Tag: the bond’s eye view of the world

In Which I Dare to Correct Felix Salmon

Felix Salmon is my favorite business blogger — super smart, cosmopolitan and impressively unimpressed by the Masters of the Universe he spends his days observing. In general, I’d expect him to be much more on top of current financial data than I am. But in today’s post on the commercial paper market, he makes an uncharacteristic mistake — or rather, uncharacteristic for him but highly characteristic of the larger conversation around finance.

According to Felix:

The commercial paper market has to a first approximation become an entirely financial market, a place for banks and shadow banks to do their short-term borrowing while the interbank market remains closed.

According to David S. Scharfstein of Harvard Business School, who also testified last week, of the 50 largest issuers of debt to money market funds today, only two are nonfinancial firms; the rest are banks and other financial companies, many of them foreign.

Once upon a time, before the financial crisis, money-market funds were a mechanism whereby individual investors could make safe, short-term loans to big corporates, disintermediating the banks. But all that has changed now. For one thing, says Davidoff, “about two-thirds of money market users are sophisticated finance investors”. For another, the corporates have evaporated away, to be replaced by financials. In the corporate world, it seems, the price mechanism isn’t working any more: either you’re a big and safe corporate and don’t want to run the refinancing risk of money-market funds suddenly drying up, or else you’re small enough and risky enough that the money market funds don’t want to lend to you at any price.

I’m sorry, but I don’t think that’s right.

Reading Felix, you get the clear impression that before the crisis, or anyway not too long ago, most borrowers in the commercial paper market were nonfinancial corporations. It has only “become an entirely financial market” relatively recently, he suggests, as nonfinancial borrowers have dropped out. But, to me at least, the real picture looks rather different.

Source: Flow of Funds

The graph shows outstanding financial and nonfinancial commercial paper on the left scale, and the financial share of the total on the right scale. As you can see the story is almost the opposite of the one Felix tells. Financial borrowers have always dominated the commercial paper market, and their share has fallen, not risen, in the wake of the financial crisis and recession. Relative to the economy, nonfinancial commercial paper outstanding is close to where it was at the peak of the past cycle. But financial paper is down by almost two-thirds. As a result, the nonfinancial share of the commercial paper market has doubled, from 7 to 15 percent — the highest it’s been since the 1990s.

Why does this matter? Well, of course, it’s important to get these things right. But I think Felix’s mistake here is revealing of a larger problem.

One of the most dramatic features of the financial crisis of fall 2008, bringing the Fed as close as it got to socializing the means of intermediation, was the collapse of the commercial paper market. But as I’ve written here before, it was almost never acknowledged that the collapse was largely limited to financial commercial paper. Nonfinancial borrowers did not lose access to credit in the way that banks and shadow banks did. The gap between the financial and nonfinancial commercial paper markets wasn’t discussed, I believe, because of the way the crisis was seen entirely through the eyes of finance.

I suspect the same thing is happening with the evolution of the commercial paper market in the past few years. The Flow of Funds shows clearly that commercial borrowing by nonfinancial borrowers has held up reasonably well; the fall in commercial paper lending is limited to financial borrowers. But that banks’ problems are everyone’s problems is taken for granted, or at most justified with a pious handwave about the importance of credit to the real economy.

And that’s the second  assumption, again usually unstated, at issue here: that providing credit to households and businesses is normally the main activity of finance, with departures from that role an anomalous recent development. But what if the main action in the financial system has never been intermediating between ultimate lenders and borrowers? What if banks have always mostly been, not to put too fine a point on it, parasites?

During the crisis of 2008 one big question was if it was possible to let the big banks fail, or if the consequences for the real economy would be prohibitively awful. On the left, Dean Baker took the first position while Doug Henwood took the second, arguing that the alternative to bailouts could be a second Great Depression. I was ambivalent at the time, but I’ve been moving toward the let-them-fail view. (Especially if the counterfactual is that governments and central banks putting comparable resources into sheltering the real economy from collapsing banks, as they have into propping them up.) The evolution of the commercial paper market looks to me like one more datapoint supporting that view. The collapse of interbank lending doesn’t seem to have affected nonbank borrowers much.

(Which brings us to a larger point, of whether the continued depressed state of the real economy is due to a lack of access to credit. Obviously I think not, but that’s beyond the scope of this post.)

An insidious feature of the world we live in is an unconscious tendency to adopt finance’s point of view. This is as true of intellectuals as of everyone else. An anthropologist of my acquaintance, for instance, did his fieldwork on the New York financial industry. Nothing wrong with that — he’s got some very smart things to say about it — but you really can’t imagine someone doing a similar project on any other industry, apart from high-tech internet stuff. In our culture, finance is just interesting in a way that other businesses are not. I’m not exempting myself from this, by the way. The financial crisis and its aftermath was the most exciting time in memory to be thinking about economics; I’m not going to deny it, it was fun. And there are plenty of people on the left who would say that a tendency, which I confess to, to let the conflict between Wall Street and the real economy displace the conflict between labor and capital in our political language, is a symptom — a kind of reaction-formation — of the same intellectual capture.

But that is perhaps over-broadening the point, which is just this: That someone as smart as Felix Salmon could so badly misread the commercial paper market is a sign of how hard we have to work to distinguish the state of the banks, from the state of the economy.

Low Interest Rates = Rape and Plunder

Via Mike Konczal, here is Carmen “Eight Centuries of Financial Folly” Reinhart indulging in a bit of folly of her own:

Reinhart is the toast of economic circles these days for speaking out about the newest way Western governments are using financial repression to liquidate their debts, particularly after a financial crisis. They’re doing this on the backs of savers, including pension funds… financial repression can lead to “the rape and plunder of pension funds,” Reinhart tells Institutional Investor. Financial repression consists of very low nominal interest rates combined with captive lending by large banks or pension funds to a government. The low, stable interest rate facilitates the servicing costs of large public debts. Sometimes modest inflation is added to the mix. This results in zero to negative real interest rates that reduce government debt. Hence, broadly defined, financial repression is a wealth transfer from savers to debtors using negative real interest rates — with the government as one of the key debtors. 

… Low interest rates are a fact of postcrash economic life, designed to kick-start greater borrowing. … “Financial repression is an expedient way of reducing debt,” she says. For banks as well as the government, debt overhang is a major economic problem. But every tax has costs, including distortionary effects. Because financial repression punishes savers, it’s unknown to what degree it inhibits savings.

Rape and plunder? Owners of financial wealth definitionally are savers? Low interest rates are a transfer to debtors? (Are high interest rates a transfer to creditors, then?) Financial asset-owners are morally entitled to low inflation and high interest rates? Not getting the risk-free, passive income you expected is “punishment”? RAPE and PLUNDER, seriously? This article is so exactly everything that I’m against that I’m kind of speechless. All I can do is point at it and say, But! Gha! But it’s! Bhehe!

* * *

In possibly related news, over at Crooked Timber, Daniel Davies contemplates the possibility that in Europe today, there might be a conflict of interests between debtors and creditors. But no there isn’t, he decides, default would be equally bad for everyone:

The example that comes to my mind of a defaulting debtor that isn’t a commodity producer is Germany and their experiences with default have been absolutely awful. Graham Greene’s The Third Man is a story about the aftermath of debt default in a non-commodity economy.

Um yeah. Central Europe, 1946. Let’s see, what has just happened? What’s just happened in Germany (or Austria, as the case may be)? Oh yes: They’ve suspended payment on their bonds.

As through this world I’ve wandered, I’ve seen lots of funny men. Some of them seem to think that they are financial instruments. It gives them a funny point of view.

Dividing the Spoils

In response to the last post, commenter 5371 asks, “An anti-managerial counterrevolution which the managers themselves ended up leading?” Fair question, here’s my answer: 

I think there is a very convincing story in which the emergence of the modern corporation in the early decades of the 20th century, and then the vast expansion of the federal administrative apparatus in the New Deal and (especially) World War II, created a class of professional managers with substantial autonomy from the notional owners of capital. (Not as cohesive as the enarques in France, but the same kind of stratum.) As managers of firms they pursued a variety of objectives, of which providing a satisfactory (not maximal) flow of payments to shareholders was just one among others.

At some point (in the late 1970s, let’s say) this arrangement broke down, with conflicts both between managers and owners over the fraction of surplus flowing to the latter, and between owners and workers, over the size of the surplus, with mangers basically on the side of owners. The second of these conflicts was, in some sense, more fundamental, but the first one was also real and important.

You then had a series of institutional changes that were intended to realign the interests of managers with owners, in terms of both conflicts. During the period of realignment, these changes took the form — at least at times — of open conflict, with recalcitrant managers forcibly removed by LBOs, etc. But over time, top management was effectively absorbed into the capitalist class proper, and stopped seeing themselves as the social embodiment of the firm as a social organism or representatives of society as a whole. At the same time, there does have to be continuous policing to ensure that management doesn’t deviate from the goal of maximizing payments to shareholders. That is finance’s other function, along with intermediation, and it’s this second function that has been responsible for finance’s growth over the past decades. (Along with the rents that financial institutions and asset-owners claim in the course of doing their enforcement work.)

So in terms of overt conflict between owners and managers, the shareholder revolution is over; the shareholders won. The fly in the ointment is that no one is policing the police, and unlike other institutional supports of the capitalist system (the actual police, say, or the legal profession or academia) they don’t have the right internal norms to make them reliable servants.

That’s how it looks to me, anyway. I realize this is just a set of assertions, which would need to be backed up with evidence/examples to convince anyone who’s not already convinced. As usual, I recommend Doug H.’s Wall Street (especially chapter 6, which I’m having my students read this semester) and Dumenil & Levy’s Crisis of Neoliberalism to see the argument developed properly. One of these days maybe I’ll write something substantive on it myself.

I should add, an interesting aspect of the counterrevolution of the rentiers is the way that the claim of shareholders on the maximum possible payments from “their” firms has become an accepted moral principle. There are lots of educated people, even liberals, who unquestioningly believe that it is morally wrong for managers to have any objectives except maximizing future dividend payments. E.g. look at this old Baseline Scenario post on Goldman Sachs’ relatively low 2009 bonuses, with the unironic title Good for Goldman:

Goldman did the right thing here.We all know that Goldman made a lot of money last year. … Many people think that it made that money because of government support, but that’s beside the point here; right now, this is purely a question of dividing the spoils between employees and shareholders.

Historically, investment banks have given a large proportion of the profits (here, meaning before compensation and taxes) to the employees. For example, in 2007 Goldman gave $20.2 billion out of $37.8 billion to its employees, or 53%. There are undoubtedly many reasons for this. … More insidiously, investment banking executives tend to see their employees as younger versions of themselves, which creates a sense of solidarity… Contrast this to, say, Wal-Mart, where top management has very little in common (socially, educationally, economically, politically, etc.) with the vast majority of their employees. As a result, investment bankers are overpaid. …

Goldman should reduce its per-employee compensation expenses even further, and should try to push the industry to a new equilibrium where the payout ratio is in the 30-40% range and average compensation for investment bankers is in the $300-400,000 range. And Goldman’s shareholders should apply pressure to make this happen; basically, they should try to squeeze labor.

I find this sort of thing fascinating. James Kwak is a liberal, one of the good guys. But it’s awfully hard not to read him here as saying it’s a good thing that Wal-Mart execs have nothing in common with the proles to distract them from serving their true masters, and that where a sense of solidarity does exist between managers and workers, it’s an “insidious” problem that needs to be stamped out. There’s nothing ironic in those “should”s.

Of course I’m no fan of traders, financial engineers, and the rest of the pirates, but as Kwak himself says, this is “purely a question of dividing the spoils.” So I don’t see why the silent partners who finance the privateers have any better claim than the guys with flintlocks and cutlasses, or why we should treat it as something to celebrate when the financiers get a bigger share of the take. [1] What’s strange is how many people, many not especially rich or conservative, have been somehow convinced that the biggest problem with businesses is that they aren’t run purely enough for profit, and that employees still have too much control over their work and pay. That in any conflict between owners and workers or managers, the social interest is obviously — obviously — on the side of the owners. It’s nuts.

[1] Ok, yes, about 15 percent of corporate equity is owned by pension funds. So yes, salaried workers (including me and probably you) do in some sense confront employees, at both Goldman and Wal-Mart, as owners. We can’t just say “the capitalist is the personification of capital” and be done with it, as Marx did; capitalist as economic function and capitalists as sociological category don’t coincide as nicely as they did in his day. But why should we let our little interest as junior capitalists dominate our much larger interests as workers, citizens, and human beings? Why should we assume that the claims on business exercised by virtue of capital ownership, are the only ones that are morally legitimate?

The Mind of the Master Class

In comments, Arin says,

my view of the world is that there were (at least) two distinct phases … First was the emergence of a market for corporate control through hostile takeovers in the 1980s, which may have changed managerial incentives to basically ward off such possibilities. However, it didn’t lead to greater power of shareholders over management … consolidation and mergers over time ended up actually increasing managerial prerogatives. However, it was of course a very different type of management … one whose incentives were quite aligned with short term capital gains which were also potentially helpful to ward off challenge for control… So yes, the market for corporate control changed the world – but ironically it changed it by passing more rents to managers, not less.

I don’t know that I agree — or at least, it depends what you mean by managerial prerogatives. Relative to workers, to consumers, to society at large? Sure. Relative to shareholders? I’m not so sure. But let’s say Arin is right. I don’t think it fundamentally changes the story. What I’m talking about isn’t fundamentally a conflict between two different groups of people, but between two functions. Capital, as we know, is a process, value in a movement of self-expansion: M-C-C’-M’. The question is whether capital as a sociological entity, as something that act on its own interests, is conscious of itself more in the C moments or in the M moments. Do the people who exercise political power on behalf of capital think of themselves more as managers of a production process, or as stewards of a pool of money? The point is that sometime around 1980, we saw a transition from the former to the latter. Whether that took the form of an empowering of the money-stewards at the expense of the production-managers, or of everyone in power thinking more like a money-steward, is less important.

I heard a story the other day that nicely illustrates this. Back in the Clinton era, a friend of a friend was on a commission to discuss health care reform, the token labor guy with a bunch of business executives. So, he asked, why don’t the Big Three automakers and other old industrial firms support some kind of national health insurance? Just look at the costs, look at how much you could save if you focus on making cars instead of being a health insurer. Well yes, the auto executives at the meeting replied, you make a good point. But you know, our big focus right now is on reducing the capital gains tax. Let’s deal with that first, and then we can talk about health insurance.

If you’re an executive in neoliberal America, you’re an owner of financial assets first and foremost, and responsible for the long-term interests of the firm you manage second, third or not at all.

The Capitalist Wants an Exit

Like a gratifyingly large proportion of posts here, Disgorge the Cash! got a bunch of great comments. In one of the last ones, Glenn makes a number of interesting points, some of which I agree with, some which I don’t. Among other things, he asks why, if businesses really have good investment projects available, rational investors would demand that they pay out their cashflow instead. Isn’t it more logical to suppose that payouts are rising because investment opportunities are scarcer, rather than, as the posts suggests, that firms are investing less because they are being compelled to pay out more?

One standard answer would be information asymmetries. If firms have private information about the quality of their investment opportunities, it may be more efficient to have capital-allocation decisions made within firms rather than by outside lenders. The cost of being unable to shift capital between firms may be less than the cost of the adverse selection that comes with information asymmetries. That’s one answer. But here I want to talk about a different one.

Capital in general, and finance in particular, places a very high value on liquidity. But if wealth owners insist on the freedom to reallocate their holdings at a moment’s notice, and need the promise of very high returns to let them be bound up in something illiquid, then investment in the aggregate will be inefficiently low. As Keynes famously wrote,

Of all the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets there is no such thing as liquidity of investment for the community as a whole.

Or as Tom Geoghegan recalls, from the last days of the old regime in the late 1970s,

Once a friend of mine from Harvard Business School came to visit, and I took him to South Works, just to see it.

“Wow,” he said. “I’ve never seen so much capital just lying on the ground. At B School we used to laugh at how conservative these big steel companies are, but then you could come out and see all this capital, just lying on the ground…”

Capitalists, in general, do not like to see their capital just lying on the ground. They prefer it to be abstract, intangible, liquid.

There’s no question that the shareholder revolution of the 1980s had a strong distributional component. Rentiers thought that workers were getting to much of “their” money. But if we’re looking specifically at the conflict between shareholders and management — as much a conflict between worldviews as between distinct groups of people — then I think “the fetish of liquidity” is central.

As Keynes understood, liquidity is what stock markets are for. What they’re not for, is raising funds for investment. That wasn’t why they were invented (the publicly traded corporation is a relatively recent innovation), and it’s not what they’ve been used for. Apart from a few years in the 1920s and a few more in the late 1990s, stock issues have never been an important source of investment finance for firms.

Let’s talk about Groupon. Huge IPO, raised $700 million, the biggest offering in years. So, those people who bought shares, they’re getting ownership of the company in return for providing it much needed funds for expansion, right?

Except that “Groupon has been shouting until it’s blue in the face that it doesn’t need the IPO cash, that it’s fine on the cash front, that the IPO is just a way of going public, and is not really about the money-raising at all.” Cashflow is more than enough to finance all their foreseeable expansion plans. So why go public at all, then?

Because their existing investors want cash, that’s why. Pre-IPO, Groupon was already notorious for using venture capitalist funds to cash out earlier investors.

Groupon is a very innovative company, and this is one of its most important innovations — the idea that the founder can and even should be able to cash out to the tune of millions of dollars very early on in the company’s lifecycle, while it is still raising new VC funds…. Historically, VC rounds have been about providing capital to companies which need it; in Groupon’s case, they’re more about finding a way to cash out early investors

But the venture capitalists need to be cashed out in their turn. After CEO Andrew Mason turned down offers from Yahoo and then Google to purchase the company, his VC bankers became increasingly antsy about being stuck owning a business, even a business selling something intangible as internet coupons, rather than safe pure money. Thus the IPO:

The board — and Groupon’s investors — had a message for Mason, though. Someday, he was going to have to either accept an offer like that one he had just turned down, or take this company public.

One investor recounts the conversation: “We said, okay Andrew, you took venture capital, and remember venture capitalists want an exit.  It doesn’t have to be tomorrow but you always have to be thoughtful when a company comes to buy your company, because it’s not just you, it’s your employees, options, investors and alike.”

That’s what Wall Street is for: to give capitalists their exit.

The problem finance solves is not how to allocate society’s scarce savings between competing investment opportunities. In modern conditions, it’s the opportunities that are scarce, not the savings. (Savings glut, anyone?) The problem is how to separate the rents that come from control of a strategic social coordination problem from the social ties and obligations that go with it. The true capitalist doesn’t want to make steel or restaurant deals or jumbo jets or search engines. He wants to make money. That’s been true right from the beginning. It’s why we have stock markets in the first place.

Historically the publicly-owned corporation came into being to allow owners (or more typically, their heirs) to delink their fortunes from particular firms or industries, and not as a way of raising capital.

In her definitive history of the wave of mergers that first established publicly-traded corporations (outside of railroads), Naomis Lamoreaux is emphatic that raising funds for investment was not an important motivation for adopting the new ownership form. In contemporary accounts of the merger wave, she says, “Access to capital is not mentioned.” And in the hearings by the U.S. Industrial Commission on the mergers,  “None of the manufacturers mentioned access to capital markets as a reason for consolidation.” Rather, the motivation for the new ownership form was a desire by the new capitalist elite to separate their wealth and status from the fortunes of any particular firm or industry:

after the founder’s death or retirement, ownership dispersed among heirs “who often were interested only in receiving income” from the company rather than running it. Where the founder was able to consolidate family control, as in Ford or Rockefeller,

the shift to public ownership was substantially delayed.

The same point is developed by historians Thomas Navin and Marian Sears:

A pattern of ownership somewhat like that in the cotton textile industry of New England might eventually have come to prevail: ownership might have spread, but to a limited degree; shares might have become available to outsiders, but to a restricted extent. It was the merger movement that accelerated the process and intensified it – to a smaller extent in the earlier period, 1890-1893, to a major degree in the later period, 1898-1902. As a result of the merger movement, far more people parted with their ownership in family businesses than would otherwise have done so; and doubtless far more men of substance (nonindustrialists with investable capital) put their funds into industry than would otherwise have chosen that type of investment. …

[As to] why individual stockholders saw an advantage in surrendering their ownership in a single enterprise in favor of participation in a combined venture …, one of the strong motivations apparently was an opportunity to liquidate part of their investment, coupled with the opportunity to remain part owners. At least this was a theme that was played on when stockholders were asked to join in a merger. The argument may have been used that mergers brought an easing of competition and an opportunity for enhanced earnings in the future. But the trump card was immediate liquidity.

The comparison with New England is interesting. Indeed, in the first half of the 19th century a very different kind of capitalism developed there, dynastic not anonymous, based on acknowledging the social ties embodied in a productive enterprise rather, than trying to minimize them. But historically the preference for money has more often won out. This was even more true in the early days of capitalism, in the 17th century. Braudel:

it was in the sphere of circulation, trade and marketing that capitalism was most at home; even if it sometimes made more than fleeting incursions on to the territory of production.

Production, he continues, was “foreign territory” for capitalists, which they only entered reluctantly, always taking the first chance to return to the familiar ground of finance and long-distance trade. Of course this changed dramatically with the Industrial Revolution. But there’s an important sense in which it’s still, or once again, true.

Disgorge the Cash!

It’s well known that some basic parameters of the economy changed around 1980, in a mutation that’s often called neoliberalism or financialization. Here’s one piece of that shift that doesn’t get talked about much, but might be relevant to our current predicament.

Source: Flow of Funds



The blue line shows the after-tax profits of nonfinancial corporations. The dotted red line shows dividend payments by those same corporations, and the solid red line shows total payout to shareholders, that is dividends plus net share repurchases. All three are expressed as a share of trend GDP. The thing to look at it is the relationship between the blue line and the solid red one.

In the pre-neoliberal era, up until 1980 or so, nonfinancial businesses paid out about 40 percent of their profits to shareholders. But in most of the years since 1980, they’ve paid out more than all of them. In 2006, for example, nonfinancial corporations had after-tax earnings of $800 billion, and paid out $365 billion in dividends and $565 in net stock repurchases. In 2007, earnings were $750 billion, dividends were $480 billion, and net stock repurchases were $790 billion. (Yes, net stock repurchases exceeded after-tax profits.) In 2008 it was $600, $470, and $340 billion. And so on. [1]

It was a common trope in accounts of the housing bubble that greedy or shortsighted homeowners were extracting equity from their houses with second mortgages or cash-out refinancings to pay for extra consumption. What nobody mentioned was that the rentier class had been doing this longer, and on a much larger scale, to the country’s productive enterprises. At the top of every boom in the neoliberal era, there’s been a massive round of stock buybacks, which you could think of as shareholders cashing out their bubble wealth. It’s a bit like the homeowners “using their houses as ATMs” during the 2000s. The difference, of course, is that if you took too much equity out of your house in the bubble, you’re the one stuck with the mortgage payments today. Whereas when shareholders use businesses as ATMs, those businesses’ workers and customers get to share the pain.

One way of thinking about this increase in the share of profits flowing out of the firm, is in terms of changing relations between managers and the owning class. The managerial capitalism of Galbraith or Berle and Means, with firms pursuing a variety of objectives and “owners” just one constituency among many, really existed, but only in the decades after World War II. That, anyway, is the argument of Dumenil and Levy’s Crisis of Neoliberalism. In the postwar period,

corporations were managed with concerns, such as investment and technical change, significantly distinct from the creation of “shareholder value.” Managers enjoyed relative freedom to act vis-a-vis owners, with a considerable share of profits retained within the firm for the purpose of investment. … Neoliberalism put an end to this autonomy because it implied a containment of capitalist interests, and established a new compromise at the top of the social hierarchies… during the 1980s, the disciplinary aspect of the new relationship between the capitalist and the managerial classes was dominant… after 2000, managers had become a pillar of Finance. 

When I’ve heard Dumenil talk about this development, he calls the new configuration at the top a “loving marriage”; the book says, less evocatively, that today

income patterns suggest that a process of “hybridization” or merger is underway. … The boundary between high-ranking managers and the capitalist classes is blurred.

The key thing is that at one point, large businesses really were run by people who, while autocratic within the firm and often vicious in defense of their privileges, really did identify with the particular businesses they managed and focused their energy on their survival and growth, and even on the sheer disinterested desire to do their kind of business well. You can find a few businesses that are still run like this — I’ve been meaning to write a post on Steve Jobs — but by far the dominant ethos among managers today is that a business exists only to enrich its shareholders, including, of course, senior managers themselves. Which they have done very successfully, as the graph above (or a look at the world outside) shows.

In terms of the specific process by which this cam about, the best guide is chapter 6 of Doug Henwood’s Wall Street (available for free download here.) [2] As Doug makes clear, the increased payouts to shareholders didn’t just happen. They’re the result of a conscious, deliberate effort by owners of financial assets to reassert their claims on corporate income, using the carrot of high pay and stock for mangers and the stick of hostile takeovers for those who didn’t come through. Here’s Michael Jensen spelling out the problem from finance’s point of view:

Conflicts of interest between shareholders and managers over payout policies are especially severe when the organization generates substantial cashflow. The problem is how to motivate managers to disgorge the cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies [by which Jensen seems to have mostly meant high wages].

Peter Rona, also quoted in Wall Street, expresses the same thought but in a decidedly less finance-friendly way: Shareholders “take pretty much the same view of the corporation as a praying mantis does of her mate.”

You don’t see the overt Jensen-type arguments as much now that management at most firms is happy to disgorge all of its cash and then some. But they’re not gone. A while back I saw a column in the business press — wish I could remember where — expressing outrage at Apple’s huge cash reserves. Because they should be investing that in new technology, or expanding production and hiring people? Of course not. It’s outrageous because that’s the shareholders’ money, and why isn’t Apple handing it over immediately. More than that, why doesn’t Apple issue a bunch of bonds, as much as the market will take, and pay the proceeds out to the shareholders too? From the point of view of the creatures on Wall Street, a company that prioritizes its long-term growth and survival is stealing from them.

UPDATE: Ah, here’s the piece I was thinking of: Forget iPad, it’s time for iGetsomemoneyback. From right before the iPad launch, it’s a gem of the rentier mindset, complete with mockery of Apple for investing in this silly tablet thing instead of just handing all its money to Wall Street.

Why is Apple hoarding its cash? A company spokesman explains: “We have maintained our cash and strong balance sheet to preserve the flexibility to make strategic investments and/or acquisitions.” … Steve Jobs really doesn’t need an acquisitions warchest of around $30 billion … He should start handing back this money to stockholders through dividends. … The money belongs to stockholders: Give. Indeed Jobs should go further. Apple should — gasp — start borrowing, and hand that money back, too.
Disgorge the cash!

SECOND UPDATE: Welcome to visitors from Dealbreaker, Felix Salmon and Powerline. If you like this, other posts here you might like include Selfish Masters, Selfless Servants; The Financial Crisis and the Recession; What Do Bosses Want?; and in sort of a different vein, Satisfaction.

[1] There’s something very odd going on in the fourth quarter of 2005: According to the Flow of Funds, dividend payments by nonfinancial firms dropped to essentially zero. The shortfall was made up in the preceding and following quarters. I suspect there must be some tax change involved. Does anybody (Bruce Wilder, maybe) have any idea what it is?

[2] John Smithin’s Macroeconomic Policy and the Future of Capitalism is also very good on this; it’s subtitle (“the revenge of the rentiers”) gives a better flavor of the argument than the bland title.

How the Other Side Thinks

At least someone is happy about the debt-ceiling deal:

Low government debt yields may reflect concern about the health of the economy and the drag spending cuts would have on gross domestic product.

Reductions are “going to be good for Treasuries, ironically, because it’s bad for the economy,” Tad Rivelle, the head of fixed-income investment at Los Angeles-based TCW Group Inc., which manages about $115 billion, said in an interview last week. “It ought to further restrain economic growth by in effect withdrawing a good deal of fiscal stimulus.” 

By “good for Treasuries,” he means good for people who own Treasuries.

This brings out a point I’ve been thinking about for a while. Marxist  and mainstream economists don’t agree on much, but one view they do generally share is that under capitalism, growth is the central objective pursued by the state. Maybe we should not take that for granted.

For individual capitals, growth, endless accumulation, is a necessity imposed by the pressure of competition. And when the individual capitalist tries to influence the state they are generally looking for measures to help them grow faster. They have to, it’s a condition of their survival. But insofar as the capitalist class as a whole (or some substantial fraction of it) exercises political agency, they’re not subject to competition. An individual capital needs to grow as fast as possible so as not to be overtaken by its rivals; but for capital as a whole, there is no equivalent pressure. What capital as a whole needs from the state is to maintain its basic conditions of existence and secure its political dominance. And that may well be as well achieved through slower growth, as through faster. Directly, because the labor supply is liable to be dangerously depleted by rapid growth. More broadly, because growth is inherently chaotic, unpredictable and destabilizing. This isn’t in the textbooks but you can learn it from Schumpeter just as well as from Marx. Or from just from looking around.

There’s a long line of arguments, going back to Marx’s reserve army of the unemployed, via Kalecki’s “Political Aspects of Full Employment,” formalized in the postwar period as Goodwin cycles or Crotty and Boddy’s political business cycles, and most fully developed in Glyn et al.’s Capitalism Since 1945, that periods of low unemployment can’t be sustained under capitalism, because they put upward pressure on wages and more broadly leave workers overly confident and politically empowered. Greenspan, bless his shriveled soul, was onto something important when he insisted in the late 1990s that the Fed could tolerate low unemployment without raising interest rates only because workers were intimidated by downsizing and the loss of job security.

Now, these are cyclical arguments. And the US hasn’t had a cycle of this kind since the 1980s. The last couple of downturns haven’t been about wages, at least overtly, but about asset bubbles and oil prices. But even if this recession wasn’t caused by the Fed raising interest rates to choke off wage growth (and clearly it wasn’t) capital and its political representatives could take advantage of it opportunistically to force down the wage share. One wouldn’t deliberately provoke a deep recession just to reduce wages, because of the political risks; but if one stumbles into it and the politics turn out to be manageable, why let a good crisis go to waste?

More broadly, if high growth rates are risky for capital, and if they were only politically necessary thanks to competition with the Soviet Union (this is an important argument that’s not quite spelled out in the Glyn book), then we shouldn’t be shocked if the post-Cold War state ends up preferring growth-reducing policies. Brad DeLong has been complaining lately about the failure, as he sees it, of the state to live up to its role as the committee to manage the collective affairs of the bourgeoisie. But maybe he just hasn’t been invited to the meetings.

UPDATE: Yglesias makes a similar argument in a less provocative way. Before the 1980s, we had episodes of high inflation, and no episodes of sustained high unemployment. Since the 1980s, we’ve had no episodes of high inflation, but we’ve had repeated episodes of sustained high unemployment. The obvious interpretation, which I share with Ygelsias, is that the Phillips Curve is not vertical even over the long run — there is a secular tradeoff between employment and price stability, and since Volcker the Fed’s preferences have shifted toward the price-stability side. Why this is the case is a different question, but it seems safe to say it has to do with the diverging interests of workers and owners and their respective political strength.

The Bond’s Eye View of the Ivory Coast

I joked a while back that any statement in the business press that something is good or bad needs to be followed with an implicit “for bondholders.” But it’s not really a joke. Here’s the Financial Times with the view from the bonds of the civil war in the Ivory Coast:

[Laurent Gbagbo’s] generals are negotiating a ceasefire at pixel time while the French think he’ll probably leave Ivory Coast within hours, after a heavy cost in bloodshed. But a brand new day for the Ivorian state?

If you’ve been watching the levitating prices on the country’s (defaulted) 2032 bond, you might think that. Having been rallying for some time, the bond is now priced more generously than before a $29m coupon payment failed in January… This is quite some faith in the ability — willingness — of Gbagbo’s successor, Alassane Ouattara, to resume debt service.

There it is: A new day for the Ivoirian state = resumption of debt payments.

But there’s a more serious point here, too. The only people in the rich world who have both an interest in what happens in the Ivory Coast, and the resources to act on it, are the owners of Ivoirian government bonds.

Of course this isn’t strictly true. There might be foreign owners of private Ivoirian assets. But in fact there doesn’t seem to be many: Of the country’s $11 billion in external debt, $8.5 billion, according to the BIS, is public and all the remaining $2.5 billion private debt is publicly guaranteed. And of course there are firms and speculators in the cocoa industry, but they aren’t going to as interested in the Ivory Coast specifically, and more importantly, they don’t have the same access to the peak institutions of capitalism. It’s the Financial Times, not the Commodities Times or even the International Trade Times. So it’s perfectly natural for the FT to take the bond’s eye view; to a first approximation, the bondholders are the representatives of the capitalist class as a whole with respect to the Ivory Coast.

Western Capital to China: Please Keep Wages Down

In today’s issue of the Financial Times, there’s a remarkably blunt warning that “Rising wages will burst China’s bubble.” True, China has enjoyed strong growth while most of the rest of the world has endured deep depressions. But don’t be fooled by such superficial measures. On the question that really counts, China is in trouble: “The Shanghai market is at less than half its all-time high, significantly underperforming the other three members of the Bric group.” Like Japan in the immediate postwar period, the piece argues, China has so far seen “workers flooding into the cities from the countryside, depressing wages and setting off a virtuous cycle of rising profitability and rising investment. In the mid-1950s, Japanese labour had taken 60 percent of total value added. in the miracle years, this ratio fell to 50 percent.” Miraculous indeed — but alas, it couldn’t last. By 1980, the labor share “had soared to a plateau of 68 percent. These gains had to be fought for. In the 1970s, Japan’s now dormant union movement was in its heyday. Profit margins were squeezed, and in real terms the stock market went nowhere for a decade.” Oh noes! And despite seemingly abundant reserves of cheap labor, the same disaster could befall China. “Can workers grab a larger share of the economic pie before the urbanization process is complete? In Japan they did. … If China were to follow Japan, the next stage would be labour strife and inflation. The best way to avoid that outcome would be a radical tightening of the current super-easy monetary policy. But that would risk a serious slowdown and probably necessitate a large revaluation of the renminbi.” So there it is. The important question about China’s future is the value of financial assets. And the great threat to asset-owners is the likelihood of rising wages, which will come about through increasing organizing among Chinese workers. The only way to prevent that is pre-emptive tightening, even at the cost of slower growth. The case for austerity is seldom made that bluntly, certainly not for the rich countries, but I don’t think the underlying motivation is much different. It’s also noteworthy that big revaluation of the renminbi is presented here explicitly as part of a program to hold down Chinese wages. In other words, China faces a choice between higher wages and a higher currency. To China-competing firms and workers in the rest of the world, either would be just as welcome. But for masters of the universe with Chinese stocks in their portfolio, they look very different indeed.
(Incidentally, these questions — the relationship between profitability, investment, demand, inflation and the politically-determined division of output between labor and capital — are largely ignored by mainstream macro, saltwater as well as fresh, but are right at the center of structuralist, Marxist, post-Keynesian and other heterodox approaches to macroeconomics. If only there were some economics department interested in supporting those approaches.)
EDIT: There was a link on a Something Awful thread sometime around March 20 that’s sending a lot of traffic to this post. Unfortunately, not being an SA member, I can’t see the thread. Anyone want to tell me what it was, in comments?

Default = Death

I’ve observed before that to make sense of the financial press, you have to adopt the view that the world exists only as a source of payments on financial assets. Here’s a beautiful example, from an article at VoxEU. The writers are discussing CDS spreads on sovereign debt, specifically the “swap curve,” which is supposed to represent the market’s best guess of the probability of default:

In normal times the slope of the swap curve is flat or slightly positive, reflecting more uncertainty about more distant future . In times of stress, however, the slope typically turns negative, mirroring fears that the country may not survive in the short term. But, if it does, it will not default later on.

Yes, paying bondholders in full is synonymous with national survival.

Which makes sense, I guess, if you’re looking at the world only through the bond trader’s terminal, where Ireland, say, is not a group of people or a political or historical entity, but simply an asset class. Doug Henwood has a wonderful quote in Wall Street from Charles Leggatt, who liquidated his family’s 172-year old art dealership: “What I came into was the art trade; what I am leaving is a financial service.” I don’t know what’s scarier about our rulers: that they are trying to do the same thing to the whole world, or that they think it’s already done.