Perversion of Capitalism
In the economic system called “capitalism,” private capital is invested for future economic gain, jobs are created, wealth spreads, and each generation can live better. Before capitalism and the Industrial Revolution, society was static; the modes of production were slavery and serfdom. Then for two centuries, capitalism’s economic freedom improved the lives of millions. Now, the legacy of passing on a better life to the next generation is in danger.
Problem: Wall Street’s “shareholder capitalism” has sacrificed economic growth for a higher stock price for over a quarter-century. Transactions on Wall Street grew to about $33 trillion daily of which 99.2% went into speculation, and only 0.8% was invested in job-producing economic growth. Millions are victims of nearly 8% unemployment and a low GDP growth rate below 1.5%. According to the U S Census Bureau, 43.6 million Americans are living in poverty; nearly 25% of workers aged 25 to 35 are without jobs, and 6 million have lost their homes. New York Times columnist Charles Blow reported that the United States, compared to 30 “advanced” nations, now ranks near the bottom on such as income inequality, student performance on math tests, average life expectancy, and the percentage of citizens in prison. According to a CBS News poll, 70 percent of Americans surveyed felt that the country was going in the wrong direction. This is the country that for most of the past two centuries inspired the world with our freedoms and comfortable living. We used to be the “light on the hill.”
The government threw trillions of dollars at the problem, but the result has been only to put “shareholder capitalism” back in the zero-sum game of buying and selling stocks. The assumption that Wall Street’s present stock market has a useful economic purpose is a colossal lie. It is a playground for the privileged few who squander trillions on speculation while our government ignores a massive failure to invest in growth.
“Shareholder capitalism” became the greatest perversion in the history of capitalism not only because it did not invest the workers’ capital in job growth but also because it cut existing jobs. “Downsizing” –firing people--became the quick and easy way to boost the price of a share of stock. CEOs passed their manhood test by announcing lay-offs of thousands of workers. The systematic stripping of growth investment, now having gone on for over a quarter-century, has left the 1% with incredible record wealth, and many of the 99% without jobs, homes, money for retirement, or hope.
Solution # 1: $2 trillion is currently sitting idle in corporate surplus, half domestic and half abroad. Most of it was the product of money managers’ failure to invest the workers’ capital in economic growth, and corporate managers’ sacrifice of growth plans to hype the price of their stock. The quarter-century of firing people has resulted in cash flow that produced this corporate surplus. Tax policies could move this lazy surplus into active capital for growth investments, and into dividends that would stimulate greater consumer demand and further growth.
Late in the 20th century, pension funding turned workers into democratic capitalists. The workers’ trillions of dollars of patient capital was the greatest savings-investment opportunity in history. When Congress passed the Employees’ Retirement Insurance Security Act (ERISA) in 1974, however, they forgot to ask where the money would go. They assumed that the social purpose of finance capitalism would be the efficient movement of savings into investment.
Solution # 2: The workers’ capital in 401 (k) retirement accounts alone totals about $3 trillion. A 5% dividend paid in cash quarterly on this capital would take billions of dollars out of Wall Street and put it into the economy. Tax deferral has kept this capital passive and within the control of the money managers. During the recent disaster, now called the “great recession,” this capital lost from 15% to 40% of value while money managers charged the worker-capitalists ten times index funds for similar performance.
A redesigned workers’ capitalism could reposition dividends as one-half of the return from capitalism. A “capital wage,” in addition to wages for labor, would generate new purchasing power for those who trigger the multiplier effect, one of the keys to large and sustained growth. A huge one-time cash dividend from this surplus could be considered as a catch-up payment of dividends that have been deferred for over a quarter-century. Worker shareholder’s rights to this capital have neither begun to be expressed, nor even to be examined.
A substantial redirection of this investment capital from corporate surplus and passive workers’ capital could bring unemployment back under 5% and push economic growth well over 3%. The Wall Street priority for this surplus, by contrast, is to waste it on stock buy-backs, another way to hype the stock price, and on deals that produce a feeding frenzy in compensation among the deal-makers. Special taxes could repatriate the surplus from abroad, penalize the Wall Street priorities, and provide workers with a “capital wage” in dividends.
Wall Street, however, does not operate on the premise of social purpose. The mission of “shareholder capitalism” was to maximize the price of the stock. This simplistic mission appealed to many, including the quants who flocked to Wall Street to design new products that would soak up the workers’ capital, and the economists who thought they had found a hard science. The destructive cycle was funded, as usual, by easy credit. In contrast to retirees’ patient capital invested for eventual return, hi-tech, high-speed Wall Street trading completes transactions in stocks and derivatives in less than 16 seconds.
Over a couple of decades, Wall Street executives have gone from earning good salaries by advising companies and risking their own money, to speculative trading in newly public companies. The last to “go public” was Goldman Sachs in 1999.
The investment banks have changed their structure and shifted their loyalty from their clients to their shareholders. Their goals? More borrowed money with which to speculate and less personal liability. Their short-term results, based on steadily increasing both risk and leverage, led inevitably to the disaster. What can the “social purpose” be when the electronic casino is 99.2% speculation? How did Wall Street talk the workers into using their capital to fund this speculation?
Peter Drucker (Post-Capitalist Society, New York: Harper Business, 1993: p. 211) indicted this perversion of capitalism well in advance of its disastrous results:
What emerged from this frantic decade was a redefinition of the purpose of business and the function of management. Instead of being managed in the best interests of stakeholders, corporations were now to be managed exclusively to “maximize shareholder value.” This will not work. It forces the corporation to be managed for the shortest term, but this means damaging, if not destroying, the wealth–producing capacity of the business. It means decline and finally swift decline. Long-term results cannot be achieved by piling short-term results on short-term results. They should be achieved by balancing short-term and long-term needs and objectives. Furthermore, managing a business exclusively for the shareholders alienates the very people on whose motivation and dedication the modern business depends: The knowledge workers. An engineer will not be motivated to work to make a speculator rich.
One of the insulting features of “shareholder capitalism” is that Wall Street not only destroyed jobs and growth but also overcharged the workers for “managing” their money. Scott Cendronski (Fortune, July 2, 2012, p. 67) asked the question this way:
Retirement plan providers have been overcharging investors for decades, creating a huge drag on returns. But new rules on fee disclosure should help drive down costs. Are you paying too much for your plan?
Cendronski traced the growth of 401(k) assets from zero in 1978 to about $1.5 trillion at the turn of the century to its present level of over $3 trillion. Imagine if the workers invested this enormous capital in growth instead of letting it get hijacked by Wall Street for the few to make money on money?
For decades, Jack Bogle, founder of Vanguard, has been an evangelist trying to get worker investors to understand how badly they were being overcharged by the money handlers for “managing” their funds and how much value they were losing in the economic disaster. Bogle argued that buying and selling stocks in which no one but the croupiers made money is a zero-sum game. Wall Street derided this as “Bogle’s folly,” but index funds are increasingly recognized as a prudent, safe investment that follows Warren Buffett’s recommendation to hold on to investments “forever.”
Bogle was featured in a New York SundayTimes (August 12, 2012) front-page article, complete with three photos, a very public vindication of Bogle’s opinion of how worker capitalists ought now to invest their money. In Bogle’s latest book--his 11th-- The Clash of Cultures,(Hoboken, New Jersey: John Wiley & Sons, 2012, p. xvii), he argues that the system is so out of balance that it threatens our entire society.
Bogle stressed that the culture of short-term speculation has come to dominate the economy:
Capital formation--that is, directing fresh investment capital to its highest and best uses, such as new businesses, new technology, medical breakthroughs, and modern plant and equipment for existing businesses-- accounted for 0.8% while speculation represented about 99.2% of the activities of the equity market system.
Bogle recommends taxes to discourage speculation, limits on easy credit for speculation, transparency for derivatives, and most urgently: “ A fiduciary standard that puts the interests of the client first.”
The fastest game on Wall Street is the gambling of hundreds of trillions of dollars on derivatives whose value is presumably based on the underlying instrument. So much money was sloshing around Wall Street, however, that the high-rollers invented fantasy derivatives based on nothing but the bet itself. For years, now, no one has known how much derivatives were worth: Most of them were not traded and valued on any market.
In 1999, Brooksley Born, head of the Commodities Futures Trading Commission (CFTC), was disturbed by the collapse of hedge fund Long Term Capital Management (LTCM) and recommended to Congress that derivatives be regulated. She was outmatched, however, by long-time head of the Fed, Alan Greenspan, and Secretary of the Treasury, Bob Rubin, who with the “President’s Working Group on Financial Markets” successfully recommended to Congress that it bar the CFTC from regulating derivatives (New York Times, December 15, 1998, p. C 1). Greenspan said:
Regulation of derivatives transactions that are privately negotiated by professionals is unnecessary.
New rules or regulatory oversight on derivatives could increase legal uncertainty in a thriving global market place.
Understandably, Ms Born resigned. Sheila Bair, however, took on many of the same Wall Street protectors, not regulators, as Chair of the Federal Deposit Insurance Corporation (FDIC) from June 2006 until June 2011. Sheila’s new book, Bull By the Horns, Fighting To Save Main Street from Wall Street and Wall Street From Itself. (New York:Free Press, 2012), is a comprehensive analysis of the causes of the economic disaster. Sheila was described as “the protector in chief,” and received many awards including the John F. Kennedy Profile in Courage.
Bair is a strong advocate for tougher regulation of large financial institutions, tighter mortgage lending, consumer protection standards, and aggressive foreclosure prevention measures. Her recommendations in her book on “How Main Street Can Tame Wall Street” include these comments:
The problems that drove the crisis--excess leverage, unbridled speculation, lack of consumer safeguards-- are really not that hard to understand. Sometimes I think people in the financial sector don’t want you to understand the issues. In making our financial institutions work better, the most successful regulations are those that create the right economic incentives, and let market forces do the rest. That is why I like skin-in-the-game requirements--because they force market participants to put their own money at risk and suffer the consequences if their actions result in financial loss. They--not taxpayers-- will take losses and have better incentives to curb their risk-taking.
Will capitalist culture in the 21st century be a continuation of the culture of speculation or will it reflect the wisdom of Drucker, Bogle,and Bair and be returned to being a culture of investment? Our economic future depends on whether worker capitalists use their shareholder voting rights to switch companies from short-term results to long-term growth, and use their citizens’ voting rights to get their government to support democratic capitalism.