THE LICENSE FOR FINANCIAL DEVASTATION
In this world the follies of the rich pass for wise sayings.
Central to the economics of contentment is the general commitment to laissez faire. This is not a formally avowed principle—or, in any case, it is not often so affirmed. Rather, it is an attitude, the belief that it is in the nature of things, and especially of economic life, that all works out for the best in the end. Nothing that happens in the short run is in conflict with longer-run well-being. The intervention of the state, with its controlling or sustaining hand, is not necessary, and except as a bank or a corporation needs to be rescued or the common defense furthered, it is never benign. One does not countenance interference with what is programmed to work or, to repeat, with what will work in the longer run whatever the adverse short-run experience or whatever the warning or prediction as to the future.
So much is in the area of largely unexpressed faith. The specific instrument for ensuring benignity, specifically cited and avowed, is the market. Here public authority is sharply forbidden to interfere, for to do so is to impair or frustrate the operation of the very mechanism that ensures socially rewarding performance. With the market, attitude becomes formal controlling doctrine.
That the market does not produce socially optimal results has, in fact, been long recognized by economists. There is monopoly, and there are numerous lesser imperfections of competition. This is accepted, as also, in large measure, the visibly unequal distribution of power between employer and employed and an intrinsically and even egregiously unequal distribution of income. A very large part of all modern economic expression, extending on to political debate and action, has concerned these less than socially equitable aspects of the market. Public programs, many of them broadly identified with the welfare state—old-age pensions, unemployment compensation, public health care, antitrust legislation, housing for the poor, environmental and consumer protection, progressive income taxation and support to trade unions—have clearly mitigated the inequities and cruelties of the system and, in doing so, have gone far to ensure the survival of capitalism. But invariably, as we have seen, such action has been most resisted by those whose economic position has been placed most at risk by the political reaction or community violence resulting from the aforementioned injustices of the market. This, the short-run response, is normal.
So much is accepted—or, in any case, is recognized as the substance of present-day political debate. Both those who support and those who oppose welfare measures can thus claim to be defenders of the system. What is not accepted and is, indeed, unrecognized is the powerful tendency of the economic system to turn damagingly not on consumers, workers or the public at large, but ruthlessly inward on itself. Under the broad and benign cover of laissez faire and the specific license of the market, there are forces that ravage and even destroy the very institutions that compose the system, specifically the business firms whose buying, selling and financial operations make the market. This is a striking development of modern capitalism; the particular devastation is of the great management-controlled corporation. Such destruction has become especially severe in the years of contentment. That it is an intrinsic feature of the uncontrolled market system is, as I’ve said, still largely unrecognized. Though much noted in economic writing and reporting, it has been seen primarily as an episodic development and not as something that is the product of inner causation.
The self-destructive tendency of modern capitalism begins with the large corporation. It has long been accepted that here effective power passes with a firm inevitability from the owners or stockholders to the management. The stockholders are numerous and dispersed; individual votes count for little or, more often, for nothing. The knowledge requisite for stockholder intervention in the diverse and complex affairs of the enterprise, some larger holdings apart, is lacking; in the clearest statement of where the authority lies, it is the management that selects the members of the board of directors, which then, ostensibly, represents the stockholders. As early as the 1930s and 1940s, distinguished scholars, among them a committed conservative, described the euthanasia of stockholder power and the dominance of managerial power.1
Out of the foregoing has come the basic anomaly of large corporate enterprise in the market system. It is assumed in all established economic doctrine that the business firm seeks to maximize its profits. For that it exists; any other purpose would reject the basic tendency of human nature. In so doing and, in the words of Adam Smith, through no intention of its own, it serves the public interest. The presumption, celebrated as theologically immutable doctrine, is that profit is maximized for the owners, the stockholders, the capitalists.
But here is the anomaly: it is the management that has the power, and the management, that power notwithstanding, is presumed to surrender its own interest to the interest of the stockholders, who are singularly without power. Thus worked into the justifying theory of the corporation is both the assumption of unrelenting profit maximization and a largely selfless surrender of the resulting gains by those responsible for such maximization.
In fact, the assumption of self-interest is valid. As managers have escaped the control of stockholders, they have come increasingly to maximize their own return. The revenue enhancement by management has been in the form of salaries and stock options; retirement benefits; exceptionally diverse and expensive perquisites, with some special emphasis on aircraft; more mundane expense accounts; golden parachutes as protection if there is loss of power; and other financial rewards.2 In 1980, the chief executive officers of the three hundred largest American companies had incomes twenty-nine times that of the average manufacturing worker. Ten years later the incomes of the top executives were ninety-three times greater. The income of the average employed American declined slightly in those years.3 It was these ample and self-endowed returns and the prestige and power associated with high managerial position that attracted, not surprisingly, the interest and obtrusive attention of those who, also not surprisingly, would prefer to have them for themselves. Thus came about two of the most spectacular financial developments of the 1980s: the corporate raids, as they were called, to gain the power and rewards of management, and the buyouts by management seeking to preserve its own position and income. Both were accomplished in essentially the same way—by the borrowing of money against the eventual credit of the corporation to buy up stock from the hitherto passive and languid stockholders.
It would be hard to imagine an economically and socially more damaging design. Both exercises loaded a heavy debt on the firm; interest on this debt then had prior claim over investment in new and improved plant, new products and research and development. In the case of the largest and most egregiously self-serving of the leveraged buyouts, that just mentioned of RJR Nabisco in 1989, heavy losses followed in the immediately ensuing period,4 and capital spending was slashed sharply in 1990. A Canadian real estate adventurer, Robert Campeau, moving in on some of the biggest and most successful American retail chains, including Bloomingdale’s and Federated Department Stores, left them in bankruptcy and briefly, it was said, in some doubt as to whether funds could be found to finance the future acquisition of the goods they were to sell.
After a takeover or buyout, there was often a forced sale of some parts of the firm, frequently the most promising or profitable, to reduce debt and meet interest charges. The high interest charges then kept the firm vulnerable in the event of any individual or general decline in revenues. Notoriously, there were, as well, large, wholly nonfunctional costs for legal, underwriting and financial guidance.5
Perhaps the worst financial devastation has been that of the nation’s airlines. Here an ill-considered deregulation—faith once again in the market in a public-service industry where utility regulation is normal—has been combined with corporate raiding and leveraged buyouts on an impressive scale. The results have been heavy debt, the bankruptcy of several of the larger airlines, the folding up of Eastern Airlines and of Pan Am, a chaotic muddle of fares and available routes, an inability to replace aging equipment and, in the end, quite possibly an exploitative monopoly by the survivors.
There were further adverse effects of the mergers and acquisitions mania. These included the socially sterile rewards received by those who traded with inside information on the offers to be made for a specific stock. And there were the losses, in some instances perhaps salutary, of those who were attracted by the prospect of high return and who bought the securities, principally the high-risk, high-interest junk bonds, that financed the operations and that went eventually to discount or default as the full consequences of the aberration became evident. From these losses there was further effect on productive investment and, at least marginally, on consumer spending and the functioning of the economy as a whole. With all else, in the oldest tradition of economic life, the mentally vulnerable, those at one time more obtrusively denoted as fools, were separated, as so often before, from their money.
Yet all was wholly plausible, given the corporate structure and the approved profit-maximizing motivation of the system. All, to repeat, was under the benign cloak of laissez faire and the market.
Legislative or executive action to limit or minimize the destruction—for example, holding hearings to require the approval on economic grounds of the regulatory agency for any large-scale substitution of debt for equity—went all but unmentioned. And such mention would have been met, in any case, with rejection verging on indignation and ridicule. The free enterprise system fully embraces the right to inflict limitless damage on itself.
The mergers and acquisitions mania was, without doubt, the most striking exercise in self-destruction of the culture of contentment. There have, however, been two other highly visible manifestations of this deeply inborn tendency.
The first of these was the real estate speculation of the 1980s, centering on commercial office space in the cities, but extending out to expensive dwellings, in particular condominiums, in the suburbs and resort areas and going on to architecturally questionable skyscrapers in New York City and admittedly hideous gambling casinos in Atlantic City.
As ever, the admiration for the imagination, initiative and entrepreneurship here displayed was extreme. Of those receiving the most self- and public adulation, the premier figure was Donald Trump, briefly and by his own effort and admission the most prestigious economic figure of the time.
The admiration extended to, and into, the nation’s biggest banks. Here the loans were large and potentially dangerous, and so, in the nature and logic of modern banking, they were handled with the least care and discretion. The security of the small borrower is traditionally examined with relentless attention; the claims of the large borrower go to the top, where, because of the enormous amounts involved, there is an assumption of especially acute intelligence. The man or woman who borrows $10,000 or $50,000 is seen as a person of average intelligence to be dealt with accordingly. The one who borrows a million or a hundred million is endowed with a presumption of financial genius that provides considerable protection from any unduly vigorous scrutiny. This individual deals with the very senior officers of the bank or financial institution; the prestige of high bureaucratic position means that any lesser officer will be reluctant, perhaps fearing personal career damage, to challenge the ultimate decision. In plausible consequence, the worst errors in banking are regularly made in the largest amount by the highest officials. So it was in the great real estate boom of the age of contentment.
Here the self-destructive nature of the system, if more diffused than in the case of the mergers, acquisitions and leveraged buyouts mania, was greater in eventual economic impact. Excessive acreages of unused buildings, commercial and residential, were created. The need for such construction, given the space demands of the modern business bureaucracy, was believed to be without limit. In later consequence, the solvency of numerous banks, including that of some of the nation’s largest and most prestigious institutions, was either fatally impaired or placed in doubt. The lending of both those that failed or were endangered and others was subject, by fear and example, to curtailment. The construction industry was severely constrained and its workers left unemployed. A general recession ensued. Any early warning as to what was happening would have been exceptionally ill received, seen as yet another invasion of the benign rule of laissez faire and a specific interference with the market.
However, in keeping with the exceptions to this rule, there could be eventual salvation in a government bailout of the banks. Insurance of bank deposits—a far from slight contribution to contentment—was permissible, as well as the assurance that were a bank large enough, it would not be allowed to fail. A preventive role by government was not allowed; eventual government rescue was highly acceptable.
Ranking with the real estate and banking aberration was the best publicized of the exercises in financial devastation: the collapse of the savings and loan associations, or, in common parlance, the S&L scandal. This, which was allowed to develop in the 1980s, had emerged by the end of that decade as the largest and costliest venture in public misfeasance, malfeasance and larceny of all time.
Again the basic principle was impressively evident and pursued: laissez faire combined with faith in the benignity of market enterprise. The short-run view took precedence over the more distant consequences. And there was an infinitely vast and obligatory public intervention as those consequences became known.
Starting well back in the last century, the savings and loan associations, under various names, played a small, worthy and largely anonymous role in the American economy. Attracting for deposit the savings of the local community, they then made these available in the form of home loans to the immediately adjacent citizenry. There was strict regulation by federal and state governments as to the interest they could pay and charge and the purpose for which they could make loans. Home ownership being a well-established social good, the S&Ls were eventually given public encouragement and support in the form of a modest government guarantee of their depositors’ funds.
Then, with the age and culture of contentment, there came the new overriding commitment to laissez faire and the market and the resulting movement toward general deregulation. The commercial banks, once released from regulation, greatly increased the interest rates there available to depositors, which meant that if the similarly deregulated S&Ls were to compete, they would need to pay higher rates to their depositors. Sadly, however, these payments would have to be met by the low rates then in place on a large and passive inventory of earlier mortgage loans. The highly improvident solution was to accord the S&Ls freedom to set rates of interest on the insured deposits and then to go beyond home loans to the widest range of other investments, or what were imaginatively so designated. Also, faithful to principle, government action in the interest of contentment was not curtailed. Instead, the once modest insurance of deposits by the federal government was raised to $100,000 on each S&L account. The selective view of the role of the state was never more evident.
The foregoing changes were variously enacted or instituted mainly in the early 1980s. They set the stage for what was by far the most feckless and felonious disposition of what, essentially, were public funds in the nation’s history, perhaps in any modern nation’s history. Deposits guaranteed by the federal government and thus having behind them the full faith and credit of the government were brokered across the country to find the highest rate of return. Such interest was, normally, offered by the institutions most given to irresponsible or larcenous employment of the funds involved. Efforts at correction or restraint, palpably small, were deliberately restricted as being inconsistent with the broad commitment to deregulation.6 Those still subject to the skeletal and ineffective regulation took their case, not without success, to the Congress. Funds from the publicly guaranteed deposits were thus recycled back to support congressional races in an innovative, if perverse, step toward the public financing of electoral campaigns.
In the latter years of the 1980s, the whole S&L experience came explosively to an end in the first and, in many respects, most dramatic exposure of the public principles implicit in the age of contentment. The prospective cost, perhaps $2,000 for each American citizen were it equally assessed, was regarded as impressive. Less impressive, perhaps, was the understanding of what underlay the debacle. Here, first of all, was the general commitment to laissez faire, the specific commitment to the market, which had led to the deregulation. But here too was the highly selective character of that commitment. As far as the culture of contentment was concerned, responsibility to find a solution for the shortfall remained firmly with the state. The depositors, large and small—the comfortable rentier community—were at risk; thus the necessity for the continuing role of the government. The whole S&L scandal was, to repeat, one of the clearest displays of the controlling principles of contentment, and certainly it was the most immediately costly.
1 The decisive work was that of Adolf A. Berle, Jr., and Gardiner C. Means, The Modern Corporation and Private Property (New York: Commerce Clearing House, 1932). James Burnham, the undeviating conservative, affirmed the dominant role of management in The Managerial Revolution: What Is Happening in the World (New York: John Day, 1941).
2 These have been detailed at no slight length in one of the small classics of the age of contentment, Barbarians at the Gate: The Fall of RJR Nabisco (New York: Harper and Row, 1990), by Bryan Burrough and John Helyar. Among the lush executive perquisites at stake in the takeover of RJR Nabisco was a whole fleet—called the Air Force—of executive jet aircraft, complete with company hangar.
In 1991, two leading business magazines, Forbes and Fortune, highlighted and, indeed, criticized—Forbes in particular—the growth in executive compensation. The reporting was especially poignant in the case of Fortune, for the most successful effort at personal profit maximization, there identified as a total reward of $39,060,000 for the year 1990, was that of Steven J. Ross, the head of Time Warner, owner, among other properties, of Fortune itself. A co-executive of the same corporation, Nicholas J. Nicholas, also received well up in the millions that year. Some 258 out of 800 chief executives of other firms had annual revenues in excess of a million dollars, giving a new meaning to the old word millionaire.
3 Benjamin M. Friedman, “Reagan Lives!” New York Review of Books, December 20, 1990.
4 The New York Times, February 6, 1990. The full story of this dementia is in Barbarians at the Gate.
5 While RJR Nabisco was the best celebrated example of the corporate-takeover, leveraged-buyout mania, the classically damaging case could have been that of Morgan Stanley and Company, an avowedly conservative investment banking firm, and the takeover of Burlington Industries, the large textile complex. Morgan Stanley extracted in fees and a special dividend an estimated $176 million from Burlington, and the latter was left under an enormous load of debt with “some of its core operations, like its research department, … chopped to pieces by cost-cutting drives,” and with a large issue of junk bonds trading for a fraction of their original value. The Wall Street Journal (December 14, 1990) dealt at length with this case, and the quotation is from its report.
6 This inconsistency was made explicit by Secretary of the Treasury Donald Regan, a decisive figure in the debacle. Mr. Regan is thought to have emerged from this service, as later from his service in the White House, as one of the more expendable political figures of the time.