In 1950, arguably the peak of U.S. global power, manufacturing accounted for 29 percent of the U.S. gross domestic product and financial services for 11 percent. By 2005, manufacturing accounted for only 12 percent of the GDP and financial services for 20 percent — more than manufacturing, health, and wholesale/retail.6 Even more than making our living selling ourselves goods made in China, we have made our living trading pieces of paper — correction: trading numbers encoded in computer files.
Actions to achieve this shift included the removal of restrictions on debt-equity ratios, consumer interest rates, and lending practices, and the formation of huge financial conglomerates that merge banking, insurance, securities, and real estate interests in a densely interconnected web of insider deals. Financial reporting requirements were simultaneously relaxed. These actions cleared the way for the subprime mortgage feeding frenzy that gave us the credit meltdown described in chapter 2.
Hedge funds, the high rollers at the leading edge of the speculative frenzy, proliferated from a couple hundred in the early 1990s to some ten thousand in mid-2007, by which time they had more than $1.8 trillion in financial assets under management. “Like digital buccaneers, and hardly more restrained than their seventeenth-century predecessors,” wrote political commentator Kevin Phillips, “they arbitraged the nooks and crannies of global finance, capturing even more return on capital than casino operators made from one-armed bandits and favorable gaming-table odds.”7
BANKING ON SPECULATION
Leveraging — also known as borrowing — became the name of the Wall Street game. Banks, backed by the Federal Reserve, used their power to create money to feed the speculative frenzy by creating a complex pyramid of loans to each other. In 2006, by Phillips’s calculations, the U.S. financial sector debt, which consists largely of financial institutions lending money to other financial institutions to leverage financial speculation, totaled $14 trillion, which was 32 percent of all U.S. debt and 107 percent of the U.S. GDP.8 According to the Virginia-based Financial Markets Center, in the late 1960s,
U.S. banks began borrowing Eurodollars in huge volumes from their offshore branches.…In each decade since 1969, the ratio of financial sector debt to GDP has nearly doubled.…With financial institutions channeling half of new lending to other financial firms, credit markets increasingly are being used less to facilitate economic activity and more to leverage bets on changes in asset prices.9
The Wall Street alchemists used a combination of complex derivative instruments, creative accounting tricks, and their capacity to create money from nothing by issuing loans to create phantom financial assets that served as collateral to support additional borrowing to create more phantom assets to serve as collateral to support additional borrowing to.…Apparently, some major portion of this trading of loans between financial institutions even involved institutions borrowing from their own branches, essentially using creative accounting to create their own money to support their gambling habit. Talk about insider trading!
Gambling with borrowed money is highly risky for both lender and borrower. But the Wall Street players convinced themselves they had eliminated the risk. In their hubris, they seem to have truly believed that they had mastered the art of creating wealth from nothing.
At the time of its collapse, Lehman Brothers was leveraged 35 to 1, which means it financed its gambling in the global financial casino with thirty-five dollars in borrowed money for every dollar of equity. This can be highly profitable in a rising market. It is disastrous when the market is falling and the highly leveraged bets start going bad. Just as gains are leveraged during the rise, so too are the losses leveraged during the decline. When others start demanding payment, liabilities can quickly exceed a firm’s net equity, which throws the firm into insolvency, as Lehman Brothers and much of the rest of Wall Street learned.
They justified their innovations in part with the argument that such innovations reduced risk. In fact, they were simply passing the risk to the credulous. In the end, the managers who made the losing bets walked away with impressive fees collected during the good times and left to others the messy work of sorting things out when Wall Street’s sophisticated version of a Ponzi scheme collapsed. In 2007 alone, the fifty highest-paid private investment fund managers walked away with an average of $588 million each in annual compensation — 19,000 times as much as an average worker earns. The top five each took home more than $1.5 billion.10
In effect, the outsized Wall Street compensation packages represented a looting of the equity that should have been serving as reserves to cover potential losses from the risks inherent in their high-stakes bets. When the bets started going bad, the firms whose equity reserves had been looted went into default. With their bailouts, the Federal Reserve and the Treasury Department — essentially trying to make up for the looted funds — stepped in to cover the losses that should have been covered by the equity that the managers expropriated.
The year 2008 was a bad one for the hedge fund set, with compensation for the top players down some 50 percent from 2007. Thanks to the public bailout, however, fund managers set new compensation records in 2009. The average compensation for the top twenty-five fund managers was $1 billion each. The biggest winner, David Tepper, walked away with $4 billion for winning his bet that the government would step in and buy up distressed assets — in effect, he got a direct transfer from the taxpayers.11
Wall Street has a simple rule: Capture the gains, pass the risk to others. It appears to be perfectly legal; it should be cause for hard time — and at the least for an effort by government to recover the looted funds on the basis of a dereliction of fiduciary responsibility.
WINNING THE CLASS WAR
Wall Street has been engaged in class warfare pure and simple. It uses its control of the money supply and its political influence to ensure that Wall Street players capture virtually all the benefits of productivity gains in the Main Street economy as interest, dividends, and financial service fees. The creation of phantom wealth further dilutes Main Street claims on real wealth relative to the claims of Wall Street.
This effort to achieve an upward redistribution of wealth was so successful that, from 1980 to 2005, the highest-earning 1 percent of the U.S. population increased its share of taxable income from 9 percent to 19 percent. Most of that gain went to the top tenth of 1 percent and came from the bottom 90 percent.12 In 2007, the top 400 U.S. tax returns reported an average annual income of $345 million; $12.7 million was the average for the top 427 returns in 1955, adjusted to 2007 dollars.13
The measures used to achieve this remarkable outcome included managing monetary policy to maintain a target level of unemployment, managing trade and tax policies to facilitate the corporate outsourcing of jobs to low-wage economies, suppressing labor unions, limiting the enforcement of laws against hiring undocumented immigrant workers, and using accounting tricks that understate inflation to suppress inflation-indexed wage and Social Security increases.
As wages fell relative to inflation, and as public services were rolled back, the household savings rate fell apace. From the beginning of 1959 to the end of 1993, the U.S. household savings rate never fell below 5 percent of disposable household income and often exceeded 10 percent. Since 1999 it has never exceeded 3.5 percent.14
Desperate to find ways to make ends meet, households that experienced shrinking real incomes turned from saving to borrowing. Eager to capitalize on the opportunity thus created, Wall Street used aggressive marketing and deceptive lending practices to encourage people to run up credit card and mortgage debts far beyond their means to repay. As the borrowers inevitably fell behind in their payments, Wall Street hit the victims with special fees and usurious interest rates, creating a modern version of debt bondage. Far from trickling down, wealth rushed upward in a gusher.
As Wall Street exported its modernization plan to the world, the wealth gap widened almost everywhere. The export process began with the World Bank and International Monetary
Fund encouraging poor countries to fund their development with foreign borrowing. Local elites loved the access to cheap credit and the opportunity to skim off fees and bribes. Foreign contractors got lucrative contracts for large loan-funded projects. And big banks had new customers for loans. It was a win-win all around — except for the poor, who got only the bill.15
After the borrowing countries were loaded up with loans far beyond their ability to repay, the World Bank and IMF stepped in as debt collectors and told them:
Sorry, but since you can’t repay, we are here to restructure your economies so we can get back the money you owe us. Eliminate social spending. Cut taxes on the rich to attract foreign investment. Sell your natural resources to foreign corporations. Privatize your public assets and services. Gear your agriculture and manufacturing to production for export to subsidize consumption in rich countries. [Of course they didn’t use the term subsidize. They probably talked about comparative advantage.] And open your borders to foreign imports. [In theory, this was to help domestic manufacturers be more competitive in foreign markets by facilitating duty-free import of inputs.]
Almost every element of the “structural adjustment” worked to the favor of global corporations.
Eventually the Wall Street players realized they could use multilateral trade agreements to circumvent democracy and restructure everyone’s economy at the same time. It worked brilliantly.
In 2005, Forbes magazine counted 691 billionaires in the world. In 2008, only three years later, it counted 1,250 and estimated their combined wealth at $4.4 trillion. According to a United Nations University study, the richest 2 percent of world’s people now own 51 percent of all the world’s assets. The poorest 50 percent own only 1 percent.16 A 2008 International Labour Organization study reported that in approximately two-thirds of the countries studied, income inequality increased between 1990 and 2005. This was in part the result of an overall fall in labor’s share of total income relative to that of managers and investors.17
An extreme and growing concentration of privatized wealth and power divides the world between the profligate and the desperate, intensifies competition for Earth’s resources, undermines the legitimacy of our institutions, drives an unraveling of the social fabric of mutual trust and caring, and fuels the forces of terrorism, crime, and environmental destruction.
Did the institutions of global finance intend these social and environmental outcomes? Presumably not. They were simply rewriting the rules of commerce to increase their own gains. The titans of Wall Street are much too focused on competing to be the top billionaire to notice the devastated environment or the penniless people at the bottom who have nothing left to be expropriated.
The business press has reported that some hedge fund managers are taking up philanthropy to aid the poor. If any of them have noticed a connection between the power games they play on Wall Street and the condition of the desperately poor they presume to help, I’ve not seen any mention of it.
The driving dynamic of unregulated markets is to destroy the market discipline that makes the market an innovative and efficient instrument of resource allocation and to take control of government to implement an agenda of elite privilege. Environmental balance, a just distribution of wealth, and achievement of the democratic ideal of one-person, one-voice will come only through political action by a strong political movement.
Wall Street presents itself to the public as a financial services sector concerned with and committed to the well-being of people, family, and community. The public-relations image has little foundation in reality. Its real intentions are revealed in what it does, not what it says. Its actions reveal a cultural-institutional complex devoid of morality, which cares for nothing but acquiring money and power by any means.
CHAPTER 6
BUCCANEERS AND PRIVATEERS
Advocates of capitalism are very apt to appeal to the sacred principles of liberty, which are embodied in one maxim: The fortunate must not be restrained in the exercise of tyranny over the unfortunate.
BERTRAND RUSSELL
The presidency of Ronald Reagan is commonly referred to as the Reagan “revolution,” which sought a restoration of traditional conservative values and free markets. The aggressive deregulation efforts begun under Reagan and carried forward by the Bush and Clinton administrations did indeed restore some traditional conservative values, but perhaps not the ones most U.S. conservatives intended.
Note that the term conservative originally referred to the monarchists who fought efforts to establish the democratic accountability of kings. As Wall Street was deregulated, the economy regressed to a state reminiscent of an earlier day when the seas were ruled by buccaneers and privateers.
Buccaneer is a colorful name for the pirates of old. The ultimate libertarians, they pursued personal fortune with rules of their own making. They were in their time an iconic expression of “free market” capitalism in its purest form.
Privateers, the forerunners of publicly traded corporations, were pirates to whom a king granted legal immunity in return for a share of the booty.
Wall Street hedge fund managers, day traders, currency traders, and other unlicensed phantom-wealth speculators are the independent, unlicensed buccaneers of our day. Wall Street banks are the commissioned privateers who ply a similar trade with state backing. The economy is their ocean. Publicly traded corporations serve as their favored vessels of plunder, leverage is their favored weapon, and the state is their servant-guardian.
Here in brief is the fascinating story of the adventurous forebears of today’s Wall Street swashbucklers.1
LAUNCHING THE COLONIAL ERA
From the decline of the Roman Empire until 1500, Europe was burdened by the turmoil of endless and pointless wars in which rival noble factions fought one another to exhaustion in a competition to expand their personal power. Imperial rulers enlarged their domains primarily by pushing their borders outward through the military conquest of contiguous territories. The vanquished people and their lands were brought under the central military and administrative control of the city in which the ruling king or emperor resided.
Continuing violence and chaos led to a yearning for monarchs with the power to restore order within stable borders, giving rise to what historians call the modern era. Once the continent was divided into relatively stable domains, Europe’s kings satisfied their ambitions for imperial expansion by projecting their power over long sea routes to establish dominion over distant lands, peoples, and resources.
National military forces and colonial administrations remained important to this new model of empire, but for the most part the European kings of the modern era projected their power and augmented their treasuries by granting commissions to favored adventurers, brigands, and corporations who worked for their own account.
Thus began the historic transition from rule by imperial monarchs to rule by imperial corporations, and from the rule of the sword to the rule of money.
ADVENTURERS ON THE HIGH SEAS
Most of us know the period of Europe’s drive for colonial expansion primarily by the names of the great adventurers commissioned and financed by their sovereigns to carry out expeditions of discovery, plunder, and slaughter.
In search of a westward sea route to the riches of Asia, Christopher Columbus landed on the island of Hispaniola (present-day Haiti and the Dominican Republic) in the West Indies in 1492 and claimed it for Spain. Hernando de Soto made his initial mark trading slaves in Central America and later allied with Francisco Pizarro to take control of the Inca empire based in Peru in 1532, the same year the Portuguese established their first settlement in Brazil. Soto returned to Spain one of the wealthiest men of his time, although his share in the plunder was only half that of Pizarro.2 By 1521, Hernán Cortés had claimed the Mexican empire of Montezuma for Spain.
The vast amounts of gold that Spain ultimately extracted from South and Central America ruined the Spanish economy and fueled inflation throughout Europe.
With so much gold available to purchase goods produced by others, Spain became dependent on imports and its productive capacity atrophied. The result was an economic decline from which Spain never recovered.
The pattern is disturbingly similar to that of the current import-dependent U.S. economy — the primary difference being that U.S. imports are financed not by stolen gold but by foreign debt.
Although licensed by the Crown, the celebrated adventurers of old operated with the independence and lack of scruples of crime lords, competing or cooperating with one another for personal gain and glory as circumstances dictated. Their mission was to extract the physical wealth of foreign lands and peoples by whatever means — including the execution of rulers and the slaughter and enslavement of Native inhabitants — and to share a portion of the spoils with their sovereigns.
The profits from Spain’s conquests in the Americas inspired the imperial exertions of the English, Dutch, and French, who soon divided Africa, Asia, and North America into colonies from which to extract plunder and profits from the monopoly control of trade for the benefit of the mother state.
PRIVATEERS
The competition for foreign spoils among the European powers led to the embrace of the ancient practice of privateering — essentially, legalized piracy — as a major instrument of state policy and a favored investment of both sovereigns and wealthy merchants. Why endure the arduous exertions of expropriating the wealth of foreign lands through conquest and trade when it was much easier to attack and plunder the ships carrying the spoils expropriated by others on their way back to European ports?
Agenda for a New Economy Page 8