One such game has been to hand out stock “performance awards” on the basis of nothing more than an upward drift in the value of the stock market as a whole, over which CEOs presumably played no role other than watch as their company’s stock price rose along with that of almost every other company. The Economic Policy Institute estimated that between 2007 and 2010, a total of $121.5 billion in executive compensation was deducted from corporate earnings. Roughly 55 percent of this total was for such effortless “performance-based” compensation.
As if all this weren’t enough, the tax system is biased toward the owners of wealth and against people whose income comes from wages. Capital gains are taxed at a lower rate than ordinary income. Among the biggest winners are CEOs whose options and bonuses are tied to the stock market, which can therefore be treated as capital gains when cashed in. The bull market of 2010 to 2014 gave them all fabulous after-tax windfalls.
If shareholders have a property right in a publicly held corporation—if they in fact own it (an issue to which I will return)—presumably shareholders are the ones who should decide on CEO pay. In addition, CEOs presumably would have to disclose to shareholders how much shareholder money they spend on political activities. If the notion of “pay for performance” has any practical meaning as a contract between a CEO and shareholders, presumably a CEO should also be responsible for the company’s long-term performance and required to return to the company any pay reflecting mere temporary increases in share prices. If bankruptcy were on a level playing field, CEOs would not be permitted to sock away generous executive pay out of the reach of a bankruptcy judge. If enforcement of these building blocks were not tilted toward CEOs, presumably the Securities and Exchange Commission would bar CEOs from pumping up share prices through buybacks and then cashing in their options, as the SEC once did. Moreover, CEO pay in excess of $1 million would not be deductible, even if linked to performance. If all the building blocks were not tilted toward large corporations, these companies would not be earning the substantial profits that have allowed their top executives to earn princely sums to begin with.
But none of this is in the cards because CEOs of big corporations have sufficient political power to stop any such initiatives. The campaign contributions of CEOs constitute a substantial share of all contributions. Many are also major bundlers of contributions coming from other top executives in their firms. Taken together, their campaign contributions, bundled contributions, influence over their corporate political action committees, lobbyists, and implicit promises of future employment to certain government officials give them substantial say over the rules of the game.
So are CEOs worth their pay in any sense other than the senseless tautology equating the compensation packages they receive with their worth? Any objective assessment would conclude they are not.
12
The Subterfuge of Wall Street Pay
If you still believe those at the top are paid what they’re worth, take a closer look at Wall Street, whose inhabitants typically earn even more than top corporate executives. Are Wall Street bankers “worth” it? Not if you figure in the hidden subsidy flowing to the big Wall Street banks that since the bailout of 2008 have been considered too big to fail. Recall that their near meltdown was brought on by excessive risk taking. During the ensuing financial crisis, the biggest banks then received significantly more help from the government than other banks, in order to keep them from going under. In important ways, that subsidy continues to this day, because the biggest banks are still too big to fail.
Here’s how the hidden subsidy works. People who park their savings in these banks accept a lower interest rate on deposits or loans than they require from America’s smaller banks. That’s because smaller banks are riskier places to park money than the big banks, which will almost certainly be bailed out if they get into trouble. This gives Wall Street’s biggest banks a competitive advantage over the nation’s smaller banks. In consequence, the biggest banks make even more money. And as their profits grow, the big banks grow even larger. If they were too big to fail before, they’re absolutely too big to fail now. As I’ve noted, by 2014, Wall Street’s five largest banks held about 45 percent of America’s banking assets, up from 25 percent in 2000. They are far too big to fail or jail or curtail.
How large is the hidden subsidy? Two researchers, Kenichi Ueda of the International Monetary Fund and Beatrice Weder di Mauro of the University of Mainz, have calculated it to be about eight-tenths of a percentage point. This may not sound like much, but multiply it by the total amount of money parked in the ten biggest Wall Street banks and you get a very large sum. In 2013, this hidden subsidy came to $83 billion. This estimate, by the way, is consistent with estimates of other researchers from the International Monetary Fund and the Government Accountability Office. Economists from New York University, Virginia Tech, and Syracuse University, comparing the interest rates offered by small banks on money-market accounts over the FDIC guarantee with rates offered by the large banks, found the big banks had an advantage of more than a percentage point, which would make the actual subsidy far higher.
You do not have to be a rocket scientist or even a Wall Street banker to calculate that the hidden subsidy the Wall Street banks enjoy because they are too big to fail totaled about three times Wall Street’s 2013 bonus payments of $26.7 billion. Without the subsidy there would have been no bonus pool at all. The lion’s share of that subsidy, $64 billion, went to the top five banks—JPMorgan, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs. Sixty-four billion dollars just about equals these banks’ typical annual profits. In other words, take away the subsidy and not only does the bonus pool disappear, so do all the profits.
The reason Wall Street bankers got $26.7 billion in bonuses in 2013 was not because they worked so much harder or were so much more clever or insightful than most other Americans. They received those bonuses because they happen to work in institutions that hold a privileged place in the American political economy. The subsidy going to the big banks comes from you and me and other taxpayers because we paid for the last bailout, and it is assumed we will pay for the next one.
Under the Dodd-Frank financial reform act, each of the biggest Wall Street banks was required to create a “living will,” to go into effect if it was ever again unable to pay its bills. Essentially, these living wills were supposed to be blueprints for unwinding the banks’ operations without harming the rest of the financial system. But don’t bank on it. After reviewing these wills, investigators from the Federal Reserve Board and the Federal Deposit Insurance Corporation concluded in August 2014 that they were “unrealistic.” Thomas Hoenig, vice chairman of the FDIC, called each of the plans “deficient” because each “fails to convincingly demonstrate how, in failure, any one of these firms could overcome obstacles to entering bankruptcy without precipitating a financial crisis.” If you have followed my argument, you will understand why the biggest banks would rather that their living wills remain unrealistic. Realistic plans for avoiding another bailout would cause the hidden subsidies—and the competitive advantage they produce, along with the bonuses that embody that competitive advantage—to vanish.
The Federal Reserve has made moves toward increasing the capital requirements of big banks, which may trim their sails slightly. But it seems doubtful Congress or administrators will force them to come up with realistic living wills, or limit their size, or break them up, or impose a special tax on them equal to the amount of the hidden subsidy. As I have pointed out, the reason these institutions continue to hold such a privileged place in the American political economy is that Wall Street accounts for such a large proportion of campaign donations to major candidates for Congress and the presidency of both parties and maintains a lucrative revolving door connecting it to Washington. The executives of small banks, let alone most Americans, do not have these unique capacities. They cannot afford to make major contributions or offer lucrative jobs to former public officials. This helps e
xplain why most small bankers don’t earn large bonuses, and neither do most other Americans.
Not incidentally, the $26.7 billion distributed to Wall Street bankers in 2013 bonuses would have been enough to more than double the pay of every one of America’s 1,007,000 full-time minimum-wage workers that year. The remainder of the $83 billion hidden subsidy going to the biggest banks on the Street was $20 billion more than what the government provided that year to twenty-eight million low-wage workers and their families in the form of wage subsidies under the Earned Income Tax Credit.
This hidden subsidy does not completely account for the sums commanded by others on the Street, such as Steven A. Cohen’s $2.3 billion in 2013. That year the top twenty-five hedge-fund managers took home, on average, almost $1 billion each. Even run-of-the-mill portfolio managers at large hedge funds averaged $2.2 million each. Some economists have suggested the reason they command these sums (typically in the form of a 2 percent annual fee plus 20 percent of returns over a given benchmark) is that investors want to reduce the temptation of hedge-fund and portfolio managers to pocket some of the vast amounts of money they manage. The theory is that the managers will not rake off any for themselves illegally for fear of losing the generous incomes they receive legally. As economist Eric Falkenstein explains, “The portfolio managers know the best price, outsiders don’t, that’s why they get paid a lot. In the context of a moving market, and illiquid securities (such as mortgages), you don’t really know how much money you are leaving on the table, but look at the incentives at the individual level, and expect people to act in their self interest.”
By this logic, which might apply equally well to many of the Street’s investment bankers and traders, the earnings of hedge-fund managers are best understood as bribes paid by investors so that the managers don’t rob them blind. The more money hedge-fund managers oversee, the higher the bribes need to be.
The problem with this logic is that the bribes still provide no guarantee that hedge-fund and portfolio managers will not skim off some investor money in side deals and kickbacks. In fact, that is exactly what the portfolio managers at Cohen’s SAC Capital were caught doing. It is a fair supposition that other managers and traders on Wall Street do the same but are not caught. As I have noted, Congress banned insider trading in 1934 but gave wide latitude to the members of the Securities and Exchange Commission, federal prosecutors, and judges to determine its precise meaning. Cohen’s moneymaking methods had been well known on the Street for many years. SAC Capital managed so much money that it typically accounted for as much as 3 percent of the average daily trading on the New York Stock Exchange and 1 percent of NASDAQ’s. It thereby handed over more than $150 million annually in commissions to bankers on the Street, who possessed a great deal of information of potential value to Cohen and his associates at SAC Capital. This generated possibilities for lucrative deals. In fact, according to a Bloomberg Businessweek story from 2003, a decade before the prosecutions, the commissions that SAC routinely gave the bankers “grease the superpowerful information machine that Cohen has built” and “[win] Cohen the clout that often makes him privy to trading and analyst information ahead of rivals.” One analyst is quoted as saying, “I call Stevie personally when I have any insight or news tidbit on a company. I know he’ll put the info to use and actually trade off it.” The firm’s credo, according to one of its former traders, was always to “try to get the information before anyone else.”
But even though nine of Cohen’s portfolio managers were convicted of insider trading, Cohen himself got off rather lightly. His firm was fined $1.8 billion, but the rest of his accumulated gains were left untouched in the settlement with federal prosecutors. Nor was he sent to jail. Perhaps Cohen was spared because the battalion of high-priced lawyers he hired to represent him showed federal prosecutors how long and difficult any legal confrontation would be. (In this sense, his lawyers were worth what they were paid.) But Cohen’s treatment may also have had something to do with the fact that during the years he earned much of his fortune, between 2000 and 2008, Republican appointees headed the Justice Department and the Securities and Exchange Commission, and that Cohen had been one of the Republican Party’s major contributors, and that in the 2008 election, SAC and Cohen became big supporters of Obama.
If confidential information is indeed “the coin of the realm” on the Street, as the lawyer for Anthony Chiasson (an alumnus of Cohen’s SAC Capital) claimed in 2014 when Chiasson was charged with insider trading—a view with which the court of appeals seemed to agree when it reversed his conviction—SAC Capital is not that unusual. Given the huge flows of money under the hedge-fund industry’s supervision, the ready availability of confidential information, and the large amounts that can be earned on trades that utilize such information, it would not be unreasonable to conclude that much if not all of the business is premised on confidential information. Hedge-fund managers are well positioned to receive such coins of the realm and to cash them in royally. In consequence, their vast compensation packages likely reflect two different sources of largesse: legal bribes from investors who don’t want to be ripped off, and illegal (or at best legally questionable) kickbacks from investors with whom they trade confidential information. It is a win-win, at least for them. If they devote even a small portion of these winnings to political candidates, lobbyists, and platoons of lawyers, they can minimize the risk and the costs of getting caught and prosecuted for insider trading. Consider Steven A. Cohen, for example.
They can also continue to get a tax loophole available to them but to few others, allowing hedge-fund and private-equity managers to treat their incomes as capital gains, subject to a lower tax rate than ordinary income. No logical argument can be summoned for this loophole. Such managers do not even risk their own capital; they invest other people’s money. When, in 2007, Michigan congressman Sander M. Levin proposed treating such carried interest, as it is called, as ordinary income, annual political spending by the hedge-fund industry increased dramatically. Not surprisingly, such legislation has gone nowhere since then.
Are those on Wall Street “worth” the vast amounts of money they receive? Apart from the platitude that everyone is, by definition, worth what he or she earns in the market, the specific mechanism by which they earn their incomes—including the hidden too-big-to-fail subsidy as well as the utilization of insider information—suggests that much of what they receive is involuntarily transferred to them from taxpayers and small investors. They have enough wealth to influence the rules of the game, but they are not “worth” their pay in any meaningful sense of the term.
13
The Declining Bargaining Power of the Middle
When I was a boy, my father sold dresses and blouses to the wives of factory workers, as I said earlier. As the wages of those workers rose in the late 1940s and through the 1950s, my father earned enough to expand his business to a second shop in another town not far away. We were by no means rich, but he earned enough to make us solidly middle class.
For three decades after World War II, the average hourly compensation of American workers rose in lockstep with productivity gains. It was a virtuous cycle, from which our family and tens of millions of others benefitted: As the economy grew, the middle class expanded, and as its purchasing power rose, the economy grew faster, spawning new investments and innovations that further enriched and enlarged the middle class.
But then, beginning in the late 1970s, the virtuous cycle came to a halt. While productivity gains continued much as before and the economy continued to grow, wages began to flatten (see figure 4). Starting in the early 1980s, the median household’s income stopped growing altogether, when adjusted for inflation. In 2013, the typical middle-class household earned $51,939, nearly $4,500 below what it earned before the start of the Great Recession in 2007. By 2013, the median household was earning less than it did in 1989, nearly a quarter of a century before. Job security also declined, as did the percentage of working-age Americans
with jobs. In short, much of the American middle class has become poorer. (My father, not incidentally, had to close his shops.)
In 2013, an American household smack in the middle of the earnings scale received less than the equivalent household did fifteen years before, in 1998, when pay is adjusted for inflation. Median household earnings were 8 percent below what they were in 2007. It was much the same story for individual workers paid an hourly wage. Their average pay was $20.67 in September 2014. After adjusting for inflation, this was almost the same purchasing power such workers had in 1979 and even less than they had in January 1973 (which would have been $22.41 in 2014 dollars).
FIGURE 4. THE ROOT OF AMERICAN INEQUALITY: WAGES DETACHING FROM PRODUCTIVITY
Net productivity and real hourly compensation of production/nonsupervisory workers, 1948–2012
Note: Data are for compensation of production/nonsupervisory workers in the private sector (in 2012 dollars); net productivity is for the total economy and is equal to the growth of output of goods and services minus depreciation per hour worked.
Source: Economic Policy Institute analysis of unpublished total economy productivity data from Bureau of Labor Statistics (BLS) Labor Productivity and Costs program, BLS Current Employment Statistics, and Bureau of Economic Analysis National Income and Product Accounts
This chart originally appeared at go.epi.org/2013-productivity-wages.
The standard explanation attributes this U-turn to “market forces,” especially globalization and technological improvements that have rendered many working Americans less competitive. Their jobs could be outsourced to workers in Mexico and then Asia who were eager to do them far more cheaply, or done at home more cheaply by automated equipment, computerized machine tools, and robots. Either way, it is commonly argued, American workers who had once earned good paychecks had priced themselves out of the labor market. If they want jobs, they have to settle for lower wages and less security. If they want better jobs, they need better skills. So hath the market decreed.
Saving Capitalism Page 12