Invest the Peoples’ Capital, or
How the Government Corrupted Capitalism
In 1964 Studebaker went broke and did not have the money to pay its pension obligations. Congress responded by passing ERISA  in 1974 to protect the peoples’ pensions. The enormous amount of money designated for investment, however, made this a potentially dramatic moment in the history of capitalism. It was a perfect investment profile: large amounts of patient capital looking for return many decades in the future along with a “capital wage” from dividends averaging 6% at that time.
As much as $100 billion a year from private and public plans was available for investment. Where would it go and how would it get there? The possibilities were exciting: stronger economic growth by companies issuing stock for investment in new product development; public investment in education, urban transit, research in new energy sources, and environmental needs. Companies could also address their infrastructure needs, for example utility companies could add capacity to handle peak loads, and oil companies could upgrade transmission lines.
At about the same time Senator Russell Long’s committee was passing 15 laws giving tax benefits to forms of worker ownership that motivated and rewarded the wage earner to build more wealth. The Information Age industries were adding amazing productivity and opportunities to unite people. The power of economic freedom to improve lives was being used in both democratic and authoritarian countries and millions were being taken out of extreme poverty. Late in the 20th century these were solid reasons for optimism that the world had finally found the way to peace and plenty.
Think of ERISA as a hydraulic pressure being applied to the stock market. With about 70% of the total funds there was $70 billion of new money coming into the market in the early years. Where would it go? It could be cycled into the economy paid to companies for new stock they issued for growth, it could increase in the value of stocks then in the market, and it could go to the managers of money for fees, commissions and other compensation.
Directors and executives of public companies were personally threatened by the ERISA and rushed to place investment responsibility outside the company. Company executives and committees then reviewed the performance of the money managers quarterly and fired those whose performance for the year was not competitive with other managers. This was the genesis of the perversion of potentially very patient capital to very short term that changed the nature of capitalism in America. The discipline to invest surplus for long-term benefit is the essence of capitalism and the results of which cannot be measured in less than three years. The shift to short-term measurement eventually provoked cost cutting as the quick way to improve earnings.
Corporate raiders showed the way by taking advantage of the easy credit now amplified by the flow of pension money to attack companies with a premium offer over the stock price and then fire people and strip benefits to pay for the acquisition. Takeovers almost always increased the price of the stock and for that short-term reason gained the support of the money managers motivated to improve their standing in measurements such as the Becker Median. This was an extraordinary perversion of capitalism: the very people responsible for the future value of the peoples’ investment were financially motivated by the system to chose short-term results that cut back on long-term investment!
The way to get there was Wall Street. The investment bankers would handle the bonds and the stock market would move the money coming into the market out of the market in new growth stock. This simple dynamic, however, had a few important conditions to be understood and observed by the designers of ERISA. For the free market to reach full potential money must be neutral, that is, without influence on the commercial process. This, in turn, required that asset inflation in either stocks or real estate must be controlled by tax policies, bank and margin requirements. The obligation of government to control currency and credit for the general welfare meant that the tendency of excessive liquidity, too much money, to move to speculation would have to be anticipated and controlled.
Too bad! None of this was done and most of the money flowed into the stock market and not enough of it flowed out in new stock for growth. The money had no where to go but up and the longest bull market in history began. The pension money flowing into the stock market soon dominated the economy with enormous rewards or punishment for a few cents change in quarterly earnings per share. Instead of the peoples’ money democratizing capitalism, it was perverted into a new mercantilism in which firing people was the way to produce quarterly earnings. Stocks that had been held for six years on average were sold in less than a year. Dividends shrank from 6% to less than1% in the bull market. Despite the greater volume of transactions, fees for handling the money went higher. Mutual fund fees reached ten times that of index funds that produced the same or better results. Profits from financial services exploded from 4% of total corporate profits to over 40%.
In this environment, CEOs’ overriding consideration was building up and protecting the short-term price of the stock. Shortfall of a few cents a share in quarterly earnings per share could wipe hundreds of millions, even billions, of dollars off market value. A high stock price also made acquisitions possible, and a low one made takeover more likely. They “smoothed earnings” by dipping into inventory or bad-debt reserves; slipped into “creative accounting” to prevent a miss against quarterly targets; and finally some plunged criminally into faking earnings. CEOs trapped in this dynamic hoped that the shortfall was temporary and that good times coming would correct the books. When this did not happen, they were hooked on faking earnings.
Once CEOs were trained like Pavlov’s dog the Wall Street agenda was easily implemented. Wall Street did not like dividends because they did not make money on dividends and preferred that companies keep the cash and use it for stock buybacks or as an attraction for a deal. Wall Street hated dilution so those companies thinking about using the stock market for its original purpose of raising cash for investment thought twice before they would sacrifice stock price for possible dilution.
ERISA money turned into easy credit that drove the bull market and funded adventures from LTCM to Enron. Global companies practiced wage arbitrage moving quickly into the lowest wage opportunity with no thought of wages high enough for reciprocal purchases without which free trade does not work. The Southeast Asian countries had their economic momentum reversed by hot money and currency speculation. Muslim leaders called America “economic imperialists.” Russia tried to move to this form of capitalism with “shock therapy” with disastrous results.
At the time of ERISA the stock market valued earnings at about 7 times, that is a dollar of earnings per share meant a stock price of $7. This was low as the long-term average was 15 times. . As most of the hydraulic pressure went, not into new equity for growth but rather into pushing up the value of stocks by the end of the century earnings were valued at about 30 times. That same dollar of earnings was now worth $30 on the market. Extraordinary amounts of personal wealth was produced by this phenomena. With easy credit and favorable tax policies deals proliferated on Wall Street and a crucial change was made in how they priced services. Instead of hourly-based advisory annual fees they now priced on a percentage of the deal. As deals proliferated and became bigger finance capitalists were the first to be comfortable with annual compensation in the $5o million to $100 million range. With the encouragement of the finance capitalists and money managers CEOs were then encouraged to participate in the feast with millions of stock options and increasing compensation from a growing smorgasbord of plans. The practice of Board Compensation Committee to review the internal logic of compensation was abandoned for comparison only to a peer group of overpaid CEOs.
During the 1980s and 1990s everyone seemed to be enjoying enormous wealth. Hidden was the reality that the big increases in productivity were going to the top 1% and not being spread to the wage earner. Inequalities of wealth reached record levels. The business schools and financial press adopted this new “shareholder capitalism” as the sought for new mode of production. Managers who tried to hang on to long-term building plans were derided as “entrenched management,” and support went to the raiders. Well known people warned of the developing dangers; Warren Buffett persistently recommended long-term investment, famous speculator George Soros warned that instabilities in the international monetary system threatened both the economy and social cohesion; famous M&A attorney Marty Lipton warned that we were sacrificing long-term growth for short-term earnings.
 Employees’ Retirement Insurance Act