High Finance Run Amok
The lurid 2002 portrait of the U.S. economy as a bunch of Enrons and Tycos, overpaid CEOs running corporations like casinos, electronic speculators, predatory hedge funds, fraudulent stock values, deceptive investment firms and collusive accountants didn’t develop overnight. Unfortunately, while some of the excesses may shrink, they are not likely to fade away.
That’s because much of the “financialization” that occurred in the 1980s and 1990s has been built into the system, save for the possible purgative of a market crash. The most visible evidence of this--the mushrooming of CEO compensation and the private sector’s “imperial corporate presidency"--ironically parallels the dangerous growth and hubris of the governmental “imperial presidency” in the 1960s and early 1970s. Unhappily, reform of business and finance may be harder to achieve this decade than were the public-sector reforms following Watergate. Washington’s business and financial lobbies are mobilizing.
Over the past 20 years, the U.S. economy has been reoriented from making, growing, building and transporting things to moving, massaging and manipulating money and securities. So great has this transformation been that by the mid-1990s, the finance, insurance and real estate (FIRE) sector had raced ahead of manufacturing in gross-domestic-product and national-income numbers. By 2001, the FIRE sector had pulled ahead of manufacturing in profits; in the 1960s, manufacturing led by 4 to 1.
This staggering displacement isn’t a blip, even though some yardsticks, like CEO compensation and financial profits, may have peaked for now. Examples of previous world economic powers suggest that once a nation’s financialization escalates to this extent, it becomes systemic and isn’t easily reversed.
During the 1920s, under the spell of a soaring stock market, the United States underwent some kindred changes. Market volume ballooned; mutual funds sprang into being; consumer loans caught on and debt surged. Americans were mesmerized by ticker tapes. However, during the three years after the bubble burst in 1929, stocks fell so low, so many banks failed and so much business and financial dirty laundry came into view that Americans soured on corporations, banks and stocks. President Franklin D. Roosevelt pushed through hundreds of reform laws and regulations, and the harsh economics of the Great Depression put finance through a wringer.
The shenanigans played by Enron, Arthur Andersen and a number of major banks and investment firms, with corporate names being added each week, resemble the financial and corporate dirty laundry exposed from 1930 to 1933. Toward the end of manic booms, frauds and swindles run rampant, inevitably employing techniques that evade the strictures of outdated legislation and regulation. In theory, new legislation and regulation could restore order in 2002-2004. The rebuttal, though, is that the financialization of the United States is deep and pervasive enough to make the speculative beginners’ games of the 1920s look like a real-economy study group.
Consider two barometers. Between 1919 and 1929, the volume of stocks traded increased eightfold, and the amount of money in mutual funds climbed from a few million to $8.5 billion. Between 1980 and 2000, by contrast, the volume of stocks traded on the major exchanges increased by roughly 50 times, and mutual-fund assets soared from $135 billion to $7.8 trillion. Many Americans closed savings and checking accounts and put their cash or assets into money market or stock funds.
So bolstered, the Dow Jones industrial average jumped from 775 in summer 1982 to 11,700 in early 2000. The Nasdaq skyrocketed from around 120 in 1982 to just above 5,000 in early 2000. At the same time, the rapid computerization of the financial sector made possible a whole new spectrum of speculative instruments and vehicles for the securitization of loans and income streams. This accounts for part of the financial sector’s growth.
Government favoritism accounts for another chunk. Beginning in the early 1980s, the Federal Reserve Board, the U.S. Treasury and allies like the International Monetary Fund embarked on a two-decade march of bailing out failing or shaky portions of the U.S. and international financial sectors. Among those rescued: Latin American bond issuers; the stock market after the 1987 crash; S&L; creditors and depositors; the Mexican peso and its U.S. bondholders; Asian currencies; the hedge fund Long-Term Capital Management; and banks menaced by the Y2K scare.
As the financial sector, in short, became too important to fail, the Fed and the Treasury abandoned market economics to embrace socialization of credit risk. No other sector of the U.S. economy, save possibly defense, received such governmental assistance. In the early 1980s, some in Washington had urged a government industrial policy to rescue manufacturing. What we got instead--there was no official announcement--was a “financial policy.”
All this had a frenetic effect on corporate executives determined to share in the feast. In the 1980s and 1990s, top executives gave many U.S. corporations a financial tuneup. Some, like American Can and General Electric, became financial companies in whole or in part. Others recalibrated corporate success in financial terms--quarterly profits, stock options, creative accounting, currency arbitrage and derivatives trading, employee and benefits reduction--to raise the company’s stock price and give senior management a seat at capitalism’s high table.
This corporate reorientation fed the stock market’s rise, which, in turn, fed the buccaneering chief executives. Business Week magazine, which annually charts top-executive compensation in the U.S., found that between 1981-2000 the average package of the 10 highest-compensated U.S. executives had rocketed from $3.45 million to $155 million.
The last time such self-aggrandizing management practices occurred was during what historian Arthur Schlesinger Jr. called the imperial presidencies of John F. Kennedy, Lyndon B. Johnson and Richard M. Nixon. These administrations were associated with proliferating White House staffs, special operating funds, espionage apparatchiks, military retinues, aircraft and helicopters and an escalating sense of global omnipotence and hubris.
What we have seen over the last two decades is the swelling arrogance, hubris and excess of the private sector, led by Wall Street’s “masters of the universe” and the executive-suite monarchs of the imperial corporate presidency. But reform won’t be easy, given that the overall finance (FIRE) sector is Washington’s biggest spending lobby and No. 1 writer of checks to politicians.
It’s possible that the Nasdaq crash, topped by Enron, Tyco and the rest of the frauds and swindles, may become the private-sector equivalent of Watergate, especially if more market declines are ahead. Public demand for regulatory and legislative reform, although considerable, still falls short of the crisis level needed to overcome the Washington lobbies and big political donors.
Nevertheless, a deeper market crisis could come if growing public suspicion of financial and regulatory integrity makes it impossible to sustain today’s very high price-earnings ratios. Despite the collapse of the Nasdaq, price-earning ratios, overall, remain at boom-period highs. Should they merely decline to bear-market norms, the various stock indexes could lose another 25% to 40%. John and Jane Q. Public in the suburbs are already nervous at the prospect of their 401(k) retirement plans becoming 201(k)s.
None of this is a given, and it’s hard to know what odds to assign. Even so, the history of the leading world economic powers before the United States does underscore the danger. In their later stages, both Holland and Britain were rapidly financializing and losing commitment to their old “real-economy” livelihoods. For several decades, the financialization appeared to succeed, although the polarization between the rich and everyone else rapidly widened in the two countries. However, at a certain point, usually involving wartime stress, each nation’s debt structure and global network of finance, communications and commercial services become vulnerable. Starting a war with Iraq--on top of anti-terrorist mobilization--could become a U.S. equivalent.
But if these latter aspects are conjecture, the rapid onset of the financialization of the U.S. economy in 1980s and 1990s is not. The Sept. 11 terrorist struck at finance--the World Trade Center--not at industry or agriculture. There is more new about the United States of the 21st century than many Americans realize.