ARCHIVES: WALL STREET / Class Racket

By Doug Henwood
THE LEFT BUSINESS OBSERVER
The author made no money on this book, so please consider a donation.

Wall Street was first published in hardcover by Verso in 1997, and in paperback in 1998. Since Verso chose not to reprint it when it went out of stock, the rights reverted to the author in March 2005.

license. It may be recirculated freely for noncommercial use only. No alterations are allowed, and the author must be credited.

The book is a definitive overview of the financial markets and their economic and political role.

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Marxian economics, for those of you who care about such arcane things – the real is what matters, and money and finance are either subordinate or peripheral. Insofar as economists consider money and finance, it’s in a fairly mechanistic fashion – the effects of changes in interest rates, say, on real investment. While such considerations are, of course, important, it misses a whole aspect of money, its role as an instrument of power. Or as Antonio Negri put it in one of his more lucid moments, “Money has but one face, that of the boss.”

Innocent money

Adam Smith, in recommending a legal ceiling on the rate of interest, observed that:

If the legal rate of interest in Great Britain, for example, was fixed so high as eight or ten percent, the greater part of the money which was to be lent would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people, who will give for the use of money no more than a part of what they are likely to make by the use of it, would not venture into the competition. A great part of the capital of the country would thus be kept out of the hands which were most likely to make a profitable and advantageous use of it, and thrown into those which were most likely to waste and destroy it.

This provides an interesting gloss on the junk bond era. Leave it to the ancient to be concerned more about the social good than the modern, who worries mainly about the mathematics of market clearance and the risk to creditors. Or, as David Ricardo put it:

Michael Perelman, who teaches economics at California State University at Chico, said that when he told Stiglitz about these classic prefigurations of his argument, Stiglitz reacted with surprise. To become a famous economist, you need not be familiar with the founding documents of your discipline.

Friedrich Hayek, drawing on European writers of the 1920s, the concept goes back to the beginning of modern economics in the mid-18th century David Hume famously said “it is of no manner of consequence … whether money be in greater or less quantity.” There are two other famous soundbite versions of the theory – one from John Stuart Mill, who said that “there cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money,” and the second from Irving Fisher, “money is a veil.” That’s probably Fisher’s second most famous statement, the first being his observation in August or September 1929 that stock prices had reached a permanently high plateau.

Keynes noted another fortunate side-effect of neutral money doctrine. The classical economists of the 18th and 19th centuries, said Keynes, wrote as if money didn’t exist, or, more precisely, existed only “as a neutral link between transactions in real things and real assets and does not allow it to enter into motives or decisions.” In such a world, the level of prices has no effect on production, consumption, or the willingness to lend or borrow. But, as Keynes pointed out, wages are “sticky,” meaning they don’t change as rapidly as commodity prices, and debt contracts are denominated in money terms, meaning that if prices fall, entrepreneurs will have trouble meeting their wage bills and servicing their debts. In classical doctrine, a fall in prices would be either neutral, since money prices don’t matter for real exchange, or to some eyes even stimulative, since a fall in prices could increase demand. The 1930s made such ideas disreputable. Conveniently, Keynes noted, in a world of neutral money, “crises do not occur” (emphasis in original). For someone writing in 1933, at the trough of depression, this “assumed away the very matter under investigation.”

A few years ago, Claudio Borio, an economist with the Bank for International Settlements, wrote:

 

Guilty money

bankrupt. So the goal of the financial managers was to find the ideal leverage point and stay there.

Michael Milken, used the theory to convince people that debt doesn’t hurt either, and thanks to tax deductibility, it really can make you better off. Here’s how Business Week characterized the popular influence of the MM theory, just after a wave of high-profile leveraged buyouts went bad in the summer of 1989:

Euromoney argued that the $200-400 billion in recent corporate restructurings were not enough – that work had only just begun, and that a quasi-Trotskyist doctrine of permanent restructuring was well advised by “the rise of modern corporate finance theory.” Work that had originally said that capital structure didn’t matter had spawned an industry, or at least an apology for that industry, based on the perpetual rejiggering of those structures.

Dizzy money

Hamptons beachhouses goes back into the markets, to buy more stocks and bonds, and assert ever-more financial claims.

Of course, some individual corporations do raise money on the stock market, but surprisingly little of the proceeds go to real investment. Typically, the money raised in initial public offerings goes to cash out founding investors rather than to fund an investment program.

Money’s secret

Kohlberg Kravis Roberts started doing its earliest leveraged buyouts. At first, they were quite prudent, at least on their own terms, with smallish firms as the targets, and involving reasonable amounts of leverage and reasonable purchase prices. As the decade wore on, the deals became bigger, more expensive, more grandios, and less focused. But in all cases, the idea was that financiers and a new management team – with a tight owner-manager circle taking the place of the conventional public firm – could do a better job than entrenched pre-existing managers. Debt would act as a great incentive to pare costs. Slimmed-down firms with a new lease on life would then be offered to the public again, at great profit to the leverage artists.

Calpers) would become the avatar of the shareholder revolution. That revolution’s most dramatic effect was the wave of corporate downsizings that characterized the headlines for the first half of the 1990s – downsizings that were typically blamed on abstract forces like “globalization” and “technology,” rather than the preferences of portfolio managers. Though Calpers worked mainly with short lists of underperforming firms, the message wasn’t lost on other managers. By 1993, it was clear that the quickest way to add 5 points to your stock price was to lay off 50,000 workers.

 

Money and state

While easy access to commercial bank loans in the 1970s and early 1980s allowed countries some freedom in designing their economic policies (much of it misused, some of it not), the outbreak of the debt crisis in 1982 changed everything. In the words of Jerome I. Levinson, a former official of the Inter-American Development Bank:

International Finance Corporation, the World Bank’s private sector arm. “The debt crisis could be seen as a blessing in disguise,” he said, though admittedly the disguise “was a heavy one.” It forced the end to “bankrupt” strategies like import substitution and protectionism, which hoped, by restricting imports, to nurture the development of domestic industries. “Much of the private capital that is once again flowing to Latin America is capital invested abroad during the run-up to the debt crisis. As much as 40-50 cents of ever dollar borrowed during the 1970s and early 1980s…may have been invested abroad. This money is now coming back on a significant scale, especially in Mexico and Argentina.” In other words, much of the borrowed money was skimmed by ruling elites, parked profitably in the Cayman Islands and Z urich, and Third World governments were left with the bill. When the policy environment changed, some of the money came back home – often to buy newly privatized state assets for a song.

The American model

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