the long-term rotation of the American economy from production to finance. The moves have led to a host of changes in the broader economy, lending credence to John Maynard Keynes’s fear that speculation would one day dominate over production. Many economists argue that financialization has created rising personal debts, a surge in complex financial products, and more powerful and frequent financial bubbles. It has also generated vast amounts of wealth for entrepreneurs and investors like the Sterns.
That wealth, however, has come with a price. Today’s fortunes are more abstracted from the real world and therefore less stable. While the wealthy will earn far more during booms, they will also be far more vulnerable to busts as they ride the increasingly violent waves of finance. Pet food sales don’t suddenly fall off a cliff. Financial markets, however, can suddenly crash due to elusive factors like “confidence” and “sentiment.”
Stocks and financial markets can be twenty times more volatile than the broader economy. Because the fates of so many of today’s rich are linked to those markets, the wealthy have also become more manic. Their pre-1982 financial patterns, where they gained less than the population during booms and lost more during busts, have been reversed. During all of the expansions of the past thirty years, the top earners have gained far more than the population. During the expansion of 1982 and 1989, the incomes of the top 1 percent grew by 8 percent—four times the growth of the rest of the population. The disparity was repeated during growth spurts in the late 1990s and mid-2000s.
On the way down, the biggest earners are also the biggest losers. In the recession of 1989–1991, the top 1 percent saw their incomes drop an average of 3.5 percent, compared to 1.7 percent for all Americans. In the 2000–2003 downturn, rich incomes fell 5.8 percent, compared to 2.3 percent nationally, and in 2007–2008, their incomes fell 8.4 percent compared to 2.6 percent for the country. The incomes of the top-earning four hundred Americans fell four times as much as the rest of the population’s. Between 2007 and 2009, the number of Americans earning $1 million or more a year dropped by a staggering 40 percent, according to the IRS. With each economic cycle, the gains and losses of the rich became greater.
These gains and losses can be measured by their “beta.” Beta, the second letter of the Greek alphabet, is perhaps better known as a reference to a software prototype or a physics particle. In the world of statistics and finance, however, it refers to relative volatility. Merriam-Webster defines “beta” as “a measure of the risk potential of an investment portfolio expressed as a ratio of the stock’s or portfolio’s volatility to the volatility of the market as a whole.”
Put another way, beta measures how much something moves compared to its peers. A beta of 1.0 indicates that the stock (or whatever is being measured) closely follows the movements of the overall market. A beta of more than 1.0 means the stock swings higher or lower than the rest of the market. For instance, the stock of Wynn Casinos, the Las Vegas gambling company, is one of the most volatile stocks in the S&P 500 and has a beta of 1.7, due to the fickle nature of gambling profits. Companies like General Mills and Kellogg’s have a beta of .45, since their profits and stock movements are fairly constant.
The earnings beta of the rich makes gambling stocks look downright safe by comparison. In their groundbreaking study of high incomes, economists Jonathan Parker and Annette Vissing-Jorgensen found that the beta of the top 1 percent of earners before 1982 was lower than 1.0, meaning the volatility of their incomes was lower than that of the rest of the population. After 1982, their beta soared to an astounding 2.0. For the super-earners, or the top .01 percent, the beta jumped to more than 3.0, making the earnings of the super-rich even more volatile than the most speculative stocks on Wall Street. This is hard to believe, of course, especially in our age of ever-growing wealth and income disparities. Every day we see headlines about the rich getting ever richer and grabbing more and more of the national wealth. This is true, to some extent. As we noted earlier, the top 1 percent of earners now earn 22 percent of the nation’s income, up from 9 percent in 1982. We hear about CEOs and Wall Street bankers getting multimillion-dollar bonuses even if they destroy shareholder value and rely on bailouts from the taxpayers.
Yet CEOs have actually seen their pay become less stable. A study of pay for all the CEOs of S&P 500 companies (which include the vast majority of the highest-paid corporate chiefs) found that their average income has become far more volatile since the 1980s. It more than quadrupled during the 1990s before falling by 50 percent in the early 2000s. It then jumped 50 percent and fell by half again in the late 2000s, according to the study by Steven N. Kaplan of the University of Chicago Booth School of Business.
These CEOs still make huge money, an average of $8 million each—when they have a job. But turnover has soared along with competition, leaving half of the low-performing CEOs out of work within five years.
As for the Wall Street bankers, they remain a small minority in Richistan, even if they make a lot of headlines. One of the most detailed studies to date on the occupations of the top earners, by Jon Bakija, Adam Cole, and Bradley T. Heim, found that financial professionals (which also includes those who work in the insurance industry) accounted for only 18 percent of the top 1 percent of earners. The largest category was executives, managers, and supervisors—with many or most of that group being owners of privately held businesses.
Some might argue that the money swings of the rich are voluntary, since they can manage their incomes through their investments, especially stock sales. A rich investor, for instance, might decide to sell $20 million in stock one year but none the next. He might be selling because he’s buying a house, or because he thinks markets will go down, or because taxes might be going up. The investor’s income appears to change dramatically. But the change doesn’t reflect hardship or any change in lifestyle.
Yet even without these voluntary factors and stock sales, the incomes and wealth of the rich have become far more volatile. The Parker and Vissing-Jorgensen study stripped out stock sales, transfers, taxes, and capital gains and found that the incomes of the rich “moved substantially more (in percentage terms) than the overall average in each boom and recession since 1982.” They added that “prior to 1982, this was not the case.”
It’s not just their incomes that have become wobbly. It’s also their total net worth, or accumulated wealth. The median wealth of the American population fell by 3 percent during the 1990 recession, while the median wealth for the richest 20 percent of American fell three times as much. In the 2001–2002 recession, the top 20 percent lost three times as much of their wealth as the rest of America. Federal Reserve economists noted that during the 1990 and 2001 recessions, “only households in the highest quintile [top 20 percent] experienced significant decreases in mean and median wealth.” The top 20 percent were also the biggest wealth losers during the beginning of the 2007 recession.
Between 2008 and 2010, millionaire investors lost between 20 percent and 30 percent of their net worth, one of the largest losses among the rich since the early 1930s. Nearly a fifth of millionaire investors lost nearly half of their fortunes.
Wealth in America, of course, has always been transient: As an anonymous banker wrote in 1932, “So often have I seen the most solid and respected fortunes swept away, so often have I watched the cycle from shirt sleeves to shirt sleeves, that I am inclined to regard money riches as a restless visitor who seldom sits down.”
Yet wealth is now more restless than ever—even during good times. A Census Bureau study shows that from 2004 to 2007, about a third of the households in the highest income quintile moved down to another income group. In the same period, a third of those in the lowest income group moved to a higher group.
At the very top, the losses during downturns can be staggering. Sheldon Adelson, the Las Vegas casino king, lost more than $25 billion (or more than 80 percent of his net worth) during the Great Recession as his company’s stock crashed. His losses worked out to $65 million a day (or $2.7 million an hour) during 2008, topping the Forbes list of biggest losers. Adelson and twenty-five other billionaires lost a combined $167 billion in eleven months, as their shares fell an average of 59 percent.
Adelson took the paper losses in stride—as he should have, since he was still a billionaire after the drop and would quickly recover most of his wealth within the next two years. “So I lost $25 billion,” Adelson told ABC News. “I started out with zero. There is “no such thing as fear—not to an entrepreneur. Concern, yes. Fear, no.”
Yet several CEOs of big companies were publicly embarrassed in 2008 and 2009 by margin calls from banks that lent them money against their company stock. The executives were essentially borrowing against their shares to make other investments or purchases. When the stocks tanked, they had to pay the loan back or sell shares.
Bruce Smith, the former CEO of Tesoro Corp., an oil refiner based in San Antonio, was forced to sell 251,100 shares, or 14 percent of his holdings in the company, to meet a margin call from Goldman Sachs Group. The co-founders of medical equipment maker Boston Scientific Corp. were forced to sell 31 million shares, which had been pledged to collateralize a loan, the company said. The CEO of Williams-Sonoma Inc. reported the sale of $13 million in company stock, also due to a margin call.
Chesapeake Energy CEO Aubrey K. McClendon had to unload almost all of his stake in Chesapeake because of a margin call. Bankers who saw McClendon’s portfolio said he had pledged many of his shares for loans that he then used to leverage and invest in private equity and other investments—essentially piling risk upon risk. He later auctioned off thousands of bottles of wine from his collection to raise capital, though a spokesman for McClendon insisted he simply wanted to trim his collection.
The losers included not only Wall Street bankers and executives with stock options but also the legions of entrepreneurs and family business owners who cashed in on the asset bubbles and market booms by selling their companies. We’ll explore the most radical wealth blowups in the second part of the book. But to understand the day-to-day risks of turning a business fortune into a financial one—a widespread phenomenon among the wealthy over the past thirty years—consider the story of the Maher family.
In 1945, a young American soldier named Michael Edward Maher left behind the battlefields of France and sailed to New York to rebuild his life. He had grown up in Manhattan’s Hell’s Kitchen, the son of poor Irish immigrants. His father worked as a longshoreman, and his mother died when he was young. As a boy, Michael knew only one kind of work: loading cargo on the docks of Manhattan. He spent summers working alongside his father on Manhattan’s Chelsea Piers, and later he worked on the docks to put himself through law school. He got a law degree from St. John’s University and set up his own practice in Queens, hoping to finally escape the backbreaking drudgery, the union thugs, and the corruption of cargo work.
When he enlisted in the army in 1942, he hoped to work in the Judge Advocate General’s Corps. The army said it had too many lawyers, but it was suffering from a shortage of shipping experts. When they learned Michael had experience as a longshoreman, they placed him in the Transportation Corps.
He was sent off to Le Havre, France, where he helped oversee the supply chain for military campaigns in Africa and Europe. When the war ended, Michael planned to return to his law practice. But a colonel from the army who had a barge business in New York harbor convinced him to return to the docks. Michael bought up surplus army cranes and other shipping equipment and began renting them out to stevedoring companies.
He won a few contracts with shipping companies and eventually built a successful small business. His efforts to expand, however, were blocked by the tight ring of unions, organized crime families, corrupt politicians, and entrenched stevedoring companies that had a lock on the New York waterfront. Maher decided to venture farther south in search of more welcoming shores.
In 1951, he set up shop in Port Newark, in the tidal wetlands of New Jersey’s Newark Bay. He started buying cranes and equipment and formed Maher Terminals to load and unload ships pulling into the port. Later he moved to nearby Port Elizabeth, an old swamp that had been filled in and developed by the Port Authority of New York and New Jersey.
The unions in Port Elizabeth were far more hospitable, since they were desperate for work. As the major New York ports became overcrowded and priced out of the market, Maher’s terminal in Port Elizabeth started getting the overflow. Maher’s inability to break into the secret society of the New York cargo docks proved to be his greatest stroke of luck.
His success, however, came from more than just being at the right place at the right time. Michael Maher made two big business bets that would eventually wipe out his competitors and create one of the country’s largest shipping fortunes.
In the mid-1950s, Port Newark served as the launchpad for one of the world’s first shipping containers—the giant, uniform metal boxes that could be loaded onto trains, planes, and trucks. While many cargo terminal operators saw containers as a costly fad that would never catch on, Maher saw them as the future. He became one of the first in the country to convert his port operations to containers. Port Elizabeth also had far better access to interstate highways, railroads, and airports than New York, making it an ideal container hub. As containers became the building blocks of global trade, Maher’s terminal flourished.
He was also was an early adopter of computers. He hired a team of young programmers in the 1970s to design one of the first systems to track and manage cargo, and Port Newark’s terminals became some of most technologically advanced in the country. In 1985, thanks in large part to Michael Maher, Port Elizabeth became the largest port in the world as measured by volume.
In his personal life, Michael remained a modest man. He invested most of his profits back into the company and lived with his wife and five children in a three-story colonial house in Short Hills, New Jersey. He carried a beat-up leather briefcase and drove Volvos that had been damaged during shipping and were sold for a discount. “His life was the business,” says Joe Curto, president of Maher Terminals and a longtime employee. “He was on the docks at night, weekends, whatever it took.”
Michael’s two sons, Basil and Brian, grew up working alongside their father as forklift mechanics or messengers. Basil said some of his earliest memories were of the mountains of rubber, steel, and fragrant coffee piled high in the terminal warehouses. The boys later worked in the corporate office learning the finances and management of the business.
In the 1980s, Michael began to gradually hand over control of the business to his sons, especially to Brian. Michael remained chairman until the day he died in 1995. Basil and Brian followed their father’s path of innovation and opened up a new terminal in Prince Rupert, British Columbia, which they saw as a new Port Elizabeth. They had plans to pass the business to their own children and continue to grow beyond the shores of the United States.
Like their father, the Maher brothers saw their life as their work. They both lived in New Jersey, and on their rare days off they liked to golf or go trout fishing. “All we ever knew was the shipping business,” said Basil, a soft-spoken man with a weathered face and starched white dress shirts. “It’s in our blood.”
By the mid-2000s, however, a new era was dawning in the shipping business. Overseas giants such as Dubai Ports World, with backing from their governments, were swallowing up ports around the globe and consolidating their power. The Mahers worried about their ability to compete and raise capital. They never liked debt. And they were stunned by the huge prices that Dubai and others were willing to pay for operations such as theirs.
So in 2007, Basil and Brian and their families decided to sell Maher Terminals to an investment unit of Deutsche Bank. The price: more than $1 billion. The sale was the culmination of three generations of work and planning by the Maher family. For more than fifty years they had outsmarted and outfought unions, organized crime, Greek shipping dynasties, Korean cartels, and fast-changing global trade patterns to preserve their business. Now that they had finally achieved what the rich call a “liquidity event”—a sudden windfall from the sale of a company—they assumed their toughest business fights were behind them. They could spend the rest of their lives relaxing, playing golf, supporting charities, and spending time with their families.
While the Mahers could overcome even the toughest union bosses and organized crime families, they were no match for the Wall Street firms that promised to help them manage their newfound fortune.
Michael Maher had always told his sons to avoid Wall Street and avoid buying stocks. “He would tell us, ‘I was poor once. I don’t ever want to be poor again,’ ” recalled Brian.
Michael invested only in municipal bonds, both for himself and for the company pension fund. His sons followed his lead—for the most part. Basil made a brief foray into stock picking in the 1980s but quit after losing $1,000. “That was a lot for me at the time,” he said.
When they sold their business, the Mahers knew that they couldn’t trust themselves with their windfall. They were shipping guys, not investors. They wanted to park their cash in a safe place until they could hire their own staff of well-trained investors and create a long-term plan that included their charities, kids, and estates.
They deposited their money in three different banks—Lehman Brothers, UBS, and JPMorgan Chase—so that they could spread the risks. On the advice of a Wall Street friend, the Mahers sent the banks written investment guidelines with one chief goal: to preserve capital.
The accounts were “discretionary,” meaning the banks could invest the money as they pleased, as long as they followed the chief goal. In addition to preserving capital, the Mahers stated that they wanted the money to be highly liquid and easily accessible if they ever wanted to withdraw it. Basically, they were asking for a savings account with a slightly better interest rate.
UBS and JPMorgan Chase put the money into U.S. Treasuries, money-market funds, and government bonds, which were all among the most conservative investments. Lehman, which received $600 million of the Mahers’ money, was more creative.
When the Mahers saw their first account statement from Lehman, it showed that $400 million of their money had been invested in securities with mysterious names such as Tortoise TYY I and INC 2003–2. The Mahers called a friend who worked on Wall Street, and the friend called Lehman and asked, “What’s this ‘Tortoise’ doing in the Mahers’ portfolio?” Lehman explained that the investments were auction-rate securities—a kind of short-term bond that Wall Street had introduced in the late 1980s. Bankers had been telling investors for years that auction-rate securities were “cash equivalents,” meaning they were just as safe as cash.
The problem with auction-rate securities—a problem that bankers usually failed to explain—is that they trade in an obscure and largely opaque Dutch auction market. Every week or every month, depending on the security, an auction-rate security comes up for sale at an auction and has its interest rate reset. For more than twenty years, the auctions had gone smoothly. Then in 2008, just when the Mahers discovered they had $400 million in auction-rate securities, the auctions started failing, meaning their $400 million was frozen and impossible to value. Their goals of preserving capital and maintaining liquidity had been shattered.
Through their Wall Street intermediary, the Mahers instructed Lehman to sell their auction rates. Lehman was able to sell about $114 million of their holdings. Before they could dump the rest, the auction market seized up because there were no buyers. In early 2008, the subprime mortgage crisis was beginning to turn into a full-blown credit crisis, which left auction-rate securities stranded and the Mahers with $286 million of worthless paper. They filed a claim against Lehman, accusing the company of mishandling their investments.
Lehman would later go bankrupt itself, due in part to its own holdings of poorly understood debt products. Yet before the firm failed, Lehman justified its decisions to the Mahers by saying that auction-rate securities had always been as safe as cash. They added that since their account was discretionary, the brothers had agreed to allow Lehman to make the investment decisions. They said the Mahers’ investment statement expressly allowed for auction-rate securities and other “cash equivalents” and that the Mahers were just looking for someone to blame for a broader financial crisis.
The Mahers still had plenty of money—hundreds of millions, in fact—even if they assumed their $286 million was gone for good. They could fund charities, set up trusts for grandkids, and pay for as many golf games and trout-fishing trips as they wanted. Yet the loss still stung. “I don’t care who you are—$286 million is a lot of money,” Brian said.
The Mahers hated public attention, and until I talked to them in 2008—after repeated phone calls, written requests, and discussions with their attorney—they had never given an interview to the mainstream press. Filing a lawsuit was a painful act of highly visible protest. What the Mahers really wanted was for Lehman to admit wrongdoing. It wasn’t just about the money. It was about the principle of a Wall Street firm squandering years of hard work by the Maher family. It was about holding Wall Street accountable.
“We entrusted our money to Lehman believing them to be looking out for our best interests,” Brian said. “They didn’t.”
Even though they lost $180 million, the Mahers got off rather lightly relative to their overall fortune. Other rich people weren’t so lucky. While some investors and Wall Streeters recovered quickly from the recession, the American rich who rode the asset bubbles and lending booms of the past two decades have done far worse.