naked capitalism

I don’t mean to beat up on Spencer at Angry Bear, who has provided an interesting set of comparisons on the perennial question of many investors, “Whither the stock market?”

But one section of his discussion, precisely because it is such conventional thinking, is an illustration of how the blind pursuit of “maximizing shareholder value” is not all it is cracked up to be:

The recent productivity report received much attention. But I did not see anyone point out that the spread between nonfarm corporate prices and unit labor cost was 5.25%, the widest spread on record.

This spread is the single most important variable driving corporate profit margins and implies that you should expect major positive earnings surprises.

Yves here. Translation: employers are continuing to squeeze down on workers to improve their margins. And the US has been pursuing that strategy for some time, of shifting the composition of GDP growth away from increases in worker incomes (via hiring and/or paying them more) to increases in corporate profits. The shift was dramatic in the last supposed expansion; it was called a “jobless recovery” for good reason. In every previous postwar growth period, the labor share of GDP growth was never less than 55% and had averaged not much less than 60%. In the pre-crisis expansion, it plunged to 29%.

Before some readers contend that this pattern is inherent to the “maximizing shareholder value,” let’s start with one consideration: strategies that focus on that goal actually do less well than ones that pursue broader aims. John Kay notes in a 2004 Financial Times article (sadly, no longer available on line):

Paradoxical as it sounds, goals are more likely to be achieved when pursued indirectly. So the most profitable companies are not the most profit -oriented, and the happiest people are not those who make happiness their main aim. The name of this idea? Obliquity….

Obliquity is characteristic of systems that are complex, imperfectly understood, and
change their nature as we engage with them…..

Obliquity is equally relevant to our businesses and our bodies, to the management of our lives and our national economies. We do not maximise shareholder value or the length of our lives, our happiness or the gross national product, for the simple but fundamental reason that we do not know how to and never will. No one will ever be buried with the epitaph “He maximised shareholder value”. Not just because it is a less than inspiring objective, but because even with hindsight there is no way of recognising whether the objective has been achieved.

For most of the 20th century, ICI was Britain’s largest and most successful manufacturing company. In 1987, ICI described its business purpose thus: “ICI aims to be the world’s leading chemical company, serving customers internationally through the innovative and responsible application of chemistry and related science. “Through achievement of our aim, we will enhance the wealth and well-being of our shareholders, our employees, our customers and the communities which we serve and in which we operate.”….

In 1991, Hanson, the predatory UK conglomerate that had successfully acquired and reorganised sluggish British manufacturing businesses such as Ever Ready and Imperial Tobacco, bought a modest stake in ICI. While the threat to the company’s independence did not last long, the effects were galvanising. ICI restructured its operations and floated the pharmaceutical division as a separate business, Zeneca. The rump business of ICI declared a new mission statement: “Our objective is to maximise value for our shareholders by focusing on businesses where we have market leadership, a technological edge and a world competitive cost base.”….

ICI made the opposite shift – from a grand vision of the responsible application of chemistry to a narrow concentration on established, successful activities. The aim of bringing benefit to a wide range of stakeholders was replaced by the specific objective of creating shareholder value from narrowly focused operations. The company translated this into an operational strategy by disposing of the company’s interests in bulk chemicals to acquire a niche group of speciality businesses: ICI, once the main supplier of chemical products to one third of the world, was reinvented as a smells company.

The outcome was not successful in any terms, including those of creating shareholder
value. The share price peaked in 1998, soon after the new strategy was announced.
The decline since then has been relentless. After two successive dividend cuts the
company was ejected in early 2003 from the FTSE 100 index, the transition from
industrial giant to mid-cap corporation had taken only 12 years…..

Obliquity gives rise to the profit -seeking paradox: the most profitable companies are
not the most profit -oriented. ICI and Boeing illustrate how a greater focus on
shareholder returns was self -defeating in its own narrow terms. Comparisons of the
same companies over time are mirrored in contrasts between different companies in
the same industries. In their 2002 book, Built to Last: Successful Habits of Visionary
Companies, Jim Collins and Jerry Porras compared outstanding companies with
adequate but less remarkable companies with similar operations….

Collins and Porras….found the same result in each case: the company that put more emphasis on profit in its declaration of objectives was the less profitable in its financial statements.

Yves again. Simple-minded profit seeking is not what it is cracked up to be. And worse, squeezing worker wages to not simply preserve, but increase profits, is destructive on an economy-wide level (note the rising gap between wages and prices disproves the canard that the wage pressure is necessary to preserve competitiveness).

US business used to operate with the idea that the returns resulting from productivity gains would be shared by workers and the company; that notion now seems as dead as the dodo. But not allowing workers to participate in improvements in corporate returns blunts overall economic growth. Companies are fattening their current bottom lines at the expense of future top line growth. But in our current climate, this strategy looks just dandy….until government stimulus starts to be withdrawn.

From the December 2009 issue of The Baffler (no online version of this article available). For those not familiar with The Baffler, this is the revival of a magazine of business and culture edited by Thomas Frank that had previously been published from 1988 to 2007. This issue was called “Margin Call” and included articles by Matt Taibbi, Naomi Klein, Michael Lind. I believe readers will find this piece to be relevant. Enjoy!

Since inequalities of privilege are greater than could possibly be defended rationally, the intelligence of privileged groups is usually applied to the task of inventing specious proofs for the theory that universal values spring from, and that general interests are served by, the special privileges which they hold.

Reinhold Niebuhr, Moral Man and Immoral Society

A year on from its brush with Armageddon, the financial services industry has resumed its reckless, self-serving ways It isn’t hard to see why this has aroused simmering rage in normally complacent, pro-capitalist Main Street America. The budget commitments to salvaging the financial sector come to nearly $3 trillion, equivalent to more than $20,000 per federal income tax payer. To add insult to injury, the miscreants have also availed themselves of more welfare programs in the form of lending facilities and guarantees, totaling nearly $12 trillion, not all of which will prove to be money well spent.

Wall Street just looted the public on a massive scale. Having found this to be a wondrously lucrative exercise, it looks set to do it all over again.

These people above all were supposed to understand money, the value of it, the risks attendant with it. The industry broadly defined, even including once lowly commercial bank employees, profited handsomely as the debt bubble grew. Compensation per worker in the early 1980s was similar to that of all non-government employees. It started accelerating in 1983, and hit 181 percent of the level of private sector pay by 2007. The rewards at the top were rich indeed. The average employee at Goldman Sachs made $630,000 in 2007. That includes everyone, the receptionists, the guys in the mail room, the back office staff. Eight-figure bonuses for big producers became standard in the last cycle. And if the fourth quarter of 2009 proves as lucrative as the first three, Goldman’s bonuses for the year will exceed bubble-peak levels.

The rationale for the eye-popping rewards was simple. We lived in a Brave New World of finance, where the ability to slice, dice, repackage and sell risk led to better outcomes for all, via cheaper credit and better diversification. We have since learned that this flattering picture was a convenient cover for massive risk-taking and fraud. The industry regularly bundled complicated exposures into products and dumped them onto investors who didn’t understand them. Indeed, it has since become evident that the industry itself didn’t understand them. The supposedly sophisticated risk management techniques didn’t work so well for even the advanced practitioners, as both top investment banks and quant hedge funds hemorrhaged losses. And outside the finance arena, the wreckage is obvious: housing market plunges in the U.S., UK, Ireland, Spain, the Baltics and Australia; a steep decline in trade; a global recession with unemployment in the U.S. and elsewhere hitting highs not seen in more than 25 years, with the most accurate forecasters of the calamity intoning that the downturn will be protracted and the recovery anemic.

With economic casualties all about, thanks to baleful financial “innovations” and reckless trading bets, the tone-deafness of the former Masters of the Universe is striking. Their firms would have been reduced to sheer rubble were it not for the munificence of the taxpayer—or perhaps, more accurately, the haplessness of the official rescuers, who threw money at these players directly and indirectly, through a myriad a programs plus the brute force measure of super low interest rates, with perilous few strings attached.

Yet what is remarkable is that the widespread denunciations of excessive banking industry pay are met with incredulity and outright hostility. It’s one thing to be angry over a reversal in fortune; it’s one of the five stages of grief. But the petulance, the narcissism, the lack of any sense of proportion reveals a deep-seated pathology at work.

Exhibit A is the resignation letter of one Jake DeSantis, an executive vice president in AIG’s Financial Products unit, tendered in March 2009 as outcry over bonuses paid to executives of his firm reached a fever pitch. The New York Times ran it as an op-ed. “I am proud of everything I have done,” DeSantis wrote.

I was in no way involved in—or responsible for—the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage….

[W]e in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials.…

I take this action after 11 years of dedicated, honorable service to A.I.G. … The profitability of the businesses with which I was associated clearly supported my compensation. I never received any pay resulting from the credit default swaps that are now losing so much money. I did, however, like many others here, lose a significant portion of my life savings in the form of deferred compensation invested in the capital of A.I.G.-F.P. because of those losses.

Anyone with an operating brain cell could shred the logic on display here. AIG had imploded, but unlike a normal failed business, it left a Chernobyl-scale steaming hulk that needed to be hermetically sealed at considerable cost to taxpayers. Employees of bankrupt enterprises seldom go about chest-beating that they did a good job, it was the guys down the hall who screwed up, so they therefore still deserve a fat bonus check. That line of reasoning is delusional, yet DeSantis had no perspective on it. And there is the self-righteous “honorable service,” which casts a well-paid job in the same terms as doing a tour of duty in the armed forces, and the hyperventilating: “proud,” “betrayed,” “unfairly persecuted,” “clearly supported.”

And to confirm the yawning perception gap, the letter was uniformly vilified in the Times’ comment section, but DeSantis’s colleagues gave him a standing ovation when he came to the office.

The New York press has served as an occasional outlet for this type of self-righteous venting. Some sightings from New York Magazine:

[I]f someone went to Columbia or Wharton, [even if] their company is a fumbling, mismanaged bank, why should they all of a sudden be paid the same as the guy down the block who delivers restaurant supplies for Sysco…?

I’m attached to my BlackBerry. … I get calls at two in the morning. … That costs money. If they keep compensation capped, I don’t know how the deals get done.

It never seems to occur to them, as Clemenceau once said, that the graveyards are full of indispensable men. So if the cohort with glittering resumes no longer deems the pay on offer sufficiently motivating for them to get out of bed, guess what? People with less illustrious pedigrees will gladly take their places.

And the New York Times has itemized how the math of a successful banker lifestyle (kids in private school, Upper East Side co-op, summer house in Hamptons) simply doesn’t work on $500,000 a year. Of course, it omitted to point out that outsized securities industry pay was precisely what escalated the costs of what was once a mere upper-middle-class New York City lifestyle to a level most people would deem stratospheric.

Although the word “entitlement” fits, it’s been used so frequently as to have become inadequate to capture the preening self-regard, the obliviousness to the damage that high-flying finance has inflicted on the real economy, the learned blindness to vital considerations in the pay equation. Getting an education, or even hard work, does not guarantee outcomes. One of the basic precepts of finance is that of a risk-return tradeoff: high potential payoff investments come with greater downside.

But how did that evolve into the current belief system among the incumbents, that Wall Street was a sure ride, a guaranteed “heads I win, tails you lose” bet? The industry has seen substantial setbacks—the end of fixed commissions in 1975, which led to business failures and industry consolidation, followed by years of stagflation, punitive to financial assets and securities industry earnings; the aftermath of savings and loan crisis, which saw employment in mergers and acquisitions contract by 75 percent; the dot-com bust, which saw headhunters inundated with resumes of former high fliers. Those who still had jobs were grateful be employed, even if simultaneously unhappy find themselves diligently tilling soil in a drought year, certain to reap a meager harvest.

But you never heard any caviling about how awful it was to have gone, say, from making $2 or $3 million to a mere $400,000 (notice how much lower the prevailing peak numbers were in recent cycles). And if you were having trouble paying your expenses, that was clearly bad planning. Everyone knew the business was volatile. Indeed, the skimpy salaries once served as a reminder that nothing was guaranteed.

So why the unseemly whining? It’s a symptom of longstanding pathologies in the industry that were once narrowly useful but which have gotten wildly out of hand.

It wasn’t always that way. I worked for a few years in the early 1980s in investment banking at Goldman Sachs, and later in the decade starting up the M&A business for a Japanese bank, then the second largest in the world, in that brief window when the island nation seemed to be buying up America. I have continued to consult to the industry.

Unfortunately, it isn’t hard to see how those on the investment banking meal ticket come to have an unduly high opinion of their worth.

Wall Street jobs have long been the prime objective at the top of the MBA food chain, and that has always been a function of the money. Aside from looking for people who are well groomed, articulate and reasonably numerate (image is important, given the fees charged to corporate clients), firms screen job candidates for money orientation and what is politely called drive. At Goldman, the word “aggressive” was used frequently a term of approbation.

But the firms are white-collar sweatshops with glamorous trappings. You do not know how hard you can work, short of slavery, unless you have been an investment banking analyst or associate. It is not merely the hours, but the extreme and unrelenting time pressure. Priorities are revised every day, numerous times during the day, as markets move. You have many bosses, each with independent demands and deadlines, and none cares what the others want done when. You are not allowed to say no to unreasonable demands. The sense of urgency is so great that waiting for an elevator is typically agonizing. If you manage to get your bills paid and your laundry done, you are managing your personal life well. Exhaustion is normal. On a quick run home en route to the airport after an all-nighter, a co-worker tried to shower fully clothed.

A setting that would seem to reward, nay require, cutting corners has another striking feature: intolerance for error. A computation mistake or a typo in a client document is a career-limiting event. Minor miscues undercut the notion that your firm can execute the more complex and risky elements correctly

And the dynamic doesn’t change much over the course of one’s career. The drill of being a medical resident (or pre-Iraq, a tour of duty) has a known endpoint. But investment bankers have signed a Faustian contract: You have no right to personal boundaries. The business says how high to jump, and you are expected to deliver. Yes, more senior people have more dignity, but the idea that your needs are second to those of the business never changes.

In my day, it wasn’t uncommon for the firm to ask associates to reschedule weddings if they conflicted with a deal. It wasn’t that firms were opposed to marriage; indeed, the partners knew a young man was theirs once he procured a wife and, better yet, kids. He was tied hopelessly into a personal overhead structure that would keep him in the business.

Not that there was any real risk that someone would leave voluntarily. Exhaustion and loss of personal boundaries are an ideal setting for brainwashing, which is why people who have spent much of their career in finance have such difficulty understanding why their firm and their worldview might not be the center of the universe, why they might not be deserving of their outsized pay.

The finance community has other elements in common with cults. One is the implicit and explicit reinforcement of bankers’ “specialness,” their elite status. In how many lines of work do you get to meet with CEOs at a tender age, much less work on matters where hundreds of millions, often billion, are routine? Senior people in the investment banks are political fundraising heavyweights and sit on high-prestige nonprofit boards. Anyone of a Calvinist persuasion would be impressed.

Another parallel to cult indoctrination is that the demands of the job remove new hires from established friends and family and plunge them into a new environment. Most people who come to Wall Street are not New York natives, and the extreme and erratic hours make it difficult to maintain old ties. Season tickets are likely to be given away. Vacations (save for the week before Labor Day and the Christmas-New Year’s period) are frequently rescheduled.

Class consciousness is felt nowhere more keenly than in the world of high finance. Wall Street denizens earn more money than most people—that’s the point, after all. And that means they become accustomed to the perks, such as eating at restaurants that might strain the budget of those less well situated. And, frankly, with their lives revolving around finance and business, other interests wither. In most cases, it’s more fun for them to talk shop than to relate to people outside their cloistered world. The incestuousness often extends to one’s personal life. When I was at Goldman, the only married women professionals who were not married to men at Goldman had come to the firm hitched.

These values become deeply internalized. One buddy, a vice president in hard-charging, testosterone-filled M&A, spent the better part of a weekend lying on her side on the floor of her office, reading deal documents. She kept reassuring concerned colleagues that she was fine, until the pain got so bad that she relented and called her boyfriend. He came and took her straight to the hospital. The doctors operated immediately, assuming she had appendicitis. They found instead diverticulitis, which usually afflicts the elderly, and she was so close to a colon rupture that they had to remove half of it.

The partners at her firm instructed her to not to return until she had recovered fully. But this was September. Bonuses were paid at year end, and as she read the unwritten code, and knew that staying away too long would be seen as a sign of weakness. She was back at the office three weeks later, looking wan.

She later became the first woman investment banking partner at her prestigious firm. Her instincts served her well. Or maybe not. She later lost 90 percent of the vision in one eye to glaucoma, an easily treated disease, because her overloaded schedule made eye exams seem like a luxury.

Trading, the other side of the business, is stereotyped as the antipode of investment banking, with the market makers and the dealmakers viewing each other in disdain. While there are other subcultures within large firms, the bankers and the traders are the alphas and set the tone.

In the old days, traders were almost without exception order flow traders who served the socially useful function of making markets in instruments that weren’t listed on exchanges. It’s an adrenaline-filled game, with quick highs and gut-wrenching lows. Unlike bankers, who can never truly take personal credit for the profits on a deal (even if they brought it in, the firm’s franchise usually played a role), traders see their P&L as their own output, even though they use the firm’s infrastructure, research and capital.

Historically, traders often came from modest backgrounds Indeed, some scrappy firms such as the former bond market king Salomon Brothers didn’t care if traders had two heads as long as they produced.

But as Wall Street became a bigger and more profitable, in part by eating commercial banks’ lunch, trading-related jobs became more sought after. Even Tom Wolfe took note in his 1987 novel Bonfire of the Vanities, portraying Sherman McCoy as inordinately proud of the Ivy Leaguers reporting to him.

As markets became more liquid, and more complex instruments were created, firms began creating specialist trading groups to make bets with house funds. Unlike the traditional market makers, they did not deal with customer orders but were strictly out to make money into more money. The pattern for the so-called proprietary traders was set nearly 20 years ago. Securities industry denizens were taken aback to learn that Larry Hilibrand, a member of Salomon Brothers’ bond arbitrage group, made $23 million in 1990, then an unseemly sum. But even that wasn’t enough for Hilibrand; he and his colleagues decamped to form the now infamous Long Term Capital Management, which did spectacularly well before nearly bringing down the entire financial system in 1998.

Trading is an autistic activity. Markets are impersonal. And despite the shows of bravura, there’s an ever-present undercurrent of terror. Even if things look to be working out well, they could turn swiftly into monstrous losses. And again, as LTCM illustrated, it’s all too easy for successful traders to lose that sense of fear, to start believing in their own genius and take risk recklessly.

The picture of traders, both in the media and too often in their own eyes, reveals more than a bit of a John Galt fantasy, casting them as brilliant, productive people, with others piggybacking on their earnings. That’s hogwash. Traders conveniently forget that they have managed to get themselves in a hugely advantageous position: They get a slice of their profits if they win, but don’t disgorge them when they screw up. The worst that happens is they lose their job. And a remarkable number fail upwards, or at least sideways. Witness how John Meriwether, is now raising his third fund after heading two firms (LTCM and JWM Partners) that failed.

Moreover, traders benefit from massive subsidies, such as artificially low interest rates (not just now, but certainly since 2001 and, some argue, even earlier), plus industry-serving policies that produced a highly concentrated structure, with a small number of firms sitting at the nexus of massive capital and information flows. The big Wall Street firm trader’s claim that he is an independent operator fully deserving his earnings is a wonderful bit of mythology. It’s like claiming prowess in hunting based on the results achieved at a well-stocked game reserve, with some of the prey drugged to boot.

Many psychological disorders are otherwise healthy tendencies carried too far, unchecked by other personal attributes. Single-mindedness, drive to succeed, aggressiveness and lack of remorse are useful traits in business, but when do they tip into the psychopathic? In the case of Wall Street, the collective psyche has suffered as important checks on ego and behavior have eroded.

One no longer operative constraint is the partnership form of ownership. In the days when partnerships prevailed, senior management had good reason to keep pay demands in line. The partners had most of their wealth tied up in the business; they lived poor and died rich. If the firm suffered a loss, the consequences were disruptive to catastrophic. You couldn’t replenish capital easily; mortgaging the house will only go so far. And the partners were personally liable. They were on the hook for any shortfall. Many once famous Wall Street names lost their independence due to weak performance or losses: Kuhn Loeb, First Boston (over a series of years), Bache & Company, A.G. Becker, Lehman Brothers Kuhn Loeb (in 1984), Drexel Burnham Lambert.

But despite the peril it posed to the owners, the partnership form had some compelling advantages: Compensation levels were confidential, so as not to annoy less well remunerated clients, and the firms were not exposed to double taxation. And the partnerships had a cachet that the public firms, mainly retail brokers, sorely lacked.

That mode of operation in turn produced a great deal of vigilance, at least in the firms that proved to be survivors. The management committees needed to set pay levels so that the business was also retaining sufficient capital to remain competitive. These owners also had narrow spans of control, acting as players in as well as managers of businesses they had grown up in. In the market-making businesses, they were usually the senior traders on the desks and knew the foibles of their subordinates.

And so performance-inducing levels of compensation and the long-term health of the business were held in balance. Moreover, the leadership had reason to rein in big egos, since they could feel emboldened to take risks that would jeopardize the firms.

In the early 1990s, Sallie Krawchek, then an equity analyst covering publicly owned investment banks for Sanford Bernstein, remarked, “It’s better to be an employee of a Wall Street firm than a shareholder.” Being public changed all the incentives. Management had less reason to be cautious. Indeed, that also showed up in her analysis. The most profitable business was fixed income, meaning the debt-trading business, and even then the firms were on a trajectory of taking on more risk.

And more risk changes the meaning of trader profits. The private partnerships had managed against the fact that the non-partner market-makers didn’t share in the downside, and a key device was making sure that joining the partnership was the richest reward. That alone encouraged underlings to be more judicious.

To illustrate how much values have shifted in a money-minded business, John Whitehead, the former co-chairman of Goldman who presided through 1984, blasted the current CEO Lloyd Blankfein over the “shocking” pay levels. “They’re the leaders in this outrageous increase,’’ Whitehead remarked in 2007. He urged the firm to be “courageous” enough to lower bonuses and re-instill a sense of propriety.

But Whitehead, like most seasoned hands trying to persuade younger generations of the error of their ways, was ignored.

In the “other people’s money” world, there was less reason for restraint. Indeed, an expression has become common that would have been unthinkable in the 1980s: “IBG, YBG”— “I’ll be gone, you’ll be gone.” In other words, long-term consequences (likely damage) don’t matter; all that counts is this year’s kill. And if it’s big enough, you will never need to work again.

This attitude is predatory. And it has become widespread. A former Deutsche Bank employee, Deepak Moorjani, wrote:

When speaking about the banking sector, many people mention a “subprime crisis” or a “financial crisis” as if recent write-downs and losses are caused by external events. Where some see coincidence, I see consequence. At Deutsche Bank, I consider our poor results to be a “management debacle,” a natural outcome of unfettered risk-taking, poor incentive structures and the lack of a system of checks and balances.

In my opinion, we took too much risk, failed to manage this risk and broke too many laws and regulations. … [T]he system of incentives encourages people to take risks. I have seen honest, high-integrity people lose themselves in this cowboy culture, because more risk-taking generally means better pay. Bizarrely, this risk comes with virtually no liability, and this system of O.P.M. (Other People’s Money) insures that the firm absorbs any losses from bad trades.

And remember, in the Brave New World of OPM, management has every reason to be in on the game. Their bonuses are a function of the profitability of the businesses that report to them. And now that the consequences are evident, it is easy to rationalize the behavior: Everyone else was operating the same way, there was money to be made, you were just providing what the “market” wanted.

A second change has been in how members of the industry see themselves. Most I ran across were proud to be members of respected firms (the reaction when offering your card was quick confirmation), but no one labored under the delusion that finance was an elevated calling. It was a necessary function, the plumbing of a capitalist economy. If there was anything to congratulate yourself for, it was having discovered and gotten into a field that offered outsized rewards, thanks to regulatory and scale-based barriers to entry. The same M&A banker who jeopardized her health in her successful pursuit of partnership once commented dismissively, “It’s indoor work.” A successful institutional salesman said he had never run into more mediocre overpaid people than on Wall Street.

Thirty years of conservative extolling of the virtues of “free markets” seems to have contributed to the banking sector’s inflated ego. Even though the securities markets are far from “free” (they are regulated to varying degrees), the mythology has taken hold that players in finance allocate capital to its best uses—a role of vital importance to society—and therefore deserve to be more richly compensated than everyone else. Such rationales became necessary as growth in capital markets pay greatly outstripped that of other forms of indoor work.

But this flattering self-image is inaccurate. It’s the end investors that are making the capital allocation decisions; the brokers and bankers are facilitators and an information hub. And, unfortunately, as we’ve seen with auction rate securities and dodgy collateralized debt obligations sold to hapless investors as far away as Norway and Australia, the sellers were sometimes less than forthcoming about the quality of the wares they were peddling.

Nevertheless, one sees bankers and brokers, who concede that much of the anger directed at fancy finance is “very well deserved” nevertheless take DeSantis-like exception to their specialty being spattered in the mud-slinging. From the blogger Epicurean DealMaker:

And, in twenty years of offering M&A and financial advice to corporate clients, I have yet to meet someone who has intentionally pushed a “bad” M&A idea to a client, either. Sure, I’ve been in pitches where a banker has proposed silly, ill-thought-out, or downright stupid M&A ideas to a client, but those instances are either unintentional—in which case the client throws the banker out of his office and said banker usually gets fired in the next round of layoffs—or intentionally designed to provoke a deeper and more productive dialogue with the client.

One wonders, has the Epicure ever actually worked on the sell side? There, the banker’s role is to elicit the best possible price. And, trust me, plenty of crappy businesses get peddled. That’s precisely when a broker adds most value, in monetizing a garbage barge, and I saw tons of them when representing one of the preferred dumping grounds, the hapless Japanese. Ah, but of course! They aren’t your client; it’s perfectly OK if the guy on the other side of the table is a stuffee.

Yet to prove his point that the critics have gone overboard, the Epicure wraps himself and his colleagues in a mantle of “we’re good guys in our sector.” What is troubling is that his black-and-white portrait doesn’t appear to be a rhetorical device; he seems to believe it.

Later he writes:

Would the esteemed economist from the New York Times care to explain to me exactly how the finance industry was able to unilaterally increase demand for its services while drastically expanding its operating margins? Maybe I don’t remember my entry-level Economics so good, but that strikes me as a somewhat dubious proposition. And yet, that is exactly the conclusion an inattentive or ill-informed reader would draw from Mr. Krugman’s tendentious screed: regulate those nasty bankers, before they force our country to lever up and make them filthy rich again!

The anger is as telling as the logic, or lack thereof. The Epicure never addresses the inconvenient truth that lay at the heart of all those arguments for stricter regulation: that the rising asset values that fueled the securities industry boom in turn were the result of ever-increasing borrowings. Private sector debt to GDP rose gradually in the 1980s, more steeply in the 1990s, and went near hyperbolic from 1999 onward.

In modern economies, we don’t let banking systems that lend money on a reckless scale go bust, as much as that would be a useful cautionary practice. We socialize the losses. Those who weren’t perps fail to acknowledge that they benefited from the wanton risk-taking nevertheless. In the case of the Epicurean Dealmaker, how can he not recognize that transaction prices were pushed up enormously by the easy access to cheap deal funding? And that his fees, set as a percentage of the deal price, were higher as a result? Many of the cheap loans that funded transactions and pushed M&A prices into the stratosphere were in collateralized loan obligations. The big lenders and investment banks hadn’t unloaded them when the crisis hit, so they are part of the losses that taxpayers are now eating.

That’s why the great unwashed public is furious. They may lack the sophistication to grasp the arcana of the financial crisis, but they sense that the explanations for the costs they are bearing are insufficient; they see that a lot more people were feeding at the trough, directly or indirectly, than the poster children served up for public ridicule. And they’re right.

So the whining, the petulance, the defensiveness, the distorted reasoning, signifies something much deeper and more troubling.

Finance has lost sight of its role.

Banking and capital markets have become important to advanced economies, but also they represent a charge on the productive economy, just like lawyers and national defense. Ironically, the Japanese understood this well, and were still unable to prevent a turbo charged borrowing binge that left their economy a mess. They recognized that letting banks be very profitable comes at the expense of industry. And indeed, until the global financial crisis, while Japan’s domestic economy remained mired in deflation, its export sector was still robust. When our crisis broke out, Japanese policy makers were uncharacteristically blunt and warned the US that the mistake they had made was not cleaning up their banking sector quickly. We are repeating their error for the very same reason: financial firms have great political clout.

Or, as John Maynard Keynes put it, “When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill done.”

Yet the people at the heart of this system, even with the wreckage they created all around them, still fail to acknowledge that the rich pay of recent years was the product of a debt binge. It wasn’t just the makers of the pernicious securities who benefited; all boats in the finance industry rose with the surge of borrowing. Trying to defend the status quo ante shows a willful, self-serving blindness to the proper place of financial markets in a healthy economy.

Worse, it bespeaks a dangerous, destructive ideology that has somehow managed to live on, zombie-like, through the crisis. The idea that the needs of the financial sector trump those of the productive sector isn’t just specious; as the crisis so vividly demonstrated, it’s outright dangerous. But its strange persistence as an article of faith among our leadership class, both in government and the media, has yielded inertia and fecklessness where there should be energy and resolve. It seems that before we can confront the challenge of mending our broken financial system, a battle of ideology must be waged and won. And the hour is getting late.

In case you somehow harbored the notion that the other half doesn’t live differently than the rest of us, an eye-opening report released by the Insight Center for Community Economic Development, “Lifting as We Climb,” analyzes a topic that too often gets short shrift, the net worth, or “wealth” of the lower economic strata. The media (to the extent it has taken up the issue of income inequality) has focused on the rising concentration of income and assets at the very top, and less attention has gone to the obverse side of this coin: the relative decline of the standing of lower ranks.

This study drew on the 2007 Survey of Consumer Finances, which is conducted one in every three years and is considered one of the most relaible sources of information on wealth disparities. The analysis uses the same definition of net worth as the Federal Reserve does. The report notes:

While the 2007 data is the most recent release of the SCF to date, it is important to take into consideration that most of the data were collected prior to the economic downturn and therefore present a more favorable portrait of levels of wealth than is likely to be the case currently. Nonetheless, the overall patterns depicted with respect to wealth of whites versus non-whites are likely to hold. If anything, the portrait of wealth holdings for people of color is likely to be less favorable today than it was in 2007 since people of color hold greater amounts of their assets in homeownership (see Table 4) and communities of color have been hardest hit by the foreclosure debacle. Therefore, the data provides a “conservative estimate” of the current wealth holdings for women of color.

Here is the punch line:

However, while white women in the prime working years of ages 36-49 have a median wealth of $42,600 (still only 61% of their white male counterparts), the median wealth for women of color is only $5.

Once they get past their childbearing/rearing years, single black women do better. Their net worth rises to nearly $60,000 for the 50 to 65 cohort. But single white women show a greater increase in net worth across the two age groups, of nearly $70,000.

One of the few papers to pick up this story, the Pittsburgh Post-Gazette (hat tip reader John D) add some more disheartening factoids:

Black women, in general, were more likely to have participated in the subprime loan crisis with upper-income black women being five times more likely to have received a high-cost mortgage than upper-income white men.

“The popular image is they spend too much, which is the reason they are running up credit card and consumer debt, but the cost of living has risen faster than income, and they need to go into debt for basic daily necessities,” Ms. Lui said. “It’s compounded because unemployment is twice as high in the black community than it is in the white community.”

Huffington Post has a short write-up by a project manager at the Insight Center, but that is the sort of exception that serves to prove the rule, that of lack of media interest in the fate of the poor and near poor.

On a separate but related sighting, The Big Picture’s post ” An Epidemic of Laziness?” takes issue with the idea that extending unemployment insurance creates a disincentive to find work, when the fact that there are more than five job-seekers for every opening would seem to be a more significant impediment. The comment stream at points veers into vitriol

From the Independent:

Chief executives from the world’s banks discussed the plans at a secret dinner held at Claridge’s, the London hotel, last October, at which several leading British bankers are said to have suggested that the sector should take greater responsibility for its part in the crash, and do more to reduce the vast bonuses paid to staff.

But the recommendations were met by stiff opposition from the US banks JP Morgan, Morgan Stanley and Goldman Sachs, according to one source. “Some of the US bankers were furious about attempts to reduce pay throughout the industry, arguing that any such move smacked of socialism and would be fiercely resisted,” the source said on Friday. “It’s not the way the Americans like to go about their business.”

Yves here. The evidence that US capital markets firms are firmly in the hands of hopeless sociopaths continues to mount.

The fact set is undeniable: the big firms in the industry engaged in a massive campaign of looting, of running enterprises in which the employees were consistently overpaid relative to the risks and true profits of the firms. The result was that they were overleveraged. The only reason the industry survived was due to massive public subsidies, from equity injections to special lending programs to super low rates to regulatory forebearance. By any right, the firms should have failed, and the bankruptcy course should have gone full bore after the pay earned in the bubble years as fraudulent conveyance.

The British bankers seem to understand:

1. The industry is responsible for the financial crisis and the toll it has inflicted on innocent bystanders

2. The industry should be very grateful indeed for all the emergency rescue, particularly since virtually nothing has been done to prevent the industry from resuming the same sort of profitable-looking reckless behavior that nearly drove the world economy off the cliff

3. Banks’ current profits are also due in significant measure to all that lovely cheap funding on offer from central banks, in effect an unexpected reward for having caused the crisis. Reader NYT pointed out:

GS [has] gone from a privately funded balance sheet to a government funded balance sheet since the October meltdown. They paid only $6.5B interest on only $500B of debt in 2009. That’s about 1.3%. Given that some of their debt is long term debt (e.g Buffet’s 10% loan etc) issued prior to 2009, they must have replaced almost all of the $500B in debt with loans from the Fed.

Looks like the financial crisis worked out very well for GS. They are paying $25B a year less in interest than they paid in 2008 and it looks like no one is even talking about why GS should not be given this huge and ongoing government subsidy.

4. The wisest course of action is to try to resume as much of status quo ante as possible while keeping a low profile so that the public and officialdom will not decide to interfere in this juicy little racket. That means avoiding in engaging in the most press and public annoying behavior, namely, paying lavish bonuses, is not a very good idea right now

5. But the US banks are convinced of their divine right to feed at the trough

The astonishing bit is that the US banking execs have the temerity to self-restraint on pay “socialism”. They are benefitting from what most would call socialism for the rich, but is more accurately termed Mussolini-style corpocracy or good old fashioned pilfering from the public purse.

A successful investor would often say, “Little pigs get fed. Big pigs get slaughtered.” A lot of people are waiting for these big pigs to get their just deserts.

Hhhm. Even though the UK 50% bonus “supertax” was deemed to be a bit of a failure (the banks just grossed up bonuses to compensate for the levy), Senators Barbara Boxer and James Webb have proposed a similar measure, and one wonders how it might fend off the sort of gaming that plagued the UK effort.

The one-time tax would be limited to bonuses of more than $400,000 at firm that received more than $5 billion in TARP funds. Bloomberg notes:

The bill would affect 13 firms and could raise $10 billion to help cut the federal deficit, Boxer said.

“It’s outrageous that many of these companies are doling out millions of dollars in bonuses while the rest of America feels the pain of reckless decisions,” said Boxer.

By Edward Harrison of Credit Writedowns. I hope this is a good subject to discuss in light of the recent Obama Administration machinations regarding Fannie and Freddie, Big Pharma, and Healthcare.

Before the Christmas break, I wrote a post to tie together my thoughts on why I have found the Obama economic program so unsatisfying despite some obvious success in stabilizing the economy. This first part framed the status quo as an unequal division of spoils that has become more and more unequal due to kleptocracy aka looting.

In this post, I want to talk about Obama’s economic policies in the context of what I perceive as a crony capitalism which is now endemic in Washington. As I see it, Americans are angry because the economy is still quite fragile and the personal financial situation for many ordinary Americans is still quite dire. Yet, the so-called fat cats seem more pigs eating at the trough of government largesse. This juxtaposition is galling and undermines any success that the Obama Administration has achieved.

Sellout, bamboozler, or ingénue?

The question is this:

• Did President Obama sell out (i.e. he was a good guy but has been corrupted in short order) or;
• Did Obama find out he couldn’t change the status quo so easily (i.e. he was a good guy who was naive about the President’s real power) or;
• Did the President simply bamboozle us (i.e. he was a bad guy who tricked the electorate with his silver tongue)?

I will assert that this question is irrelevant as it ascribes intent when we should be looking either at motive or outcome. If you do look at motive and outcome, you will see why I will focus more on government’s allowing a purge of malinvestment and less on government’s stimulating aggregate demand going forward.

The Obama Way

First, as to intent, Ross Douthat has an interesting piece in the New York Times.  He contends that Barack Obama is a knee-jerk liberal who believes in working within institutions for change. According to Douthat, that makes him Obama an odd bird who seems a Machiavellian willing to cut any deal juxtaposed with the soaring rhetoric of fairly ideological big government liberalism.

The part I found most interesting is this:

Between the stimulus package, the pending health care bill and a new raft of financial regulations, Obama will soon be able to claim more major legislative accomplishments than any Democrat since Lyndon Johnson.

I think Obama could make those claims as well.  I was going to write about this in January 2010 after Obama’s first year anniversary and after healthcare had passed. But now seems a good time to reflect on this: How many President’s can point to the record of accomplishments he can (prevented depression, stabilized finance, saved auto industry, overhauled healthcare). You may not like his methods. You may not like his results. You may not like him. But, President Obama has actually been quite productive – far more productive in his first year than Bush, Clinton or Bush II.

But, despite this productivity, the President’s poll numbers are falling.  He is not benefitting from any of his so-called successes. Clearly, he is doing something wrong. Is it messaging, process, outcomes – what gives?

This is where Douthat is right on the mark when he says in his article:

The assumption that a compromised victory is better than no victory at all can produce phony achievements — like last week’s “global agreement” on climate change — and bloated, ugly legislation. And using cynical means to progressive ends (think of the pork-laden stimulus bill or the frantic vote-buying that preceded this week’s Senate health care votes) tends to confirm independent voters’ worst fears about liberal government: that it’s a racket rigged to benefit privileged insiders and a corrupt marketplace floated by our tax dollars.

The gulf between Obama’s rhetoric and his actions is quite large and that leaves independents who voted for him quite dissatisfied.

Obama’s Intent

People do want to focus on the ‘why?’ They want to know why there is such a large gap between what the President says and what he does. After the November elections, I wrote the politics of economics, saying:

What experimenters here have shown is that there is a real human need to explain. Things happen for a reason, don’t they?  Why did the stock market rally? Why did Harry do that? Why didn’t we do something to stop this? Why did I vote for that guy back then, when I now don’t like him as much?

To the degree there is an explanation void, it will be filled. The question is: filled with what?

Confirmation bias and the psychology of politics

In politics, how the void gets filled has much to do with philosophical/political predisposition and one’s world view.

This is a mistake.  If you want to know why someone does something, it is better to use preponderance of evidence, the burden of proof used in civil trials, as a measure.

Preponderance of the evidence, also known as balance of probabilities is the standard required in most civil cases. The standard is met if the proposition is more likely to be true than not true. Effectively, the standard is satisfied if there is greater than 50 percent chance that the proposition is true. Lord Denning, in Miller v. Minister of Pensions, described it simply as "more probable than not." Until 1970, this was also the standard used in juvenile court in the United States.

As with many issues we discuss, I have started to view this through the lens of intent and motive. In a court of law, intent is the primary difference between manslaughter and murder. In the court of public opinion, a politician who intentionally violates public trust for a hidden agenda is ‘evil,’ but one who does so unintentionally is ‘misguided.’ In general, we like to ascribe intent because it makes it easier to denigrate or glorify the person in question.

Crony Capitalism

This is where cronyism enters the picture. There is a rather large body of evidence demonstrating that the Bush and Obama Administrations have favored large banks in an unseemly way. The same is true for the Congress and other big business insiders like Big Pharma, the Defense Industry and Health Insurance companies.

Witness these posts from the last month alone:

• The less optimistic view of Treasury’s handling of the crisis – Nov 2009
• Healthcare insurance industry insider: “We win” – Dec 2009
• Why is Barney Frank allowing lobbyists to gut financial reform? – Dec 2009
• Bank lobbying e-mail: Quid Pro Quo to kill mortgage modification bill – Dec 2009
• Obama and the Fat Cat bankers – Dec 2009
• U.S. forfeiting billions in future taxes to let Citi repay TARP  – Dec 2009
• Gasparino: No woodshed for the fat cats, just a lovefest – Dec 2009
• The phony Senate health care reform bill – Dec 2009
• On releasing Citi from TARP and banking by accounting subterfuge – Dec 2009
• Blodget: Obama suffers because “taxpayer always finishes last” –Dec 2009

I could provide you with a far longer list of posts from the January to April period when the Citi and BofA bailouts were conducted and the alphabet soup of liquidity programs began which Bank of America and Citi were prepared to game.

I said in March it’s the writedowns, stupid. When accounting rules were formally changed to reflect the de-facto accounting policies favoring banks, I knew the big banks were on easy street and The Fake Recovery had begun. So, by April, I said Wells profit forecast is a clear bullish sign.

Don’t even get me started on the stress tests. They were a sham from the start and were merely a means of recapitalizing the banks via inflated equity valuations. They were neither tests nor stressful, as Bill Black has demonstrated.

More recently, posts by Yves Smith and Bruce Krasting confirmed my long-held suspicions that Fannie Mae and Freddie Mac would be used as a nationalization of America’s mortgage problems via a back door bailout of banks.

The evidence, therefore, tends to demonstrate that we have witnessed an orchestrated campaign by the Bush and Obama Administrations to recapitalize too big to fail institutions by hook or by crook, bypassing Congressional approval if necessary. And when it comes to healthcare, both Congress and the White House have bent over backwards to keep the lobbyists onside. As I see it, our government has favored special interests in the past year of Obama’s tenure to our detriment.

Political legacy

Personally, I don’t buy the line that Obama is a liberal. I consider him more a corporatist (i.e someone who coddles big business). But, from a political perspective, it’s not really relevant, is it? What difference does it make whether President Obama is a liberal sellout as Matt Taibbi claims or a pragmatic corporatist, if the outcome for the electorate is largely the same? Forget about intent. Focus on actions.

As an aside, I should point out the logic likely employed by Geithner et al in bailing out the banks. I gave voice to this last month in the wildly optimistic view of Treasury’s handling of the crisis. Noam Schreiber takes this one better in the New Republic. If you still want a why – this is as good as any:

There’s an interesting back-and-forth between Dan Gross and Tim Geithner in Newsweek’s year-end interview issue:

GROSS: There have been, and continue to be, calls for you to go. How do you deal with those?

GEITHNER: I spent most of my professional life in this building. Watching the politics of the things we did in the past financial crises in Mexico and Asia had a powerful effect on me. The surveys were 9-to-1 against almost everything that helped contain the damage. And I watched exceptionally capable people just get killed in the court of public opinion as they defended those policies on the Hill. This is a necessary part of the office, certainly in financial crises. I think this really says something important about the president, not about me. The test is whether you have people willing to do the things that are deeply unpopular, deeply hard to understand, knowing that they’re necessary to do and better than the alternatives. …

This is a theme I wrote about in my profile of Larry Summers earlier this year. I don’t think you can underestimate the extent to which the financial crises in Mexico and Asia were a formative experience for the Obama economic team–especially in shaping their thinking on the intersection of politics and economic policy.

In his memoir, then-Treasury Secretary Robert Rubin, who both men worked for at the time, summed up his views on the Mexican crisis by citing "the difficulties our political processes have in dealing effectively with issues that involve technical complexities, shorter-term cost to achieve longer-term gain, incomplete information and uncertain outcomes, opportunities for political advantage, and inadequate understanding." Obviously, these same difficulties made a big impression on Geithner and Summers, too. So they were more prepared than most for the political backlash this time around, even if the intensity may have surprised even them on occasion.

The recent Fannie-Freddie end run around Congress demonstrates Schreiber is right about the Asian and Tequila Crisis legacy -  as do the TARP money stimulus slush fund and the earlier liquidity packages.

The problem for Obama politically is this:

At the same time, Obama doesn’t enjoy the kind of deep credibility with his base that both Reagan and Kennedy spent decades building. When Kennedy told liberals that a given compromise was the best they could get, they believed him. Whether the issue is health care or Afghanistan, Obama’s word doesn’t carry the same weight.

This leaves him walking a fine line. If Obama’s presidency succeeds, it will be a testament to what ideology tempered by institutionalism can accomplish. But his political approach leaves him in constant danger of losing center and left alike — of being dismissed by independents as another tax-and-spender, and disdained by liberals as a sellout.

Come 2011, I expect the perverse math of GDP reporting to spell a double dip recession. As the associated economic slowing will begin much earlier, expect to see the disdain for Obama that Douthat writes about exhibited at the polls in 2010.

See also “We’ll Be Judged on How We Dealt With the Things That Were Broken” from Slate to see how Tim Geithner feels things are going.

By Edward Harrison of Credit Writedowns

Yesterday, I indicated I would write a few thematic posts as a look back at some of the more important economic topics that this credit crisis has uncovered. Tying posts together in a theme definitely gives a better holistic view of a the themes than the posts do in isolation. But I also enjoy writing this because the review process gives me a better perspective of where we have come from and helps judge where we are headed.

Yesterday, I wrote about economic stimulus. My conclusion was that while stimulus may have helped avert crisis, the process made clear that crony capitalism is alive and well. So, the second topic I wanted to address today was crony capitalism. However, in writing this post, the lead in describing kleptocracy became so long that I decided to cut this into two bits; this first one is on kleptocracy and a later one will be on crony capitalism.

The first post I wrote related to kleptocracy was in March of 2008 called “A populist interpretation of the latest Boom-Bust cycle.” At the time, I wasn’t really blogging very seriously. I had just started two weeks earlier and wanted to flesh out some ideas that I had long considered germane to the understanding of the credit crisis. But, in retrospect, the thesis I developed in this post has become central to my thinking about how the American and global economy have evolved in the fiat currency era.

Kleptocracy defined as the status quo

The thesis was this:

[Jared] Diamond postulates that more stratified societies are by definition less egalitarian, but more efficient and are, thus, able to eradicate or conquer more egalitarian, less stratified societies. Thus, all ‘advanced’ societies with high levels of GDP are complex and hierarchical.

The problem is: these more stratified, more complex societies are in essence Kleptocracies, where those in power re-distribute societal wealth to themselves. Those at the bottom of the society’s pyramid accept this unequal, non-egalitarian state of affairs because they too benefit from their society’s relative advancement. It’s a case of a rising tide lifting all boats.

In short, the playing field in all modern day nation states is by definition unequal. The question is whether this should be tolerated, mitigated or eliminated. An unwritten assumption I made when I wrote the post is that humans are genetically programmed for fairness. My understanding is that scientific studies have convincingly demonstrated that human beings will actually consciously disadvantage themselves to seek revenge as a means of restoring justice and fairness.

This would suggest that a major flaw in neoclassical economic models, especially as regards a self-equilibrating economy, is the focus on rational expectations and efficiency at the expense or fairness and/or irrationality. A neoclassical economist might tell you that a rising tide lifts all boats and it is rational self-protection for economic agents (aka real human beings) to accept inequality for this very reason. But, in the real world, fairness and justice are important as well. And when an economic system is deemed unfair, people will go so far as to hurt themselves economically in order to level the playing field.

Stability of status quo leads to overreach and instability

So, my thinking is this: because of the natural state of inequality endogenous to any stratified society, over time the natural tendency of any ruling elite is to deploy the state’s coercive power for greater and greater self-benefit. I liken this to Hyman Minsky’s instability of economic stability theorem. The stability of power leads to overreach and overthrow. This is a view largely consistent with Paul Kennedy’s themes of imperial overstretch in his book The Rise and Fall of the Great Powers.

In the post I expressed these sentiments saying:

Diamond says the Kleptocrats maintain power using 4 different methods:

“1. Disarm the populace, and arm the elite.”

“2. Make the masses happy by redistributing much of the tribute received, in popular ways.”

“3. Use the monopoly of force to promote happiness, by maintaining public order and curbing violence. This is potentially a big and underappreciated advantage of centralized societies over noncentralized ones.”

“4. The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy.”

Kleptocracy in America?

The obvious corollary of this theory is that most successful modern societies are, in fact, kleptocracies. The key is to use the four methods to gain popular support in order to re-distribute as much wealth to the ruling class as the populace will support. If the ruling class takes too much, it will be overthrown and replaced by a new ruling class (which in turn will re-distribute wealth to itself using the same four methods).

How the status quo maintains the status quo

Let me take these points one by one. I will preface this by saying that, as the stability of the economic status quo disintegrates into instability via economic depression, you should expect the ruling elite to step up uses of these methods of retaining power.  So when I wrote in my Depression piece about “more muscular forms of government,” this is part of what I was referring to.

As Libertarians see it, the right to bear arms is an essential in stopping the elite from maintaining power unjustifiably. Obviously, which arms, when they can be borne and how is a constitutional issue that goes to the heart of American democracy.

The second issue is about “bread and circuses” or what I call the anesthetizing of the populace as ironically demonstrated in this Star Trek “Bread and Circuses” from TV, our own modern-day agent of mental anesthesia.

The third issue is about totalitarianism.  Civil libertarians like myself see the permanent war state as promulgated by the Bush administration post 9/11 – and now maintained by the Obama Administration – as a clear sign that the state’s use of the monopoly of force to promote order is rising and will continue to do so. Eisenhower’s military industrial state warnings were warranted. You can see some of the articles on that very topic here in my bookmarks. And you should note Obama’s poor record on civil liberties.

The last (and perhaps most important) issue, in my view, has to do with the unabiding faith in free markets that many now have. It is with religious zeal that these so-called Libertarians defend the primacy of markets over all else when in reality common sense would tell you that those with the greatest influence and money will always be at an advantage without some check on that influence and power.

How ideology is central to retaining the status quo ante

I think this last point is important. Think of how Diamond phrased this:

The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy.

The important thing to realize here is that ideology is a tool used to control the masses while those in power re-distribute to themselves. Diamond was probably talking here about ancient societies: the Mayans, Incas, the Greeks, the Romans, Easter Island. But, it does apply quite well to the modern-day. After all, in the U.S. average hourly earnings peaked more than 35 years ago. And we can see that most of the economic gains of the last two decades has been an illusion masked by gobs of debt.

But freshwater economists have this view that the economy is always self-equilibrating and this means government must be held at bay any- and everywhere lest it reduce the efficiency of the free market. This is an extreme ideological position which gained sway in the aftermath of the disaster of the 1970s. Fed Chairman Alan Greenspan was an adherent of this ideology despite holding a central planning position as Federal Reserve Chairman which was antithetical to the views he espoused.

Markets are wonderful. A largely market-based economy is certainly more ‘efficient’ than a non-market based one (ask the Soviets). But, markets are not self-regulating. They fail – and catastrophically so. But no manner of real world experience seems to shake ideologues’ free-market zeal. To give you an example of the mindset, Alan Greenspan is reported to have thought that markets could even self-regulate fraud – no regulatory oversight necessary. 

See the video in Frontline – The Warning: Who Knew About the Looming Financial Crisis for this particular revelation and Ms. Watkins, why does Charlie have lit dynamite? for why this is absurd. Even when you think Greenspan has learned something, he proves time and again that he just doesn’t get it. And don’t think he is alone in officialdom. Former Fed official Frederic Mishkin has shown he doesn’t get it either.

Not only is the freshwater view of rational economic agents and efficiency completely ignorant of the role of fairness, it also disregards the very real tendency for power to consolidate over time and to lead to crony capitalism. This is what I refer to as “deregulation as crony capitalism.” I see it as central to the causes of the crisis.

I will pick up on this theme in a later post. Next up on my year in review is a post on crony capitalism in action and how the credit crisis solutions reveal that the ruling elite want to return to the status quo ante. Overreach has been the order of the day and will ultimately invite an opposing response.

As Jim Chanos, who pointed out this Bloomberg piece “Arming Goldman With Pistols Against Public,” remarked, “Well, it appears that Goldman’s Best and Brightest may be hedging their goodwill built up by doing ‘God’s work’.”

I’ve heard the expression, “Trust in Allah, but tie up your camel,” but I can’t recall an exhortation that links faith with carrying firearms (although I suppose that gap in my knowledge may reflect a cloistered upbringing). The only heavily armed observant types I can think of in the US are the Branch Davidians, and we know how that movie turned out. Goldman has always been a cult, but one has to wonder what models they are now channeling.

In all seriousness, having grown up in a parts of the country where hunting season (deer and turkey) were a big deal, I get nervous when people who have little or no history of using firearms start toting them. There are rules most people who use guns routinely are taught, and my experience is that those individuals are far more careful than newbies who have seen way more movie and TV gunplay than real world use.

If you are worried about self defense, programs like this one (I’m not endorsing it , just using it as an example) are a safer and more effective solution to the real problem (what good is your pistol if you are jumped from behind?)

End of sermon and back to fun. From Alice Schroeder at Bloomberg:

“I just wrote my first reference for a gun permit,” said a friend, who told me of swearing to the good character of a Goldman Sachs Group Inc. banker who applied to the local police for a permit to buy a pistol. The banker had told this friend of mine that senior Goldman people have loaded up on firearms and are now equipped to defend themselves if there is a populist uprising against the bank.

I called Goldman Sachs spokesman Lucas van Praag to ask whether it’s true that Goldman partners feel they need handguns to protect themselves from the angry proletariat. He didn’t call me back. The New York Police Department has told me that “as a preliminary matter” it believes some of the bankers I inquired about do have pistol permits. The NYPD also said it will be a while before it can name names…..

Has it really come to this? Imagine what emotions must be billowing through the halls of Goldman Sachs to provoke the firm into an apology. Talk that Goldman bankers might have armed themselves in self-defense would sound ludicrous, were it not so apt a metaphor for the way that the most successful people on Wall Street have become a target for public rage.

Yves here. This isn’t hard to understand at all. Goldman ran afoul of one of Machiavell’s big rules: “Men sooner forget the death of their father than the loss of their patrimony.” Or its 21st century variant: “You can take from all of the people some of the time, and some of the people all of the time, but you cannot take from all the people all of the time. ” But the banksters, and Goldman in particular, have been determined to push the limits of those formulas, and are learning, much to their surprise, that they neglected to consider the intensity of the backlash that might result from their considerable success in extracting rents from the populace. Or did they? Back to Schroeder:

Common sense tells you a handgun is probably not even all that useful…As for carrying a loaded pistol when you venture outside, dream on. Concealed gun permits are almost impossible for ordinary citizens to obtain in New York or nearby states.

In other words, a little humility and contrition are probably the better route.

Until a couple of weeks ago, that was obvious to everyone but Goldman, a firm famous for both prescience and arrogance. In a display of both, Blankfein began to raise his personal- security threat level…He keeps a summer home near the Hamptons, where unrestricted public access would put him at risk if the angry mobs rose up and marched to the East End of Long Island.

He tried to buy a house elsewhere without attracting attention…Then, Blankfein got permission from the local authorities to install a security gate at his house two months before Bear Stearns Cos. collapsed…. Blankfein somehow anticipated the persecution complex his fellow bankers would soon suffer. Surely, though, this man who can afford to surround himself with a private army of security guards isn’t sleeping with the key to a gun safe under his pillow. The thought is just too bizarre to be true.

So maybe other senior people at Goldman Sachs have gone out and bought guns, and they know something. But what?..

There you have it. The bailout was meant to keep the curtain drawn on the way the rich make money, not from the free market, but from the lack of one. Goldman Sachs blew its cover when the firm’s revenue from trading reached a record $27 billion in the first nine months of this year, and a public that was writhing in financial agony caught on that the profits earned on taxpayer capital were going to pay employee bonuses…

No, talk of Goldman and guns plays right into the way Wall- Streeters like to think of themselves. Even those who were bailed out believe they are tough, macho Clint Eastwoods of the financial frontier, protecting the fistful of dollars in one hand with the Glock in the other. The last thing they want is to be so reasonably paid that the peasants have no interest in lynching them.

Yves here. For the record, in the 1980s, people in the industry were greedy on a much more modest scale. A nice (and I mean nice, not ostentatious) apartment on the Upper East Side, private school for the kids, summer home, nanny, and a BMW or equivalent meant you were successful. And pretty much all i-Bankers, those at Goldman included, were careful not to flaunt their wealth. There was genuine horror when the story broke that Mike Milken made $500 million in a single year. It was seen as not as a titanic achievement, but as confirmation that something crooked must be up at Drexel. Back to the article:

And if the proles really do appear brandishing pitchforks at the doors of Park Avenue and the gates of Round Hill Road, you can be sure that the Goldman guys and their families will be holed up in their safe rooms with their firearms. If nothing else, that pistol permit might go part way toward explaining why they won’t be standing outside with the rest of the crowd, broke and humiliated, saying, “Damn, I was on the wrong side of a trade with Goldman again.”

In America, it isn’t hard to answer the question in the headline “yes.” The oft recited, “Our employees are our greatest asset” is pure Orwellian prattle; most companies treat employees as liabilities, doing everything they can to minimize labor costs, getting rid of workers whenever possible. And this now extends well up into the management ranks, with most people who are still on the corporate meal ticket assigned responsibilities that would have constituted 1.5 to two jobs a decade ago.

And before readers argue that this is a necessary response to globalization, the evidence does not support that view. If companies were simply responding to tougher competition (in this case, lower cost suppliers from overseas), you’d expect to pressure on wages AND profits. Instead, we’ve seen wage stagnation (save at the very top) with (pre bust) record profits.

If you look at past post-war expansion periods, the vast majority of GDP growth went to labor, in the form of increased hiring and higher wages. The post war average (pre the last upturn) was close to 60%; the low was 55%. The jobless recovery lived up to its billing, with under 30% of GDP gains going to workers. By contrast, the portion of GDP growth that went to profits was an all-time record.

Similarly, as any properly-trained MBA will tell you, companies can compete on other axes besides cost: convenience, product features, speed of delivery, other types of service. And US businesses have a huge advantage: physical proximity to the biggest consumer market. Offshoring and outsourcing create considerable rigidity and risk (more coordination required, which increases the odds of snafus) Some evidence supports the idea that outsourcing is a fad that US companies embraced whether or not it fully made sense. Most companies find outsourcing to be overrated as a cost saver. A former senior executive at Ethan Allen told me there was not reason for the US to cede anywhere close to as much furniture manufacturing as it did, particularly given the cost of shipping (often two ways, since much of the raw materials come from North America). But in Ethan Allen’s case, Wall Street wanted to hear they were manufacturing overseas, and they complied.

Moreover, other countries, equally exposed to globalization, have not seen a squeezing down on workers to the benefit of the top 1% to anywhere the degree the US has, nor is the international pattern consistent with globalization (or other common culprits) being the driver. The Luxembourg Income Study (LIS) group put out a working paper by Andrea Brandolini and Timothy Smeeding with some international comparisons on income inequality, titled “Inequality Patterns in Western-Type Democracies: Cross-Country Differences and Time Changes”:

National experiences vary during the last four decades and there is no one overarching common story. There was some tendency for the disposable income distribution to narrow until the mid-1970s. Then, income inequality rose sharply in the United Kingdom in the 1980s and in the United States in the 1980s and 1990s (and still continuing), but more moderately in Canada, Sweden, Finland and West Germany in the 1990s. Moreover, the timing and magnitude of the increase differed widely across nations. Inequality did not show any persistent tendency to rise in the Netherlands, France and Italy. Commonality seems to be greater for market income inequality: in five of the six countries for which we have data, we observe an increase in the 1980s and early 1990s and a substantial stability afterwards.

Changing public monetary redistribution appears to be an important determinant of the time pattern of the inequality of disposable incomes. Changes in inequality do not exhibit clear trajectories, but rather irregular movements, with more substantial changes often concentrated in rather short lapses of time. Together with the lack of a common international pattern, this suggests to look at explanations based on the joint working of multiple factors which sometimes balance out, sometimes reinforce each other, rather than to focus on explanations centered on a single cause like deindustrialization, skill-biased technological progress, or globalization. Identifying and characterizing episodes and turning points in the dynamics of inequality may reveal more fruitful than searching for overarching general tendencies.

Other factors are that changes in policy have reduced the bargaining power of workers, and to a much greater degree than most realize. For instance, MIT economists Frank Levy and Peter Temin argued that, “Institutions and norms affect the distribution of economic rewards.” The paper combines some novel analyses with a Depression-to-present-day narrative of evolving labor-business-government relationships (one nice touch is a comparison of starting salaries at Cravath versus that of average graduate degree holders to illustrate the rise of “winner take all” inequalities).

Government also gave signals through tax structures and other mechanisms of their view of the appropriate level of labor compensation. For example, when Kennedy implemented tax cuts, the Council of Economic Advisers announced wage and price guidelines that indicated that labor should share pro rata. The paper describes other ways that the government let businesses know that it expected productivity gains to be shared with workers. Again, these measures took the form of guidance rather than intervention, but also reflected prevailing ideas of fairness.

By contrast, a piece today in Firedoglake (hat tip reader John D) illustrates how much values have changed, first with a graphic, and some scathing commentary:

Friday, a group of Trade Associations ran a full-page ad in the New York Times demonstrating their loathing for the employees of their members:

Expensive new mandates on businesses will result in lost jobs, lower wages, less flexibility and higher health care costs.

Let me translate that from scary talk to plain English. Business will dump every last cent of the costs of health care on employees. No business will give up a single penny of its profits to keep its workers healthy. Anyone who wants health care has to pay for it at whatever price the insurance companies want to charge, and business will cooperate in shifting costs to workers. And there is nothing you can do about it. The profits we suck out of your labor belongs to us, and you don’t get any.

Sound a bit like class warfare? It’s not a surprising reaction when one party keeps cutting itself the an overly large slice of the pie, and then adding insult to injury through spurious rationalizations.

Reader and life-long Chicago resident John Bougearel asked me to reissue a post encouraging readers to participate in peaceful demonstrations during the American Bankers Association annual meeting in Chicago October 25-27. The sessions are organized by a coalition of community, consumer and labor organizations and are called “Showdown in Chicago“. You can find more details via the link.

A number of commentators are planning a series of related posts and hopefully op-ed and news articles around this time. William Black and Dean Baker are among those leading the effort.

John Bougearel reacted to something I wrote two days ago:

But per the social psychology research, this “you are in a minority, you are wrong” message DOES dissuade a lot of people. It is remarkably poisonous. And it discourages people from taking concrete action. I was surprised that some people bothered to comment on a post I put up yesterday, calling on people in the Chicago area to attend some peaceful demonstrations against the banking industry during the American Bankers Association national meeting, October 25 through 27. Some people weighed in, saying (basically) “don’t bother”.

I suppose it makes a difference whether one is old enough to remember the 1960s. Because people in large numbers got out and protested, two sets of changes that seemed impossible came about: civil rights for blacks and an end to the US involvement in Vietnam.

His comment:

I will be more than happy to be in the minority and told I am wrong. The truth of the matter is we who object are neither the minority or wrong. Being told such is intended to be dismissive and minimize our voice.

I have reached the point where it is high time to push-back on the message we are being spoon-fed and to educate and promote the message that it is time to push back on the powers that be. We can start with peaceful demonstrations in the style of MLK. What was startling watching the MLK and Malcom X video clips is how relevant their experience of being black in America relates to being middle class in America today. It is high time middle class America finds its voice and is heard above controlled messages press releases leaked to MSM.

We can not, above all, allow our voice to be drowned out by mainstream media and the powers that be who influence what is peddled through MSM. Our voices are certainly not being represented through our votes, and when that happens, it is no different than the early colonists who fought against taxation without representation. Since our votes find no voice in Congress or Capitol Hill, it is time for grassroots organizations to take over the role that was intended for our elected officials.

And I get the pseudo-protest and protest points cited above in comments, and I get the Malcolm X message, but the MLK message of non-violent protest is authentic and not pseudo as some might imagine. There is power in non-violent protest, resulting in change that can be durable and long-lasting. But an effort must be made at a grass-roots level and it must sweep through the nation.

Here are excerpts from the original post:

Dean Baker, a couple of days ago at Huffington Post, called on readers to go to Chicago to participate in peaceful protests during the annual meetings of the American Bankers Association on October 25 to 27. A coalition of community, labor, and consumer groups are organizing this “Showdown in Chicago.”

If you saw Michael Moore’s Capitalism: A Love Story, a disconcerting bit was his discussion of a series of research reports put out by Citigroup for some of its asset management client in 2005 on “Plutonomy”. It argued that a world ordered to suit the whims of the top 1% was well underway. The only thing that might get in the way was that the other 99% had the force of numbers on its side.

Sometimes it takes a show of numbers to change the dynamic. As Baker pointed out:

The elites hate to acknowledge it, but when large numbers of ordinary people are moved to action, it changes the narrow political world where the elites call the shots. Inside accounts reveal the extent to which Johnson and Nixon’s conduct of the Vietnam War was constrained by the huge anti-war movement. It was the civil rights movement, not compelling arguments, that convinced members of Congress to end legal racial discrimination. More recently, the townhall meetings, dominated by people opposed to health care reform, have been a serious roadblock for those pushing reform….

A big turnout at this event can make a real difference. Just to review the scorecard, most of the country is still suffering the fallout from the bankers’ irrational exuberance of the housing bubble era. The Congressional Budget Office (CBO) and other forecasters expect the suffering to endure for years to come.

As we noted yesterday, ordinary people who still have jobs are often seeing their wages cut, while Wall Street, the beneficiary of rich subsidies, is expecting a banner year.

If you live in or near Chicago, see if you can organize others to join you. And dress nicely! One favorite strategy is to dismiss protestors as ruffians.