April 15, 2007
Herbert M. Allison, Chairman and CEO
Fred R. Buenrostro, Jr.
Dear Messrs Allison and Buenrestro:
Your industry has the fiduciary responsibility and latent democratic power to reform the economic system to democratic capitalism in order to build more wealth and distribute it broadly. Unfortunately, for the past quarter century institutional investors have supported ultra-capitalism, the system that treats the wage earner as a disposable cost commodity, dominates the job-growth economy, and concentrates wealth in record amounts.
In 1974 the government passed a law, ERISA, that required companies to take money, most of it then used for growth or paid out in dividends, and give it to money managers to invest for the retirement income of the wage earner. Trillions of dollars were available in this greatest savings-investment opportunity in the history of capitalism. Instead, the short-term measurement of your industry’s performance was applied to corporate performance and the money was perverted into a weapon to force the liquidation of long-term growth for short-term profits. Congress could have designed the system to assure that the money went into growth investment, environmental and infrastructure needs but it didn’t. Your industry could have caught this monstrous error and corrected it consistent with your fiduciary responsibility, but you didn’t.
Late in the 20th century the world was moving towards economic freedom and economic common purpose, providing the greatest opportunity in human history for peace and plenty This opportunity is being lost by a spectacular failure of leadership by America. Capitalism was corrupted by policies lobbied by the ultra-capitalists, democracy was corrupted by the few using the benefits of their lobbied privileges in financial support of the politicians. The destructive cycle was complete. Your industry is largely responsible because you did not have an agenda designed for the benefit of the wage earner and did not use your democratic power to implement it. You should have been the antidote to the lobby power of the few but you became their shock troops.
We are in the post-capitalist age in which the wage earner is a capitalist and the Information Age work culture must be democratic. Despite these potentially transformative events the few still control fiscal and monetary policy and the work culture in many cases is still fear and intimidation. Your agenda must be long-term but must also treat America’s position in the world. Your fiduciary responsibility includes lobbying for the few conditions Adam Smith required for the success of economic freedom, viz., neutral money and control of the speculators. As war is the greatest economic waste at home and abroad, your agenda must provide the antidote to the few with illusions of an American Empire and lobby for a foreign policy based on economic common purpose, not coercion and force.
Our Founders believed that government should reflect the “will and wisdom” of the people filtered by an aristocracy of “talent and virtue.” It did not work that way. From the beginning the few have lobbied the privileges that concentrate wealth and keep economic freedom functioning at a fraction of potential. The educational process does not equip citizens to use their democratic power to deny the privileges and allow economic freedom to function at full potential at home and this results in failure abroad to lead towards economic common purpose the only way stop the violence.
Your industry should compensate for this failure of education. Your responsibility to maximize the retirement benefits of the wage earner means responsibility to lobby government for the economic system that maximizes the creation of wealth and distributes it broadly. To do this you must activate the latent democratic power of the wage earner which, in turn, means educating them in those conditions necessary for the success of economic freedom. Just as the concept of eliminating material scarcity was a vague wish before Adam Smith identified the productivity of the Industrial Revolution as having that capability, the Information Age communication technology now provides the opportunity to educate your constituency and activate their democratic power. What do you think their “will and wisdom” would say about a bill in Congress for Private Equity firms to pay a 35% ordinary tax on their 20% cut of profits instead of the 15% capital gain that they have managed to lobby?
You have the extraordinary opportunity to finally make America the land of, for, and by the people. We now have seen the mistakes made by a few ignorant and arrogant people from Iran in 1953, to Viet Nam, and twice in Iraq. At the beginning of this greatest of democratic experiments most of our Founders felt that the egregious mistakes of monarchs would be eliminated by substituting the will and wisdom of educated citizens. You can make that democratic promise a reality.
Institutional investors can propose the following reforms to the wage earners. With their support you can free democratic capitalism to eliminate material scarcity, unite people, and stop the violence. The second section lists the reforms needed to neutralize the damage from ultra-capitalism. They are base on my experience and study. I was the president of a small division of General Dynamics at age 32, later Chairman and CEO of ADT, Inc. for 18 years, and since, for over 20 years, a student of the world’s economic-political system. Please refer to my book Democratic Capitalism, The Way To a World of Peace and Plenty, and my web site www.democratic-capitalism.com.
Institutional investors’ actions in support of democratic capitalism (reference-EX I)
Use referendum to determine the “will and wisdom” of the wage earners
1) Change measurement of corporate performance from quarterly e.p.s to a three-year average of sales growth, profits, and cash flow against managements’ predictions
2) Give priority to growth investment and dividends in the distribution of surplus.
3) Change responsibility for the distribution of surplus from the CEO to the Board
4) Tax-free dividends for low-and-middle income wage earners, a “capital wage” that would be 50% of the return from capitalism.
5) Prevent recessions by control of easy credit and asset inflation with bank reserves, taxes, brokers’ margins, and interest rates.
6) Profit sharing and ownership opportunities for all associates
7) Disclosure of company’s internal compensation logic
8) Internal audit with dual reporting to CEO and Board Audit committee
9) No sale of company stock by executives or directors while employed
10) No company loans to executives
11) All bonuses in company stock
12) Maximum use of broad based index funds with an annual cost less than .15%
13) Educate wage earners in economic matter
14) Stock market resumes its function of equity for economic growth
15) Support BIS in their efforts to limit asset inflation
16) Stop subsidies of American cotton, European sugar, and Japanese rice
17) Control “hot money” by mix with long term and conversion in a crisis
18) Profit sharing and ownership income for reciprocal purchases
19) Tobin taxes on speculation to help emerging economies and environment
20) Support single reserve currency
21) Support reform of U N Security Council
22) Support American as team player in U. N.
23) Support elimination of all nuclear weapons
24) Subsidies and training to get poor countries up to commercial critical mass
25) Sponsor competition among nations on improving lives measured by the U.N. Human Development Index
Three factors created this opportunity: first, mandated pension funding provided $100 billion a year for investment in the job growth economy, infrastructure, and environmental needs while making the wage earner new capitalists; secondly, Information Age industries needed the democratic capitalistic work culture of participation, trust and cooperation to compete; and finally more countries, authoritarian and democratic, were using economic freedom to improve the lives of their people. The world was beginning to unite in economic common purpose in a beautiful inversion in which the standard of living goes up the violence goes down. The new worker-capitalists would be motivated to create more wealth and share in the rewards of capitalism.
Tragically, it did not work that way. Instead the pension money was used by Wall Street, with the help of your industry, to force companies to abandon long term building for quarterly e.g. The rewards from this peoples’ capitalism did not go to the new owners, rather it went into an extraordinary increase of compensation for the handlers of the money, into stock buy backs, into deals, and into higher stock prices. Ultra-capitalism was launched, a combination of modern mercantilism in which the wage earner is treated as a cost commodity and profits are maximized by suppressing wages and benefits combined with a finance capitalism that is dominant, not supportive, of the job growth economy. The results were a record concentration of wealth at home and the reversal of economic momentum in emerging economies such as Indonesia, the world’s largest Muslim nation.
Three agents caused this perversion of capitalism: the government passed a poorly designed law. A precondition of capitalism is the investment of present surplus for economic growth and future profit. The design of ERISA did not address where the money would be invested, and how much is would cost to get there. Secondly, Wall Street lobbied a steady stream of non-democratic privileges that diverted most of this capital to present consumption by the various handlers; and finally, your industry became the willing partners of Wall Street and joined in the short-term pressure and voted the shares of the wage earners in support of stock buy backs and non-strategic deals. The money went mainly into the stock market and annually into the pockets of the money managers with little of it making it through into new equity for growth.
These are the actions by institutional investors on behalf of your customers the wage earners that can put the world back on the way to peace and plenty:
- Change the measurement of companies from quarterly and annual e.p.s to a three-year running average of sales, profits, and cash flow against management prediction. This will emancipate companies from the short-term pressure and move the stock market back to its proper function of providing new equity for growth. The cash flow against prediction protocol would have prevented most of the damage at Enron. This action would be started tomorrow at 8:00 a.m. from a more accurate understanding of your long-term fiduciary responsibility.
- Tax free dividends from the pension and 401 (k) savings of the wage earner. This would activate the trillions of dollars now held hostage by Wall Street and your organizations. Institutional investors should pressure companies to make distribution of surplus a Board, not CEO, responsibility with priority reinvestment in growth and dividends instead of the ultra-capitalist priority for stock buy backs and non-strategic acquisitions.
- Lobby the government on behalf of the wage earner to limit borrowed money for speculation. Easy credit from banks and leveraged speculation have caused every recession in American history in which the rich get richer before the poor get poorer. Control of currency and credit for the general welfare means fighting asset inflation in stocks and real estate as vigorously as price inflation. Greenspan denied this responsibility in testimony to Congress but recent papers by the BIS ask the question “Is Price Stability Enough.” Protection of the retirement savings of your customers from the damage from speculation and recessions is another fiduciary responsibility of your industry. Lacking application of such democratic power it is no surprise that the government fights price inflation that hurts the wealth but will not fight asset inflation that hurts ordinary people.
In contrast to the pragmatic opportunity for society to eliminate material scarcity and unite the world in economic common purpose, there is also a threat of folly and violence that will dwarf earlier failures of society. Your organizations can be pivotal in which direction the world takes. You have the democratic power and fiduciary responsibility to influence both companies and government to move from the present short term and greedy ultra-capitalism to democratic capitalism that creates more wealth and distributes it broadly. Reform is urgently needed because Adam Smith’s conditions for the success of free markets, neutral money and control of the speculators, are being violated as never before in the history of capitalism. Excessive liquidity and volatility have allowed finance capitalism to dominate the domestic economy and reverse economic momentum in emerging nations abroad.
Once America has purged the corruptions in its economic system it can again help the world move towards economic common purpose. At the present China is going around the world making commercial arrangements with the message, “Let’s get rich together” while American fascists are going around the world with the message “Do it our way, or else!” Whether USA continues to waste a half-trillion a year on military expense or invests a lot of it in environment, infrastructure and reduction of debt will have a major effect on the retirement money of your constituency and for that reason is part of your responsibility.
20th century social philosopher Peter Drucker commented: “Every few hundred years in Western civilization there occurs a sharp transformation.” He describes a sharp transformation that is creating the post-capitalist society because “ In developed countries pension funds increasingly control the supply and allocation of money.” Drucker also saw the culture change along with the change in the source of capital tracing history from the Knights of the Middle ages to the bourgeois of capitalism to the present when “ the educated person will represent society in the post-capitalist society in which knowledge becomes the central resource” Information Age industries must have the decentralized, empowered work culture to release the cognitive power of their people. An environment in which as Drucker added “Managing a business exclusively for the shareholders alienates the very people on whose motivation and dedication the modern business depends: The knowledge worker. An engineer will not be motivated to work to make a speculator rich.”
With an owners’ motivation more wealth would be created and distributed broadly allowing the system for the first time to function at full potential and feed, clothe, shelter, educate and provide good health and hope for all the people of the world. The vision of 18th century Scot Enlightenment member Adam Smith would be fulfilled.
This great leap forward in the human march to freedom follows as Drucker observed by a few hundred years the founding of America. The creation of a nation by reason in which freedom was disciplined by laws in a carefully balanced structure can now move up to the world level for the same reason and with the same values and rule by law. the America a notion designed by reason for the general welfare. The new opportunity was to move these American freedoms to the world level
This leap forward into peace and plenty for the world is the final step in the human march towards freedom following the success of founding a nation a product of the genius of our Founders. Educated and studious men argued strenuously over the Constitution that for the first time built a nation on human reason. It took the members of the American 18th century Enlightenment” Washington simply by his presence, and the exhortations of 81-year old Franklin to finish the imperfect process but it was done. Alexander Hamilton later in Federalist # 1 posed the question at the national level that now faces us at the world level: “Whether societies are really capable or not of establishing good government from reflection and choice, or whether they are forced to depend for their political constitutions on accident and force.” Immanuel Kant a Prussian member of the 18th century Enlightenment had done the reflection and recommended “ a perfectly constituted state as the only condition in which the capacities of mankind can be fully developed , and also bring forth that external relation among states which is perfectly adequate to this end.” Kant added advice that should be reflected upon and supported by institutional investors to eliminate the greatest threat to the retirement savings of their customers: a process that would “force the states to the same dicision (hard though it may be for them) that savage man was reluctantly forced totake, namely to give up brutish freedom and to seek quiet and security under a lawful constitution.” This is a challenge to the institutional investors to use their democratic power to lobby reform of the UN instead of the persistent efforts to undermine it by the American fascists.
Both Marx and Mill in the 19th century saw that capitalism had the capacity to eliminate material scarcity in the world but that concentrated wealth was limiting it to a fraction of potential. Marx’s vision of a work culture of cooperation and a world uniting in economic common purpose were integrated by Mill with private property, competition and skilled management to complete the definition of democratic capitalism. It was too early., those with the concentrated wealth had no interest in reform and the collectivists interested in reform had no of what “control currency and credit for the general welfare “ meant and instead of reform concentrated on redistribution through government benefits.
This post-capitalist age will displace the post-modern age in which comprehensive solutions to improve the human condition were abandoned and idealism was a victim. Those philosophers could not find a secular moral basis common with religion because they looked in the wrong places; they concentrated on political and cultural changes and ignored the economic solution. Democratic capitalism depends on a work culture founded on a moral basis of trust and cooperation.
The post-capitalist system will maximize the creation of wealth by motivating the participating wage earners, and distribute it broadly through wage earner ownership. This system is described in detail in my book Democratic Capitalism, The Way to a World of Peace and Plenty. It is a synthesis of Adam Smith, Karl Marx, and John Stuart Mill. It was Mill that integrated Marx’s visions with private property, competition, and skilled management thereby completing the definition of democratic capitalism. It has been demonstrated that economic freedom can feed, clothe, shelter, educate, provide good health and hope for all humans, and that economic common purpose can steadily reduce the violence. For example, China and India have used forms of economic freedom to take 500 million people out of extreme poverty in a decade; the European Union has substituted economic cooperation for killing millions of each generation of their young men in stupid wars.
The enormous lobby power of finance capitalism has successfully resisted democratic capitalism and as a consequence it has had a long gestation period since Marx and Mill. Recent developments however, make its emergence inevitable: Information Age industries depend on the democratic work culture of participation, decentralization, and empowerment to release the cognitive power of their people, and trillions of dollars of pension and 401 (k) savings make the wage earner the majority owner of corporate America.
This historical opportunity is in suspense because of a spectacular failure of American leadership. The country that has been the beacon for freedom has instead corrupted the economic system with record concentration of wealth, and corrupted its foreign policy with militaristic, imperialistic actions.
Institutional investors’ fiduciary responsibility to maximize the wage earners’ retirement savings required support of democratic capitalism, not ultra-capitalism, defined as modern mercantilism that treats the wage earner as a disposable cost commodity and finance capitalism that is dominant over, not supportive of, the productive economy.
During the last quarter-century America has entered into a financialization phase that has been a terminal condition for other strong nations since Spain in the 16th century. It saps the growth out of the economy with the myriad ways of cashing in growth investment for present consumption. The simple changes recommended above can reverse this momentum and restore the American dream. The institutional investors such as you can be the agents of such change.
The financialization of our economy is the subject of my letter to Cato enclosed but I would like to highlight three examples for your consideration each of which cries for reform:
- ERISA initiated the greatest investment opportunity in the history of capitalism but with the help of the institutional investors it converted American capitalism to short term and greedy while reversing economic momentum in emerging economies. Most of the money went into the stock market and deals not into growth investment. Capitalists who had traditionally exploited the wage earners’ labor learned how to exploit their capital, an intolerable contradiction that cannot continue much longer. There has been no transparency or accountability for these trillions of dollars. The tax deferrable feature helps keep the wage earner ignorant of their investment and without any influence on the policies of the institutional investor. Despite books written on the superior performance of index funds with an annual cost of .15% most of the money is still being massaged by the money managers at ten times the annual cost. There is a fundamental conflict in that the financial motivations of the handlers of money, at every stage are contradictory to the interests of the customer, the wage earner.
- Hedge Funds are described as “lightly” regulated a euphemism for no regulation. Long Term Capital Management, Aramath Advisors, Enron and Goldman Sachs have many things in common. They are all hedge funds now, they are slaves to improvement in short-term earnings and as more funds are attracted to the feast the earnings improvement comes harder; there is no transparency or accountability, they are able to change future values for the benefit of short term earnings and their 20% profit share, they can borrow from willing banks and leverage their bets ten fold although when Greenspan was head of the FED he told Congress that Hedge Funds did not need to be regulated because they got the money from regulated banks and he was not kidding. The first two abandoned hedging to be “market neutral” and instead with “directional” in one case on bonds in the other on oil and in both cases lost most of their customers equity. Enron successfully lobbied additional privileges to speculate on commodity futures shortly before they crashed. Hedge funds are now successfully lobbying extension of their activities to pension money. I noticed that CALPERS “earned” $125 million for their constituents by loaning stock to the funds for either short selling requirements or to vote the shares in preparation for a short sale. Did you explain this to your customers? A you add to your investment in hedge funds have you explained to the wage earners why you are doing this when the world’s greatest investor Warren Buffett has called them a time bomb and a Fortune magazine article described them as “alligators in the swamp” over ten years ago.
- The latest fad of financialization is Private Equity who have the same mission of the takeover artists of the 1970s but with more sophistication by celebrities of both Wall Street and Washington. Paradoxically they rationalize their activity as a cure for the short-term pressure of the stock market. Along with stock buybacks they are shrinking the supply of stock by 5% a year while the pension and 401 (k) money keeps flowing in. As less of it is being converted into job growth investment the effect of less stock and more demand gives the market an artificial push. A typical deal is to take the company private in the usual acquire and fire mode but now with additional cutting of health and pension benefits. The deal makers take millions in fees and then add compensation in special dividends funded by borrowed money, hurting the bond holders in the process.
This financialization will change. With the Democrats in power they will make political capital by exposing the total costs and conflicts of interest and probably pass oversight laws, like SOX, that hurt more then they help. Even more compelling, the lawyers are discovering a new enormous opportunity and several lawsuits, including one against Fidelity, had been filed, as I am sure you are aware.
I am proposing in this letter that TIAA-CREF and CALPERS, do not get trapped in playing defense but rather take the lead to usher in the post-capitalist age with maximum creation of wealth broadly distributed.
I have sent a copy of my book and a couple of chapter of volume 2 not yet published. They outline how this perversion of capitalism happened and how the institutional investors can change the domestic economy from ultra-capitalism to democratic capitalism qualifying America then to again lead the world in economic common purpose. These thee actions are proposed for your consideration:
- Pressure on companies to use surplus for investment in growth and dividends instead of stock buy backs and non-strategic acquisitions. Pressure government to make these dividends tax free for low-and-middle income wage earners, a “capital wage” for their ownership. Hundreds of billions of dollars will thus be returned to the wage earner to be spent or saved both adding economic growth. This capitalism combining income and appreciation will make profit sharing and ownership plans universal and will add spendable income for reciprocal purchases and make free trade the way eliminate material scarcity in the world.
- Change the measurement of corporate performance from quarterly earnings per share to a three-year running average of sales, profits, and cash flow against management’s predictions. This simple change will emancipate companies from the short-term pressure to fire people and shut down long-term growth programs. The measurement of cash flow against prediction would have prevented most of the damage at Enron.
- Reduce the amount of borrowed money for speculation that has caused asset inflation throughout our history and damaged the people. Our government takes aggressive action to stop price inflation that erodes the wealth of the few but denies responsibility to stop asset inflation that has always allowed the rich to get richer before the poor get poorer. There are ample tools available to prevent asset inflation such as taxes, interest rates, bank reserves and brokers’ margins.
Let me know if you wish to meet to discuss these propositions about how to move to the post capitalist age.
There are several reasons that the economy does not appear in crisis: The benefits of the Information Age, strong world economic growth, low interest rates, extraordinary profits from financial services; the wage earners’ savings keeps pouring in while the total supply of stock is now shrinking at the rate of 5% a year; the baby boomers have not yet switched from buying stock for retirement to selling stock in retirement; the profit surge from sacrificing long-term programs for short term earnings, and the expenditures of a half-trillion a year on the military. Most of these are temporary
During the last quarter century institutional investors have been the shock troops of ultra-capitalism that has concentrated wealth in record amounts. The wage earner may now be the source of capital but they are not yet enjoying the rewards of capitalism. The monetary and tax rules are still written for the benefit of the privileged few. It is your responsibility to reform them in support of democratic capitalism. It is your responsibility to lobby for neutral money and control of the speculators. There is a grid lock between the thinkers and the managers, the collectivists and the market fundamentalists and this is why Drucker proposed: “to transcend this dichotomy in a new synthesis will be a central philosophical challenge for the post-capitalist society.’