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The Daily Reckoning | Wednesday, December 11, 2011
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The Real Crisis in Capitalism
Reckoning today from Johannesburg, South Africa...
Bill Bonner
The Financial Times led off its series on ‘Capitalism in Crisis’ with a wandering piece that attempted to outline the problem. Unfortunately, theFT writers don’t seem to understand what capitalism is, let alone what is wrong with it. They say they are “rethinking capitalism.” But it doesn’t appear that they ever thought about it the first time.
“At the heart of the problem is widening income inequality,” they write.
Anatomically, income equality is right on the surface...not at the heart. It is more like warts or boils...on the skin of the system for all to see. Right out in the open. The question is what causes these blemishes... More in just a minute...
First, let’s look briefly at what is going on in the markets. A quick preview — nothing much. The Dow rose 69 points yesterday. Gold shot up $23.
Meanwhile, The Wall Street Journal tells us that consumers have begun to borrow again:Consumer borrowing leapt as holiday spending kicked in late last year, according to a new Federal Reserve report that hinted the era of household debt reduction that has held the economy back for years might be entering a new, milder phase.
Whoa... Does this mean the Great Correction is over? Have households decided to go back to their old free-borrowing, free-spending ways? Is it 2005 all over again? Let’s hold that question...
The Fed said Monday that household borrowing on credit cards, car loans, student loans and other kinds of installment debt rose at a 9.9% seasonally adjusted annual rate in November, the fastest monthly increase since November 2001. That was when the economy was bouncing back from the Sept. 11 terror attacks and Detroit car companies were rolling out zero-percent...
What are consumers doing? Are they taking their cue from the US government? USA Today reports that federal debt is now as big as the entire economy. That is, we have a government debt-to-GDP ratio of 100%. And only if you don’t count the rest of government’s debt — such as the debt of Fannie and Freddie, and unfunded pension debt, as well as state and local obligations. Add them to the calculation and the ratio jumps to high heaven.
Fortunately for the feds, they have no trouble borrowing money. Bloomberg reports that there are plenty of people willing to give the Treasury more rope:The Treasury attracted record demand at today’s $32 billion auction of three-year notes as concern that a resolution to Europe’s sovereign-debt crisis is far off drove investors to the safety of the securities.
How do you like that, dear reader? Lend money to the world’s biggest debtor...who has no plausible plan for ever paying off these debts...and get a paltry third of a percent on a three-year note. Pretty soon, you’ll have to pay to lend the feds money.
The auction’s bid-to-cover ratio, which gauges demand by comparing total bids with the amount of notes offered, was 3.73, the highest since at least 1993, when the government began releasing the data. Yields on US debt securities were little changed. German Chancellor Angela Merkel was meeting International Monetary Fund Managing Director Christine Lagarde as pressure grows to complete a Greek debt resolution.
“There is still strong risk aversion in the market,” said Adrian Miller, fixed-income strategist at Miller Tabak Roberts Securities LLC in New York. “There is still enough headline risk out there that it should keep the Treasury market relatively in check and in this very narrow range.”
The yield on the current three-year note was little changed at 0.36 percent at 5 p.m. in New York, according to Bloomberg Bond Trader Prices.
Is that strange, or what?
And now let’s return to the “Crisis in Capitalism”...
In 1965, US chief executives received 24 times the wages of the average worker. Over the next 25 years, the ratio went to 70 times. Then, it exploded to the upside, rising to 299 times in 2000 and 325 times today. People look at these figures with the same look of appalling disgust as they once looked at syphilitics. It is ugly, the outward sign of an inner sin, they believe.
But it is hardly the heart of capitalism. Nor the liver. Nor the kidneys. Nor any other vital organ. Executive pay is not a benefit to capitalism. It’s not what makes the system works. It’s a cost. A drag. An impediment. It’s only a benefit to a very special segment of the working class, the managers. They are the cadres...the insiders...the controllers. More like plantation overseers and prison wardens than capitalists, their interests are very different from either the working stiffs or the shareholders. They squeeze the former and cheat the latter. They cut costs...deliver profits...and pay a large percentage of them to themselves.
According to John Kay, also writing in the FT, a breach opening between capitalists and managers was observed as early as the 1930s. The capitalists still owned the capital. But the managers controlled it.
“Modern titans derive their authority and influence from their position in a hierarchy, not their ownership of capital,” Kay explains. “They have obtained these positions through their skills in organizational politics, in the traditional ways bishops and generals acquire positions in an ecclesiastical or military hierarchy.”
They are bureaucrats, in other words...glad handlers...schmoozers...not entrepreneurs or capitalists. And over time, like major domos, regents, and regisseurs, they use their control of the institution for their own benefit.
How do they get away with it? It is a part of the process we call ‘zombification.’ Institutions all tend to shift, over time, from fulfilling some outward-centered purpose — such as making bread or making war — to looking out for themselves. Whether it is a government or a corporation, hustlers, anglers, and idlers figure out how to take advantage of them. These ‘insiders,’ pervert the organization and divert its power and money to themselves.
The club secretary, the company president, the charity director, the dictator and the senator...all look for ways to build their own power and wealth. National economies are undermined. Whole industries are corrupted.
We thought the idea was somewhat original. We thought we had come up with something new. But once again, Mansur Olson, a professor of institutional economics at the University of Maryland, was way ahead of us. He described the process as it applies to government in his 1982 book, The Decline of Nations. His view of it was a little narrower and more responsible than ours. He described how lobbyists and special interest groups corrupted the government and the economy. Businesses — protected, subsidized, heavily regulated — became inefficient. Real output per unit of investment went down. The nation declined.
We’ve already seen how in the US, the health care, education and defense industries have been thoroughly zombified. Huge amounts of money have been “invested” in these industries over the last four decades. Despite all the money, people are statistically no healthier...and no better educated. As for defense, military lobbyists insist that we are safer. But never have so many foreigners had a grudge against America.
Reminiscing from Laguna Beach, California...
Eric Fry
In light of Bill’s remarks above about the Crisis in Capitalism, in which he characterized American CEOs as “glad- handlers...schmoozers...not entrepreneurs or capitalists,” your editors have decided to break with protocol and re-publish a column from the passed entitled, “Pinstriped Psychopaths.”
Your California editor believes Bill is exactly correct about the sorts of folks who are running many of America’s publicly traded corporations. They are, indeed, glad-handers and schmoozers...At least the best ones are. Some of the worst ones are far, far worse — perhaps even psychopathic, as we pointed out in the July 8, 2005, edition of The Daily Reckoning.
Four years later, in the midst of the ashes of the 2008 credit crisis, we revisited that theme, while also highlighting the corruption that typified the corporate bailouts of late 2008 and 2009.
When these columns first appeared, they fell on deaf ears. In mid- 2005, the US was in the midst of an economic boom/real estate bubble that seemed immortal. The American CEO was a folk hero — certainly not a psychopath.
Even in early 2009, when the second of today’s “Classiques” appeared, most investors still believed that CEOs would do the right thing, especially in cooperation with upstanding public servants like Treasury Secretary Paulson.
But today, a different viewpoint is ascendant — a viewpoint that regards “public servants” with suspicion and CEOs with contempt.
So perhaps both of today’s “Classiques” are more timely and relevant now than when they first appeared. Let the reader decide... Is Obama waging a “secret war?”
Have you heard yet about Obama’s new “secret war?”
Watch this shocking new presentation for details.The Daily Reckoning Presents Greed and Deception on Wall Street
By Eric Fry — [A Rude Awakening Classique, originally published on February 6, 2009] For the last several months, the sordid tales of greed and deception issuing from Wall Street have read like the story line from a riveting suspense thriller. But the most recent tales are so unbelievably gruesome that they resemble the story line from a documentary about Jeffrey Dahmer or John Wayne Gacy...or some other serial killer.
Each subsequent act is more grisly and disturbing than the one before it. Your editors are now afraid to open their Wall Street Journals at night, even with the doors locked and all the lights on.
The horrifying truth, dear investor, is that very few prison cells in America contain more psychopathy — pound for pound — than Wall Street’s corner offices and board rooms.
Late last week, for example, we learned that AIG, Citigroup and several other struggling financial institutions duped the US government out of billions of dollars, even as the government was in the process of tossing out lifelines to them. Yes, this story is revolting, but true.
The US Treasury overpaid by about $78 billion for toxic assets from American banks, according to a report from the Congressional Oversight Panel. “The report showed,” aReuters news story reveals, “that the Treasury got the worst [of its many bad deals] on second- round investments in American International Group for $40 billion and Citigroup for $20 billion under special aid programs tailored for the two institutions.
“For each $100 spent on these two companies,” says Reuters, “the Treasury received securities worth $41.” In other words, for those readers who do not have an abacus handy, taxpayers lost $35.4 billion dollars the second they drove their toxic securities off the lot at AIG and Citigroup.
This is a very odd expression of gratitude — kind of like a drowning swimmer who, after being rescued from certain death, thanks the lifeguard by stealing his car.
Who do you suppose would have known best about the true value of the securities the government purchased from AIG? The government employees who purchased them or the sellers at AIG? We’ll go out on a limb here and guess that the folks at AIG knew better.
So if the sellers had an inkling that the assets were worth far less than the government was paying paid, didn’t the sellers also have an obligation to divulge that information to the government — the party that was saving them from their own recklessness and stupidity? This is not a trick question. Yes, is the answer.
But since the sellers at AIG did not divulge accurate values to the buyers at the government, didn’t the sellers commit a kind of fraud? And if they did, don’t they deserve a kind of prison sentence?
But let’s not rush to judgment. If AIG executives legitimately had no idea that the prices the government paid for their securities was light-years away from real-world prices, then they are not guilty of fraud. But if they are not guilty of fraud, they are nevertheless guilty of extreme incompetence...again.
Criminal or moron. It’s one or the other. Either way, they deserve dismissal.
The chilling storyline that is unfolding from Wall Street’s corner offices prompts an obvious question that never seems to produce the obvious answer? Why do the corrupt and/or inept individuals who were the architects of the current financial crisis remain in positions of well-compensated power? Why, in other words, do we taxpayers continue to throw good money after bad? And why does the government conduct bailouts from the top of America’s financial pyramid, where the perpetrators of the crisis reside, rather than from the bottom of the pyramid, where the victims reside?
Seems like that would have been a better way to squander taxpayer dollars.
Your editors understand the rationale for dispensing trillions of dollars to failing financial institutions rather than, say, failing individual homeowners. But we emphatically reject it. The government has managed to dispense trillions of dollars of bailouts and guarantees without producing any palpable benefit for the economy at large. Despite the deluge of bailouts and guarantees that has rained down upon American financial institutions, the economy continues to atrophy and the finance sector remains comatose. So why continue the ruse? Why not squander taxpayer money to help families stay in their homes, rather than help psychopaths stay in their Armani suits?
An alarming report by Mark Pittman and Bob Ivry of Bloomberg News emphasizes the point. “The Federal Reserve, Treasury Department and Federal Deposit Insurance Corporation have lent or spent almost $3 trillion over the past two years and pledged to provide up to $5.7 trillion more if needed,” the Bloomberg duo reveal... These enormous pledges, Pittman and Ivry point out, would almost be enough to “pay off every home mortgage loan in the US, calculated at $10.5 trillion by the Federal Reserve.”
But lest you think we are kicking America’s corporate chieftains while they are down — or as close to down as we have seen them in a long time, which is actually not very down at all — we would remind you that your editors also kicked the corporate chieftains (often) while they were riding high.
Nearly four years ago, we remarked:
“A corporate culture of well-mannered avarice restrains the mighty American economy. Many public companies labor under a Soviet-style central planning — the sort of planning that arranges things very nicely for the planners themselves, but much less well for the proletariat...
“‘In 2003, the ratio between CEO Pay and worker pay reached 301 to 1, up from 282 to 1 in 2002’ according to a report from United for a Fair Economy. ‘If the minimum wage had increased as quickly as CEO pay has since 1990, it would today be $15.76 per hour, rather than the current $5.15 per hour.’ [Editor’s update: United for a Fair Economy now reports that CEO pay has soared to 343 times that of hourly workers.]
“‘By any standard, many of today’s executive compensation packages are excessive,’ BusinessWeek asserts. ‘Too often, directors have awarded compensation packages that go well beyond what is required to attract and retain executives and have rewarded even poorly performing CEOs... Moreover, a poorly designed executive compensation package can reward decisions that are not in the long- term interests of a company, its shareholders and employees.’”
Shortly after airing these remarks, we followed up with a column entitled “Pinstriped Psychopaths.” Regrettably, the observations within that column proved to be much more prescient and relevant than we could have ever imagined. In short, it pays to learn a little bit about the guys who are overseeing your capital...and to avoid the bad ones. Pinstriped Psychopaths
By Eric Fry — [A Daily Reckoning Classique, originally published on July 8, 2005] Some psychopaths occupy a prison cell. Others occupy a corner office. Both are dangerous.
Psychopaths possess a profound lack of empathy. They use other people callously and remorselessly for their own ends. Psychopathic CEOs are no different. By advancing their own interests, with little regard for the agony they might inflict on others, they jeopardize the welfare of employees and investors alike.
In short, psychopathy is bad business.
It’s true that heartless managers can achieve statistically heroic corporate triumphs. But it is also true that the garlands of such victories often contain the pink slips (and sufferings) of thousands of employees.
But before we proceed to condemn America’s self-serving CEOs, allow us to give credit where credit is due, both to Prof. Robert Hare for linking psychopathy to corporate behavior and to Alan Deutscheman for explaining the topic in a fascinating essay.
“One day in 2002,” Mr. Deutscheman begins, “a 71-year-old professor emeritus from the University of British Columbia, Robert Hare, gave a talk on psychopathy to about 150 police and law-enforcement officials. He was a legendary figure to that crowd. The FBI and the British justice system had long relied on his advice.
“According to the Canadian Press and Toronto Sun reporters who rescued the moment from obscurity, Hare began by talking about Mafia hit men and sex offenders, whose photos were projected on a large screen behind him. But then those images were replaced by pictures of top executives from WorldCom, which had just declared bankruptcy, and Enron, which imploded only months earlier.”
“These are callous, cold-blooded individuals,” Hare scowled. “They don’t care that you have thoughts and feelings. They have no sense of guilt or remorse... I always said that if I wasn’t studying psychopaths in prison, I’d do it at the stock exchange.”
Collectively, corporate psychopaths inflict pain on hundreds of thousands — if not millions — of employees and shareholders. The senseless sufferings include lost livelihoods, lost life savings and sometimes even broken families or suicides.
And all the while that these CEOs sow agony, they reap riches for themselves.
In 2004 the CEOs of 179 major companies were paid an average of $9.84 million, up 12 percent from 2003, according to a survey by Pearl Meyer & Partners. By contrast, average labor compensation rose only 4.5 percent. (Unless a guy can hit a baseball 400 feet, or create misogynistic rap lyrics, he doesn’t deserve that kind of money!)
But these highly compensated — and sometimes brutal — corporate executives, as implements of financial Darwinism, can produce a greater good, according to Robert J. Samuelson in a recent article for The Washington Post. “The obsessive drive to improve profits, though cold-blooded, also creates often-overlooked social benefits,” he asserts. “It’s not simply that growing profits bolster the stock market or finance new investment. The broader point is that advancing productivity — a fancy term for efficiency and a byproduct of the quest for profits — is the wellspring of higher living standards.”
Maybe so, or maybe we have simply baptized a social evil, in the process canonizing villains. There is a very fine line between “creative destruction” and creative annihilation. But morality is not our beat here at the Rude Awakening. We, too, pursue a profit motive that is morally ambiguous.
But even from a rabidly capitalistic perspective, investing in psychopathic management can be very bad business. Folks like Enron’s Andrew Fastow, Sunbeam’s “Chainsaw” Al Dunlap and Worldcom’s Bernie Ebbers have demonstrated the destructive capacity of corporate psychopathy.
When in doubt, therefore, the prudent investor might opt to invest in companies that do NOT promote psychopaths to positions of influence.
Given the power that CEOs wield, Prof. Hare suggests that we screen them for psychopathic behavior. “Why wouldn’t we want to screen them?” he asks. “We screen police officers, teachers. Why not people who are going to handle billions of dollars?”
The professor may have a point. Several big-name CEOs would score “mildly psychopathic” on Hare’s corporate Psychopathy Checklist, according to Deutschman.
“‘Chainsaw’ Al Dunlap [would] score impressively,” Deutschman relates. “What do you say about a guy who didn’t attend his own parents’ funerals? He allegedly threatened his first wife with guns and knives. She charged that he left her with no food and no access to their money while he was away for days. His divorce was granted on grounds of ‘extreme cruelty.’ That’s the characteristic that endeared him to Wall Street, which applauded when he fired 11,000 workers at Scott Paper, then another 6,000 (half the labor force) at Sunbeam... His plant closings kept up his reputation for ruthlessness but made no sense economically, and Sunbeam’s financial gains were really the result of Dunlap’s alleged book cooking.”
We would not be opposed to “CEO screening,” but we’d prefer to allow market forces to eradicate the scoundrels. Specifically, we’d prefer that the lessons of the past govern the investor behavior of the future. Now that we have observed the downside of corporate psychopathy, we individual investors should have learned to avoid buying into companies run by self-serving lunatics.
We cannot always know, of course, who is psychopathic and who is merely “tough.” But perhaps the time has come to attempt to discern the difference. For too long, we have revered executives who seemed charismatic, visionary, and tough...as long as they were lifting profits and share prices. We did not care about mass job layoffs, provided that they occurred as remotely and silently as a lethal injection.
“We were willing to overlook the fact that CEOs could also be callous, conning, manipulative, deceitful, verbally and psychologically abusive, remorseless, exploitative, self-delusional, irresponsible, and megalomaniacal,” Deutschman sums up. “So we colluded in the elevation of leaders who were sadly insensitive to hurting others and society at large.”
But we individual investors seem to be repenting of our complicity. In general, we no longer revere “tough CEOs,” and we no longer look the other way while psychopathic corporate managers abuse the companies they purport to lead. Morgan Stanley’s Philip Purcell was recently “shown the door,” mostly because he excelled at producing vitriol, rather than profitability. We will not miss Philip J. Purcell, and neither will Morgan Stanley Deane Witter’s shareholders.
Psychopathy is destructive, no matter whether it roams the back streets or roams on Wall Street.
Regards,
Eric J. Fry,
for The Daily Reckoning
Thursday, 12 January 2012
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