Gambling Our Future

Should Wall Street Control the Economy?

Not long ago, my wife and I were delayed in an airport in a university town. Across from us, a young woman settled herself to wait, pulled out her cell phone, and over the next half-hour or so proceeded to call everyone she knew. From what we could hear, she was calling just to say, “Hi, I’m waiting in an airport, what are you doing?”

A sociobiologist might see this as a fascinating vestige of primate grooming behavior-an evolved form of the monkey troop’s obsessive lice picking. An economist, on the other hand, would extol it as a productivity miracle. The revenues of companies like Verizon and the multiply reborn AT&T were going up, the cost per minute and megabyte of communication was going down. She was even exchanging pictures with her friends as she idled away time in the airport!

That little scene contains clues to what may be the central public-policy paradox of our time-how to square a quarter-century of strong, nearly uninterrupted economic growth at low inflation with the destruction of the social safety net-pensions, health care, unemployment protection-and the pervasive sense of personal economic insecurity.

Two new books shed light on the problem from different angles. The Yale political scientist Jacob Hacker is a leading scholar of the rise and fall of America’s traditional employment-based social-benefit system. Hacker’s The Great Risk Shift: The Assault on American Jobs, Families, Health Care, and Retirement, and How You Can Fight Back (Oxford University Press), is aimed at the general reader and focuses on family income volatility. Median family income has grown more or less steadily in recent years, if very slowly relative to the economy. But the uncertainty of income from one year to the next has increased sharply, a fact, which Hacker argues, carries quite profound consequences.

While Hacker is an up-and-coming academic, John C. Bogle is one of the grand old men of Wall Street, an embodiment of Tory-principled integrity. His book, The Battle for the Soul of American Capitalism (Yale University Press), is a bitter, meticulous account of how the financial-services kleptocracy has been looting investors and destroying companies. To pull together Bogle’s polemic, Hacker’s concerns, and the young cell-phone addict in the airport, however, will require some scene setting.

Recent decades have witnessed a remarkable trend toward greater concentration of income among the very wealthy-the thirty thousand or so people in the richest one-ten-thousandth (.01 percent) of all U.S. households. For many years after the end of World War II, that small slice of very richest families enjoyed about half of 1 percent of the nation’s income, or about fifty times their weight in the population. But in the early 1980s, that share began to climb steadily until it is now in the range of 3 percent-or three hundred times their proportionate weight, matching the previous peacetime peak in 1928, not an auspicious year. Very similar trends prevailed in Great Britain and Canada. The “Anglo-Saxon” experience, moreover, is starkly different from that in the rest of the industrialized world. In France, for example, top-income shares have hardly budged for decades.

To get a sense of how extreme the skewing in America has been, it is interesting to see how the folks who rank in merely the top 10 percent of earners have fared compared to the very rich. Almost as bad as everyone else, in fact. Before 1980 or so, the top ten-thousandth claimed about eight times the income of a household at the top 10 percent line; now they take forty to forty-five times as much.

Intuitively, the fact that the transformations took place only in the Anglo-Saxon countries must be related to the Reagan-Thatcher “revolution” of the 1980s. Interestingly, though, economists have not been able to show how actual policy changes like tax cutting, important as that particular factor may have been, could have triggered such seismic shifts.

More fundamental than specific policies, I think, was a sea change in financial and business culture. It’s easy to forget the profound sense of economic crisis that engulfed America at the end of the 1970s. The globe-bestriding American companies whose writ had run for the previous half-century had been exposed as sloppy, helpless bureaucracies. The dollar was in free fall. Saudi princes delivered condescending lectures. The chairman of Sony wrote a bestseller proclaiming that Japan was sick of coddling America. The crisis in England had somewhat different roots, but was of much the same ilk. The low point, perhaps, was in 1976, when the International Monetary Fund, normally a hospital ward for deadbeat nations of the third world, assumed effective policy control over the British Exchequer.

By a roll of the cosmic dice, the recovery, when it came, turned out to be mediated by Wall Street. The gloom, in fact, had been overdone. Yes, U.S. companies had been soundly trounced, but they were not dead. Since at least the mid-1970s, younger American managers, especially in manufacturing companies, were whipping their production lines back into shape. The stock market valuations of many solid firms were absurdly low. A few canny operators noticed that the salable assets of many companies were worth far more than their total stock price. So borrow a ton of money, buy the stock, sell the assets, and keep what’s left. The phenomenon of “The Eighties” ensued-“junk-bond king” Michael Milken, leveraged buyouts, frantic waves of buying and selling businesses, a runaway stock-market boom. Since Wall Street gets paid on a percentage of the deal, top bankers became fabulously rich. Company executives noticed and demanded the same pay. The looting of stockholders commenced in earnest.

There is a kind of intellectual Taliban in America-Friedrich Hayek and Milton Friedman are its Mohammed-like figures-who believe in the infallible wisdom of “the market.” Wall Street is their Mecca, the place where “the market” is incarnated in its purest, most friction-free, form. The true trader doesn’t deal in people, or companies, or products; he trades securities, each one a triumph of abstraction, in which every atom of information, every quaver of uncertainty, is captured in a constantly vibrating price that, for any fleeting moment, is Truth. The corollary is that anything can be converted into a tradable security-the finance professor’s version of “everyone has a price.”

The economic recovery of the 1980s secured the ascension of the free-market Ayatollahs. And-and it is important to be clear about this-a vast amount of stable cleaning was accomplished. Layers of fat-bottomed corporate bureaucrats were purged, factory goldbrickers were canned. Companies got a lot more efficient. Clogged channels of housing and consumer finance were taken over by Wall Street. Mortages and credit-card debt, it turned out, could be bundled up, sliced and diced, and turned into tradable securities, attracting a rush of new capital into those markets, and generating tens of billions in annual mortgage savings for American homeowners. The rapid adoption of the Internet and other breakthrough technologies would never have happened if the old corporate bureaucracies had still been in charge.

But those newly efficient channels of credit have allowed consumers to load up with enormous amounts of debt-how else to buy all those gadgets and pay the cell-phone bills? And in the meantime companies are piling up unprecedented amounts of cash. Instead of investing it, by and large, they return it to stockholders through dividends and stock buybacks, aided by conveniently timed tax breaks on capital gains and dividends.

With oceans of cash at their disposal, the superrich are now buying up whole companies through “private equity” funds at a scale and rate Michael Milken never dreamed of. A typical ploy is to buy a successful company, float a huge loan to finance a single massive dividend to the new owners, then pay off the loan by shutting down traditional pension plans, trimming health benefits, ratcheting up outsourcing, and converting employees to part-timers or contract workers. (The private-equity manager’s bible was written at Wal-Mart.)

The message of both Hacker and Bogle, from their different vantage points, is that it has all now gone much too far. If companies are just bundles of data, so are employees. If a division underperforms, the new breed of managers lop it off. If they are wrong, they can always buy another one. But real people aren’t interchangeable blips on an Excel spreadsheet, nor are companies purely economic entities. Companies used to be small societies defined by internal loyalties and mutual commitments as much as by what they produced. As Hacker shows, the reciprocal obligations of the employment relationship now hardly extend beyond a single pay period. More particularly, the disappearance of company-as-society has shredded the U.S. system for providing pension and health-care benefits, which have always been predicated on the stability of the employment relationship. Hacker’s book is an important one, crisp and well argued, and backed up by a good deal of legwork.

The response of free-market theologians to the problems that Hacker describes is to turn the whole mess over to Wall Street-common folk can provide their own pensions and health care through private investment accounts. The Bush administration, of course, didn’t invent the free-market religion. The signal contribution of the president and the congressional Republicans has been to sell the government to the superrich in exchange for financing a dream of eternal tenure in office. Bush’s plan to “save” Social Security was designed to channel a trillion dollars or even more into Wall Street-managed privatized Social Security accounts. If the administration hasn’t delivered, at least not yet, it hasn’t been for lack of trying.

Anyone who wonders why the privatization of social benefits is such a dreadful idea can turn to Bogle’s The Battle for the Soul of American Capitalism. The accretion of Wall Street’s power, coupled with its incessant focus on short-term returns, has led to the pervasive corruption of the financial services industry, the businesses it finances, and the legal and accounting professions that are supposed to keep them in line. One snippet, perhaps, says it all: If a retail investor put her money into the average equity mutual fund twenty years ago, more than 40 percent of her fund returns would have gone to the mutual-fund managers. Bogle shows that there is no conceivable explanation for that level of fees, except that the managers could get away with it. Rubbing it in, the average equity-fund managers also delivered substantially lower returns than the overall market. Their actual services, that is, were worth less than zero. Although Bogel writes clearly and powerfully, readers without a passing acquaintance with financial markets may find the book a bit technical.

And what of our young friend in the airport? She represents the eternal public-policy yin and yang between efficiency and fairness. For whatever reason she wants a cell phone, if she can pay for it, it will be provided. Cell-phone revenues will rise, more vendors will be drawn into the industry, and greater resources will be devoted to cell-phone socializing.

For most day-to-day transactions, there is no better allocation solution. But markets have their limitations. We spend hundreds of billions making and selling cancer drugs that add a few weeks to the life of the terminally ill, but spend very little on prenatal care for poor women. In sheer efficiency terms, more spending on prenatal care would make sense; but that is not a calculation the market understands, at least not in the way it understands the demand for cell-phone videos, Grand Theft Auto games, or jet skis. And if hard-pressed households cannot afford such delights, the market supplies extortionately priced credit so everyone can tap into consumerist pleasures. One might wish, perhaps, that free-market gurus were more honest about what’s going on, instead of merely chiding working people for their feckless savings habits.

A famous essay by the senior Arthur Schlesinger suggested that in American politics, there is a quasi-predictable back-and-forthing between efficiency and fairness that runs in roughly generational cycles. One sign that a cycle is ending is when gross excess becomes the norm. In a “fairness” cycle, the excesses emerge as the peculiar absurdities of untrammeled “planning”; in an efficiency cycle, it’s the kind of plunder and rapacity documented so eloquently by Bogle. At twenty-five years and counting, the current cycle is getting very long in the tooth.

But a cycle doesn’t end by consensus. Too many special interests barnacle the politico-economic landscape and draw their life’s breath from it. The creative phase of postwar American industrial socialism, for want of a better term, had pretty much run its course by the end of the 1960s, but it took another decade or so, and a major collapse, to expose its accumulated dysfunctions. The smart-money punditocracy seems convinced that the current dispensation is settling in for a very long run. Yet near-daily scandals on Wall Street, the vulgar excesses of the executive suite, the parade of the Enrons, the WorldComs, and the like, all suggest that an end-stage crisis may be careening onto the horizon. All that can be said for sure is that it won’t be pretty.

Published in the 2006-11-03 issue: 
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Charles R. Morris’s most recent book is The Rabble of Dead Money, a history of the Great Depression (PublicAffairs).

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