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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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This money is now coming back on a significant scaleWall Streets power becomes especially visible during fiscal crises, domestic and international. On a world scale, the international debt crisis of the 1980s seemed for a while like it might bring down the global financial system, but as it often does, finance was able to turn a crisis to its own advantage. While easy access to commercial bank loans in the 1970s and early 1980s allowed countries some freedom in designing their economic policies (much of it misused, some of it not), the outbreak of the debt crisis in 1982 changed everything. In the words of Jerome I. Levinson (1992), a former official of the Inter-American Development Bank: [To] the U.S. Treasury staffthe debt crisis afforded an unparalleled opportunity to achieve, in the debtor countries, the structural reforms favored by the Reagan administration. The core of these reforms was a commitment on the part of the debtor countries to reduce the role of the public sector as a vehicle for economic and social development and rely more on market forces and private enterprise, domestic and foreign. Levinsons analysis is seconded by Sir William Ryrie (1992), executive vice president of the International Finance Corporation, the World Banks private sector arm. The debt crisis could be seen as a blessing in disguise, he said, though admittedly the disguise was a heavy one. It forced the end to bankrupt strategies like import substitution and protectionism, which hoped, by restricting imports, to nurture the development of domestic industries.26 Much of the private capital that is once again flowing to Latin America is capital invested abroad during the run-up to the debt crisis. As much as 40-50 cents of every dollar borrowed during the 1970s and early 1980smay have been invested abroad. This money is now coming back on a significant scale, especially in Mexico and Argentina. In other words, much of the borrowed money was skimmed by ruling elites, parked profitably in the Cayman Islands and Zrich, and Third World governments were left with the bill. When the policy environment changed, some of the money came back home often to buy newly privatized state assets for a song. That millions suffered to service these debts seems to matter little to Ryrie. Desperate Southern governments had little choice but to yield to Northern bankers and bureaucrats. Import substitution was dropped, state enterprises were privatized, and borders were made porous to foreign investment. After Ryries celebrated capital inflow, Mexico suffered another debt crisis in 1994 and 1995, which was solved using U.S. government and IMF guarantees to bail out Wall Street banks and their clients, and creating a deep depression; to make the debts good, Mexicans would have to suffer. Once again, a dire financial/fiscal crisis the insolvency of an overindebted Mexican government was used to further a capitalfriendly economic agenda. These fortunate uses of crisis first appeared in their modern form during New York Citys bankruptcy workout of 1975. This is no place to review the whole crisis; let it just be said that suddenly the city found its bankers no longer willing to roll over old debt and extend fresh credits. The city, broke, could not pay. In the name of fiscal rectitude, public services were cut and real fiscal power was turned over to two state agencies, the Municipal Assistance Corp. (MAC, chaired by Rohatyn), and the Emergency Financial Control Board, since made permanent with the Emergency dropped from its name. Aside from the most routine municipal functions, the city no longer governed itself; a committee of bankers and their delegates did, Rohatyn first among them. Rohatyn, who would later criticize Reaganism for being too harsh, was the director of its dress rehearsal in New York City. Public services were cut, workers were laid off, and the physical and social infrastructure was left to rot. But the bonds, thank god, were paid, though not without a little melodrama, gimmickry, and delay (Lichten 1986, Chapter 6). The city was admittedly borrowing irresponsibly though the lenders, it must be said, were lending irresponsibly as well. When a bubble is building, neither side has an incentive to stop its inflation. But when it broke, all the pain of adjustment fell on the citizen-debtors. The pattern would be repeated in the Third World debt crisis, in many U.S. cities over the next 20 years, and, most recently, with the federal budget. Obviously the bankers have the advantage in a debt crisis; they hold the key to the release of the next post-crisis round of finance. Anyone who wants to borrow again, and that includes nearly everyone, must go along. But thats not their only advantage. The sources of their power were cited by Jac Friedgut of Citibank (ibid., p. 192): We [the banks] had two advantages [over the unions]. One is that since we were dealing on our home turf in terms of finances, we knew basically what we were talking about, and we knew and had a better idea what it takes to reopen the market or sell this bond or that bond. The second advantage is that we do have a certain noblesse oblige or tight and firm discipline. So that we could marshal our forces, and when we spoke to the city or the unions we could speak as one voice. Once a certain basic process has been established thats an environment in which our intellectual leadershipcan be tolerated or recognizedwere able to get things effected. Its plain from Friedguts remarkably candid language that to counter this, one needs expertise, discipline, and the nerve and organization to challenge the intellectual leadership of such supremely self-interested parties. But the city unions had none of this. According to the union boss Victor Gotbaum (in an interview with Robert Fitch, which Fitch relayed to me), the unions main expert at the time, Jack Bigel, didnt understand the budgetary issues at all, and deferred to Rohatyn, whom he trusted to do the right thing. For the services rendered to municipal labor, the onceCommunist Bigel was paid some $750,000 a year, enough to buy himself a posh Fifth Avenue duplex (Zweig 1996). Gotbaum became a close friend of Felix Rohatyn. Politically, the unions were weak, divided, self-protective, unimaginative, and with no political ties to ordinary New Yorkers. Actually they did speak in one voice, that of surrender. Its easy to see why the bankers won. What was at stake in New York was no mere bond market concern. In a classic 1976 New York Times op-ed piece, L.D. Solomon, then publisher of New York Affairs, wrote: Whether or not the promisesof the 1960s can be rolled backwithout violent social upheaval is being tested in New York City. If New York is able to offer reduced social services without civil disorder, it will prove that it can be done in the most difficult environment in the nation. Thankfully, Solomon concluded, the poor have a great capacity for hardship (quoted in Henwood 1991). Behind a fiscal crisis lurked an entire class agenda, one that has been quite successfully prosecuted in subsequent crises for the next two decades. But since these are fought on the bankers terrain, using their language, they instantly win the political advantage, as nonbankers retreat in confusion, despair, or boredom in the face of all those damned numbers. At the national level, rampant borrowing by the U.S. government throughout the 1980s and early 1990s stimulated a boom for a while, but ended with the austerity packages of the mid-1990s. Tripling the outstanding load of federal debt not only made Wall Street a lot of money underwriting, trading, and holding the bonds it greatly increased rentier influence over policy. The opinion of the markets essentially the richest 1-2% of Americans and the professionals who manage their money is now the final word on economic and social policy. Liberals and populists who are sanguine about deficit financing should recall Friedguts words: creditors speak with one voice, and theyre able to get things effected. Those effects generally involve enriching the creditors at the expense of everyone else. notes 1. An interesting contrast is Britain, where both politicians and pundits identify bad cor porate governance as one of the sources of Britains limp economic performance. 2. Hydraulically is probably too 19th century and industrial. It deserves translation into something more virtual. 3. Though there is a large and growing literature on these topics, the basic issues are concisely summarized by Stephen Prowse (1994), especially pp. 10-15. Tellingly, workers do not appear in Prowses list of the principal actors in the corporate control drama. 4. Reflecting on his article fifty years later, Coase declared it unfortunate that he used the employer-employee example so prominently, rather than, say, the contracts that enable the organizers of the firm to direct the use of capital (equipment or money) by acquiring, leasing, or borrowing it (Williamson and Winter 1993, p. 65). But the relation of managers and external financiers is a lot more complex; one party is rarely able to tell the other to do something as easily as the boss moves Coases employee from Y to X. Interestingly, the legal text that Coase quoted from, Batts The Law of Master and Servant, used classical legal language that makes the power relationship much clearer than the modern employer-employee dyad. Writing in the 1930s, Coase used both pairs of words; writing in the 1980s, he used only the euphemism. 5. Inefficiently small scale production may be a problem with a long pedigree in Britain. In a case study of a Manchester cotton enterprise from 1798 to 1827, Harvey James (1996) argued that the lack of outside capital (and the reliance entirely on internal funds for expansion) kept the scale of the firm too small for maximum efficiency. 6. This historical sketch follows Berle and Means 1932/1967, Book II, Chapter 1. 7. Of course, interest group models owe as much to myth as fact; some interests, like bondholders and developers, are more poweful than others, like welfare moms. 8. One critique of employee stock ownership plans is that they force workers to put a large portion of their savings into a single asset, and one in which they were already invested through their jobs. If the firm fails, they would lose not only their jobs, but all their savings as well. 9. Cost of capital is usually figured as the expected returns on a companys outstanding securities that is, the average of the stock returns required by investors and the interest rate paid on the firms debts. Equity return is usually figured using the CAPM or similar models; actual interest rates are used to figure the cost of debt (Brealey and Myers 1991, Chapter 9). Surveys show that firms actually have a hurdle rate a minimum rate of return necessary for an investment project to be undertaken well above their cost of capital. For example, Poterba and Summers (1991) reported that the firms they surveyed used a hurdle rate of 12.2% after inflation far far above the longterm real return of 7% on stocks and 2% on bonds. The authors observed that these disparities raise an important question about the link between the variables that financial economists focus on in measuring the cost of capital, and the actual practices of firms. A hurdle rate this high guarantees an epidemic of free cash flow, since the average profitable corporation will throw off much more money than it should reinvest according to this standard. 10. On the other hand, managers, as Jeremy Stein (1989) argues, may deliberately underinvest, leaving themselves a degree of financial slack, in order to insulate themselves from the scrutiny of capital markets. But the overall economy might be better off if the slack funds were fully invested. . The typical financial structure of a firm after a leveraged buyout is equity, 5-20%; se nior debt, 40-70%; junior debt, 10-30% (Borio 1990, p. 36). In a crisis, first the equity holders would get wiped out, then the junior debtholders; if things went well, the junior debtholders would live to see the high interest payments successfully made, and the stock would rise sharply in value. Of course, those stock gains would merely be on paper, unless the holdings were privately sold or the firm were to go public again. 12. Max Hollands (1989) study When The Machine Stopped, paints a highly unflattering portrait of an early KKR deal, the buyout of the machine toolmaker Houdaille Industries a sad tale of industrial decline and financier rapacity. But investors in the KKR fund that financed the Houdaille buyout did smashingly; too bad the American tool industry hasnt done as well. 13. The modifer Pulitzer-prize-winning is there not as testimony to the storys excellence Faludis story is quite fine, but lots of crap wins Pulitzers and other prizes but to show that a bunch of mainstream worthies took it seriously, an index of the shift of elite opinion against Jensen and Kravis as the decade turned. A similar piece by Bill Adler (1988) in the Texas Observer garnered no such notice; Faludi says she didnt learn of Adlers piece until she was well along in her research (Rothmyer 1991). 14. Older financial keiretsu include Mitsubishi, Mitsui, and Sumitomo, with ancestors in the pre-World War II zaibatsu; the looser, newer groups include Fuyo, Sanwa, and DKB. The zaibatsu themselves have roots in 19th century family firms that diversified. It should be emphasized that keiretsu are not cartels; they compete quite intensely in the domestic Japanese market. 15. In the mid-1990s, it became very fashionable to denounce Japanese practices and cel ebrate American ones, because of Japans lingering recession after its financial bubble burst in 1989. This conveniently overlooks Japans extraordinary growth in the five decades following World War II from an average income equal to 11% of the U.S. in 1945 to 86% of the U.S. in 1994 (Maddison 1995, table D-1a). 16. As was pointed out earlier, fees during the recent (post-1980) merger wave have prob ably totaled between $20 billion and $40 billion. Fees for individual deals can be truly breathtaking; Lazard Frres billed the airline pilots union $8.25 million for advising them on their failed buyout bid for United Airlines a deal whose collapse brought about a mini-crash in the stock market in October 1989. That sum works out to $41,045 per banker per day on a busted deal (Henwood 1990). Even if they worked around the clock, thats an hourly rate of $1,710. 17. Long and Ravenscrafts study covered several hundred LBOs consummated between 1981 and 1987; the exact number varies from 192 to 821, depending on the data series in question. It uses quite detailed Census data at the firm and plant level. There were 91 1981-84 LBOs, and 107 1985-87 deals. . Margaret Blair said in an interview that most of the firm- and economy-wide gains in productivity claimed by buyout partisans were the result of shutting weaker plants, rather than of an improvement in the performance of sites that remained open. Improving productivity at ongoing operations is a very complicated task. 19. Low qs are often associated with mergers. For example, targets of predatory acquisi tions during the 1960s were disproportionally low-q firms (Barber, Palmer, and Wallace 1994). 20.In the same interview, Jensen claimed that GM was overstaffed by 25-50%. He didntdisclose how he knew this. . Poison pills are an antitakeover tactic that kick in when a firm is under attack by a hostile suitor. Specifically, they are warrants to buy the firms stock at a bargain rate that are issued to existing shareholders once a hostile suitor has accumulated a specified amount of stock. The intent is to make a hostile takeover prohibitively expensive. 22. A legal reason for the new institutional assertiveness was a set of important changes in securities regulation in 1992 that made it much easier for shareholders to unite and submit proxy resolutions that force other shareholders to vote on corporate policy or board makeup, and also made it legal for a group of shareholders to lobby their colleagues and present a case to management. Restrictions on communications among shareholders were first imposed to prevent big guys from putting small holders at a disadvantage, but small fry have not yet objected to the new regime, no doubt because the lobbying efforts seem to have led to higher share prices (Blair 1995, pp. 70-73). 23. An announcement that a firm is the target of a governance campaign by institutional shareholders boosts its share price in the short term, but provides little long-term gain in either share price or profitability (Gillian and Starks 1995; Wahal 1995). But of course, shareholder assertiveness takes many more forms than such public finger-pointing. 24. Robert Monks (1995), a former Reaganite who is an eager polemicist on behalf of shareholder rights, is imaginative enough to argue that since pension funds represent the masses capital, they are the institutions to which corporations should be accountable. (By pension funds he means their managers, of course.) This accountability represents a check on what Monks admits to be the rather anomalous position of corporations in a professedly democratic society. 25. The Twentieth Century Funds (1992) most recent take on governance, Whos Minding the Store?, is built around an essay by Robert Shiller on excess volatility. Yet the policy conclusions the Fund draws from Shillers work are the weakest tea imaginable: encouraging patient capital through moral suasion, while taking no tax or regulatory steps towards that goal. 26. In some cases, like Japan and South Korea, the protectionist strategies succeeded; in Latin America, however, they often protected corrupt and incompetent friends of the government. Theres no guarantee that protectionism can work as advertised, but its hard to find an example of a country that industrialized successfully including the U.S. in the late 19th century without restricting imports. |
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