Wall Street

WAII STPEET
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WAII STPEET
Hu 1I W::
uuu J: WIu
DOUG HENWOOD
lirst pullishoJ ly Vorso 199
This paporlack oJition 1998
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This Acrolat lilo can lo circulatoJ lrooly lor non-commorcial uso. lt may not lo altoroJ,
anJ tho author must lo iJontilioJ anJ croJitoJ.
DosignoJ anJ typosot ly IBO Graphics, Nov \ork
TI~ c:~u:I :):I~u, uI:cI Iu: :I: JcuI j:uI :u II~ uII~~uI) uuI:uuI
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u~ ~u:uu: c~uI:uI:zuI:u uuu ::~: II:: cIu:: J ju:u::I~: u JuIuIu:
ju~: uI uI) I u~c:uuI~ II~ :uuu:I::uI cuj:IuI::I: j~::u:cuII) IuI
uI: I :uI~:J~:~ :u ucIuuI j:uucI:u :u II~ u:I uuu~:u: uuuu~:-
uuu II:: c:~u uu uII:u J j:uucI:u uuu Iu:~ uII:u uI uII I
u u:II :I
- Varx, uj:IuI, vol. 3, chap. 33
1u uI u ju:u::I~ 1u uu invostor
- Iyonya Gululkov, JoscriloJ ly tho N~u : T:u~: as a lumlling
Pussian Evoryman` rosponJing to Soviot-stylo` taunts in an aJ lor tho
lrauJulont VVV invostmont schomo vhich collapsoJ in 1994
Contents
AcknovloJgmonts ix
lntroJuction 1
1 lnstrumonts 10
2 Playors 56
3 Ensomllo 118
4 Varkot moJols 13
5 PonogaJos 18
6 Govornanco 246
What is (not) to lo Jono? 301
ApponJix 323
Billiography 333
lnJox 35
Acknowledgments
Though ono namo usually appoars on tho covor, a look is a lar moro
collalorativo projoct than that. l`vo onjoyoJ splonJiJ rosoarch assistanco
lrom (in chronological orJor) Vichaol Tromonto, vho gathoroJ most ol
tho matorial lounJ in tho lilliography: Kim Phillips: Iisa Wostlorg: Josh
Vason, vho assomlloJ lots ol last-minuto articlos anJ numlors: AJria
Scharl: anJ Shana Siogol. Thanks to Joan Bratton lor roaJing tho prools.
Thanks too to all tho sourcos, namoJ anJ unnamoJ. lor all tho laults ol
Amorican socioty, l`vo long loon amazoJ at its oponnoss: loth pullic-
anJ privato-soctor sourcos aro almost alvays happy to holp an author out.
Thanks as voll to my cylor-colloaguos in tvo computor notvorks, tho
Progrossivo Economists Notvork anJ Post-Koynosian Thought (lor inlor-
mation on loth, visit http:csl.coloraJo.oJu), anJ to my roal-lilo lrionJs
Patrick BonJ, Bol litch, Dan Iazaro, John Iiscio, Bol Pollin, anJ Grogg
Wirth. Doop oxprossions ol gratituJo aro also Juo to throo oJitors: Bon
Sonnonlorg ol :uuu I:~~I anJ Victor Navasky ol TI~ NuI:u, vho gavo
mo a pullic lorum vhon my novslottor vas young anJ littlo moro than a
vanity oporation, anJ Colin Polinson ol Vorso, vho not only olloroJ mo a
look contract vhon l vas ovon moro olscuro than l am nov, lut vho
also put up vith my onJloss Jolays in gotting this thing Jono.
Thanks, along vith lovo, to my paronts, HarolJ anJ Victorino HonvooJ,
lor a lilotimo ol support ol ovory kinJ, anJ to Christino Bratton, my com-
panion anJ partnor in lilo anJ in many aspocts ol vork as voll. Chris has
not only spont a JocaJo roaJing anJ improving my proso, lut sho put up
vith mo as l vroto this look. lor yoars, l thought that authors` oxpros-
sions ol gratituJo lor inJulgonco lrom intimatos voro moro loilorplato,
lut vhon l think lack on vhat a cranky, prooccupioJ monstor l vas lor
noarly six yoars (not to montion tho lriol paporlack rolapso), l nov roal-
izo just hov Jooply lolt thoy voro. l`ll say onco again that lilo voulJ lo
unimaginallo vithout hor.
i
1
lntroduction
lt`s raro that somoono shoulJ Jovolop an olsossion vith Wall Stroot vith-
out sharing its Jriving passion, tho accumulation ol monoy. lt voulJ prol-
ally tako yoars ol psychoanalysis to untanglo that contraJiction, not to
montion othors too sonsitivo to namo horo.
No Joult that contraJictory olsossion has oarly roots, lut its most po-
tont aJult inlluonco vas prolally my lirst jol out ol collogo, at a small
lrokorago lirm in Jovntovn Vanhattan. Tho lirm haJ loon startoJ ly a
lormor Boll Ials physicist, vho vantoJ to uso his ouantitativo skills to
analyzo anJ traJo a thon-nov instrumont knovn as listoJ options. Tho
rolugoo physicist vas consiJorally ahoaJ ol his timo: lov pooplo unJor-
stooJ options in 195, anJ lovor still voro intorostoJ in using tho kinJs ol
high-toch traJing stratogios that voulJ lator svoop Wall Stroot.
Vy titlo vas socrotary to tho chairman, vhich moant not only that l
typoJ his lottors, lut also that l got his lunch anJ vont out to luy him nov
socks vhon ho`J lolt his olJ onos in a massago parlor. AnJ l stuJioJ tho
placo liko an anthropologist, alsorling tho montality anJ culturo ol monoy.
lt vas lascinating in its ovn vay, lut it also struck mo as uttorly cynical
anJ ompty, a prolounJ vasto ol human ollort.
Ono morning, riJing tho olovator up to vork, l noticoJ a cop stanJing
noxt to mo, a gun on his hip. l roalizoJ in an instant that all tho sophisti-
catoJ machinations that vont on upstairs anJ arounJ tho vholo Wall Stroot
noighlorhooJ rostoJ ultimatoly on lorco. linancial povor, too, grovs out
ol tho larrol ol a gun. Ol courso a sorious analysis ol tho political oconomy
ol linanco has to Jolvo into all thoso sophisticatoJ machinations, lut tho
imago ol that gun shoulJ lo kopt lirmly in minJ.
On vhat is loosoly calloJ tho lolt, such as it is thoso Jays, tvo unhappy
attituJos tovarJs moJorn linanco provail - ono, tho ovorything`s-changoJ-
WALL STREET
2
anJ-capital-no-longor-mattors school, anJ tvo, a stanco ol uninlormoJ
conJomnation. An oxamplo ol tho lirst is this silly lut roprosontativo orup-
tion lrom Joan BauJrillarJ (1993, pp. 10-11, 33):
Varx simply JiJ not lorosoo that it voulJ lo possillo lor capital, in tho laco
ol tho imminont throat to its oxistonco, to transpoliticizo itsoll, as it voro: to
launch itsoll into an orlit loyonJ tho rolations ol proJuction anJ political
contraJictions, to mako itsoll autonomous in a lroo-lloating, ocstatic anJ
haphazarJ lorm, anJ thus to totalizo tho vorlJ in its ovn imago. Capital (il
it may still lo so calloJ) has larroJ tho vay ol political oconomy anJ tho
lav ol valuo: it is in this sonso that it has succosslully oscapoJ its ovn onJ.
HoncolorvarJ it can lunction inJoponJontly ol its ovn lormor aims, anJ
alsolutoly vithout roloronco to any aims vhatsoovor.. Vonoy is nov tho
only gonuino artilicial satollito. A puro artilact, it onjoys a truly astral molil-
ity: anJ it is instantly convortillo. Vonoy has nov lounJ its propor placo, a
placo lar moro vonJrous than tho stock oxchango: tho orlit in vhich it
risos anJ sots liko somo artilicial sun.
This isn`t that surprising lrom a vritor vho can Joclaro tho Gull War a
moJia ovont. But it Jisplays an unJorstanJing ol linanco apparontly Jo-
rivoJ lrom capital`s ovn pullicists, liko Goorgo GilJor, vho cololrato tho
olsolosconco ol mattor anJ tho transconJonco ol all tho olJ hostilo rola-
tions ol proJuction. Cylortopians anJ othor immatorialists aro lost in a
soconJ- or ovon thirJ-orJor lotishism, unallo to JocoJo tho rolations ol
povor lohinJ tho JisomloJioJ ocstasios ol computorizoJ traJing.
AnJ, on tho othor hanJ, loltios ol all sorts - liloral, populist, anJ so-
cialist - vho havon`t succumloJ to vulgar postmoJornism havo contin-
uoJ tho long traJition ol loating up on linanco, Jonouncing it as a stinkpot
ol parasitism, irrolovanco, malignancy, anJ corruption, vithout proviJing
much Jotail loyonJ that. Vany critics Jonounco spoculation` as a vasto
ol social rosourcos, vithout making any connoctions lotvoon it anJ tho
supposoJly moro lunJamontal vorlJ ol proJuction.` Sociologists vho
stuJy povor structuros vrito portontously ol tho lanks,` lut thoir ovi-
Jonco is olton vaguo anJ olsoloto (soo, lor oxamplo, Glaslorg 1989l, a
pioco vritton at tho onJ ol ono ol tho groat linancial manias ol all timo that
nonotholoss rolios hoavily on oviJonco lrom tho 190s). lt`s as il such pooplo
stoppoJ thinking anJ collocting oviJonco 20 or ovon 60 yoars ago.
This look is an attompt to got Jovn anJ Jirty vith hov moJorn Amori-
can linanco vorks anJ hov it`s connoctoJ to tho roal vorlJ. lt`s a systom
that sooms ovorvholming at timos - almost sullimo in its comploxity anJ
lNTRODUCTlON
3
povor, rominiscont ol lroJric Jamoson`s (1991, pp. 39-44) roaJing ol John
Portman`s Bonavonturo Hotol, at onco packoJ anJ ompty, a spatial ana-
loguo ol our Jisoriontation as suljocts in tho Jizzy vorlJ ol moJorn mul-
tinational capitalism. (lt sooms ospocially Jizzying as l vrito this in oarly
1998, vith tho U.S. stock markot at or noar its highost lovols ol valuation in
125 yoars, anJ tho lroaJ pullic tho most Jooply involvoJ it`s loon in
JocaJos, anJ maylo ovor.) As an antiJoto to that sonso ol Jisoriontation,
Jamoson suggostoJ tho nooJ lor cognitivo mapping,` critical oxpositions
ol that vortiginous vorlJ that rominJ us that Jospito its vast scopo, it is tho
proJuct ol human intolligonco anJ socioty, comprohonsillo vith a littlo
ollort, anJ maylo ovon translormallo vith a littlo moro.
ln a sounJlito, tho U.S. linancial systom porlorms Jismally at its aJvor-
tisoJ task, that ol olliciontly Jirocting socioty`s savings tovarJs thoir opti-
mal invostmont pursuits. Tho systom is stupolyingly oxponsivo, givos
torrillo signals lor tho allocation ol capital, anJ has surprisingly littlo to Jo
vith roal invostmont. Vost monoy managors can laroly match markot av-
oragos - anJ thoro`s oviJonco that activo traJing roJucos porlormanco
rathor than improving it - yot thoy still haul in lig loos, anJ thoir lrokors,
lig commissions (Iakonishok, Shloilor, anJ Vishny 1992). Ovor tho long
haul, almost all corporato capital oxponJituros aro intornally linancoJ,
through prolits anJ Joprociation allovancos. AnJ instoaJ ol promoting
invostmont, tho U.S. linancial systom sooms to Jo ouito tho opposito: U.S.
invostmont lovols rank tovarJs tho lottom ol tho lirst WorlJ (OECD) coun-
trios, anJ aro lolov vhat ovon ouito orthoJox oconomists - liko Darrol
Cohon, Kovin Hassott, anJ Jim KonnoJy (1995) ol tho loJoral Posorvo -
torm optimal` lovols. R~uI invostmont, not luying sharos in a mutual lunJ.
Tako, lor oxamplo, tho stock markot, vhich is prolally tho contorpioco
ol tho vholo ontorpriso.
1
What Joos it Jo? Both civilians anJ prolossional
apologists voulJ prolally ansvor ly saying that it raisos capital lor in-
vostmont. ln lact it Joosn`t. Botvoon 1981 anJ 199, U.S. nonlinancial
corporations rotiroJ $813 lillion moro in stock than thoy issuoJ, thanks to
takoovors anJ luylacks. Ol courso, somo inJiviJual lirms JiJ issuo stock
to raiso monoy, lut surprisingly littlo ol that vont to invostmont oithor. A
WuII I:~~I {u:uuI articlo on 1996`s Jizzying paco ol stock issuanco
(VcGoohan 1996) namoJ ovorsoas privatizations (somo ol vhich, liko
Doutscho Tolokom, spilloJ into U.S. markots) anJ tho continuing rostruc-
turing ol U.S. corporations` as tho Jriving lorcos lohinJ tho torront ol
nov papor. ln othor vorJs, ovon tho nov-issuos markot has moro to Jo
vith tho arrangomont anJ roarrangomont ol ovnorship pattorns than it
WALL STREET
4
Joos vith raising lrosh capital - a point l`ll roturn to throughout this look.
But most ol tho traJing in tho stock markot is ol oxisting sharos, not
novly issuoJ onos. Nov issuos in 199 totaloJ $100 lillion, a rocorJ -
lut that`s alout a vook`s traJing volumo on tho Nov \ork Stock Exchango.
2
Ono thing tho linancial markots Jo vory voll, hovovor, is concontrato
voalth. Govornmont Jolt, lor oxamplo, can lo thought ol as a moans lor
upvarJ roJistrilution ol incomo, lrom orJinary taxpayors to rich lonJ-
holJors. lnstoaJ ol taxing rich pooplo, govornmonts lorrov lrom thom,
anJ pay thom intorost lor tho privilogo. Consumor croJit also onrichos tho
rich: pooplo sulloring stagnant vagos vho uso tho VlSA carJ to mako
onJs moot only latton tho vallots ol thoir croJitors vith oach monthly
paymont. Nonlinancial corporations pay thoir stockholJors lillions in an-
nual JiviJonJs rathor than roinvosting thom in tho lusinoss. lt`s no von-
Jor, thon, that voalth has congoaloJ so spoctacularly at tho top. Chaptor 2
ollors JotailoJ numlors: lor tho purposos ol this introJuction, hovovor, a
couplo ol goo-vhiz lactoiJs vill Jo. Ioaving asiJo tho principal rosiJonco,
tho richost
1
2/ ol tho U.S. population claims a largor sharo ol national
voalth than tho lottom 90/, anJ tho richost 10/ account lor ovor throo-
ouartors ol tho total. AnJ vith that voalth comos oxtraorJinary social povor
- tho povor to luy politicians, punJits, anJ prolossors, anJ to Jictato
loth pullic anJ corporato policy.
That povor, tho suljoct ol Chaptor 6, is somothing oconomists olton
ignoro. With tho vast incroaso ol govornmont Jolt sinco tho Poagan ox-
porimont logan has como an incroasing political povor ol tho markots,`
vhich typically moans cuts in social programs in tho namo ol liscal pro-
lity. Ioss visilly, tho incroasoJ prominonco ol institutional invostors, par-
ticularly ponsion lunJs, in tho stock markot has incroasoJ rontior povor
ovor corporato policy. Though glolalization anJ tochnology havo gotton
most ol tho llamo lor tho rocont vavo ol Jovnsizings, tho primo culprits
aro roally portlolio managors JomanJing highor stock pricos - a JomanJ
that translatos into layolls anJ invostmont cutlacks. This grovth in stock-
holJor inlluonco has como Jospito tho lact that outsiJo sharoholJors sorvo
no usolul social purposo: thoy traJo on omotion anJ porcoptions ol omo-
tion, anJ knov nothing ol tho lusinossos vhoso managomont thoy`ro in-
croasingly Jirocting. Thoy`ro valking argumonts lor vorkor ovnorship.
This look concontratos almost ontiroly on Amorican markots. That`s not
only lor roasons ol tho author`s nationality, lut also locauso tho U.S. (anJ
British) linancial systom, vith tho contral rolo it accorJs to loosoly rogu-
lNTRODUCTlON
5
latoJ stock anJ lonJ markots, has loon sproaJing arounJ tho glolo. Honry
Kaulman (1994) calloJ this tho Amoricanization` ol glolal linanco.` Tho
WorlJ Bank anJ its comraJos in tho Jovolopmont ostallishmont havo urgoJ
a stock-markot-Jrivon moJol ol linanco anJ corporato control on its cliont
countrios in tho ThirJ WorlJ anJ tho lormor socialist vorlJ, anJ tho En-
glish-languago lusinoss pross is lull ol storios on hov tho Gormans anJ
Japanoso aro coming to thoir sonsos, or havo to il thoy knov vhat`s gooJ
lor thom, anJ junk thoir stoJgy olJ rogulatoJ, lank-contoroJ systoms lor a
Wall StrootCity ol IonJon moJol. AnJ all oviJonco is that thoy aro, though
novor ouickly onough lor tho oJitorialists.
Also, tho intornational linancial markots, vhich Japanoso anJ Gorman
invostors participato in, rosomllo tho Anglo-Saxon systom in all thoir looso-
noss anJ spooJ. linally, tho stock markot has locomo a kinJ ol oconomic
iJoal in tho minJs ol nooliloral rolormors ovoryvhoro: ovory markot,
vhothor lor airlino tickots or human lalor, has loon or is loing rostruc-
turoJ to rosomllo tho constantly lluiJ vorlJ ol Wall Stroot, in vhich pricos
lloat lrooly anJ arrangomonts aro as impormanont as possillo. lor thoso
roasons, a stuJy ol tho U.S. linancial markots, particularly tho stock mar-
kot, coulJ lo ol intorost to an auJionco loyonJ thoso spocilically curious
alout tho Amorican vay ol linancial lilo.
This look inhalits a strango vorlJ lotvoon journalism anJ scholar-
ship: tho lirst throo chaptors in particular look at tho ompirical roalitios ol
tho linancial markots - tho instrumonts traJoJ anJ tho agonts Joing tho
traJing - anJ thon tho lourth anJ lilth chaptors look at somo ol tho things
oconomists havo saiJ alout linanco ovor tho past tvo conturios. l hopo
that l`vo managoJ to lring tho tvo normally soparato vorlJs togothor in
an illuminating vay, lut ol courso tho risk is that l`ll only succooJ at alion-
ating loth tho popular anJ tho acaJomic auJionco. lt`s vorth tho risk.
Vost linancial journalism is innocont ol any thoorotical anJ historical por-
spoctivo, anJ acaJomic vork - mainstroam anJ raJical - is olton inJil-
loront to Jaily practico.
l must conloss that l am not a trainoJ` oconomist. lor somoono not
initiatoJ into tho priosthooJ, sovoral yoars spont oxploring tho prolossional
litoraturo can lo a traumatic oxporionco. Ono ol tho linost glossos on that
oxporionco camo long ago lrom, ol all pooplo, H.I. Vonckon, in his ossay
Tho Dismal Scionco`: Tho amatour ol such things must lo contont to
vrostlo vith tho prolossors, sooking tho violot ol human intorost lonoath
tho avalancho ol thoir gracoloss parts ol spooch. A harJ lusinoss, l Jarosay,
to ono not practicoJ, anJ to its harJnoss thoro is aJJoJ tho Jisouiot ol a
WALL STREET
6
Joult.` That Joult, Vonckon vroto - altor concoJing that in things oco-
nomic ho vas alout as orthoJox as thoy como - vas inspiroJ ly tho lact
that tho Jisciplino
hits tho omployors ol tho prolossors vhoro thoy livo. lt Joals, not vith iJoas
that alloct thoso omployors only occasionally or only inJiroctly or only as
iJoas, lut vith iJoas that havo an imminont anJ continuous inlluonco upon
thoir porsonal vollaro anJ socurity, anJ that alloct prolounJly tho vory loun-
Jations ol that social anJ oconomic structuro upon vhich thoir vholo oxist-
onco is lasoJ. lt is, in lriol, tho scionco ol tho vays anJ moans vhoroly
thoy havo como to such ostato, anJ maintain thomsolvos in such ostato, that
thoy aro allo to hiro anJ loss prolossors.
Apostatos, Vonckon arguoJ, voro lar moro unvolcomo in tho liolJ than in
othors ol loss matorial consoouonco (liko, say, litorary stuJios).
Thoro aro lov sulspocialtios ol oconomics vhoro this is truor than in
linanco. Tho lulk ol tho linanco litoraturo consists ol painlully lino-grainoJ
stuJios JosignoJ lor tho ovnors anJ managors ol monoy capital. lmpor-
tant mattors, liko vhothor tho linancial markots sorvo thoir aJvortisoJ pur-
poso ol allocating social capital olloctivoly, aro stuJioJ vith an inlroouoncy
surprising only to somoono unlamiliar vith Vonckon`s Iav.
But tho violot ol intorosts is no longor hiJJon lohinJ gracoloss parts ol
spooch alono: mathomatics is nov tho prolorroJ Jisguiso. Tho Jismal sci-
onco nov llattors itsoll vith Jolusions ol rigor - an olalorato statistical
apparatus luilt on tho voakost ol lounJations, isolatoJ lrom tho othor
social scioncos, not to montion tho lroaJor culturo, anJ totally JoaJ to tho
asking ol any lunJamontal ouostions alout tho goals ol oithor tho Jisci-
plino or tho organization ol oconomic lilo itsoll.
l Jo ask, anJ l hopo ansvor, lots ol thoso Jillicult ouostions, lut l also
vant to tako on tho Jismal sciontists on thoir ovn torms. lor many non-
spocialist roaJors, this may soom liko hoavy going. l`vo trioJ, vhorovor
possillo, to isolato tho hoavily tochnical lits anJ plastor appropriatoly cau-
tionary hoaJlinos on tho Jangorous soctions. But too much vriting thoso
Jays, anJ not only on tho lolt, consists ol anocJoto, narrativo, moralizing,
anJ oxhortation. Evon though loth tho linancial markots anJ tho Jisci-
plino ol oconomics havo ponotratoJ so Jooply anJ lroaJly into much ol
social lilo, thoso institutions romain largoly immuno to critical oxamina-
tion. Tho noxt 300 pagos unJortako that oxamination, anJ porhaps in moro
Jotail than somo roaJors might liko, lut l Jon`t ovor vant to loso sight ol
this simplo lact: lohinJ tho alstraction knovn as tho markots` lurks a sot
lNTRODUCTlON
7
ol institutions JosignoJ to maximizo tho voalth anJ povor ol tho most
privilogoJ group ol pooplo in tho vorlJ, tho croJitor-rontior class ol tho
lirst WorlJ anJ thoir junior partnors in tho ThirJ.
l`vo committoJ at loast tvo commorcial sins in vriting this look -
ono, tho omission ol practical invostmont aJvico, anJ tvo, going lightly
on scanJal-mongoring anJ naming ol rotton applos. As ponanco lor tho
lirst, l`ll ollor this lit ol aJvico: lorgot alout loating tho markot: it can lo
Jono, lut thoso vho can Jo it aro raro. AnJ lor tho soconJ: pointing to
rotton applos implios that tho rost ol tho larrol is puro anJ rolroshing. Vy
point is that tho ontiro latch ol applos is protty poor nourishmont. By this
l Jon`t moan to imply that ovoryono vho vorks in linanco is Jovious,
corrupt, or moroly rapacious. Thoro aro many lino pooplo vho unJor-
vrito, analyzo, traJo, anJ soll socuritios: somo ol thom aro my lrionJs anJ
noighlors. Thoir porsonal charactoristics havo nothing to Jo vith vhat
lollovs. That`s tho point ol a systomic analysis - to tako apart tho institu-
tions that aro largor than tho porsonalitios vho inhalit thom.
Botvoon tho pullication ol tho harJcovor oJition ol this look anJ tho
paporlack, tho U.S. stock markot roso almost vithout intorruption, to truly
oxtraorJinary lovols ol valuation, tho highost sinco moJorn rocorJs login
in 181. ln tho past, high valuations havo loon associatoJ vith nasty sul-
soouont Joclinos, lut it`s alvays possillo this is a nov ora, a Nirvana ol
capital, in vhich tho olJ rulos Jon`t apply. ll Social Socurity is privatizoJ,
it coulJ constituto an ollicial stock prico support mochanism.
HousoholJs - prosumally mostly in tho uppor hall ol tho incomo Jis-
trilution - plungoJ into stocks (through tho moJium ol mutual lunJs) in
a vay not soon in 30, or maylo 0, yoars. At tho samo timo, housoholJs -
prosumally pooror onos than tho mutual lunJ luyors - havo also contin-
uoJ to go Joopor into Jolt, anJ vith rocorJ Jolt lovols matchoJ ly rocorJ
lankruptcy lilings. Tho moro a socioty polarizos, tho moro pooplo on tho
lottom lorrov lrom thoso on tho top.
Whon l startoJ this look, tho prostigo ol Anglo-Amorican stock-markot-
contoroJ capitalism vas a lot lovor than it vas vhon l linishoJ it. l say a
lov kinJ things alout Japanoso anJ Gormanic systoms ol corporato linanco,
ovnorship, anJ govornanco that voulJ havo loon takon as somi-
rospoctallo in 1992. ln 1998, it is Jooply against tho grain (though not as
against tho grain as saying kinJ things alout Varx). But l`ll stick to my
position. Tho stagnation ol Europo has a lot loss to Jo vith rigiJ structuros
anJ pamporoJ citizons than it Joos vith liscal anJ monotary austority
JictatoJ ly tho Vaastricht projoct ol unilication. To llamo Japan`s prolloms
WALL STREET
8
on ovorrogulation is to ignoro that tho 1980s lulllo vas tho proJuct ol
Jorogulation anJ a spoculativo mania. lsn`t onthusiasm alout tho Amorican
Way in 1998 a lit rominiscont ol that alout Japan ton yoars oarlior?
Coming altor Japan`s oxtonJoJ slump, tho collapso ol tho Southoast
Asian oconomios in 199 vas a groat loostor shot lor Amorican
triumphalism. Ouickly lorgotting tho oxtraorJinary grovth porlormanco
that loJ up to it - vhich, togothor vith Japan`s is vithout procoJont in
tho history ol capitalism, sustainoJ ratos ol grovth tvo to throo timos vhat
Britain anJ tho U.S. oxporioncoJ Juring thoir riso to voalth - Alan
Groonspan, oJitorialists, anJ prolossors ol oconomics havo pronouncoJ
this tho linal vorJ on oconomic policy.
lt`s not cloar vhy tho voakost U.S. oxpansion in JocaJos shoulJ lo
takon as vinJication ol tho Amorican Way. Grovth lotvoon tho rocossion`s
trough in 1991 anJ tho last ouartor ol 199 vas tho slovost ol any post-
WorlJ War ll lusinoss cyclo. Dospito tho mighty stock markot, invostmont
lovols aro only miJJling, anJ proJuctivity grovth, moJost. lrom tho hypo,
you`J also think tho U.S. vas loaving its major rivals in tho Just, lut com-
parisons ol por capita GDP grovth ratos Jon`t loar this out. At tho onJ ol
199, tho U.S. vas tioJ vith lranco at soconJ in tho grovth loaguo, lo-
hinJ CanaJa, anJ just tonths ol a point ahoaJ ol tho major Europoan coun-
trios. Stop lack a lit, anJ tho U.S. sags laJly. lor tho 1989-95 porioJ,
vhon tho U.S. vas stuck in a croJit crunch anJ a sputtoring rocovory, it
vas at tho lottom ol tho G grovth loaguo, along vith CanaJa anJ tho
U.K. Botvoon 199 anJ 1988, thoro`s no contost, vith tho U.S. tying lranco
lor tho vorst numlors in tho G-. Comparisons vith tho pro-crisis Asian
tigors aro harJly vorth making.
lt may lo as capitalisms maturo, linancial surplusos lroak tho lounJs
ol rogulatoJ systoms, anJ lorco an Amorican-stylo loosoning ol tho lonJs.
So all thoso ouostions ol comparativo capitalisms may lo acaJomic: it may
lo tho Jostiny ol Japan anJ Wostorn Europo to locomo moro liko tho U.S.
Cortainly that`s ono ol tho likoly ollocts ol Europoan monotary union. But
il that`s tho caso, thon tho Jolato shoulJn`t turn on vhat vorks lottor` in
somo sort ol onginooring sonso.
AnJ moving loyonJ this tochnocratic torrain, to say a U.S.-stylo systom
vorks lottor` Joosn`t say vhat it`s lottor at. Tho Novomlor 22, 199,
issuo ol tho 1:uuuc:uI T:u~: haJ throo storios alovo its lolJ: tvo on tho
crisos in Asia, anJ ono hoaJlinoJ Polorm may push US poor into soua-
lor.` AccorJing to tho last, a survoy ly tho U.S. Conloronco ol Vayors
roportoJ that hugo numlors` ol poor Amoricans coulJ laco uttor ruin
lNTRODUCTlON
9
vhon vollaro rolorm` takos lull olloct in 1999. That prospoct, suroly a
social Jisastor ol groat magnituJo, is not JolinoJ ly ollicial loxicographors
as oithor a Jisgraco or a crisis.
Tho plannoJ immisoration ol tho Amorican poor has a lot to Jo vith
tho suljoct ol this look. U.S. linancial anJ ovnorship rolations, vhich aro
lragmontoJ, alstract, anJ manic, soom Jooply connoctoJ to othor social
mochanisms - partly as causos, partly as ollocts - that mako this such a
voracious, atomizoJ, polarizoJ, turlulont, olton violont culturo, ono that
insists oach ol us lo in compotition vith ovory othor. ll this is succoss,
thon tho U.S. moJol is a groat succoss. lt may ovon lo partly Juplicallo in
countrios intorostoJ in a lrosh lilostylo stratogy.
Altor sovoral hunJroJ pagos ol Jiagnosis, roaJors havo a right to ox-
poct a proscription lor curo at tho onJ. l`vo trioJ to lullill that, lut tho linal
chaptor is short anJ mainly suggostivo. l coulJ got high-minJoJ anJ say
that tho roason lor that is that a translormativo agonJa is vorth a look in
itsoll, vhich is truo onough. But anothor roason is that linancial rolorms
aro no oasy or isolatoJ mattor. Vonoy is at tho hoart ol vhat capitalism is
all alout, anJ rolorms in tho monotary sphoro alono von`t cut much ico. ll
you linJ tho hyportrophy ol linanco to lo appallingly vastolul anJ Jo-
structivo thon you`ro making a juJgmont on capitalism itsoll. That`s not
vory chic thoso Jays, lut il l thought that this cultural pathology voulJ
porsist lorovor, thon l voulJn`t havo vritton this look.
Doug HonvooJ
(JhonvooJ4panix.com)
Nov \ork, April 1998
tetual note .Iu:I uII II~ J:u:~: :u II:: ~u:I:u Iu:~ I~~u ujuuI~u
::uc~ II~ Iu:uc:~:. uu: ~.c~jI:u: u:~ II:~ u:~u J: :IIu:I:uI::~ ju:-
j:~: uI) .::u~ J:u c::~cI:u u J~u I)j: uuu ~:~:u: uuucI:-
u::u:, II~ I~.I :: uucIuu~u
notes
1. ln many vays, croJit markots aro moro important, lut thoy Jon`t onjoy tho samo atton-
tion lrom tho lroaJ pullic, nor Jo thoy inspiro tho samo lusts that stocks Jo.
2. Dospito tho prominonco ol tho stock markot, Jaily traJing volumo in U.S. Troasury
socuritios is ovor lour timos that ol tho N\SE - alout $225 lillion in loJoral papor in
oarly 1998, comparoJ vith $50 lillion in stocks.
10
! lnstruments
ln lolruary 1998, $1.4 trillion a Jay cr ossoJ tho viro connocting tho vorlJ`s
major lanks. That ligur o - vhich capturos most ol tho vorlJ`s linancial
action vith tho U.S. Jollar on at loast ono siJo ol tho traJo - vas a mor o
$600 lillion ar ounJ tho timo ol tho 198 stock markot crash. Altor that
inconsoouontial cataclysm, Jaily volumo r osumoJ its mighty riso, passing
$800 lillion in 1989, anJ $1 trillion in 1993 (Grant 1995, 1996). lt is a pr o-
Jigious numlor: an amount ooual to a yoar`s U.S. gr oss Jomostic proJuct
(GDP) tur ns ovor in a vook, anJ total vorlJ pr oJuct in alout a month.
Whoro Joos it all como lrom, anJ vhor o Joos it go? Opon tho WuII
I:~~I {u:uuI or tho lusinoss soction ol a major motropolitan Jaily, anJ
you got a cluo. Evory Jay, thoy pullish an ovorvholming array ol prico
ouotos - thousanJs upon thousanJs - lor stocks, lonJs, curroncios,
commoJitios, options, luturos, options on luturos, inJoxos, options on
inJoxos, mutual lunJs.. ll you ovn a hunJr oJ sharos ol lomoga, or you`ro
short vhoat lor April Jolivory, thon you havo no prollom JociJing vhat
thoy all moan - your monoy is at stako. But Jo all thoso pricos, vith acr os
ol typo anJ graphics JovotoJ to analyzing anJ charting thoir olton lo-
voroJ movomonts in loving Jotail, havo any moaning loyonJ tho narr ovly
morconary? ls tho movomont ol tho Dov, roportoJ in alout 30 soconJs on
ovory ovoning notvork novscast, ol intorost to anyono losiJos tho hall ol
tho population that ovns stocks, or tho 1/ ol tho population that ovns
thom in moaninglul ouantity? AnJ Jo thoso prico gyrations havo any r ola-
tion to tho othor novs roportoJ in tho papor or on TV - to tho lato ol
corporations, to tho roal stanJar J ol living, to our pullic livos?
liguring that out has to start vith a pictur o ol tho olomonts ol this linan-
cial univorso - tho instrumonts anJ institutions that construct tho claims
that pooplo mako on oach othor ovor timo anJ spaco. Thoso claims aro
JonominatoJ in monoy, tho stul l that oconomists stuJy, lut oconomists
lNSTRUMENTS
11
lorgot that monoy is a lorm ol social povor. Ono ol tho porsistont Jolu-
sions ol convontional thoory is that monoy is noutral,` a lulricant vith no
inlluonco ol its ovn, ono that mor oly simplilios transactions in an oconomy
lasoJ on tho oxchango ol gooJs.
1
ln a lartor oconomy, tho sollor ol vhoat
voulJ havo to linJ a porsonal luyor: in a monoy oconomy, tho vhoat-
holJor can soll lor monoy, anJ lot tho systom tako caro ol tho rost.
Vonoy is a richor phonomonon than that oxplanation allovs: it is ono
ol our lunJamontal principlos ol social or ganization. Ovnorship is r opro-
sontoJ through monotary claims, anJ tho oxchango ol thoso claims in tho
linancial markots amounts to tho social construction ol ovnorship.
Ovor tho last JocaJo or so, thoso markots` - usually convoniontly
rolorroJ to as an anonymous oxtor nal lor co, as porvasivo anJ inovitallo as
gravity - havo gr ovn onormously. lt`s a clicho ol tho Jaily pross that tho
markots ar o nov moro povorlul than govor nmonts, that tho Jaily votos
cast ly tho lonJ anJ curr oncy markots ar o moro important than oloctions,
logislatur os, anJ pullic luJgots. Tho clicho contains a partial truth: thoso
markots ar o tromonJously povorlul. But thoy ar o social institutions, in-
strumonts ol povor, that Jorivo thoir povor in part lr om tho sonso ol pov-
orloss avo thoy inspiro among non-initiatos. Say tho markots von`t liko`
a minimum vago incr oaso or a pullic jols program, anJ critical scrutiny
olton ovaporatos, liko vishos crushoJ ly tho unlrionJly voico ol GoJ.
Whilo moJorn linancial markots soom sullimoly complox, thoy`r o os-
sontially composoJ ol sovoral lasic instrumonts anJ institutional partici-
pants. Vost ol tho instrumonts, Jospito thoir apparont novolty, aro ouito
olJ, thoir ago moasur oJ lottor in conturios than JocaJos.
What ar o thoso markots, anJ vho populatos thom?
stocks
To many pooplo, tho stock markot is Wall Str oot, anJ tho Nov \ork Stock
Exchango (N\SE) is tho stock markot. A rocont oJition ol Paul Samuolson`s
varhorso oconomics toxt ovon JoscriloJ tho oxchango as tho hul` ol
capitalism, vith no lurthor oxplanation. Goography r oinlorcos this por-
coption: tho N\SE stanJs at tho intorsoction ol BroaJ anJ Wall, at tho spiri-
tual opicontor ol Vanhattan`s linancial Jistrict. But in lact, stock markot
traJing volumo is Jvar loJ ly traJing in lonJs anJ lor oign oxchango, anJ
tho N\SE itsoll accounts lor a Joclining shar o ol stock markot volumo.
Thoso moro lacts asiJo, thoro is somo justilication in giving tho stock
markot tho prominonco it onjoys in tho popular minJ. But ono notion that
WALL STREET
12
must lo ouickly JismissoJ is tho iJoa that tho markot raisos lots ol capital
lor roal invostmont.
2
Corporations typically soll lar go llocks ol stock vhon
thoy go lrom privato (a small cir clo ol lamily or othorviso tight ovnors) or
stato hanJs (in a privatization) to pullic` hanJs. lt goos vithout saying
that a vory narr ov sogmont ol tho pullic is involvoJ. AltorvarJs, pullic
lir ms rar oly issuo signilicant amounts ol stock, anJ nov llotations ar o lut
a llip in tho chart ol corporato cash llovs. Sinco tho oarly 1980s, thanks to
luyouts anJ luylacks, mor o stock vas rotiroJ than novly lloatoJ, trans-
actions that vor o mostly lunJoJ through hoavy lorroving.
But just locauso tho stock markot plays a vory minor r olo in raising
invostmont linanco Joosn`t moan it`s a siJoshov. Shar os ol stock ropro-
sont ovnorship claims on an oconomy`s roal proJuctivo assots, anJ claims
as voll to a portion ol tho prosont anJ lutur o prolits gonoratoJ ly thoso
assots. Though managors ol pullic corporations onjoy partial autonomy
- just hov much is a mattor ol Jisputo - thoy ar o tho hiroJ agonts ol tho
stockholJors, anJ ultimatoly ansvorallo to thom. ln momonts ol crisis,
stockholJors can intorvono Jiroctly in tho running ol thoir corporation: in
moro normal timos, ploasing invostors, vhich moans pushing up tho stock
prico, is a primo managorial concor n. lailur os to ploaso aro punishoJ ly a
chronically lov stock prico, a conJition that can lo an invitation to a tako-
ovor. ln mainstr oam thoory, this is hov tho markot Jisciplinos managors:
that it Joosn`t vork vory voll is ono ol tho thomos ol this look.
Stock comos in many llavors. Vost provalont - 98/ ol tho markot valuo
ol tho N\SE, almost all tho NasJao - is common stock. Common stock-
holJors havo tho last claim on a corporation`s incomo anJ assots: though
lir ms vill occasionally str otch to moot a JiviJonJ, JiviJonJs ar o normally
paiJ altor intor ost ovoJ to croJitors - making common stockholJors ro-
siJual claimants` in logal jar gon. Altor JoltholJors lut ahoaJ ol common
stockholJors aro holJors ol prolorroJ stock, vho must lo paiJ all Jivi-
JonJs Juo thom loloro ovnors ol tho common stock can got a ponny. ln
a lankruptcy, common stockholJors ar o olton vipoJ out: croJitors anJ
holJors ol tho prolorroJ got paiJ oll lirst. Common`s allur o is that il a
corporation Joos voll, croJitors anJ pr olorroJ stockholJors can lo oasily
satislioJ, anJ tho oxcoss juico all goos to tho stockholJors.
ToJay`s stock markots havo thoir roots, as Jo many institutions ol moJorn
linanco, in moJioval ltaly, though unliko tho moro sophisticatoJ oarly ltalian
linancial institutions, thoir oarly stock markots vor o protty ruJimontary.
lNSTRUMENTS
13
VoJorn vorsions took shapo lirst in AmstorJam in tho 1th contury anJ
thon in IonJon in tho 18th, vith tho gr ovth ol govornmont Jolt anJ cor -
porato sharos. lroo-markot iJoology to tho contrary, tho rolo ol govorn-
mont Jolt in tho Jovolopmont ol linanco can`t lo oxaggoratoJ: vhilo
Amorican practico tr oats stock anJ govornmont lonJ markots as loing as
Jistinct as chur ch anJ stato, in Britain, vhor o church anJ stato ar on`t so
soparato oithor, pooplo still call pullic Jolt cortilicatos govornmont stock.
ln tho oarly 1th contury, tho Dutch anJ English East lnJia Companios
issuoJ sharos to tho pullic to lunJ thoir oarly imporial ontorprisos (an-
othor stato link to tho Jovolopmont ol linanco): in roturn, invostors voro
grantoJ a shar o ol tho prolits in tho lorm ol JiviJonJs. But sinco tho invos-
tors JiJn`t vant to voJ thomsolvos irrovocally to thoso companios vith-
out any possilility ol Jivorco, tho sharo cortilicatos voro maJo lr ooly
translorallo. As P.C. Vichio (1992) puts it, vhat vas loing ostallishoJ
voro markots to claims to lutur o incomo` - lictitious capital, in Varx`s
lamous phraso: not r oal capital, lut claims on capital. This onallos a vholo
class to ovn an oconomy`s proJuctivo assots, rathor than loing lounJ to
a spocilic proporty as thoy onco voro.
Tho translormation ol a lutur o stroam ol JiviJonJ or intor ost paymonts
into an oasily traJoallo capital assot is tho lounJing principlo ol all linan-
cial markots. Whilo tho lutur o paymont stroam ol a lonJ is usually lixoJ,
anJ larring Jolault lairly cortain, JiviJonJs anJ tho pr olits on vhich thoy
ar o lasoJ aro lar goly unproJictallo. ln most casos, thoy can lo oxpoctoJ
to grov ovor timo vith tho rost ol tho oconomy, lut not alvays. liguring
out tho likolihooJ anJ spooJ ol that grovth is vhat much ol tho stock
gamo is all alout.
AmstorJam`s oarly markot vas ouito loosoly organizoJ: lr okors anJ
thoir clionts simply congrogatoJ ar ounJ tho pillars ol tho oxchango luilJ-
ing anJ JiJ Joals. Thor o vas no lormal or ganization JosignoJ to polico
conJuct anJ ol lor somo guarantoo against Jolault until 18. Tho lirst lor -
mally or ganizoJ oxchango vas ostallishoJ in Paris in 124. Tho r ovolu-
tion, hovovor, so JisturloJ traJing - var isn`t alvays gooJ lor lusinoss
- that IonJon stoppoJ into tho lroach.
Tho oponing ol tho IonJon Stock Exchango in 1802 markoJ tho r oal
loginning ol r ocognizally moJorn stock oxchangos, vith rogular traJing
anJ a lixoJ, soll-r ogulating momlorship. Nov \ork`s stock oxchango vas
lounJoJ 10 yoars loloro IonJon`s (ly 24 lrokors mooting unJor a lutton-
vooJ troo at vhat is nov 68 Wall Str oot), lut tho Nov \ork markot voulJ
tako a lack soat to IonJon until lairly lato in tho 19th contury. Paris voulJ
WALL STREET
14
roturn to prominonco somo JocaJos lator as tho major oxchango lor traJ-
ing continontal Eur opoan sharos (not just lronch onos), lut it voulJ novor
again match IonJon as a linancial contor .
What govornmont Jolts anJ stato-liconsoJ monopolios voro to tho li-
nancial markots ol tho 18th contury, railr oaJ shar os anJ lonJs voro to tho
19th - claims on voalth that pr oliloratoJ vilJly anJ pr oviJoJ rich rav
matorial lor traJing. British railvay shar os grov lrom \48 million in 1848
to \1.3 lillion in 1913: ovor tho samo porioJ, U.S. railvay stocks gr ov
lrom $318 million to $19.8 lillion. Also ovor tho samo porioJ, tho IonJon
oxchango sav a tr omonJous incroaso in traJing ol lor oign shar os - a
rominJor that in spito ol toJay`s talk alout tho glolalization ol linanco,
linanco has long loon as transnational as politics anJ tochnology allovoJ.
VoJorn Amorican stock markots camo ol ago in tho lato 19th anJ oarly
20th conturios, simultanoously vith tho omor gonco ol moJorn corpora-
tions, vith JisporsoJ ovnors anJ prolossional managors. Tho stock mar-
kot vas contral to tho ostallishmont ol thoso nov institutions in tho lirst
placo, as small lir ms voro comlinoJ into giants, anJ it ouickly locamo
ossontial to sottling mattors ar ounJ thoir sulsoouont ovnorship. Iato 19th
contury promotors also thought ol tho markot as a vay to oaso tho lurJon
on smal l pr oJucors vho voro loi ng JisplacoJ or onvol opoJ ly
corporatization: moJost stock holJings voro a componsation lor tho loss
ol roal capital ovnorship (Iivingston 1986).
Altor WorlJ War l, thor o vas an attompt to r ostoro tho lorJorloss orJor
ol tho JocaJos loloro tho conllict, lut tho attompt novor roally took. Though
tho U.S. onjoyoJ a tromonJous loom Juring tho 1920s, Eur opo vasn`t so
lucky: Britain sul loroJ chronically high unomploymont, anJ Gor many vas
a vr ock. Whon tho U.S. loom onJoJ vith tho 1929 crash, anJ tho vorlJ
ontoroJ Joprossion, tho looso linancial markots ol tho 1920s voro inJictoJ
as primo suspocts. Vany Europoan markots voro shut or sharply rostrictoJ,
anJ tho Nov Doal lrought tho U.S. markot unJor tight r ogulation.
3
Stock markots anJ linancial gunslinging in gonoral r omainoJ unJor
hoavy suspicion until voll altor onJ ol WorlJ War ll: policy anJ halit con-
spiroJ to koop stock anJ othor linancial markots sloopy lor JocaJos. Nov
\ork Stock Exchango traJing volumo lor all ol 1950 totaloJ 525 million
shar os, ooual to alout tvo avorago Jays` traJing in 1993, anJ a vigor ous
Jay in 1996. By tho onJ ol tho 1950s, hovovor , tho markot vas loginning
to shako oll this torpor: volumo took oll in tho 1960s, platoauoJ in tho
190s, anJ thon oxploJoJ Juring tho 1980s (Nov \ork Stock Exchango
1994, pp. 100, 101).
lNSTRUMENTS
15
As this is vritton, stock markots in gonoral ar o onjoying a porioJ ol high
pricos anJ high pr ostigo, anJ not only in tho lirst WorlJ.
4
EncouragoJ ly
ollicial institutions liko tho WorlJ Bank anJ lntor national Vonotary lunJ
(lVl), Thir J WorlJ stock markots havo llourishoJ as tar gots lor lirst WorlJ
invostors, loroJ vith tho prospocts ol thoir ovn maturo homo markots.
Dospito thoir grovth in tho last JocaJo, thoy romain ouito small, hovovor,
anJ it Joosn`t tako much Northor n monoy to Jrivo up pricos ton- or a
hunJr oJ-lolJ - nor Joos it tako much to gonorato a panic oxit anJ a
stunning collapso in pricos.
Whilo just alout ovory country in tho vorlJ nov has a stock markot, thoir
sizo anJ importanco vary gr oatly. Ono oasy vay ol making this point is ly
grouping national linancial systoms into lank-contor oJ anJ stock-mar -
kot-contoroJ onos. ln tho lormor, stock markots tonJ to lo small in sizo
anJ importanco: not only Jo lanks, rathor than tho stock anJ lonJ mar -
kots, proviJo most corporato linanco, thoy ovn a groat Joal ol corporato
stock as voll. Gormany is tho classic oxamplo ol a lank-contor oJ systom,
vith a markot capitalization (moasur oJ rolativo to GDP) a ouartor tho lovol
ol tho U.S. anJ a lilth that ol tho U.K. Vost ol tho continontal Eur opoan
countrios tonJ tovar Js Gormanic lovols ol markot capitalization, vhilo
othor English-spoaking countrios tonJ tovarJ Anglo-Amorican onos.
With tho vavo ol lroo-markot rolorms` ol tho last 15 yoars has como a
tromonJous grovth in stock markots in vhat is altor natoly calloJ tho Jo-
voloping` or ThirJ WorlJ: in linancial jar gon, thoir stock markots aro usu-
ally calloJ tho omorging` markots (though at momonts liko tho 1994-95
Voxican crisis, vits call thom sulmor ging markots). On lalanco, tho
omorging` markots r omain ouito small, ovon altor all this gr ovth: in 1996,
tho markots lollovoJ ly tho lntornational linanco Corporation, tho W orlJ
Bank`s in-houso invostmont lank, accountoJ lor just 11/ ol vorlJ stock
markot capitalization, hall thoir 21/ shar o ol glolal GDP. Still, vithin that
group, thoro ar o consiJorallo variations, vith Chilo anJ South Alrica shov-
ing markot caps that voulJ put thom in tho Anglo-Amorican loaguo, anJ
China lar oly on tho raJar scr oon, at loast in 1996. \ ot Jospito tho rolativo
sizo ol somo ol thoso markots, thoy romain tiny on a vorlJ scalo: an inllux
ol vhat voulJ soom liko pockot chango to invostors in Nov \ork or Ion-
Jon coulJ oasily luy up tho ontiro Philippino or Argontino stock markot.
Tho small sizo, vhon comlinoJ vith tho limitoJ numlor ol stocks traJoJ,
mako tho omorging markots oxtraor Jinarily volatilo.
WALL STREET
16
stock market capitalization, 1996
percenl ol nillions ol percenl
CDP US$ ol world
emerging
alavsia 3!0 307,!79 !.5
Soulh Alrica !9! 24!,57! !.2
Taiwan !05 273,603 !.4
Philippines 96 30,649 0.4
Chile 39 65,940 0.3
Thailand 54 99,323 0.5
ndonesia 40 9!,!06 0.5
ndia 34 !22,605 0.6
exico 32 !06,540 0.5
Brazil 29 2!6,990 !.!
Korea 29 !33,3!7 0.7
Argenlina !5 44,769 0.2
China !4 !!3,755 0.6
deveIoped
Hong Kong 290 449,33! 2.2
Singapore !60 !50,2!5 0.7
U.K. !52 !,740,246 3.6
Swilzerland !37 402,!04 2.0
U.S. !!6 3,434,433 42.0
Sweden 99 247,2!7 !.2
elherlands 97 373,72! !.9
Canada 34 436,263 2.4
Auslralia 79 3!!,963 !.5
Japan 67 3,033,350 !5.3
Spain 42 242,779 !.2
France 33 59!,!23 2.9
Cernanv 29 670,997 3.3
lalv 2! 253,!60 !.3
totaIs
energing 37 2,225,957 !!.0
developed 3! !7,95!,705 39.0
world 72 20,!77,662 !00.0
The lerns energing and developed are in connon use,
lhough one could wrile a book on lhal choice ol words alone.
arkels shown accounled lor 36' ol energing narkels
and 93' ol developed narkels. Belween !994 and !996,
world narkel capilalizalion grew nore lhan lhree lines as
lasl as CDP (33' vs. !!'. Source: nlernalional Finance Cor
poralion,
lNSTRUMENTS
17
ln tho proJominantly English-spoaking countrios, stock markots ar o also
ossontial mochanisms lor r ogulating hov corporations ar o ovnoJ anJ run.
(This markot stylo is somotimos calloJ Anglo-Saxon, Jospito tho prosonco
ol many non-Anglo-Saxons in thoir populations. Anglo-Amorican is a loss
prollomatic lalol.) Noarly anyono vith sul liciont cash or cr oJit can ontor
tho opon markot anJ luy a contr olling intor ost in a pullicly traJoJ corpo-
ration.
5
ln Gormanic countrios, hovovor, controlling intor osts aro typically
in tho hanJs ol lar go lanks, anJ it`s practically impossillo lor lir ms to lo
lought anJ solJ on tho opon markot. With incr oasoJ loroign invostmont
ly Gorman lir ms, anJ thoir listings on lor oign stock oxchangos, thoir moJol
appoars to lo taking on a mor o Anglo-Saxon cast.
Japan has sliJ in tho rankings, lr om noar-Anglo-Amorican in its sizo, to
tho lovor thirJ ol tho tallo. Controlling intor osts aro typically holJ ly lanks
anJ closo lusinoss partnors liko suppliors anJ customors, making it noarly
impossillo lor uninvitoJ actors to luy up a Japanoso lir m.
ln tho U.S., stocks anJ othor socuritios aro traJoJ in tvo kinJs ol insti-
tutional onvir onmonts: organizoJ oxchangos anJ ovor -tho-countor (OTC).
ln oxchango traJing, or Jors to luy or soll aro transmittoJ lr om customors
to a contral traJing lloor vhich, Jospito computorization, is still populatoJ
ly spocializoJ human traJors vho shout anJ gosticulato at oach othor to
consummato Joals. With OTC traJing, thor o is no contral lloor - just a
virtual oxchango maJo up ol notvorkoJ computors.
Tho largost U.S. oxchango is tho Nov \ork Stock Exchango, vhich Jo-
spito its rolontloss loss ol markot sharo to OTC traJing, is still tho homo ol
tho sharos ol most largo Amorican corporations - ovor 2,300 lir ms in all
- as voll as tho U.S. traJing lor major lor oign lir ms. To lo listoJ on tho
N\SE, lirms must moot sovoral critoria: a r ocorJ ol consocutivo prolitalil-
ity at loast thr oo yoars long, tangillo assots anJ a total markot valuo ol $18
million or mor o, a minimum ol 1.1 million shar os outstanJing, anJ at loast
2,000 shar oholJors (N\SE 1994, p. 31). Whilo thoso stanJar Js may not
sounJ too rigorous, thoy rulo out most U.S. corporations.
A customor luying a stock traJoJ on tho N\SE, vhothor an inJiviJual
traJing 10 shar os or a monoy managor traJing 100,000, transmits an or Jor
to his or hor lrokor. Tho lrokor transmits tho orJor to tho lirm`s traJing
Josk, vhich passos it on to tho N\SE lloor . (To traJo on tho lloor, tho lirm
must lo a momlor ol tho oxchango.) Tho orJor can lo lilloJ in ono ol tvo
vays. Small, simplo orJors ar o lilloJ through tho N\SE`s SuporDot com-
WALL STREET
18
putor systom: liggor orJors ar o lilloJ ly human lr okors cutting Joals on
tho oxchango lloor.
At tho hoart ol tho N\SE is its spocialist systom. Spocialists aro inhalitants
ol tho oxchango lloor vho aro assignoJ to mako markots in spocilioJ stocks:
thoy`ro annointoJ in this r olo ly a loarJ oloctoJ ly oxchango momlor.
Though thoir rolo isn`t ospocially olscuro, thoir namos usually ar o: unliko
lrokors anJ portlolio managors, thoro aro no cololrity spocialists. Thoy
havo sovoral tasks, lor vhich thoy aro hanJsomoly rovarJoJ. Spocialists
maintain tho look,` onco litorally a papor r ocorJ lut nov a computor-
izoJ r ogistry, containing prico anJ ouantity inlor mation on curr ont liJs
(ollors to luy) anJ asks (ollors to soll) lor tho stocks assignoJ to thom.
Customor orJors may lo placoJ oithor at tho markot or at a limit - that is,
oithor at provailing pricos or at a spocilic prico. Iimit or Jors can lo placoJ
at pricos lar avay lr om tho provailing prico: invostors may vant to soll
shar os thoy ovn il thoy hit a cortain prico, oithor to limit lossos or lock in
prolits. Whon tho markot prico hits tho limit, tho customor`s orJor is ox-
ocutoJ ly tho spocialist.
ln unusual casos vhor o spocialists aro unallo to linJ a villing luyor lor
an oagor sollor, or vico vorsa, usually locauso ol a lor ocious luying or
solling stampoJo, thoy aro supposoJ to stop in anJ satisly tho orJor, using
stock lrom thoir ovn invontory or monoy lrom thoir ovn pockots. Somo
Jiscrotion is allovoJ horo: spocialists aron`t supposoJ to lankrupt thom-
solvos to maintain a lair anJ orJorly markot,` as thoir lriol is usually
phrasoJ. But thoy Jo soom to smooth out tho gyrations in moJoratoly
oxtromo markots.
Spocialists mako a gooJ Joal ol monoy in this rolo. Thoir looks ol lor
thom insights into pattorns ol supply anJ JomanJ that ar o olloroJ to no
othor markot playors, anJ thoy knov vhon it`s lottor to moot orJors lrom
thoir ovn rosourcos or ly matching pullic customors` orJors. Varkot stu-
Jonts olton scrutinizo pullishoJ Jata on spocialists` positions lor insights
into vhat tho supposoJly smart monoy is Joing.
6
ln ovor-tho-countor traJing, thor o is no contral auction markot. Cus-
tomors still transmit or Jors to lrokors, lut instoaJ ol going to tho cornor
ol BroaJ anJ Wall, tho orJor is prosontoJ ly phono or computor notvork
to othor lrokors, calloJ markot makors, vho spocializo in traJing cortain
stocks. A markot makor, accor Jing to tho Socuritios Exchango Act ol 1934,
is any Joalor vho holJs himsoll out.as loing villing to luy anJ soll
socurity lor his ovn account on a r ogular or continuous lasis.` T o Jo that,
a markot makor pullishos, oithor on papor or on computor scroons, liJ
lNSTRUMENTS
19
anJ ol lor prico ouotations, anJ, in tho vor Js ol tho Socuritios anJ Ex-
chango Commission r ogulation, is r oaJy, villing, anJ allo to ol loct trans-
actions in r oasonallo ouantitios at his ouoto pricos vith othor lrokors anJ
Joalors` (ouotoJ in Watson 1992).
At tho organizational poak is tho National Association ol Socuritios Doal-
ors (NASD) anJ its automatoJ ouotation systom (NasJao), vhich pr oviJos
livo computor ouotos ol stock traJos to lrokors arounJ tho vorlJ. Tho
National Varkot Systom (NVS), a sulsot ol NasJao univorso, is tho traJing
homo ol tho liggost OTC stocks, liko Vicr osolt anJ lntol. Vany ol tho
NVS companios coulJ traJo on tho N\SE, lut lor various roasons thoy
chooso not to havo thoir stocks listoJ thor o. But Jospito tho sprinkling ol
giants, listing r oouiromonts lor tho NVS aro signilicantly loosor than tho
N\SE`s: il a lir m is prolitallo, it nooJs tangillo assots ol at loast $4 million
anJ a markot valuo ol at loast $3 million: il tho lir m is unpr olitallo, it
nooJs to hit valuos ol $12 million anJ $15 million r ospoctivoly. ln most
casos, it nooJs only 400 pullic shar oholJors.
Travoling Jovn tho looJchain, you pass tho NasJao stocks that ar on`t
part ol tho national systom: thoso tonJ to lo rolativoly olscuro companios
vhoso stocks aro somovhat thinly traJoJ: a listing on tho NasJao SmallCap
(small capitalization) markot r oouiros only $4 million in assots, a markot
valuo ol $1 million, anJ 300 pullic shar oholJors. But thoso look liko lluo
chips comparoJ to stocks outsiJo tho NasJao systom - liko thoso that
traJo on tho so-calloJ pink shoots, a prico list JistrilutoJ Jaily to lr okors
on pink papor containing prico ouotos lor stocks that traJo ossontially ly
appointmont only, vith as lov as ono markot-makor. By contrast, tho lig
NVS stocks can havo as many as 30 or mor o markot-makors, vith tho
avorago NasJao stock having ar ounJ 10.
ln 1994, tho NasJao camo unJor hoavy criticism in tho acaJomic anJ
popular pross lor unlair traJing practicos, notally viJo spr oaJs lotvoon
liJ anJ ask pricos (Christio anJ Schultz 1994). That is, in comparison to
N\SE traJing, luyors ol stock paiJ high pricos, anJ sollors rocoivoJ lov
pricos, vith tho Joalors pockoting tho Jilloronco. ln particular , suspiciously
lov NasJao ouotos voro lor oJJ-oighths ol a point anJ too many lor ovon
ouartors - liko 10 14 instoaJ ol 10 18 or 10 38 - a r ounJing that, ol
courso, lavoroJ tho Joalor. Tho acaJomics concluJoJ, moJostly, that this
raisoJ tho ouostion ol vhothor NasJao Joalors implicitly colluJo to
maintain viJo spr oaJs.` Thoso sproaJs mystoriously narr ovoJ tho momont
proliminary linJings vor o pullishoJ in tho pross (Christio ot al. 1994).
Tho Amorican Stock Exchango Jr ov markoting llooJ ly pointing out
WALL STREET
20
that no major lr okor - tho NasJao`s markot-makors - lists its stock on
tho NasJao. ll it`s so vonJorlul lor invostors anJ listoJ companios aliko,
vhy Jo thoso vho knov its vorkings lost not shar o in its vonJors? But
acaJomic stuJios anJ popular r oporting (Stoinor anJ Salvon 1992) havo
also shovn that spocialists olton Jon`t pullicizo attractivo liJs anJ ol lors,
prolorring to rosorvo tho svootost Joals lor thomsolvos.
ln August 1996, tho Socuritios anJ Exchango Commission JociJoJ that
NasJao Joalors haJ, in tho vor Js ol tho 1: .u~I~: T:u~:, colluJoJ to
loost prolits ly harming customors` (Paltr ov 1996). Tho National Asso-
ciation ol Socuritios Doalors agr ooJ (vithout aJmitting to vr ongJoing) to
rovamp its traJing systoms to provont such alusos in tho lutur o. ln roloas-
ing its Jocision, tho SEC also r oloasoJ tapos ol convorsations among Joal-
ors, incluJing oxchangos such as this:
TraJor 1: l lought 10 at
1
8, anJ Jon`t print it |roport itl lor, lor a lov min-
utos, `causo l tolJ tho guy l`m just making a salo out ol tho lluo.`
TraJor 2: l`ll, l`ll print altor tho loll.`
TraJor 1: Thanks, luJ.`
-
TraJor 3: What can l Jo lor you?`
TraJor 4: Can you go
1
4 liJ lor mo?`
TraJor 3: \oah, suro.`
TraJor 4: l solJ you tvo (200 sharos) at
1
4. Just go up thoro, OK?`
TraJor 3: l`m goosing it, cuz.`
TraJor 2: Thank you.`
Whatovor tho rolativo virtuos ol tho systoms, thoro`s no ouostion that
tho N\SE is losing sharo to tho NasJao. ln 1980, tho NasJao traJoJ 54/ as
many shar os on tho avorago Jay as tho N\SE: in 1994, NasJao shar o vol-
umo vas ovor 101/ ol tho N\SE`s. Sinco N\SE stocks aro, on avorago,
moro oxponsivo than tho NasJao`s, sharo volumo ovorstatos things a lit,
lut tho tronJ is visillo thoro, too: in 1980, tho monoy valuo ol shar os traJoJ
on tho NasJao vas 1/ ol tho N\SE`s: in 1994, it vas 56/ ($1.4 trillion vs.
$2.5 trillion). Still, tho N\SE is harJly Jying: tho Jollar volumo ol its traJ-
ing grov moro than sixlolJ lotvoon 1980 anJ 1994 - though tho NasJao`s
grov moro than tvontylolJ (U.S. Buroau ol tho Consus 1994, pp. 528-9).
Ol Jocroasing signilicanco in tho stock vorlJ is tho N\SE`s noighlor
sovoral llocks to tho vost, tho Amorican Stock Exchango (Amox). Onco
tho homo ol small grovth companios, tho Amox is nov a moro llyspock.
lov stocks ol any signilicanco ar o traJoJ thoro, anJ traJing volumo vas a
lNSTRUMENTS
21
moro $36 lillion in 1990. Amox volumo loll lr om 10/ ol tho NasJao`s in
1984 to 6/ in 1994 (NASD 1995).
ln an ol lort to loost its shally imago, tho Amox has loon tightoning
listing stanJar Js, altor scanJal struck its Emor ging Company Varkotplaco
(ECV) shortly altor its Var ch 1992 oponing. Tho ECV vas toutoJ ly thon
Amox-prosiJont Jamos Jonos - a lormor Oklahoma congr ossman vho
lolt tho Amox to locomo U.S. amlassaJor to Voxico, vhoro ho sorvoJ
Juring tho Voxican crisis ol 1994 anJ 1995 - as homo to tho kinJ ol
companios that vill gr ov anJ mako this country gr oat.` Unlortunatoly lor
Jonos anJ tho Amox, tho companios JiJ littlo lut omlarrass tho oxchango.
Ol tho 22 companios, ovor hall vont pullic through tho sholl company
routo - that is, a lir m vith no actual lusinoss oporations solls stock as a
llinJ pool` to invostors (i.o., a pig in a poko) anJ thon acouir os a small
oporating company vith tho procooJs ol tho stock salo. That mothoJ al-
lovs tho initial ovnors ol tho sholl to ovaJo tho scrutiny ol tho Socuritios
anJ Exchango Commission anJ its nor mal r ogistration anJ Jisclosur o ro-
ouir omonts. But that vas only tho loginning ol tho ECV`s maloJor ous
lilo. Sovoral vooks lator, it omorgoJ that ono ol tho ECV 22, a makor ol
llamo r otarJants, vas contr olloJ ly an aJmittoJ insiJo traJor anJ stock
manipulator vho vas also a convictoJ arsonist. AnJ anothor ECV com-
pany vas run ly somoono vho`J proviously loon suoJ ly tho SEC lor
various misJooJs: tho logal trail vas covoroJ ly tho lact that hor laJ r ocorJ
vas run up vhon hor namo vas John Huminik, lolor o tho intorvontion ol
hormonos, scalpol, anJ a logal vrit haJ tur noJ hor into Eloanor Schulor
(U.S. Gonoral Accounting Ol lico 1994l: Norris 1995).
Stock porlormanco is usually summarizoJ ly inJoxos. Vost oxchangos
ar ounJ tho vorlJ pullish thoir ovn inJoxos, vhich aro not Jiroctly com-
parallo vith oach othor. To aJJr oss tho comparalility prollom, tho
1:uuuc:uI T:u~: anJ Vorgan Stanloy Capital lntor national ol lor stanJar J-
izoJ intor national inJoxos, covoring countrios anJ r ogions: anJ tho lntor-
national linanco Corporation, tho W orlJ Bank`s in-houso invostmont lank,
pullishos inJoxos lor tho omorging` markots.
ln tho U.S., tho Dov Jonos lnJustrial Avorago, an avorago ol 30 lluo-
chip inJustrial stocks, is tho most lamous ol avoragos, lut it is lar lr om
roprosontativo ol tho vholo markot. A lroaJor lluo-chip inJox is tho Stan-
JarJ 8 Poor`s 500, an inJox ol 500 inJustrial, sorvico, anJ linancial stocks:
it`s tho most viJoly usoJ moasuro lor graJing tho porlormanco ol monoy
managors. S8P pullishos scoros ol soctoral inJoxos, anJ thoy anJ othor
lir ms proJuco inJoxos to moasuro lig stocks, small stocks, moJium stocks,
WALL STREET
22
anJ ovon moral stocks (thoso that ar o appropriato lor socially r ospon-
sillo` invostmont).
bonds and other credits
Dospito tho groator pullic visilility ol stock markots, tho linancial hoart ol
capitalism is in tho cr oJit markots, a tor m covoring loans arrangoJ thr ough
a varioty ol instrumonts anJ institutions, lr om simplo lank loans to com-
plox lonJ proJucts. As Varx (1981, p. 596) put it, intor ost-loaring capital
|isl tho mothor ol ovory insano lorm`: Jolts, moro promisos to pay, aro
nonotholoss translormoJ into commoJitios in tho oyos ol croJitors. This
capitalization ol pr omisoJ incomos onallos noarly ovorything, lrom an
inJustrial plant to an unspoiloJ vilJor noss to a human lilo, to lo moJoloJ
as a ouasi-cr oJit, vhoso valuo toJay is tho valuo ol its luturo oarnings
stroam - prolits or vilJornoss sorvicos or vagos, aJjustoJ lor valuo ovor
timo using pr ovailing intor ost ratos anJ maylo an ostimato ol risk.
Varx ontor oJ that passago lrom a moJitation on tho strangonoss ol gov-
ornmont Jolt, a placo vhoro a nogativo ouantity appoars as capital` -
no assot lohinJ it othor than a govor nmont`s promiso to pay. But stato
Jolt is lar lr om uniouoly insulstantial. Unliko stock, most lonJs - loans
that can oasily lo traJoJ on tho markots - givo you no claim ol ovnor -
ship on a lir m`s capital assots. Though somotimos a ploJgo ol collatoral is
involvoJ (as in so-calloJ mortgago lonJs), most ar o socuroJ ly tho
lorrovor`s promiso anJ tho lonJor`s laith in that pr omiso. Tho lonJ`s valuo
at any momont is tho lutur o stroam ol intor ost paymonts that tho lorrovor
promisos to pay, vith tho roturn ol principal at tho lonJ`s maturity.
Soxy variations ar o plontilul - lloating rato lonJs, vhoso intorost is
aJjustoJ porioJically: inllation-linkoJ lonJs, vhich guarantoo a lixoJ rato
alovo tho inllation rato: zor o-coupons, vhich aro solJ at a lig Jiscount to
laco valuo, pay no intor ost Juring thoir lilo, anJ ar o closoJ out vith tho
paymont ol tho lull laco valuo at maturity. Whatovor tho kink, vhilo cor -
porations can cut or skip JiviJonJ paymonts to shar oholJors, sulloring
only a llov to tho stock prico, missing a lonJ intorost paymont is likoly to
rosult in lankruptcy, or lovoroJ nogotiations to avoiJ lankruptcy.
A lar go, liouiJ markot in govornmont Jolt vith a contral lank at its
coro is tho laso ol moJorn linancial systoms. Contral lanks manago thoir
Jomostic monoy supply through tho purchaso anJ salo ol ollicial papor,
anJ historically govor nmont lorr ovors havo usually loon at tho vanguar J
ol tho Jovolopmont ol a national linancial systom. ln a panic, monoy llooJs
lNSTRUMENTS
23
out ol stocks anJ privato lonJs anJ into govornmont socuritios, ospo-
cially short-tor m onos. Practically spoaking, intor ost ratos on pullic Jolts
act as a lonchmark lor tho r ost ol tho croJit systom: intorost ratos lor lor-
rovors othor than a contral govor nmont - stato anJ local govor nmonts,
housoholJs, corporations - aro usually sot in r oloronco to govornmont
ratos at tho samo maturity. Varkots in gonoral soom to nooJ lonchmarks
liko this: Juring tho oarly 1990s, vhon traJing in Iatin Amorican lonJs
vas highly lashionallo, Voxico sorvoJ as tho lonchmark, vith intorost
ratos ouotoJ as so much ovor Voxico, tho markot`s lluo chip.
Pullic papor is a nico mochanism lor pr olit making anJ incomo r oJis-
trilution. lt pr oviJos rich unJorvriting anJ traJing pr olits lor invostmont
lankors anJ intor ost incomo lor inJiviJual anJ institutional r ontiors, cour-
tosy ol nonrich taxpayors. Wall Str oot, Jospito its iJoological loalty to lal-
ancoJ luJgots, has maJo a lortuno Jistriluting anJ traJing tho
Poagan-Bush-oarly Clinton Jolicits. This oxporionco has loon r oproJucoJ
on a smallor scalo in many othor parts ol tho vorlJ, as govor nmont Jolt
GDP ratios mor o or loss JoulloJ lotvoon 1980 anJ tho oarly 1990s
(GolJstoin ot al. 1994, p. 35). ll tho U.S. luJgot Jolicit stays closo to zor o
lor yoars, Wall Str oot vill havo to mako somo vory sharp aJjustmonts,
though lonJs coulJ acouir o a scar city valuo.
Govornmont Jolt not only promotos tho Jovolopmont ol a contral na-
tional capital markot, it pr omotos tho Jovolopmont ol a vorlJ capital mar-
kot as voll. Short-torm papor liko troasury lills - placos that invostors
can park short-tor m cash - is important lor a curr oncy`s aJmission to
vorlJ markots: tho yon has romainoJ a highly pr ovincial curr oncy, ac-
counting lor only 6./ ol tho traJo among tho six liggost oconomios anJ
8.6/ ol ollicial lor oign r osorvos transactions, in part locauso yon holJors
lack a Joop troasury lill markot.
Contral lanks also Joal in thoir ovn anJ

othor govornmonts` papor in thoir olton vain attompts to manago thoir
curr oncios. lnstitutions liko tho WorlJ Bank loJ tho vay in intor nationaliz-
ing tho cr oJit markots, raising lunJs in ono curr oncy, translor ming thom
into anothor lor tomporary storago, anJ olton lonJing in yot anothor .
Pullic Jolt is a povorlul vay ol assuring that tho stato r omains saloly
in capital`s hanJs. Tho highor a govor nmont`s Jolts, tho moro it must ploaso
its lankors. ShoulJ lankors grov JisploasoJ, thoy vill roluso to roll ovor
olJ Jolts or to oxtonJ nov linancing on any lut tho most punishing tor ms
(il at all). Tho oxplosion ol loJoral Jolt in tho 1980s vastly incr oasoJ tho
povor ol croJitors to JomanJ austor o liscal anJ monotary policios to
Jampon tho U.S. oconomy as it rocovoroJ, hositantly at lirst lut thon vith
WALL STREET
24
incr oasing vigor, lrom tho 1989-92 slovJovn. Bill Clinton ouickly loar noJ
thoir povor, vhon ho haJ to alanJon his topiJ stimulus pr ogram in 1993
anJ tur n himsoll into an Eisonhovor Popullican,` to satisly vhat ho calloJ
a lunch ol lucking lonJ traJors` (W ooJvarJ 1994).
That oxplosion ol loJoral Jolt vas proJigious. At tho onJ ol 1952, out-
stanJing Jolt ol tho U.S. Troasury totaloJ 61/ ol GDP. That ligur o loll
stoaJily lor tho noxt 20 yoars, lottoming out at 23/ in 194: it r oso a lit in
tho lato 190s, to ar ounJ 25/ in 1980, anJ thon hoaJoJ straight upvar Js
to 49/ in 1994, thon Jrilting tovn to 4/ in 199. Gr ovth in agoncy Jolt
- mortgago agoncios liko lannio Vao anJ lr oJJio Vac, tho stuJont loan
agoncy Sallio Vao,
8
anJ tho Posolution Trust Corp., vhich lunJoJ tho
savings anJ loan lailout - vas ovon mor o Jramatic. V irtually invisillo at
unJor 1/ ol GDP in 1952, it r oso slovly to just unJor 5/ in 190: JoulloJ
to noarly 10/ ly 1980: mor o than JoulloJ again to 25/ in 1990: anJ hit
35/ vith no sign ol a pauso ly tho onJ ol 199.
With tho grovth in Troasury Jolt camo a torr ont ol traJing not only in
tho lonJs thomsolvos, lut also in associatoJ proJucts,` as Wall Str oot
markotors call thom, liko lutur os, options, ropos, anJ svaps. This con-
lir ms tho accuracy ol anothor ol Varx`s (19, p. 919) olsorvations:
Tho pullic Jolt locomos ono ol tho most povorlul lovors ol primitivo ac-
cumulation. As vith tho stroko ol an onchantor`s vanJ, it onJovs unpro-
Juctivo monoy vith tho povor ol croation anJ thus turns it into capital,
vithout lorcing it to oxposo itsoll to tho troullos anJ risks insoparallo lrom
its omploymont in inJustry or ovon in usury. Tho stato`s croJitors actually
givo nothing avay, lor tho sum lont is translormoJ into pullic lonJs, oasily
nogotiallo, vhich go on lunctioning in thoir hanJs just as so much harJ
cash voulJ. But lurthormoro, anJ ouito apart lrom tho class ol iJlo :~uI:~::
thus croatoJ, tho improvisoJ voalth ol tho linanciors vho play tho rolo ol
miJJlomon lotvoon tho govornmont anJ tho nation, anJ tho tax-larmors,
morchants anJ privato manulacturors, lor vhom a gooJ part ol ovory na-
tional loan porlorms tho sorvico ol a capital lallon lrom hoavon, apart lrom
all thoso pooplo, tho national Jolt has givon riso to joint-stock companios,
to Joalings in nogotiallo ollocts ol all kinJs, anJ to spoculation: in a vorJ,
it has givon riso to stock-oxchango gamlling anJ tho moJorn lankocracy.
Tho markot in U.S. govornmont lonJs is tho liggost linancial markot in
tho vorlJ. At tho contor ol tho markot aro 38 major invostmont anJ com-
morcial lanks vho ar o cortilioJ as primary Joalors ly tho loJoral Posorvo
lNSTRUMENTS
25
Bank ol Nov \ork - tho choico innor cir clo vith vhich tho loJ conJucts
its ollicial monotary lusinoss. At tho onJ ol 1992, accor Jing to a Nov \ork
loJ survoy, total Jaily traJing volumo avoragoJ $400-550 lillion, or ovor
$100 trillion a yoar . TraJors tur noJ ovor an amount ooual to a yoar`s GDP
in alout thr oo vooks. Ol tho total, $40-50 lillion (9/) vas among pri-
mary Joalors: $50-60 (11/) vas among primary Joalors anJ thoir custom-
ors: $45-115 lillion (20/) vas among nonprimary Joalors: anJ $250-300
lillion (55/) consistoJ ol linancing transactions,` Joals that uso U.S. T roa-
sury papor as collatoral.
9
lt`s lar goly a lamily r omanco among linanciors.
A lit surprisingly, in this ora ol glolalizoJ linanco, only alout 4/ ol
that traJing vas Jono in IonJon anJ anothor 1/ in T okyo - moaning
that 95/ ol tho markot vas in tho U.S., mainly Nov \ork. But tho IonJon
anJ Tokyo action is onough to assuro that thoro`s a r ounJ-tho-clock mar-
kot lrom 8 o`clock in tho Tokyo VonJay morning to 5 PV on tho Nov
\ork lriJay. Though somo lirms organizo traJing locally, tho glolal housos
run a singlo portlolio in all thr oo contors. lor traJors in glolal lir ms, tho
traJing Jay logins in T okyo: thoy pass tho look` at alout 4 or 5 in tho
altor noon Tokyo timo to IonJon, vhoro it is or 8 in tho mor ning, anJ
pass it vostvarJs at 1 PV to Nov \ork, vhoro it is 8 in tho mor ning. Tho
traJing Jay onJs vhon Nov \ork closos.
Troasury Jolt lalls into thr oo catogorios - lills, vith maturitios run-
ning lr om throo months to ono yoar: notos, ono yoar to 10: anJ lonJs,
ovor 10. Vost traJing occurs in tho tvo- to sovon-yoar rango. Shovn on p.
26 ar o throo yiolJ curvos,` plots ol intorost ratos at various maturitios.
Normally tho yiolJ curvo slopos gontly upvarJ, vith intor ost ratos rising
as maturitios longthon. Tho r oason lor this is protty simplo - tho longor a
maturity, tho mor o possilility thoro is lor somothing to go vrong (inlla-
tion, linancial panic, var), so invostors r oouiro a svootor roturn to tompt
thom into parting vith thoir monoy. lt`s rar o, hovovor, that a lonJholJor
voulJ actually holJ it to maturity: holJing porioJs ol vooks anJ hours ar o
moro common than yoars. Tho Bank lor lntor national Sottlomonts (Bonzio
1992, p. 43) ostimatoJ that tho avorago holJing porioJ lor U.S. T roasury
lonJs anJ notos vas just ono month, vith a similar ligur o provailing in
Japan, Gor many, anJ Britain. Tho avorago holJing porioJ lor a T roasury
lill vas thr oo vooks, ton vooks short ol tho shortost-livoJ T -lill.
Excopt in timos ol crisis or hyporinllation, short-torm intor ost ratos ar o
gonorally unJor tho contr ol ol tho contral lank. ln tho U.S., tho lonch-
mark short-torm intor ost rato is loJoral lunJs, vhich is vhat lanks char go
oach othor lor ovornight loans ol r osorvos.
10
ll tho loJ vants to ropross tho
WALL STREET
26
oconomy ly lorcing intor ost ratos highor anJ r ostricting tho availallo sup-
ply ol croJit, it vill Jrain r osorvos lrom tho lanking systom ly solling part
ol its invontory ol Troasury socuritios. Unliko a privato salo ol socuritios,
vhich voulJ koop tho monoy sloshing vithin tho linancial systom, a salo
to tho loJ moans that tho Jollars loavo it. This lorcos tho prico ol rosorvos
- loJ lunJs - upvar Js. To stimulato, tho loJ luys socuritios using monoy
croatoJ out ol thin air: this in-
cr oasos tho supply ol rosorvos,
vhich nuJgos Jovn tho lunJs rato.
Iong-torm ratos, hovovor, aro not
so oasily analyzoJ nor controlloJ.
Vost ol tho timo thoy movo vith tho
short-torm ratos JictatoJ ly tho con-
tral lank, lut in oJJ timos thoy Jon`t.
ln tho oarly 1980s, tho curvo vas
nogativo, as Volckor`s loJ Jrovo
ratos up to rocorJ lovols to kill inlla-
tion: in tho oarly 1990s, it vas ouito
stoop, anJ Groonspan`s loJ lorcoJ ratos Jovn to koop tho linancial systom
lrom imploJing. lt`s likoly that invostors assumoJ that loth oxtromos voro
not sustainallo, anJ that short ratos voulJ r oturn to moro normal` lovols,
vhich is vhy tho longor onJ ol tho curvo novor got so carrioJ avay.
loJoral govornmont lonJs ar on`t tho only kinJ, ol courso. Citios anJ statos
soll tax-oxompt municipal lonJs, vhich holp rotiroJ Jontists to sholtor
incomo anJ local govor nmonts to luilJ sovors anJ sulsiJizo shopping
malls in tho namo ol inJustrial Jovolopmont.` Tho muni lonJ markot is
smallor than tho U.S. Troasury markot - at tho onJ ol 199, stato anJ local
govornmonts haJ $1.1 trillion in Jolt outstanJing, compar oJ to $3.8 tril-
lion lor tho Troasury anJ anothor $2. trillion lor govor nmont-r olatoJ li-
nancial institutions - anJ traJing is usually sloopy anJ unintor osting. But
it can lo lucrativo lor practitionors. UnJorvriting lir ms - tho lig invost-
mont anJ commor cial lanks - contriluto mightily to tho campaigns ol
local tr oasurors anJ comptrollors. Sinco so many givo, it`s har J to soo hov
tho local ollicials can JociJo among smooth Wall Str ootors loaring gilts.
Dospito somo attompts to roin in this ossontially logal lor m ol gralt, it`s
almost cortain to continuo (T aylor 1995). Tho noxus ol lonJ Joalors vho
raiso monoy lor local govornmonts, r oal ostato Jovolopors anJ construc-
U.S. Treasury yield curves
vears !o na!uri!v
0'
2'
4'
6'
3'
!0'
!2'
!4'
!6'
3no ! 2 3 5 7 !0 30
Dec !930
Ocl !992
Jan !997
lNSTRUMENTS
27
tion contractors vho prolit lrom tho capital oxponJitur os so linancoJ, tho
lavyors vho sorvico all siJos, anJ tho politicians supportoJ ly tho rost ol
tho gang ar o common structur os ol urlan anJ r ogional povor in tho U.S.
Thoy assuro that tho luJgot vill lo lull ol sulsiJios anJ tax lr oaks to
Jovolopors anJ contractors, that lr osh lanJ vill lo JovolopoJ olton at tho
oxponso ol oxisting sottlomonts, anJ that in a crunch vollar o anJ othor
pullic sorvicos vill lo cut lut Jolt sorvico vill continuo to llov.
lt vas long holJ ly tho courts that intor ost on municipal Jolt coulJ not
lo taxoJ lor Constitutional r oasons, lut a 1988 Supr omo Court Jocision
changoJ that. Tho inJulgonco has loon oxcusoJ on tho grounJs that it
lovors tho lorroving costs lor citios anJ statos: lrom a lonJholJor`s point
ol viov, a 6/ tax-lr oo intorost rato is as gooJ as an 8-9/ taxallo ono,
assuming an incomo tax rato ol ar ounJ 30/.
11
But a closor look rovoals a
nico sulsiJy to tho rich at tho oxponso ol tho U.S. Troasury. Tho oxomp-
tion ol municipal lonJ intor ost costs tho loJoral govornmont just ovor $20
lillion a yoar (U.S. Ol lico ol Vanagomont anJ BuJgot 1995, p. 42). lor mor
Nov \ork Stato Comptrollor EJvarJ Pogan (1996) ostimatoJ that alout
tvo-thirJs ol tho sulsiJy goos to stato anJ local govornmonts, anJ ono-
thir J to voalthy lonJholJors. Pogan concluJoJ, ll you`ro not in high
|taxl lrackots anJ Jon`t ovn thoso lonJs, you loso ovory timo your stato
or local govornmont lorr ovs,` sinco tho municipal sulsiJy moans highor
loJoral taxos (or r oJucoJ loJoral sorvicos) lor tho non-lonJholJor.
Corporato lonJs aro tho last major typo. Tho markot is lar go - at $3.3
trillion in 199, starting to appr oach tho U.S. Troasury markot in sizo -
lut Joosn`t traJo anyvhor o noar as lr onotically, anJ hasn`t maJo much
novs sinco tho junk lonJ loom anJ lust ol tho 1980s. Annual tur novor
amounts to only a lov Jays` vorth ol Troasury action.
Whilo nonlinancial corporato lonJ Jolt has gr ovn improssivoly - lrom
an amount ooual to 13/ ol GDP in 1980 to 18/ in 199 - linancial lir ms
voro lusior issuors, rising lr om 3/ ol GDP to 1/ ovor tho samo porioJ.
Vuch ol this vas accountoJ lor ly tho grovth in assot-lackoJ socuritios
(ABS) - cr oJit car J rocoivallos anJ mortgagos packagoJ into lonJs anJ
solJ on tho markots rathor than r omaining vith tho lanks originating tho
loans). Nonoxistont in 1983, ABS issuors` lonJs outstanJing vor o vorth
9/ ol GDP in 199. Such socuritization has shiltoJ risk lr om lanks to tho
institutional invostors vho luy assot-lackoJ lonJs, anJ has cr oatoJ vast
nov pots ol monoy to lunJ tho consumor croJit loom.
WALL STREET
28
ln most casos, only tho lost corporations aro grantoJ accoss to lonJ
markots - onos vhoso conJition is lairly viJoly knovn, anJ oasily ana-
lyzoJ. This is ospocially truo ol tho short-torm corporato Jolt calloJ com-
morcial papor (CP) - tho unsocur oJ Jolt ol largo lirms, vhich is socuroJ
only on thoir promiso anJ r oputation. Tho Jovolopmont ol tho CP markot
has loon a llov to lanks, vhich usoJ to havo a lock on thoso lluo-chip
customors. CP anJ socuritization havo r oplacoJ rolationship` lanking -
long-torm associations lotvoon lirms anJ thoir lankors - vith transac-
tions` lanking, in vhich all that mattors is tho loauty ol tho Joal.
Small, olscur o lirms ar o rar oly grantoJ accoss to tho lonJ markot. A
momorallo oxcoption vas tho junk momont ol tho 1980s, vhon tho most
improlallo aJvonturos voro linancoJ, anJ intor ost vas olton paiJ not in
roal cash, lut in a listlul ol nov lonJs. Tho markot collapsoJ in 1989,
languishoJ lor yoars loloro onjoying a vigorous rocovory into tho lato 1990s,
though nothing liko its hoyJay a JocaJo oarlior . Thoro`s oviJonco that tho
collapso ol tho junk markot vas gooJ lor lanks, vho pickoJ up somo
junk-class lorr ovors, vho pay high intorost ratos - high onough, pro-
sumally, to alsorl tho occasional Jolault.
derivatives
This onco-olscuro vorJ locamo lamous in 1994, vhon altor livo yoars ol
inJulgont policios, tho loJoral Posorvo logan hiking intorost ratos, caus-
ing Jorivativos to llov up all ovor. Putativoly sophisticatoJ giant corpora-
tions, vho thought thoy voro limiting risk thr ough oxotic instrumonts
craltoJ ly Wall Str oot, lounJ thomsolvos losing millions instoaJ. Orango
County, Calilor nia, lost millions on Jorivativos, anJ liloJ lor lankruptcy
rathor than tax its rich citizons onough to mako gooJ on thoir Jolts,
12
anJ
a small ar my ol Wall Str oot hotJogs voro oithor laJly vounJoJ or Jrivon
(at loast tomporarily) out ol lusinoss. To avoiJ omlarrassmont anJ pos-
sillo runs, sovoral prominont mutual lunJ companios haJ to sulsiJizo
Jorivativos lossos in lonJ anJ monoy-markot lunJs.
Pooplo hoarJ anJ saiJ laJ things alout Jorivativos vithout too cloar a
sonso ol vhat thoy aro. Tho vorJ rolors to a lroaJ class ol socuritios -
though socuritios sooms too tangillo a vorJ lor somo ol thom - vhoso
pricos aro JorivoJ lrom tho pricos ol othor socuritios or ovon things. Thoy
rango lr om ostallishoJ anJ stanJar JizoJ instrumonts liko lutur os anJ op-
tions, vhich ar o vory visilly traJoJ on oxchangos, to custom-maJo things
liko svaps, collars, anJ svaptions.
lNSTRUMENTS
29
As vith most lasic linancial instrumonts, Jorivativos ar o ouito olJ. A
1688 tr oatiso on tho vorkings ol tho AmstorJam Stock Exchango JoscriloJ
tochniouos vory much liko moJorn lutur os anJ options. OrganizoJ lu-
tur os traJing ol agricultural commoJitios ar oso in Chicago tho miJ-19th
contury: tho moJorn lutur os contracts in cor n anJ vhoat logan traJing in
1859. Options on lutur os traJoJ in Chicago in tho 1920s, until tho Nov
Doalors snulloJ thom as part ol tho gonoral var on spoculation, iJontilioJ
as a primo suspoct in causing tho Gr oat Doprossion (Vorton 1992: Novlorry
1992: U.S. CommoJity lutur os TraJing Commission 1995).
lutur os markots oxist in a rango ol r oal anJ linancial commoJitios: op-
tions ar o traJoJ on inJiviJual stocks, stock inJoxos, anJ lutur os contracts.
13
A lutur os contract is an agr oomont maJo ly its luyor to tako Jolivory ol a
spocilic commoJity on a spocilic Jato, anJ ly its sollor to mako Jolivory.
Options contracts givo luyors tho right to luy or soll a particular assot
oithor on a particular Jato (Eur opoan option) or at any timo lr om vhon
tho option contract is oponoJ until its oxpiration Jato (Amorican option).
Options to luy aro calloJ calls, anJ options to soll, puts. An ossontial Jil-
loronco is that somoono vho holJs a luturos contract on its oxpiration
Jato must tako Jolivory ol tho unJorlying commoJity, vhilo tho holJor ol
an option nooJ not. ln practico, hovovor, almost all lutur os contracts ar o
closoJ out loloro thoir maturity Jato: loss than 1/ ol annual traJing onJs
up loing consummatoJ in possossion-taking.
Somo oxamplos might put llosh on thoso Jolinitions. A singlo luturos
contract in vhoat covors 5,000 lushols. Pooplo vho luy July vhoat con-
tracts in April agr oo that shoulJ thoy still holJ tho contracts como July,
thoy vill tako possossion ol tho vhoat at tho contract`s statoJ prico. (ll
vhoat actually changos hanJs, it`s typically in tho lor m ol var ohouso ro-
coipts, not railcars lull ol grain.) ShoulJ tho prico havo rison, thon that vill
look liko a gooJ Joal: il it`s lallon, it vill look laJ.
April sollors ol July vhoat, hovovor, agroo to tho rovorso - that thoy vill
Jolivor tho vhoat como July. As vith most linancial markots, sollors nooJ not
actually ovn tho commoJity thoy soll. larmors may inJooJ soll thoir crops
lorvarJ in tho luturos markots. But your avorago spoculator has no vhoat
to soll: ho or sho is simply hoping tho prico vill Jrop. A salo maJo ly
somoono vho Joosn`t ovn tho unJorlying assot - anJ this applios to
lonJs anJ stocks as voll as vhoat - is solling it short,` on tho anticipa-
tion ol luying it lack at a lovor prico, or , in a pinch, luying it in tho opon
WALL STREET
30
markot at vhatovor prico provails anJ Jolivoring tho gooJs.
14
Short-solling
oxposos tho practitionor to onormous risks: vhon you luy somothing -
go long, in tho jar gon - your loss is limitoJ to vhat you paiJ lor it: vhon
you go short, hovovor , your lossos aro potontially vithout limit. ln thoory,
lrokors aro supposoJ to lo sur o thoir clionts havo tho croJit rating to jus-
tily short-solling, though things Jon`t alvays vork out ly tho look.
Options aro similar. On April 18, 1995, tho July vhoat contract closoJ at
$3.515 por lushol lor a contract covoring 5,000 lushols, or $1,58.50
por contract. Tho typical playor voulJ havo to put up 5/ mar gin - a
gooJ laith cash Joposit vith tho lrokor, vho troats tho othor 95/ as a
loan, on vhich intor ost is chargoJ - or $880. An option to luy that July
contract at $3.50 a lushol, calloJ a 350, closoJ tho samo Jay at 12.5 por
lushol, or $625 lor tho lull 5,000 lushols. Tho option to luy it at $3.60 -
a 360 - closoJ at 8.5, or $43.50 lor tho vholo contract. ShoulJ vhoat
climl in prico, tho option pricos voulJ incroaso also - gonorally point
lor point vith tho 350 option (sinco it`s so closo to tho targot, or striko`
prico), anJ loss than point lor point vith tho 360 (sinco it`s avay lr om tho
tar got, or out ol tho monoy`). Pights to soll tho vhoat at 350 - puts -
closoJ at 10.5lushol: tho 360 puts closoJ at 16.5. Sinco tho 360 puts
givo thoir ovnor tho right to soll at a prico alovo tho curront markot, thoy`ro
calloJ in tho monoy.` ln gonoral, calls ar o mirr or imagos ol puts: calls riso
in prico as thoir unJorlying assot risos: puts lall in prico. Tho principlos ar o
tho samo lor a stock option. A singlo lBV July 90 call` givos tho luyor tho
right to luy 100 shar os (a r ounJ lot`) ol lBV at $90 a shar o: an lBV July
90 put` givos its luyor tho right to soll lBV at 90.
Tho prico ol an option is gonorally a r olloction ol markot intorost ratos,
tho timo to maturity, tho closonoss ol tho prico ol tho unJorlying assot to
its striko prico, anJ that unJorlying assot`s historical prico volatility. Highor
intor ost ratos, a longor timo to maturity, anJ gr oator volatility tonJ to raiso
pricos. ln tho 190s, lischor Black anJ Vyr on Scholos JovolopoJ an op-
tions pricing lor mula that has locomo a classic: it`s loon tinkor oJ vith
ovor tho yoars, lut thoir lunJamontal tochniouo r omains canonical.
Put- anJ call-luying is lairly simplo. Things Jo got mor o complicatoJ, much
moro complicatoJ. An ovnor ol 100 shar os ol lBV can soll a call against
thoso sharos: shoulJ tho prico riso, ho or sho voulJ havo to luy lack tho
call at a loss - tho loss loing partly ollsot ly tho (papor) riso in tho valuo
ol tho unJorlying shar os - or run tho risk ol having tho stock calloJ
lNSTRUMENTS
31
avay` ly tho lortunato luyor ol tho call. Pooplo vith losing positions usu-
ally closo thom out at a loss loloro thoir maturity Jato: actual or Jors to
Jolivor, or oxorcisos, aro lairly rar o.
Plungors can also soll calls vithout ovning tho unJorlying assot: this is
calloJ going nakoJ.` Tho nakoJ call sollor runs a risk lar gr oator than
moro omlarrassmont: as vith any short salo, tho lossos ar o thoorotically
limitloss. Somoono vho shorts a stock at 90, or solls a 90 call vhon tho
unJorlying stock is traJing at 90, runs tho risk that a sharp runup in tho
stock, vhothor locauso ol a mania or a takoovor, coulJ lorco tho prico to
150 or highor.
AnJ things got moro complicatoJ still. Complox comlinations ol lu-
tur os anJ options positions aro common. ln options: short loth calls anJ
puts, on tho hopo that tho unJorlying assot vill go novhoro: long loth
calls anJ puts, on tho hopo that it vill tako ol l Jramatically in ono Jir oc-
tion or anothor, it mattors not vhich: long anJ short calls in strango com-
linations ol maturity anJ pricos: long an assot anJ short calls lor tvico tho
ouantity ol tho unJorlying assot (a vay ol going short lut hoJging ono`s
lots): long an assot anJ short hall tho ouantity ol calls (a vay ol going
long lut hoJging ono`s lots). ln luturos: long cruJo oil anJ short gasolino,
on tho hopo that tho sproaJ lotvoon rav anJ r olinoJ proJucts vill nar -
rov: short cruJo anJ long gasolino, on tho r ovorso hopo (so-calloJ crack
sproaJs): long soyloans anJ short soy oil: long Troasury lills anJ short
Troasury lonJs, or long Eur oJollar Joposits anJ short Troasury lills -
loth on tho hopo that intorost rato sproaJs vill chango in ono`s lavor.
But it`s not just spoculation alono that coulJ motivato complox posi-
tions liko this. ConsiJor tho manulactur or ol cooking oil: it luys grains
anJ solls oil maJo lr om that grain - in linancial tor ms, it goos long tho
rav proJuct anJ short tho r olinoJ. But tho timing Joosn`t alvays vork in
unison: it coulJ luy tho grain toJay, only to linJ tho prico ol oil collapsing
tomorrov. Using luturos, it coulJ lock toJay`s prico sproaJ lor lusinoss it
vill Jo sovoral months Jovn tho roaJ. That voulJ insulato it lr om tho
ollocts ol any prico changos, vhothor lavorallo or unlavorallo.
All thoso stratogios, simplo purchasos or salos or complox comlina-
tions ol loth, can lo motivatoJ oithor ly gut instinct or complox math-
omatical moJols, ly tho Josiro to limit oxposuro or to lot tho houso, ly
routino lusinoss Jocisions ol intorostoJ partios or spoculativo intorosts ol
playors vho coulJn`t toll soyloans lrom sooJ corn. But vhatovor tho mo-
tivation or stratogy, it`s usually ostimatoJ that 80-90/ ol nonpr olossional
lutur os anJ options traJors loso monoy.
WALL STREET
32
Norm ZaJoh, a monoy managor anJ savant lasoJ in Bovorly Hills vho
usoJ to run an option-traJing compotition, saiJ that somo ol his vinnors
voro litorally slooping on gratos` a yoar or tvo altor thoir victorios. Somo
voulJ rack up 1,300/ r oturns, tako out aJs, attract clionts, anJ thon loso
all thoir monoy anJ thon somo.
Iongor-livoJ vinnors ar o oithor commorcial intor osts or prolossionals
liko lloor traJors anJ lr okors. Vost nonprolossionals havo no iJoa vhat
thoy`ro Joing anJ olton loso thoir shirts. Pr os spoak mockingly ol pooplo
vho luy calls just locauso thoy think a stock is going to go up: tho ama-
tours nogloct to Jotormino vhothor tho call is unJor - or ovorpricoJ ac-
corJing to thoorotical computor moJols, or nogloct to limit thoir risks
through tho uso ol complox hylriJ structuros.
As complox as this is, most ol it is transpar ont to tho participant.
15
Custom-
ors sulmit orJors to thoir lrokors, vho transmit thom to tho oxchango
lloor. Tho lloor is populatoJ ly omployoos ol tho lig lr okorago housos
vho aro tho moJium lor thoso orJors, as voll as ly inJoponJont traJors,
knovn as locals, vho traJo lor thoir ovn accounts. Whilo thor o must lo a
luyor lor ovory sollor, tho oxchangos tako car o ol tho Jotails ol matching
tho tvo partios. This task is simplilioJ ly tho lact that tho contracts ar o so
highly stanJar JizoJ. StanJar Jization anJ contralization vor o tho koy to
tho Jovolopmont ol moJorn lutur os oxchangos, vhich havo changoJ littlo
(oxcopt lor tho roplacomont ol papor ly computors) sinco tho turn ol tho
contury vhon lormal cloaringhousos r oplacoJ inlormal rings` ol traJors
(Williams 1986, p. 5). Cloaringhousos ol lor stanJar JizoJ contracts anJ a
painloss (to tho traJors) matching ol luyors anJ sollors, in placo ol custom
Joals that onco voro maJo among inJiviJual ring momlors.
Tho moJorn oxchango anJ cloaringhouso systom JiJn`t omor go lully
lormoJ. lnlormal traJing arrangomonts, not mor oly vithin rings that knov
oach othor, lut among rings anJ inJiviJuals vho haJ no gr oat lamiliarity
vith oach othor, lalloonoJ in comploxity. Tho Chicago BoarJ ol TraJo
(CBOT) at lirst only olloroJ a lorum lor inJiviJual traJors, a contral loca-
tion lor lir ms` clorks. Boloro tho CBOT cloaringhouso vas lormoJ, clorks
voulJ run alout vith var ohouso rocoipts, oxchanging titlos to gooJs on
lohall ol thoir omployors. ln hoctic momonts, lirms voulJ pass rocoipts
along to othor lirms, somotimos a chain as long as 10 or 25 lir ms, vithout
any vritton r ocorJ: lir ms voulJ olton rocoivo rocoipts lor contracts thoy
novor maJo. With tho cloaringhouso, a singlo clork coulJ oxamino all tho
lNSTRUMENTS
33
traJing lists simultanoously, anJ arrango translor ol tho traJoJ gooJs.
Options ovolvoJ a lit moro slovly. Calls anJ puts on stocks havo loon
traJoJ lor a long timo, lut tho traJing vas lairly thin. Doals haJ to lo
noarly custom-maJo: luyors anJ sollors haJ to lo matchoJ spocilically,
vhich kopt traJing slov anJ markots illiouiJ. Hovovor, tho Chicago Boar J
Options Exchango, a spinoll ol tho CBOT, logan traJing listoJ options -
stanJarJizoJ contracts sottloJ at a cloaringhouso - in tho miJ-190s. Al-
tor a slovish start, traJing oxploJoJ: lr om no contracts (asiJo lr om a lov
custom Joals) in 190, to 9 million in 1980, to 202 million in 1992.
16
Cloaringhousos ar o at tho hoart ol tho procoss. Evory Jay, lirms sulmit
a list ol thoir traJos to tho cloaringhouso - luying vhoat, solling lonJs
- anJ tho cloaringhouso chocks anJ r oconcilos tho lilings. Thon tho cloar-
inghouso oithor pays or lills tho momlor, JoponJing on tho not monotary
valuo ol tho Jay`s traJos. Tho important loatur o ol tho moJorn systom is
that sottlomont is typically in cash: tho oconomic point is that a lutur os
contract is a vay ol tur ning a thing pr omptly into monoy - anJ monoy ol
a lor m that can lo translor moJ into scoros ol othor assots. With lutur os, a
lushol ol vhoat can almost instantly lo traJoJ lor its oouivalont in cash,
vhich thon can lo tur noJ into oil, Troasury lonJs, or a lolstor Jinnor.
Whilo outright markot manipulation - cor nors anJ such - is rar o to-
Jay, minor ol lonsos aro common anJ cortain kinJs ol insiJor action ar o
porloctly logal. Whon tho major grain companios nogotiatoJ tho salo ol
vhoat to tho USSP in tho 190s, thoy JiJn`t announco tho Joal pullicly lor
a vook or so. ln tho moanvhilo, thoy loaJoJ up on luturos, a practico
ouphomistically knovn as anticipatory hoJging.` Or vhon lloor traJors
got lig orJors lrom customors, orJors lig onough to movo pricos signili-
cantly in ono Jir oction or anothor, thoy vill lroouontly vink at a luJJy,
vho thon makos tho appropriato traJo just loloro tho lig orJor is placoJ.
Tho conspirators can split tho prolit lator ly arranging Jummy traJos.
But in tho lig pictur o, thoso aro lairly minor ovonts: tho populist claim
that tho lutur os markots rig pricos in a major vay - hoar J at ono timo
lrom hoartlanJ lar mors, anJ nov mainly lr om ThirJ WorlJ commoJity
oxportors - has littlo lasis in lact. Tho cr oation ol lutur os markots usually
unJor minos cartols, rathor than r oinlorcing thom. Vajor commoJity prico
tronJs ar o tho rosult ol tho intorplay ol supply anJ JomanJ ar ounJ tho
cost ol proJuction, a Jull oxplanation, lut lunJamontally truo. Thir J WorlJ
commoJity oxportors laco chronic prolloms ol ovorsupply that aron`t
causoJ ly tho gnomos ol Chicago.
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34
This soction is lor roaJors vho vant to got somo iJoa ol vhat roally com-
plox Jorivativos aro alout: thoso vho Jon`t caro ar o aJvisoJ to skip a lov
pagos lor a Jiscussion ol tho point ol all this invontivonoss.
Playors vho linJ tho oll-tho-rack Jorivativos that traJo on oxchangos
too common can alvays tur n to custom-tailor oJ instrumonts. Tho lack ol
stanJar Jization makos thom untraJoallo, lut tho possililitios ar o limitoJ
only ly imagination anJ tho numlor ol villing partnors. As vith oxchango-
traJoJ Jorivativos, tho custom kinJ - also calloJ ovor-tho-countor (OTC)
- can sorvo as a hoJgo or a lot, or ovon loth at onco.
Dotails ol custom Jorivativos may lo moro than many r oaJors vant to
knov, lut thoy Jo involvo tho lull richnoss ol linancial imagination. Svaps
voro pionooroJ in tho lato 190s, lut tho lirst Joal to attract viJo attontion
vas a curr oncy svap lotvoon lBV anJ tho WorlJ Bank in 1981, anJ tho
lirst intor ost rato svap vas ono involving tho StuJont Ioan Varkoting As-
sociation (Sallio Vao), a U.S.-govor nmont-sponsoroJ vonJor ol stuJont
loans (Alkon 1991).
1
Unliko oxchango-traJoJ Jorivativos, svaps Jon`t
roally involvo a claim on an unJorlying assot: in most casos, tho partnors
in tho svap, calloJ countorpartios, svap tvo sots ol cash llovs, cash llovs
that ar o usually thr ovn oll ly positions in othor socuritios (lonJ intorost,
stock JiviJonJs, otc.).
That sounJs torrilly alstract: maylo a lit mor o Jotail alout so-calloJ
plain vanilla` svaps vill mako it cloar or. ln a curr oncy svap, tho tvo
countorpartios oxchango spocilic amounts ol tvo Jilloront curr oncios,
vhich ar o ropaiJ ovor timo accorJing to a lixoJ schoJulo vhich r ollocts
tho paymont ol intorost anJ amortization ol principal. Essontially, tho
countorpartios ar o lonJing oach othor curr oncios anJ paying lack tho loan
ovor timo. Tho intorost ratos char goJ can lo oithor loth lixoJ, or loth
lloating, or ono lixoJ anJ ono lloating.
ln an intor ost rato svap, tho countorpartios oxchango paymonts lasoJ
on somo unJorlying principal amount (calloJ tho notional` amount). Ono
sot ol paymonts coulJ lo at lloating ratos (that is, aJjustoJ vith changos in
markot ratos) anJ tho othor lixoJ, or loth coulJ lo at lloating ratos, lut
tioJ to Jilloront markot ratos.
This still sounJs vory alstract. Tho ovolution ol tho curroncy svap lrom
its 190s ancostor , tho parallol loan agr oomont, may mako things cloar or.
lmagino that a U.S. lir m voulJ liko to lorrov Gorman marks, lor uso ly a
Gorman sulsiJiary, anJ a Gor man lir m voulJ liko to lorrov Jollars, lor
lNSTRUMENTS
35
complomontary roasons. Both tho Gorman anJ tho U.S. lir ms coulJ issuo
lonJs in thoir Jomostic markots in similar amounts, svap tho principal,
loaving tho U.S. lirm paying mark-JonominatoJ intor ost anJ tho Gorman,
Jollar intor ost. ln olloct, oach has lorr ovoJ in tho othor`s capital markots
- somothing thoy might othorviso havo loon unallo to Jo locauso ol
logal rostrictions or tho lack ol namo r ocognition. Tho prollom vith such
agr oomonts vas that il ono party JolaultoJ, tho othor vas still on tho hook
lor principal anJ intor ost. Curroncy svaps tako caro ol this ly stipulating
that a Jolault ly ono party moans tho onJ ol tho agr oomont: this limits risk
only to tho Jilloronco lotvoon tho tvo intorost stroams, not tho lull laco
valuo ol principal anJ intor ost.
AnJ horo`s an oxamplo ol an intor ost rato svap (Alkon 1991). Say a
lank issuos a ono-month cortilicato ol Joposit, anJ thon invosts tho pro-
cooJs in a tvo-yoar noto vhoso intorost paymonts aro tioJ to tho IonJon
lntorlank OlloroJ Pato (IlBOP, tho rato lanks char go oach othor in tho
IonJon-lasoJ Euromarkots). Tho CD vill matur o voll loloro tho noto,
anJ tho rato tho lank might havo to pay tho CD holJor may not movo in
lockstop vith IlBOP. ShoulJ tho tvo intorost ratos mar ch to thoir ovn
Jrummors, tho lank coulJ linJ itsoll losing monoy on tho tvo-siJoJ trans-
action. To protoct itsoll, tho lank coulJ visit its svap Joalor, anJ vork out
a IlBOP-CD svap. Tho lank voulJ pay tho Joalor tho IlBOP intorost
rato on tho unJorlying principal, anJ tho Joalor voulJ pay somo CD-linkoJ
inJox rato (minus a loo, ol courso). Tho svap Joalor coulJ oithor lo acting
on its ovn account, hoping to mako monoy on tho loo anJ maylo somo
clovor traJing, or it coulJ lo acting on lohall ol a customor vith complo-
montary nooJs. Tho principal amount novor changos hanJs, hovovor , only
tho intorost paymonts Jo. That`s vhy tho unJorlying principal is r olorroJ
to as tho notional` amount.
An olJ-lashionoJ lankor might also ar guo that lunJing a tvo-yoar in-
vostmont ly a sorios ol 24 monthly loans is a Juml thing to Jo, anJ tho
svap is a lancy vay ol gotting ar ounJ that: vhy not issuo a tvo-yoar CD
to lunJ a tvo-yoar invostmont? But intor ost ratos on tvo-yoar CDs may not
lo vory lavorallo, anJ it may lo that tho lank vill como out ahoaJ vith
tho svap. ll all goos voll, ol courso.
Thoso aro only tho simplost oxamplos: intonsoly moro complox Joals
can lo arrangoJ. Svaps can lo comlinoJ vith options in orJor to limit
svings in lloating rato paymonts. Say tvo partios ontor an intor ost rato
svap that logins vith noithor having to oxchango monoy: loth tho lixoJ
anJ lloating rato ar o tho samo, at 8/, say. But a month lator , vhon it`s timo
WALL STREET
36
to aJjust tho ratos on tho lloating hall ol tho Joal, markot ratos havo rison
to 10/. That moans tho payor ol tho lloating rato voulJ havo to hanJ ovor
to tho countorparty 2/ ol tho unJorlying notional principal. ShoulJ ratos
riso Jramatically, tho Joal coulJ got vory oxponsivo. PruJonco might loaJ
tho payor ol tho unproJictallo rato to luy a cap` - an option that limits
tho maximum lloating rato to a lixoJ lovol, say 9/ in our oxamplo. Tho
sollor ol tho cap, hovovor , has to pay any amount alovo 9/.
lurthor complications ar o immoJiatoly possillo: tho cap sollor vill no
Joult vant to hoJgo somohov, anJ tho lloating-rato payor might vant to
ollsot tho cost ol luying tho cap ly solling a lloor,` tho mirr or imago ol
tho cap. By solling a lloor, tho lloating-rato payor limits any gains lr om a
lall in markot intor ost ratos. A cap anJ lloor togothor croato an intor ost rato
collar` - tho ostallishmont ol uppor anJ lovor lounJs on a lloating
rato. Tho linal vorJ in tho oxotic vocalulary is svaption,` an option to
ontor into a svap, lor thoso vho aro shy alout making commitmonts.
Altor all this manouvoring, it looks suspiciously liko a Pulo GolJlorg vor-
sion ol a lixoJ intor ost rato, lut participants ar o aJamant that all tho com-
ploxity is vorth it - vith tho lankors vho soll tho instrumonts tho most
aJamant ol all.
OTC Jorivativos logan thoir stunning takool l in tho miJJlo 1980s, par -
alloling tho riso in traJing ol thoir oxchango-traJoJ cousins. But vhor o
much ol tho riso in oxchango-traJoJ instrumonts vas simply a mattor ol
Europo anJ Japan catching up vith U.S. linancial lutur os markots, OTC
grovth vas mainly tho proliloration ol nov instrumonts vorlJviJo. ln
1986, notional principal in intor ost rato svaps vas $400 lillion, vith an-
othor $100 lillion in curr oncy svaps outstanJing: at tho onJ ol 1990, tho
ligur os voro $2.3 trillion anJ $58 lillion, r ospoctivoly, to vhich haJ loon
aJJoJ anothor $561 lillion in caps, lloors, collars, anJ svaptions: in 199,
notional principal on intor ost rato svaps totaloJ $22.1 trillion, anJ cur -
roncy svaps, $1.5 trillion (Bank lor lntor national Sottlomonts 1998).
Tho liggost usors ol curroncy svaps onco voro nonlinancial corpora-
tions - tho multinationals that Jominato vorlJ traJo, vho lorr ov anJ
Jo lusinoss in scoros ol curroncios arounJ tho vorlJ. But linancial institu-
tions havo loon stoaJily incr oasing thoir uso, vith 40/ ol notional princi-
pal outstanJing, a lit ahoaJ ol nonlinancial lir ms, vith govornmonts a
Jistant thir J. linancial institutions Jominato tho markot lor intor ost rato
svaps: altor all, intor ost-loaring papor is tho lasic commoJity thoy Joal
in. Corporations accountoJ lor just 23/ anJ govor nmonts, 6/. Tho U.S.
shar o ol svap markots is surprisingly small - loss than a thir J ol intorost
lNSTRUMENTS
37
rato svaps anJ ouartor ol tho curr oncy kinJ - anJ tho Jollar`s shar o has
loon shrinking stoaJily, lr om 9/ ol intor ost rato svaps in 198 to 30/ in
1996, vith tho yon anJ tho Eur opoan curr oncios rising Jramatically. No
Joult Europoan anJ Asian oconomic intogration is at vork hor o, though
tho morgor ol Continontal countrios into tho our o vill chango ovorything.
Vovos aro alroaJy unJorvay to traJo stanJar JizoJ svaps on oxchangos,
or Jovolop cloaringhousos lor OTC svaps, lut it`s not cloar that this vill
vork: nooJs may lo too porsonal, anJ countorpartios may not vant to
oxposo thomsolvos to tho scrutiny ol taking pullic positions.
Having inspoctoJ tho machinory, tho ouostion arisos - vhat`s tho point?
lsn`t this all just a lancilul ovorlay, somovhor o lotvoon irrolovant anJ
malignant, on r oal` activity? Ono ansvor might lo that Jorivativos mar -
kots aro simply tho commoJity lorm raisoJ to a highor lovol ol alstraction:
tho commoJity is a thing vhoso purposo in lilo is to lo solJ anJ trans-
lormoJ into monoy: onco translor moJ into monoy, linancial markots Jo-
volop so that monoy itsoll might lo JoployoJ pr olitally. A r olatoJ ansvor
voulJ lo that tho purvoyors ol Jorivativos havo a groat incontivo to invont
nov proJucts: prolits ar o alvays highost on novlorn instrumonts, though
this aJvantago ouickly Jotorioratos as compotitors mimic tho pr oJuct.
But thoso oxplanations ar o too cruJo lor sophisticatos. ln polito Jis-
courso, Jorivativos ar o olton justilioJ ly rosort to parallos alout lar mors
anJ millors. Tho lar mor solls vhoat lorvarJ to lock in a harvost prico vhilo
it`s still in tho gr ounJ, anJ tho millor luys lorvar J to guar J against un-
ploasant prico spikos. ln loth casos, potontial gains - a lall in prico lor
tho millor, a riso lor tho lar mor - ar o surronJoroJ in aJvanco to avoiJ
potontial lossos. This is tho insuranco` thoory ol luturos markots. Thoro`s
also a liouiJity thoory - that tho lar mor solls toJay to loost cash llov,
sinco monoy toJay alvays lools lottor than tho hopo ol monoy tomorrov.
This moJol is cloan, anJ it ovon allovs lor spoculators. Spoculators,
vho vant to gamllo on movomont in pricos - up or Jovn, tho liggor tho
lottor - aro gooJ lor a markot, locauso thoy can stanJ on tho othor siJo
ol a traJo, thor oly lringing Jopth anJ liouiJity to a markot. Dorivativos
markots sorvo tho social lunction ol shilting risk lr om tho hoJgor to tho
spoculator, prosumally incr oasing tho happinoss ol loth.
Tho rural cast ol charactors givos tho moJol a homoy appoal, lut r oal
lilo is Jilloront. lirst, agricultural lutur os aron`t roprosontativo ol tho actual
traJing vorlJ. TraJing in linancial lutur os (stocks, lonJs, anJ curroncios)
WALL STREET
38
accounts lor almost 0/ ol tho total: onor gy proJucts, anothor 12/: anJ
motals, 4/: ag commoJitios ar o only 15/. Tho solo proJucor ol Troasury
lonJs is tho U.S. govornmont, lut it has no pr osonco in tho luturos mar-
kots in its papor: tho major playors ar o tho lig linancial institutions vho
traJo it. Thoy uso lutur os markots to spoculato lor thoir ovn prolit, or to
hoJgo positions takon vhon luying or holJing instrumonts lor customors
or thoir ovn invontory. Tho lar mor anJ tho millor ar o strangors to tho
vonJorvorlJ ol Troasury Jolt.
But tho homily har Jly applios ovon vhoro thoy aron`t strangors, in tho
classic agricultural markots. A 19 survoy (citoJ in Shillor 1993, p. 101)
lounJ only 6/ ol lar mors lought or solJ any lutur os: ovon in tho liggost
sizo class, no moro than 13/ JiJ. But tho traJing lar mors voro mainly
spoculating, not classically hoJging: tvo in thr oo voro traJing in cr ops
othor than thoso thoy voro groving, anJ thr oo in lour lought contracts
rathor than solling thom, as tho homoy myth tolls it. (lar mors may lo voll
positionoJ to spoculato in thoir ovn crops: thoy havo insiJo` inlo on
thoir markots that may lo unknovn to Chicago traJors or to lavyors spocu-
lating lr om Dallas.) Poughly a lilth ol vhoat salos in tho samo 19 survoy
voro Jono on a lorvar J lasis - though many ol thoso lorvarJ salos
occurr oJ altor prico spikos, moaning that lar mors voro locking in vhat
thoy thought voro to lo high` pricos. A truo hoJgor voulJn`t chango
stratogy lasoJ on a markot juJgmont.
To lo lair, lutur os markots u:~ JominatoJ ly commorcial intor osts, not
outsiJors. Grain luyors luy hoavily in tho lutur os markots, as Jo lonJ
Joalors anJ oil r olinors. AccorJing to Stovo Brioso (porsonal commu-
nication), oJitor ol tho Vinnoapolis-lasoJ lutur os novslottor TI~ 1uII::I
R~::~u, commorcial intor osts account lor alout 60-0/ ol tho opon
contracts in major commoJity anJ linancial lutur os markots. Small
spoculators account lor 20-30/, anJ lig spoculators lor ar ounJ 10/.
18
But commorcial intor osts, lo thoy larmors or lonJ Joalors, can spoculato
just liko anyono olso.
Evon apparontly cautious Jorivativos usors - multinational corpora-
tions (VNCs) vho havo to copo vith volatility in intorost rato anJ lor oign
oxchango markots that intor loro vith thoir roal-vorlJ lusinossos - can
Jisguiso aJvontur o as pruJonco. Nonlinancial lir ms ar o hoavy usors ol
Jorivativos: tvo-thirJs ol largo U.S. corporations usoJ Jorivativos rogu-
larly in 1993, accorJing to a survoy ly tho inJustry novslottor uuj:
Mu:I: (Hansoll 1994), vith lor J r oporting a notional valuo ol its posi-
tions as $45 lillion: GE, $2 lillion: GV, $25 lillion: anJ lBV, $18 lillion.
lNSTRUMENTS
39
Nonlinancial corporations ar o olton soloctivo` hoJgors, vhich moans
thoy Jon`t hoJgo vhon thoy think thoy holJ a vinning hanJ. 1:uuuc~
T:~u:u:) (1993) , a novslottor lor corporato troasur ors, JomanJoJ ol its
roaJors: Timo to conloss: aro you traJing lor pr olit or ar on`t you? ll tho
ansvor is yos, thon vhy not ovn up to it?` ln a 1992 survoy, 1T lounJ
that unJor 10/ ol VNCs JoscriloJ thoir tr oasurios as running lor -prolit
oporations: tho ollicial lino is that thoy oxistoJ to manago risk. \ ot only
13/ r oouiroJ 100/ hoJging r outinoly: ly uI hoJging, tho lirm vas con-
sciously taking on risk - risk that it coulJ only justily as an attompt at
prolit. Tho novslottor ollors tho oxamplo ol a U.S. VNC, vhich lorrovoJ
in Spanish posotas to lunJ a Gor man sulsiJiary, ovon though posota intor -
ost ratos voro highor than D-mark ratos - locauso it vas lotting on a
posota Jovaluation. lir ms ar o roluctant to aJmit to spoculating vith tho
troasury locauso stockholJors anJ rogulators might lo JisploasoJ.
Evon voro tho hoJging story a lullor oxplanation ol Jorivativos markots
than it sooms to lo, is hoJging nocossarily a gooJ thing? Barry Schachtor`s
(1992) r oviov ol options thoory makos it cloar that mainstroam linanco
thoorists Jo not spoak vith ono voico on vhothor options mako sonso or
not - vhothor, in thoir alsur Jly mathomatical vorlJ, options pr omoto
oouililrium or porturl it, vhothor thoy`r o lunctional or r oJunJant.` Thor o
ar o plonty ol thoorios, nono ol thom proJominant or torrilly convincing.
Schachtor is r oJucoJ to saying that Tho hugo volumo ol traJo in options
vorlJviJo coulJ lo takon as supporting tho conclusion that options mako
a Jil loronco.` No Joult thoy Jo, lut ol vhat sort?
19
lt`s possillo that hoJging loavos socioty as a vholo vorso ol l than it
voulJ lo il unhoJgoJ. DaviJ Novlorry (1992) olloroJ this oxamplo. Com-
paro tvo arrangomonts lor gr oving rico, ono salo, tho othor highor yiolJ-
ing anJ mor o prolitallo, lut riskior (lor oxamplo, a high-yiolJ strain suljoct
to Jisoaso in cortain climatos). W ithout lutur os markots, lar mors voulJ lo
loss likoly to grov tho risky rico than thoy voulJ il thoy coulJ soll a por-
tion ol tho crop lorvarJ to spoculators. ln tho soconJ vorlJ, supplios
voulJ lo moro volatilo than in tho lirst, anJ spot pricos pr olally voulJ
lo too. ln this caso, hoJging promotos instalility.
But ovon il markots JiJ noutralizo prico oxposur o, pricos aro only part
ol tho story. |lll pricos aro stalilizoJ,` vr oto Novlorry, lut ouantitios
romain unstallo, incomos may lo loss stallo than il pricos vor o lroo to
movo in rosponso to tho ouantity changos.` Both Novlorry`s anJ
Schachtor`s inalility to summon povor lul ar gumonts in support ol tho
Jorivativos markots is striking, givon thoir gr ovth ovor tho last 20 yoars.
WALL STREET
40
Journalists, hovovor, havo no prollom in composing apologias. Woll
along in tho 1994 Jorivativos hystoria, truo to its r olo as tho organ ol
roasssuranco, tho N~u : T:u~: (Hansoll 1994) pointoJ up tho virtuos ol
Jorivativos, calling as loaJ vitnoss William VcDonough, pr osiJont ol tho
Nov \ork loJ. VcDonough varnoJ against Jorivativos angst,` vhich
throatonoJ tho smooth lunctioning ol tho markot, vhich throatonoJ ov-
orything gooJ: Tho oxistonco ol Jorivativos,` VcDonough saiJ, spoaking
in tho miJst ol tho voakost U.S. oconomic oxpansion sinco WorlJ War ll
vith invostmont voll lolov GolJon Ago lovols, incr oasos tho lovol ol
invostmont anJ makos possillo groator oconomic grovth.`
As tho T:u~: put it, Jorivativos ar o lovoly il thoy`ro in tho right hanJs,
Jangor ous othorviso. \ou Jon`t put an avorago pilot in an l-15 lightor
vithout spocial training,` Harvar J linanco pr olossor AnJro PorolJ tolJ
corrosponJont Saul Hansoll Hansoll pickoJ up on PorolJ`s martial mota-
phor, noting that onco companios loar n hov to uso this aJvancoJ linan-
cial voaponry lor Jolonsivo purposos, it`s natural anJ olton pr olitallo lor
thom to tako on somo oxtra risk.` Just vho is tho onomy horo? ls thoro any
risk ol collatoral Jamago? lnstoaJ ol intorr ogating its ovn motaphors, hov-
ovor, tho T:u~: instoaJ solicitoJ tho opinion ol Waltor Shiploy, chair ol
Chomical Bank, vhich tho papor acknovloJgoJ to lo a lar go Jorivativos
Joalor,` vho JoclaroJ that all ol tho r ogulators.havo lunJamontally al-
lir moJ that most ol tho markot lunctions r osponsilly.`
Posponsillo` usors look to Jorivativos to shiolJ thom against volatility,
particularly in intor ost rato anJ curr oncy markots - a privato, markot-
lasoJ attompt to solvo tho social prollom ol prolounJ oconomic uncor-
tainty. VNCs Jo lusinoss in scor os ol curroncios, anJ havo Jolts in ouito
a lov too. Volatilo curr oncy anJ Jolt markots mako gooJ linancial pr ojoc-
tions impossillo, lut il lirms hoJgo proporly vith Jorivativos, thoy can
thoorotically insulato thomsolvos against such risks.
20
Tho irony ol thoso inJiviJualizoJ appr oachos to risk managomont is
that thoy soom to incroaso systomic risk ovon as thoy lovor inJiviJual risk,
at loast lor tho smartor or luckior or mor o practicoJ usors. Pooplo vho
think thoy`ro hoJgoJ can tur n out not to lo vhon markots go vilJ: all tho
assumptions on vhich thoy`vo lasoJ thoir positions lall to piocos. Nor mal
prico rolationships - lotvoon long anJ short intorost ratos, or lotvoon
tvo curroncios that nor mally traJo in noar -unison - lall apart: vast imlal-
ancos lotvoon supply anJ JomanJ can r osult in viJo sproaJs lotvoon
liJ anJ askoJ pricos: anJ liouiJity may Jisappoar (a markot can suJJonly
locomo all sollors, no luyors). Pricos gap anJ car oon in vays that com-
lNSTRUMENTS
41
putors can`t moJol. But sinco many custom Jorivativos Jo not traJo on tho
opon markot, thoro`s no lair vay to prico thom: a gr oat Joal ol guossing is
at vork. (Dorivativos portlolios aro olton pricoJ to moJol - thoy`ro car-
rioJ on thoir ovnors` looks at tho prico tho computor Jooms rational,
rathor than any prico arrivoJ at thr ough opon traJing.)
Whon things go vrong, as thoy JiJ in 1994, soomingly pruJont hoJgos
can gonorato lossos, anJ soloctivo hoJgos ovon liggor onos. Tho 1994 lossos
rosultoJ in a markoJ slovJovn ol OTC Jorivativos grovth in that yoar:
vhothor this is a pauso lor lroath or a r oal lovoling oll is an opon ouos-
tion. Historically, nov lutur os contracts havo typically startoJ slovly, thon
grovn rapiJly, anJ thon lovoloJ oll: it may lo that tho OTC Jorivativos
vorlJ is nov rounJing tho top ol this classic S-curvo.
Whilo Jorivativos gooso up systomic risk, oxposo contral lanks to hugo
potontial lossos, anJ proviJo olton illusory lonolits to usors at groat prolit
to thoir makors, thoy soom innocont ol tho chargo ol incroasing volatility.
Thoro`s no signilicant Jil loronco lotvoon pro- anJ post-1980 stock mar -
kot volatility: Troasury lill volatility vas lovor altor 1980 than lolor o.
21
Volatility vas lovor in stocks lrom 1990 to oarly 1995 than in any livo-yoar
porioJ sinco tho lato 1940s: intor ost rato volatility vas highor, lut still only
hall tho 1950s avorago. Curr oncios, ol courso, aro a major oxcoption, lut
thoy voro onco lixoJ ly Jocroo anJ thon lr ooJ, so thoir Jorivativos loom
is cloarly a r oaction to lunJamontals, not a causo ol incr oasoJ volatility.
currencies
TraJing in curr oncios is tho largost anJ prolally tho olJost markot ol all. lt
usoJ to lo that tho luying anJ solling ol loroign oxchango (aka lorox or
lX) vas an intor moJiato procoss, a stop lotvoon, say, liouiJating a U.S.
Troasury lonJ anJ luying shar os ol Vatsushita in its placo, or lotvoon a
multinational corporation`s taking its pr olits in Gorman marks anJ ship-
ping thom lack to hoaJouartors in IonJon. Nov, hovovor, hoJgo lunJs,
ponsion lunJs, anJ othor institutional invostors havo incr oasingly loon
troating lor oign oxchango as an assot class in itsoll, soparato lr om any un-
Jorlying stock or lonJ (Bank lor lntor national Sottlomonts 1993, p. ).
That moans that traJing in monoy itsoll, rathor than monotary claims on
unJorlying r oal assots, is nov ono ol tho most lashionallo stratogios avail-
allo to lig-timo plungors.
TraJo in lor oign curr oncios is anciont - anJ not only in coins anJ lills,
lut in linancial oxotica. As Var collo Jo Cocco (1992a) notoJ, Aristoto-
WALL STREET
42
lian,
22
Christian, anJ lslamic r ostrictions on usury pr omptoJ clovor lorox
transactions, so pricoJ anJ structur oJ as to allov tho lurtivo loaring ol
intor ost. That moans that lr om tho outsot, lX markots voro only partly
alout tho cross-lorJor traJo in r oal gooJs: linancial consiJorations havo
long loon contral.
With tho lroakup ol tho Poman ompiro, curr oncios proliloratoJ, as JiJ
opportunitios to prolit lrom thoir oxchango anJ translor mation. ltalians
voro voll placoJ to prolit lrom tho nov traJo - ltaly loing tho contor ol
tho lormor ompiro, anJ also tho homo ol tho church Joctors, vho voro
aJopt at Jovising schomos lor ovaJing usury prohilitions. As tho church
lan logan to loso its lito, anJ as tho contor ol Eur opoan oconomic activity
movoJ north anJ vost, ltalian Jominanco ol lX vanoJ: lirst Bolgian anJ
Dutch Joalors inhoritoJ tho lusinoss, only to loso Jominanco to IonJon,
vhoro it romains, though ol courso thoro`s still plonty to go arounJ.
ln myth, tho olJ Jays voro onos ol monotary stalility, vith golJ acting
as tho univorsal oouivalont lor all national monotary lor ms. ln lact, tho
tomptation ol statos to manipulato thoir curr oncios - to Joclaro thoir coins`
purchasing povor to lo groator than tho intrinsic valuo ol thoir motal - is
anciont anJ noarly irr osistillo, anJ tho moro insulatoJ a country is lr om
lX markots, tho loss rosistillo it sooms to lo. Tho triumph ol tho intorna-
tional golJ stanJar J vas tho rosult ol tho Enlightonmont anJ tho consoli-
Jation ol British inJustrial anJ linancial povor: tho political oconomists
ol tho 18th anJ oarly 19th conturios pr oviJoJ tho thoory, anJ tho Jovolop-
mont ol capitalist linanco pr oviJoJ tho impotus lrom practico.
With Sir lsaac Novton as Vastor ol tho Vint, Britain sot tho valuo ol tho
pounJ storling at 123.24 grains ol golJ at tho loginning ol tho 18th con-
tury. That stanJarJ vas susponJoJ in 19, locauso ol tho linancing nooJs
ol tho Napoloonic Wars. Whon poaco camo, cr oJitors` calls lor r ostoration
ol tho golJ stanJar J voro rosistoJ ly inJustrialists anJ lanJovnors. ln
1818, tho govornmont lacoJ major lunJing Jil licultios, anJ vas lor coJ to
roturn to tho olJ lormula. Tho onsuing Jollation savagoJ homo JomanJ,
lorcing British inJustrialists to soar ch alr oaJ lor oxport markots.
Tho classical golJ stanJar J vas novhoro noar as stallo nor as univor -
sal as it`s usually paintoJ ly motal lotishists. W ilJ looms altornatoJ vith
ooually vilJ lusts. AnJ vhilo tho Bank ol EnglanJ stooJ at tho contor ol
tho vorlJ golJ markot, silvor provailoJ olsovhoro, ospocially in lranco,
vhich proviJoJ Britain vith a r osorvoir ol liouiJity in tight timos.
AnJ thon thoro vas Amorica, vhich vas constantly Jisrupting things
throughout golJ`s hoyJay. Tho olton impruJont, anar chic Amorican cr oJit
lNSTRUMENTS
43
systom holpoJ linanco tho country`s oxtraorJinary gr ovth, lut tho systom`s
inJisciplino loJ to manias anJ panics in noar -ooual moasur o.
23
Tho Bank
ol EnglanJ vas olton lorcoJ to act as a lonJor ol last r osort to tho U.S.,
vhich haJ no contral lank, anJ olton littlo sonso ol liscal managomont
(Jo Cocco 1992l). HaJ Amorica loon lor coJ ly somo pro-moJorn lVl to
act accor Jing to moJorn orthoJox principlos, tho U.S. anJ porhaps ovon
tho vorlJ voulJ lo a pooror placo - at loast in monotary tor ms.
Tho U.S. vont oll golJ Juring tho Civil War - var , it sooms, is tho
groatost onomy ol linancial orthoJoxy - anJ JiJn`t r oturn until 189, vith
most othor countrios lolloving suit. That logan tho porioJ ol tho high
classical golJ stanJar J, vhich lastoJ only until 1914, vhon it vas Jostr oyoJ
ly tho outlroak ol var - a much shortor r oign than tho pr opaganJa ol
moJorn golJlugs suggosts. Thoro voro attompts to put it lack togothor
lotvoon tho tvo vorlJ vars, lut countrios sot thoir curroncios` valuos
(r olativo to golJ) unilatorally, vith no sonso ol hov tho valuos littoJ to-
gothor. That systom collapsoJ in tho 1930s, anJ thor o vas no stallo glolal
monotary orJor until altor W orlJ War ll, vhon tho Br otton WooJs lixoJ
oxchango rato systom vas ostallishoJ. Unliko tho classic golJ stanJarJ, in
vhich all countrios oxpr ossoJ thoir national curr oncy in tor ms ol golJ, tho
Brotton WooJs systom usoJ tho Jollar as tho contral valuo, anJ tho Jollar
in tur n vas lixoJ to golJ. Countrios coulJ holJ Jollar r osorvos in thoir
contral lank lor tho sottlomont ol intor national traJo anJ linanco on tho
knovloJgo that thoy coulJ cash thoso Jollars in lor a lixoJ amount ol
golJ. Tho Jollar, as vas saiJ, vas as gooJ as golJ.
Tho Josignors ol tho Brotton WooJs systom loaroJ lloating rato systoms
voro unstallo, unJor mining traJo thr ough uncortainty anJ markot ovor -
roactions. Koynos vantoJ a much mor o olastic systom than tho U.S. pay-
mastors voulJ pormit: ir onically, though, tho omorgonco ol tho Jollar as
tho contral r osorvo curroncy moant that vorlJ r osorvos voro ossontially a
mattor ol U.S. monotary policy, anJ tho U.S. JiJ not stint on supplying
thoso. lrom soon altor tho var vas ovor until toJay, tho U.S. has actoJ as
tho linal sour co ol vorlJ JomanJ. Thoro vas tho Varshall Plan, glolal
military oxpansion, invostmont alr oaJ ly novly glolalizing U.S. multina-
tionals, anJ alvays mor o anJ mor o imports - all ol vhich scattoroJ Jol-
lars ar ounJ tho vorlJ. That cascaJo ol gr oonlacks, plus rising Jomostic
inllation, moant that tho Jollar vas no longor vorth as much as it vas
supposoJ to lo - that is, tho golJ prico vas artilicially lov - anJ that
cashing in Jollars lor golJ at postoJ pricos vas a marvollous Joal. (No
ono took moro ploasuro in pointing this out than Charlos Jo Gaullo.) Strains
WALL STREET
44
logan appoaring in tho systom in tho lato 1960s: tho outllov ol golJ lr om
tho U.S. to IonJon vas so groat Juring tho vook ol tho Tot Ollonsivo in
Viotnam (Var ch 1968) that tho lloor ol tho Bank ol EnglanJ`s voighing
room collapsoJ (O`Callaghan 1993, p. 19). Tho Gor man mark lr oko lroo
anJ appr ociatoJ in 1969, anJ r opoatoJ tho lroakout in 191. Tho lr onch
cashoJ in Jollars lor golJ, anJ thor o voro rumors that Britain vas noxt. So
in August 191, Nixon closoJ tho Troasury`s golJ vinJov, onJing tho salo
ol choap golJ. Altor somo attompts at patching tho systom togothor ,
currr oncios logan lloating, ono ly ono, in 193. Nov tho valuo ol a Jollar
or a D-mark is sot ly traJing on this vast markot.
Whilo govornmonts ar o not lroo to sot tho valuo ol thoir national cur -
roncios, thoy aron`t as povorloss as casual opinion has it. Policios to man-
ago tho major curr oncios havo loon lairly succosslul sinco tho major povors
agr ooJ to tho graJual Jovaluation ol tho Jollar in 1985 (tho so-calloJ Plaza
agr oomont, namoJ altor tho Nov \ork hotol vhoro thoy mot). Nor is con-
tral lank intorvontion nocossarily tho lruitloss anJ oxponsivo thing it`s
thought to lo. lrom tho last ouartor ol 1986 to tho lirst ol 1996, tho U.S.
govornmont maJo ovor $10 lillion on oxchango markot intorvontions,
mainly to support a lalling Jollar (ly luying lots ol Jollars).
24
Tho prolits,
JiviJoJ alout ooually lotvoon tho Troasury anJ tho loJ, vor o aJJoJ to
tho Troasury`s Exchango Stalilization lunJ - $28 lillion in D-marks, yon,
anJ Voxican posos - anJ tho loJ`s holJings ol $21 lillion in lX r osorvos,
JonominatoJ in tho samo curr oncios (lishor 1996).
25
Contral lanks can`t chango tho unJorlying lunJamontals that Jrivo cur -
roncy valuos - liko proJuctivity, inllation ratos, anJ political stalility -
lut thoy can inlluonco tho spooJ anJ gontlonoss ol aJjustmont. But it`s
vorth saying a lov vorJs alout thoso lunJamontals. As loopy as cur-
roncy traJing can got lr om Jay to Jay, it`s no surpriso that oconomic crisos
olton tako on tho lorm ol a loroign oxchango moloJrama. Dospito all tho
hypo alout a lorJorloss glolal oconomy, tho vorlJ is still organizoJ ar ounJ
national oconomios anJ national curr oncios: tho loroign oxchango markot
is vhoro national prico systoms ar o joinoJ to tho vorlJ markot. Prolloms
in tho r olation lotvoon thoso countrios anJ tho outsiJo vorlJ olton ox-
pross thomsolvos as curroncy crisos. Tvo rocont oxamplos ol this aro tho
Europoan monotary crisis ol 1992 anJ tho Voxican poso crisis ol 1994. ln
loth casos, ono coulJ llamo tho turmoil on spoculators, anJ ono voulJ
lo partly right - lut also in loth casos, tho political momontum lor oco-
nomic intogration haJ gotton vay ahoaJ ol tho lunJamontals. W oakor
oconomios liko ltaly`s anJ Britain`s vor o loing thrust into Jir oct compoti-
lNSTRUMENTS
45
tion vith Gormany`s, just as Voxico vas loing thr ovn into compotition
vith tho U.S. Tho rolativo proJuctivity ol tho voakor partnors in loth casos
vasn`t up to tho valuations implioJ ly tho oxchango ratos pr ovailing lo-
loro tho outlroak ol tho crisis. Somothing haJ to givo, anJ it JiJ, vith
soismic lorco.
But Jay-to-Jay traJing in monoy itsoll typically pr ocooJs vith littlo ro-
gar J lor such roal-vorlJ consiJorations. That traJing in monoy takos many
lorms. Tho longost-ostallishoJ aro tho spot anJ lorvarJ markots, Jomi-
natoJ ly tho vorlJ`s major commor cial lanks. A spot contract allovs a
customor to luy a spocilioJ amount ol loroign oxchango - a million U.S.
Jollars` vorth ol Gorman marks, lor oxamplo - lor immoJiato Jolivory at
provailing markot ratos. (ln practico, immoJiato` usually moans tvo lusi-
noss Jays.) Tho lull amount involvoJ actually changos hanJs. Concoptu-
ally, lorvar J contracts ar o simplo onough - thoy`ro a kinJ ol JolayoJ
spot Joal, vith luyors toJay lixing a prico toJay lor a Joal to lo consum-
matoJ in a month or thr oo. ln practico, such straightlorvar J lorvarJ Joals
havo loon oclipsoJ ly svaps, in vhich tho tvo partios agroo to oxchango
tvo curroncios at a cortain rato on ono Jato, anJ thon to r ovorso tho trans-
action, usually at a Jil loront oxchango rato, somo spocilioJ timo in tho
lutur o. Tho prico` ol a lorvarJ contract - tho Jil loronco lotvoon tho
lorvarJ anJ spot pricos - is JotorminoJ lar goly ly tho Jilloronco in intor -
ost ratos in tho tvo curr oncios, vith an aJjustmont lor tho markots` oxpoc-
tations ol vhoro tho curroncios ar o going in tho noar lutur o. Thoro ar o also
lutur os anJ options contracts traJoJ on tho major curr oncios, anJ, ol courso,
oxotic custom Jorivativos aro availallo as voll.
A survoy ly tho Bank lor lntornational Sottlomonts (1996) r oportoJ that
on an avorago Jay in tho rathor placiJ month ol April 1995, $1.2 trillion in
curr oncios changoJ hanJs, up lr om $880 lillion in 1992, an incr oaso ol
only 45/ - insignilicant compar oJ to tho Joulling lotvoon 1986 anJ
1989.
26
To put that $1.2 trillion in porspoctivo, it moans that tho curr oncy
markots tur noJ ovor an amount ooual to annual U.S. GDP in alout a vook,
anJ vorlJ pr oJuct in alout a month. T ur novor has cortainly rison sinco
1992: tho Jaily volumo on tho Cloaring Houso lntorlank Paymont Systom
(CHlPS), tho notvork connocting all tho major lanks Joing lusinoss in-
volving U.S. Jollars, roso alout $200 lillion in tho thr oo yoars altor tho
survoy (Grant 1995, 1998) - a lig numlor , lor sur o, lut ono that implios
a slovor grovth rato than that ol tho 1980s or oarly 1990s.
Britain (mainly IonJon) vas tho liggost lX markot, accounting lor 30/
ol tur novor: tho U.S. (mainly Nov \ork) vas noxt, vith 16/: anJ Japan
WALL STREET
46
(mainly T okyo) thirJ, vith 10/. So tho lig thr oo contors accountoJ lor
56/ ol vorlJ curr oncy traJing: surprisingly, Gor many accountoJ lor only
5/ ol tho total, loss than lar smallor oconomios liko Singapor o, Svitzor-
lanJ, anJ Hong Kong. IonJon`s Jominanco ol tho gamo is r ovoaloJ ly
tvo striking lacts: moro U.S. Jollars ar o traJoJ in IonJon than in Nov
\ork, anJ mor o D-marks than in lranklurt.
AccorJing to tho BlS survoy, 44/ ol tho tur novor vas in tho spot mar-
kot, 9/ in tho lorvar J markots (vhich ar o JominatoJ ly roal-vorlJ cus-
tomors, Joing actual traJing ol gooJs anJ sorvicos), anJ 48/ in tho svap
markots. (ln aJJition, a moJost $15 lillion a Jay in lX lutur os anJ options
voro traJoJ on organizoJ oxchangos.) Ar ounJ 64/ ol total Jaily tur novor
vas lotvoon loroign oxchango Joalors thomsolvos, anJ anothor 20/ vith
othor linancial institutions. Only 16/ involvoJ r oal-vorlJ customors.`
ArounJ 83/ ol all traJos in tho 1995 survoy involvoJ tho U.S. Jollar .
Whilo this is Jovn lrom 90/ thr oo yoars oarlior, it`s oviJonco that tho Jol-
lar is still tho Jominant vorlJ curr oncy ly lar: ovon somothing as JocontoroJ
as tho lX markot nooJs a lixoJ r oloront. Part ol this Jominanco, hovovor,
is tho rosult ol vohiclo traJing` - tho practico ol using tho Jollar as an
intor moJiary curr oncy. lnstoaJ ol somoono vho vants to luy liro lor D-
marks vaiting to linJ somoono oagor to soll D-marks lor lir o, tho traJor
oxchangos D-marks lor Jollars, anJ thon Jollars lor lir o. Tho Jollar is also
tho vorlJ`s main r osorvo curroncy - accorJing to tho lVl, 59/ ol vorlJ
loroign oxchango rosorvos voro holJ in Jollars in 1996, up lr om 1990`s
lov ol 50/. As tho Europoan Union movos tovarJs its singlo curr oncy,
tho ouro is likoly to account lor a lar gor sharo ol vorlJ rosorvos, making it
a rival to tho Jollar as tho vorlJ r osorvo anJ vohiclo curroncy. Ioss ol tho
Jollar`s contral r olo voulJ Jocroaso JomanJ lor tho groonlack, anJ voulJ
prolally nuJgo up U.S. intorost ratos, anJ maylo ovon spoll tho onJ ol
tho U.S.`s imporial privilogo ol lorroving in its ovn curr oncy.
Though somo sontimontalists still cling to tho larlar ous rolic, tho golJ
markot is a lairly small ono. Still, it r omains a kinJ ol monoy, vorthy ol
Jiscussion horo rathor than vith mor o routino commoJitios liko cruJo oil
anJ pig parts. TraJing takos tho usual array ol lor ms, lrom tho spot anJ
lorvarJ oxchango ol physical lullion - Jono mainly vith tho oxchango
ol titlos anJ var ohouso cortilicatos, rathor than actual physical movomont
- to lutur os anJ options on lutur os. ln 1989, total traJing on vorlJ lu-
tur os anJ options oxchangos alono vas tho oouivalont ol 21 timos tho
vorlJ supply ol nov golJ, anJ alout 38/ ol tho total alovo-grounJ sup-
ply. That traJing, plus traJing in othor markots, lar outstrips tho total ol all
lNSTRUMENTS
47
tho golJ ovor minoJ (alout 80/ ol vhich is thought to lo accountoJ lor:
pooplo raroly loso or vasto golJ). Dospito this vigor ous traJing, tho vorlJ
golJ stock is not that improssivo. At $400 an ounco, tho total vorlJ supply
ol golJ is vorth alout $1.5 trillion - alout a ouartor as much as all U.S.
stocks aro vorth, loss than hall tho valuo ol all U.S. Troasury Jolt, anJ
also loss than hall tho U.S. V2 monoy supply.
2
But not all tho vorlJ`s golJ is availallo lor traJing. Tho loaJing holJors
ar o contral lanks, vith 2/ ol tho total vorlJ stock: thoy liouiJato thoir
holJings porioJically, lut ar o not major traJors. Othor ol licial holJors liko
tho lVl account lor anothor 6/ ol tho vorlJ supply, moaning a thirJ ol all
tho vorlJ`s golJ is in tho hanJs ol stato institutions, ovon though golJlugs
cololrato thoir motal lor its lr ooJom lrom tho stato. Jovolry accounts lor
noarly a thirJ (31/), anJ inJustrial uso, anothor 12/. That loavos loss than
a ouartor (24/) ol tho vorlJ`s golJ stock - unJor $400 lillion, or not
much mor o than tho U.S. curr oncy supply - in vhat ar o calloJ privato
stocks,` thoso that aro likoly to lo traJoJ. IonJon`s annual lullion tur n-
ovor alono accounts lor all this oasily traJoallo supply, anJ Jorivativos
account lor anothor 160/. Evory grain ol golJ is spokon lor many timos,
lut as long as ovoryono Joosn`t JomanJ physical Jolivory at onco, tho
markot vill lohavo.
Dospito tho small physical lounJation on vhich tho golJ markot is luilt,
tho motal still has a psychological grip on linancial playors, vho viov its
riso as a portont ol inllation or political pr olloms, anJ viov its lall as a
sign ol Jollation anJ placiJity. Calls lor a r oturn to a golJ stanJar J rogu-
larly omanato lr om tho right ving ol Wall Str oot - supply-siJors liko JuJo
Wanniski anJ Iarry KuJlov aJor o golJ, anJ ovon loJ chair Alan Gr oonspan
prolossos to lo lonJ ol paying closo attontion to it vhon sotting monotary
policy. Groonspan, a ono-timo Ayn PanJ acolyto, vr oto an ossay
(Groonspan 1966) lor hor I~cI::::I novslottor proclaiming golJ tho ulti-
mato voapon ol tho havos against inllation, a vay lor tho ovnors ol
voalth` to protoct` thomsolvos against all statist schomos to conliscato
tho voalth ol tho proJuctivo momlors ol socioty to support a viJo varioty
ol vollaro schomos.`
28
GolJ romains, in Koynos` ( W Vl, p. 259) phraso, an important part ol
tho apparatus ol consorvatism,` anJ in mor o sonsos than ono. AttonJ a
conloronco ol golJlugs anJ you aro likoly to lo surrounJoJ ly tho most
lorvont Jonizons ol tho lar right, vho lovo not only tho austority that golJ
symlolizos, lut also tho lact that it`s a non-stato lor m ol monoy. ln a tr o-
monJous rovorsal ol 19th contury populist iJoology, vhich vas lovorishly
WALL STREET
48
anti-golJ, many ol toJay`s right populists ar o vory pro-golJ, as tho only
antiJoto to tho parasitical rulo ol W ashington anJ W all Str oot. A cultural
lonus to right-ving golJlugs vas tho largo prosonco ol South Alrica in
tho inJustry anJ ol South Alricans at thoir conlor oncos: many, though cor-
tainly not all, aur ophilos voro aJmir ors ol aparthoiJ. lr onically, many loltish
South Alricans nov r oot lor monotary JisorJor in tho North, vhich voulJ
rosult in hoavy JomanJ lor golJ, alloving tho country to play tho r olo ol a
prosporous unJortakor at a lunoral.` Though South Alrican minos ar o
gotting protty tappoJ out, tho six largost South Alrican lir ms controlloJ
ovor a ouartor ol vorlJ golJ proJuction in 1993, vith tho hugo Anglo-
Amorican comlino alono r osponsillo lor ovor 18/. CanaJa, vith 8/, anJ
tho U.S., vith /, voro a Jistant soconJ anJ thir J (Togon 1994).
GolJ`s actual porlormanco is a sour co ol constant lrustration to golJlugs.
Tho motal`s main char m is that it r otains its pur chasing povor ovor timo:
shoulJ inllation soar or tho lanking systom imploJo, golJ vill not vanish
liko a papor claim. But its Jravlacks ar o plontilul, anJ thor o ar o gooJ
roasons vhy all sociotios havo gravitatoJ to stato-sponsoroJ monoy. GolJ
pays no intorost, is lulky, roouiros assay, anJ must lo storoJ. lt is hoavy
anJ physical in a vorlJ that tonJs tovar Js ovor moro immatoriality. Somo-
thing that nor mally Joos no lottor than shaJov tho gonoral prico lovol is
no lun, though golJlugs ar o alvays imagining somo Jisastor - hyporin-
llation, tho collapso ol tho stato, climatic catastr opho - that vill lring
thoir lolovoJ motal lack to lilo.
lor motallists, thoro voro no lottor Jays than tho 190s. GolJ lirst lo-
gan traJing lr ooly in 1968, anJ it immoJiatoly lr oko avay lrom tho classic
$35 an ounco prico, sot in 1934, vhon tho Poosovolt aJministration lannoJ
privato ovnorship ol monotary golJ. Tho prico roso slovly, lroaking gon-
tly alovo $40 as tho JocaJo tur noJ.
Onco tho U.S. alanJonoJ convort-
ilility, hovovor, golJ startoJ a rip-
ping lull markot. Poaching a lirst
poak just unJor $200 in oil-shockoJ
194, tho prico sottloJ lack vith tho
rocossion, anJ tur noJ up vith tho
vorlJ oconomy in 196 in a spoc-
tacular riso that onJoJ at $850 an ounco in January 1980. lr om thoro, vhon
tho Volckor clampJovn took holJ, golJ sank almost unroliovoJly to lo-
lov $300 in 1985. Altor 1985, it spont ton yoars going novhor o - vhich
shoulJ lo no surpriso ovor tho long torm, givon tho motal`s roputation as
real gold price,
1934-98 (1998S)
0
200
400
600
300
!000
!200
!400
!934 !944 !954 !964 !974 !934 !994
193498 median:
!998. !irs! quar!er on|v

lNSTRUMENTS
49
a storilo r opository ol valuo. Dospito all tho gyrations in lotvoon, tho av-
orago golJ prico ol $294 in oarly 1998 vas 31/ lolov 1934`s $409 (in
constant 1998 Jollars). Soon in a long-tor m porspoctivo, tho 190s moroly
corroctoJ tho stoaJy orosion ol tho motal`s purchasing povor Juring tho
lour provious JocaJos vhon tho prico vas lixoJ ly lav. lrom horo on
out, golJ shoulJ riso vith tho avorago prico lovol - making allovanco, ol
courso, lor tho occasional var, r ovolution, hyporinllation, or linancial panic,
shoulJ such a thing ovor happon again.
innovation in general
This roviov is likoly to lo olsoloto all too soon: tho linost minJs ol Wall
Stroot anJ similar pr ocincts ar ounJ tho vorlJ ar o constantly invonting nov
instrumonts. At tho risk ol anthr opomorphizing a social convontion, monoy
capital longs lor oxotic lorms. Ono roason lor this is that tho highost-prolit
instrumonts ar o usually tho novost: lig gains go to tho invontor ol a nov
gimmick, lut thoso laJo as tho proJuct is imitatoJ ly ovoryono olso on tho
Stroot. But that can`t lo tho only r oason: cloarly thoro`s a JomanJ, not
alvays lully thought thr ough, lor vhizlang nov tools to manago risk,`
havo a lling, or inJulgo somo othor lust lor monoymaking.
John D. linnorty, vho compiloJ tho Whitmanic cataloguo ol linancial
innovations sinco tho 1960s r oproJucoJ on pago 51, listoJ 10 stimuli to
such croativo ontorpriso. Thoy incluJo risk roJuction or tho shilting ol risk
tovarJs ono party or tho othor, r oJuction ol agoncy costs (lonJor suporvi-
sion ol managomont) anJ issuanco costs, tax anglos, complianco vith or
ovasion ol rogulation, changos in tho lovol anJ volatility ol intor ost anJ
oxchango ratos, acaJomic anJ othor r osoarch that r osult in aJvancos in
linancial thoorios,` accounting gimmickry, anJ tochnological aJvancos.
This littlo survoy ol linancial innovation voulJ lo incomploto vithout
notico paiJ to tho oaso vith vhich noarly anything can lo alsorloJ into
tho circuit ol monoy. On shutting Jovn his lamily`s 12-yoar -olJ IonJon
art Joalorship, Charlos Ioggatt olsorvoJ, Whon l startoJ in art, vhat mat-
toroJ vas loing allo to spot a gooJ picturo. What counts nov is to havo a
lirst-class linancial lrain. What l camo into vas tho art traJo: vhat l am
loaving is a linancial sorvico` (AP Tnovslottor 1992).
Art is lut ono oxamplo ol capital`s alility to capitalizo noarly anything.
Tho WorlJ Bank is a mastor at this practico: it capitalizos Jisastor itsoll. A
hoaJlino in tho April 13, 1995, issuo ol its vookly PP shoot, W:Iu 1uu
N~u:, lraggoJ, Bank Pr oparos Emorgoncy Holp lor Vassivo Pussian Oil
WALL STREET
50
Spill.` Somothing haJ to lo Jono to contain a hugo spill that voulJ lo
unloashoJ como tho spring thav, anJ tho WorlJ Bank vas r oaJy. Whilo
many Amoricans think this moans tho W orlJ Bank gavo avay thoir tax
Jollars, in lact tho Bank vas tur ning Pussian oconomic catastr opho into
$99 million in claims holJ ly tho Bank anJ its cr oJitors, to lo sorvicoJ ly
Pussian oxports. lor tho WorlJ Bank, this is all in a Jay`s vork. lt r outinoly
lunJs` gr oonhouso gas roJuction programs - thr ough loans, ol courso
- in countrios vhor o it linancoJ tho gas-spoving povor plants. lt pro-
viJos Womon in Dovolopmont` loans in countrios vhoro gonJor rola-
tions, lor gooJ or ill, haJ loon tur noJ upsiJo Jovn ly Bank-loJ
liloralization. lt pr oviJos nov loans lor tho rostructuring ol olJ loans. lor
a pullic institution, tho W orlJ Bank is ouito innovativo - anJ pr olitallo.
ln 1995, it maJo $1.35 lillion lor itsoll, anJ $6.84 lillion lor its lonJholJ-
ors: it haJ $15.5 lillion in r otainoJ assots on its lalanco shoot, accumu-
latoJ lr om Jolts sorvicoJ ly tho vorlJ`s poor (WorlJ Bank 1996).
But lack to tho moro lamiliar torrain ol vorkaJay linancial instrumonts.
Vost ol tho noarly 100 instrumonts shovn noarly ar o moroly hylriJ proJ-
ucts assomlloJ lrom sovoral lasic luilJing llocks - convorsion ol lixoJ
to lloating intor ost ratos or vico vorsa: maturity translor mation (tur ning
long-torm olligations into shortor-torm onos, or tho rovorso) instrumonts
craltoJ to movo in tho Jir oction opposito somo othor prico (invorso lloat-
ors, vhich pay loss as intorost ratos riso anJ mor o as thoy lall): tho cr oation
ol hormaphr oJito socuritios (lonJ-stock varrant, lonJ-golJ, lonJ-an-
othor country`s curr oncy, lonJ-stock luturo): tax, accounting, anJ r ogu-
latory lootvork: tho splitting ol incomo stroams (strippoJ` lonJs, onos
JiviJoJ into intor ost anJ principal sul-lonJs, anJ thon por haps JiviJoJ
again lotvoon high- anJ lov-risk): tho svapping ol incomo stroams (in-
torost rato svaps): tho pooling ol lunJs or ol olligations into largor vholos
to Jivorsily against inJiviJual risks (mutual lunJs, socuritization): schomos
lor incr oasing lovorago (options, luturos, paymont-in-kinJ socuritios) or
controlling volatility (options, lutur os, svaps). lrom thoso olomonts, hov-
ovor, inlinitoly strango cr oatur os can lo maJo.
Or, Pathor than Jovoloping nov gonoric instrumonts,` linancial inno-
vation sinco tho miJ-1980s has tonJoJ to tako tho lor m ol novol comlina-
tions ol oxisting proJucts to support complox anJ highly sophisticatoJ
invostmont stratogios.. At tho samo timo, a gr oving rango ol custom-
tailor oJ` invostmont proJucts has loon JovolopoJ to maximiso possilili-
tios lor matching actual portlolio structur os to thoorotically-lasoJ invosmont
moJols` (Bank lor lntor national Sottlomonts 1993, p. 86). Tho mor o roality
lNSTRUMENTS
51
financial innovations
adjuslable rale converlible noles adjuslable rale prelerred slock adjusl
able/variable rale norlgages AllSaver cerlilicales Anericus lrusl an
nuilv noles auclion rale capilal noles auclion rale noles/debenlures
auclion rale prelerred slock bull and bear CDs capped lloaling rale noles
collaleralized connercial paper collaleralized norlgage obligalions/real
eslale norlgage inveslnenl conduils collaleralized prelerred slock con
nercial real eslalebacked bonds connodilvlinked bonds converlible
adjuslable prelerred slock converlible exchangeable prelerred slock
converlible norlgages/reduclion oplion loans converlible resel deben
lures currencv swaps deep discounl/zero coupon bonds delerred in
leresl debenlures direcl public sale ol securilies dividend reinveslnenl
plan dollar BLS dual currencv bonds enplovee slock ownership plan
(ESOP Eurocurrencv bonds Euronoles/Euroconnercial paper ex
changeable auclion rale prelerred slock exchangeable renarkeled pre
lerred slock exchangeable variable rale noles exchangelraded oplions
exlendible noles linancial lulures lloaling rale/adjuslable rale noles
lloaling rale exlendible noles lloaling rale, raling sensilive noles lloal
ing rale laxexenpl noles loreigncurrencvdenoninaled bonds loreign
currencv lulures and oplions lorward rale agreenenls gold loans high
vield (junk bonds increasing rale noles indexed currencv oplion noles/
principal exchange linked securilies indexed lloaling rale prelerred slock
indexed sinking lund debenlures inleresl rale caps/collars/lloors inler
esl rale lulures inleresl rale resel noles inleresl rale swaps leller ol
credil/surelv bond supporl nandalorv converlible/equilv conlracl noles
nasler liniled parlnership nediunlern noles nonev narkel noles
norlgagebacked bonds norlgage passlhrough securilies negoliable
CDs noncallable longlern bonds oplions on lulures conlracls paired
connon slock parlicipaling bonds pavinkind debenlures perpelual
bonds poison pul bonds pullable/adjuslable lender bonds pullable
connon slock pullable converlible bonds pullableexlendible noles
real eslalebacked bonds real vield securilies receivablebacked securi
lies renarkeled prelerred slock renarkeled resel noles serial zero
coupon bonds shell regislralion process singlepoinl adjuslable rale slock
Slandard & Poors indexed noles slale rale auclion prelerred slock
slepup pul bonds slock index lulures and oplions slripped norlgage
backed securilies slripped nunicipal securilies slripped U.S. Treasurv
securilies svnlhelic converlible debl luilion lulures unbundled slock
unils universal connercial paper variable coupon/rale renewable noles
variable cunulalive prelerred slock variable duralion noles warranls
lo purchase bonds vield curve/naxinun rale noles zerocoupon con
verlible debl
WALL STREET
52
can lo maJo to corr osponJ to tho puro loauty ol linancial thoory, tho
lottor lilo vill lo.
lt`s lashionallo among liloral intolloctuals to tr oat linancial onginoor -
ing` as an invontion ol tho Poaganlush yoars. But linancial onginooring
vas a lavorito tor m ol AnJro Voyor, tho supromo ol Iazar J lroros lrom
tho 1950s to tho 190s, vho vas tho prolossional goJlathor ol tho liloral
intolloctuals` lavorito invostmont lankor , lolix Pohatyn. By that tor m, Voyor
moant tho cr oation ol a structur o that somohov onalloJ him to vring all
ho coulJ out ol tho Joal vith a minimum amount ol risk.` Pohatyn tracoJ
Voyor`s skill at croating this artlul risk-r ovarJ structur o to his skill at no-
gotiation. AnJro coulJ pool pooplo liko lananas,` saiJ Pohatyn (Poich
1983, p. 19).
But linancial innovations ar o moro than mor o lankors` lancy: har J is-
suos ol povor anJ risk aro sottloJ through thom. lloating rato instrumonts
shilt tho risk ol rising intor ost ratos lrom lonJor to lorrovor. AJjustallo
rato notos protoct lonJholJors against impruJont or capital-risking ac-
tions ly managomont, liko taking on gols ol nov Jolt. Ioosor rogulations
on issuanco liko sholl rogistration, vhich allovs corporations to lilo gon-
oral prospoctusos to lo kopt on lilo, rathor than proparo custom prospoc-
tusos lor a spocilic stock or lonJ issuo, allov lirms to havk thoir papor
vhon tho markot looks lrionJly.
Josoph Schumpotor (1939, vol. 2, p. 613), vriting Juring a JocaJo vhon
linancial innovation vas Jooply out ol lashion, olsorvoJ that it is ono ol
tho most charactoristic loatur os ol tho linancial siJo ol capitalist ovolution
so to molilizo` all, ovon tho longost, maturitios as to mako any commit-
mont to a promiso ol luturo lalancos amonallo to loing in tur n linancoJ
ly any sort ol lunJs anJ ospocially ly lunJs availallo lor short timo, ovon
ovornight, only. This is not mor o tochniouo. This is part ol tho coro ol tho
capitalist pr ocoss.`
Volilizo, molilizo - this is Vosos anJ tho prophots!
notes
1. Thoro is a curious roticonco alout monoy, not only in oconomics, lut moro throughout
Amorican culturo - curious locauso loth tho Jisciplino anJ tho culturo aro luilt on an
olsossion vith monoy. Along thoso linos is P.C. Iovontin`s (1995) olsorvation that tho
only tvo ouostions in tho lamous 1994 survoy ol Sox in Amorica that voro askoJ in
privato, vritton lorm rathor than oxploroJ in laco-to-laco intorviovs voro thoso on
masturlation anJ housoholJ incomo. Amorican culturo is almost as olsossoJ vith sox
as it is vith monoy, lut tho olsossions aro lraught vith amlivalonco anJ Jonial.
2. ln its ovn propaganJa, tho Nov \ork Stock Exchango (1994, p. 6) is vaguo - anJ ono
lNSTRUMENTS
53
guossos Joliloratoly so - on this mattor. lts annual 1ucI 1 says only that tho N\SE
contrilutos to tho capital-raising anJ capital-allocating procoss that is tho strongth anJ
hallmark ol tho U.S. oconomy.` Tho N\SE oncouragos savings anJ invostmont,` holps
inJiviJuals savo lor thoir luturo,` anJ oncouragos tho croation anJ Jovolopmont ol
nov iJoas, nov proJucts anJ nov sorvicos that luilJ succosslul ontorprisos anJ croato
jols.` (On a lloor tour, tho oxchango`s pross ollicor usoJ almost oxactly tho samo vorJs.)
Just hov it Joos all that is lolt to tho roaJor`s imagination: tho N\SE`s contrality to all
thoso happy procossos is, ol courso, olvious.
3. lronically, tho lirst chair ol tho U.S. Socuritios anJ Exchango Commission vas Joo
KonnoJy, vho maJo a lortuno lrom tvo classic 1920s pursuits, lootlogging anJ stock
manipulation. Prosumally this oualilioJ him to root out othor rascals.
4. Tho Voxican Jolaclo ol 1994-1995 slovoJ tho loom a lit, lut harJly killoJ it.
5. Ono nooJn`t control 100/ ol a lirm`s sharos to oxorciso a controlling intorost. Anyono
holJing 50/ ol tho outstanJing sharos plus ono can Jictato policy, anJ in practico, 10/
can lo onough to Jo tho trick, ospocially il tho othor 90/ ol tho sharos aro viJoly
JisporsoJ among numorous anJ JisorganizoJ sharoholJors.
6. Tho smart monoyJuml monoy Jistinction is vory popular among Wall Stroot prolos-
sionals anJ vannalos - typically pooplo vho assumo thomsolvos to lo among tho
smart - though acaJomic stuJonts ol linanco Jismiss it as mythology. ln gonoral, smart
monoy consists ol spocialists anJ othor oxchango momlors anJ cololrity monoy man-
agors: Juml monoy, ol small-timo spoculators among tho pullic. lronically, that moans
that analysts anJ traJors in lrokorago housos uso tho lohavior ol thoir ovn customors
as a contrary inJicator. lt`s harJ to placo tho mass ol lig-timo monoy managors on tho
smart-Juml spoctrum. Tho charitallo roason lor such agnosticism is that thoy osson-
tially u:~ tho markot, sinco thoy Jominato Jaily traJing. Tho uncharitallo roason is that
Jospito thoir allogoJ sophistication anJ voalth ol linancial anJ analytical rosourcos,
thoy turn in a moJiocro porlormanco. Tho smartJuml classilication schomo also lits in
vith tho paranoiJ vothoy minJsot ol many traJors, vho aro convincoJ that thoy`
manipulato tho markot, though vho thoy` aro is not cloar. A hint ol vho thoy aro can
lo lounJ in tho romark ol an options traJor vho onco JolinoJ a loar markot to mo as
tho timo vhon monoy roturns to its rightlul ovnors, liko, you knov, tho Pockolollors.`
. liguros lor tho yon`s sharo ol loroign traJo aro lor 198: rosorvos, 1990: loth citoJ in
GolJstoin ot al. 1992l, p. 8. lor moro on tho yon, soo VcKonzio anJ Stutchlury 1992.
8. Tho loJoral National Vortgago Association, tho loJoral Homo Ioan Bank, anJ tho
StuJont Ioan Varkoting Association, rospoctivoly. Voro alout thom in Chaptor 2.
9. Spocilically, thoso aro ropurchaso anJ rovorso ropurchaso agroomonts. A ropurchaso
agroomont (ropo) is tho salo ol an assot Jono vith tho ploJgo to luy it lack at a spocilic
timo anJ prico. Essontially it`s a loan vith tho unJorlying assot - typically U.S. Troa-
sury papor - as collatoral. A rovorso ropo is tho opposito siJo ol this transaction.
10. AccorJing to loJ rogulations, lanks must koop a spocilioJ porcontago ol Joposits oi-
thor as vault cash or on Joposit vith tho contral lank. Tho roouiromont is a constraint
on tho sharo ol Joposits that lanks can lonJ out. Banks vith rosorvos in oxcoss ol thoso
roouiroJ ly tho loJ - usually small lanks vith moro Joposits than lonJing outlots -
lonJ monoy to thoso short ol rosorvos, gonorally tho largor lanks, vho olton havo moro
voulJ-lo lorrovors than thoy can satisly, lrom manulacturing companios oagor to
luilJ invontory to linancial oporators anJ roal ostato Jovolopors.
11. ln practico, tho gap is usually narrovor, locauso municipal Jolt is not as salo as U.S.
Troasury lonJs. ln 1995, tho lost muni lonJs, ratoJ Aaa ly VooJy`s, paiJ an avorago
ol 5.80/, vhilo long-torm Troasurios paiJ 6.93/.
12. But only in part, locauso tho Jorivativos voro a lancy-Jross vorsion ol a classic strat-
ogy, lorroving lots ol monoy to mako laJ invostmonts. \ou Jon`t nooJ instrumonts
WALL STREET
54
jointly concoctoJ ly VBAs anJ thoorotical physicists to loso at that gamo.
13. Anyono vho thinks an option on a luturo is too alstract to oxist is olviously not schooloJ
in tho highor linancial consciousnoss.
14. An olJ Wall Stroot rhymo says ol short-solling: Ho vho solls vhat isn`t his`nBuys it
lack or goos to prison.`
15. What lollovs Joscrilos luturos markots, lut options markots aro vory similar.
16. Iong loloro stock options voro traJoJ on oxchangos, stock varrants voro traJoJ on
tho N\SE anJ othor oxchangos.Warrants aro ossontially long-torm options to luy a
stock, vith maturitios typically moasuroJ in yoars rathor than months: thoy`ro lroouontly
attachoJ to nov lonJ issuos to mako thom moro attractivo.
1. Noto that pullic soctor institutions voro tho pionoors ol svap tochniouos.
18. Brioso`s liguros aro lasoJ on Soptomlor 28, 1993, lilings vith tho U.S. CommoJity lu-
turos TraJing Commission, roportoJ in uu:Iu~uI: J T:uu~::
19. A stuJy ol 65 mutual lunJs shovoJ no statistically or oconomically signilicant` Jil-
loroncos in roturns lotvoon lunJs that usoJ Jorivativos anJ thoso that JiJn`t (Koski
anJ Pontill 1996).
20. Ono ol Chaso Vanhattan`s top risk managors vas a Josignor on tho Chornolyl toam.
Tho ox-Josignor, a mathomatician anJ physicist namoJ Victor Vakarov, kopt an oyo on
somo ol Chaso`s positions in 36 curroncios, lonJs, loans, stocks, anJ Jorivativos: his
history, ho says, maJo him ospocially risk-avorso (Iipin 1994).
21. Volatility is moasuroJ ly tho stanJarJ Joviation ol yoarly porcontago changos: 1980 is
as gooJ a JiviJing timo as any lotvoon tho Nov Era anJ tho OlJ. lntorost Jorivativos
logan traJing in 19: stock Jorivativos in 1981: 1980 also markoJ tho lirst lito ol
Volckor`s saJomonotarism, vas alout tho miJpoint ol linancial Jorogulation, anJ vas
tho ovo ol tho Poagan translormation.
22. Aristotlo thought that only living loings coulJ loar lruit. Vonoy, not a living loing,
vas ly its naturo larron, anJ any attompt to mako it loar lruit (I:, in Grook, tho
samo vorJ usoJ lor intorost), vas a crimo against naturo` (Jo Cocco 1992a).
23. Noarly hall ol tho lato 19th contury in tho U.S. vas spont in porioJs ol rocossion or
Joprossion: sinco WorlJ War ll, only alout a lilth ol tho timo has loon.
24. Tho loJ Joos not mako it oasy to got this inlormation. Calls to tho pross ollico inouiring
alout prolits anJ lossos lrom lX intorvontions aro mot vith tho Joclaration that tho loJ
isn`t in that lusinoss to mako monoy, anJ no lurthor holp is olloroJ. Vy rosoarch assis-
tant, Josh Vason, vas allo to put togothor liguros going lack to 1986 at tho Nov \ork
loJ lilrary, lut tho stall maJo it vory harJ to got oarlior inlormation.
25. Dollar policy is tho only aroa vhoro tho loJ takos instructions lrom tho oloctoJ govorn-
mont, spocilically tho Socrotary ol tho Troasury. On Jomostic monotary policy tho loJ
is largoly its ovn loss. Tho ESl vas tappoJ ly tho Clinton aJministration lor tho 1995
Voxican lailout, vhon it vas provontoJ ly Congross lrom using convontional sourcos
ol lunJing.
26. Thoso liguros aro aJjustoJ to oliminato all lorms ol Joullo-counting (i.o., in vhich tho
samo traJo might lo roportoJ ly loth siJos anJ countoJ tvico). Gross roportoJ turn-
ovor, loloro this aJjustmont, vas noarly $1.4 trillion.
2. U.S. liguros aro onJ-1994. Govornmonts typically valuo golJ rosorvos at voll lolov
markot ratos: tho loJ valuos U.S. golJ at $42.22 an ounco.
28. Groonspan no longor spoaks vith that clarity, though his proloronco lor noar-zoro in-
llation spoaks lor him. ln his ossay lor PanJ, Groonspan JonouncoJ govornmont lor-
roving in vhat lor him aro hoatoJ torms, lut nov in his rolo as loJ chiol ho is lankor
to tho Troasury anJ rosponsillo lor maintaining tho orJorlinoss ol tho markot lor tho
Troasury`s lonJs. ln anothor irony lor tho antistatist Groonspan - vho, ly tho vay,
has novor ropuJiatoJ PanJ anJ vho attonJoJ hor lunoral - also prosiJoJ ovor tho
lNSTRUMENTS
55
groat stato lailout ol tho U.S. linancial systom that ran lrom roughly 1989-93. Othor
Groonspan contrilutions to tho PanJian colloction in vhich his 1966 ossay is roprintoJ
incluJo an attack on antitrust anJ consumor protoction lavs.
56
2 Players
Dospito yoars ol Jorogulation, morgors, intornationalization, anJ othor
translormations, U.S. linanco still loars tracos ol Nov Doal stricturos anJ
an anciont hatroJ ol monopolistic lig city linanco. To 1933`s Glass-Stoagall
Act vo ovo tho Jistinction lotvoon invostmont anJ commorcial lanking.
Commorcial lanks voro lorliJJon to play in tho stock markot anJ simi-
larly racy aronas: thoy voro to uso thoir Jopositors` monoy mainly to mako
lusinoss loans. Glass-Stoagall also allirmoJ long-stanJing rostrictions on
lank lranching, rogulations that sprang lrom Amorican suspicions ol a
contralizing monoy trust. Banking omorgoJ lrom tho Doprossion a tightly
rogulatoJ inJustry laJon vith govornmont guarantoos, anJ tho rost ol tho
systom vas soJato anJ lairly voll-JolinoJ.
Things aro no longor soJato nor voll-JolinoJ. lnstitutional lorJors havo
laJoJ, lank intorost ratos aro no longor lixoJ ly lav, anJ intorstato lank
lranching rostrictions aro gono. But tho U.S. linancial systom still romains
highly lragmontoJ. Tho Nov \ork Stock Exchango has ovor 500 momlor
lirms: as ol 1995, tho nation vas llossoJ vith 10,450 lanks, 2,152 thrilts,
,361 mutual lunJs, anJ ovor 12,500 croJit unions: in 1990, corporato
Amorica haJ 51,440,000 inJiviJual anJ hunJroJs ol thousanJs ol institu-
tional sharoholJors.
1
Calling this hoJgo-poJgo a linancial systom roouiros
a cortain tasto lor alstraction - though ol courso it all comos togothor
arounJ monoy.
the matri of claims
Vaylo tho lost vay to got a sonso ol hov tho hoJgo-poJgo Joos lit to-
gothor is to uso tho loJoral Posorvo`s llov ol lunJs (lol) accounts as a
skoloton anJ connoctivo tissuo. Tho lol aro not as voll knovn as tho
national incomo anJ proJuct accounts (NlPA), vhich moasuro gross
PLAYERS
57
Jomostic proJuct anJ its compononts, lut thoy`ro a rich sourco ol inlor-
mation on hov tho various piocos ol tho linancial systom connoct vith
oach othor anJ vith tho roal vorlJ.
ln tho inologant vorJs ol thoir koopors, |tlho llov ol lunJs systom ol
national accounts is JosignoJ to lring tho many linancial activitios ol tho
U.S. oconomy into oxplicit statistical rolationship vith ono anothor anJ
into Jiroct rolation to Jata on tho nonlinancial activitios that gonorato in-
como anJ proJuction.|anJl to iJontily loth tho inlluoncos ol tho nonli-
nancial oconomy on linancial markots anJ tho rociprocal inlluoncos ol
Jovolopmont in linancial markots on JomanJ lor gooJs anJ sorvicos,
sourcos anJ amounts ol saving anJ invostmont, anJ tho structuro ol in-
como` (loJoral Posorvo BoarJ 1980, p. 2). lnJiviJuals, lirms, anJ govorn-
monts all savo, lorrov, anJ luy: tho lol accounts lring thoso activitios
togothor vithin a singlo sot ol covors. Tho national incomo accounts havo
nothing to say alout tho proliloration ol linancial claims or tho sizo ol tho
capital stock: thoso aro tho provinco ol tho lol accounts.
2
At tho hoart ol tho lol systom is a matrix that JiviJos tho oconomy into
34 major soctors. Thoso 34 can lo loiloJ Jovn into livo lasic soctors:
housoholJs, nonlinancial lusinossos, govornmonts, anJ linancial institu-
tions, lor tho Jomostic oconomy, along vith rost ol vorlJ,` a catch-all
soctor that incluJos ovory playor outsiJo tho U.S., privato or pullic, inJi-
viJual or corporato. Each ol thoso ontitios savos, lorrovs, anJ accumu-
latos physical capital vith its ovn anJ lorrovoJ lunJs. All thoso llovs
must lalanco in tho onJ: A cannot lorrov unloss B has savoJ (or, in this
Jizzy vorlJ, vhich is alvays gotting ahoaJ ol itsoll, A cannot lorrov un-
loss tho lonJor can linJ somo ol B`s monoy to pass along) - nor can B
savo prolitally il thoro is no A availallo to invost tho monoy. All tho instru-
monts invontoJ ly moJorn linancial alchomists havon`t altoroJ thoso os-
sontial lacts, ovon though thoy can lonJ thom protty lar out ol shapo.
BosiJos soctoral Jata, tho lol also roports transactions` Jata - tho
lorm tho transmission ol monoy takos. Though ovor 50 kinJs aro listoJ in
tho llov ol lunJs manual (loJoral Posorvo BoarJ 1993, p. 19), thoso too
can lo loiloJ Jovn into sovoral major catogorios: insuranco anJ ponsion
lunJ rosorvos: intorlank Joalings: Joposits (in lanks anJ thrilts, mainly):
stocks anJ mutual lunJs: croJit markot instrumonts (liko lonJs, mortgagos,
consumor croJit, commorcial papor, lank loans): anJ othor` (loans ly
lrokors to customors to covor socurity purchasos: traJo croJits, liko thoso
lotvoon GV anJ its parts suppliors or lotvoon garmont makors anJ Jo-
partmont storos).
WALL STREET
58
Thoro aro tvo vays ol looking at lol Jata, llovs anJ stocks. llovs
roprosont a soctor`s contrilutions anJ vithJravals lrom tho capital mar-
kots (saving anJ lorroving, tho croation ol nov assots anJ nov lialilitios)
ovor tho courso ol a ouartor or a yoar. Stocks aro tho total valuo ol assots
anJ lialilitios outstanJing (ossontially tho sum ol prior yoars` llovs, loss
lossos to olsolosconco, ropaymont ol principal, or linancial tragoJios liko
lankruptcy). Tho sizo ol ono`s lank account at tho onJ ol a yoar is tho
stock valuo: tho yoar`s Joposits anJ vithJravals aro llovs. ll tho stock at
tho onJ ol this yoar is largor than a yoar oarlior, thon tho yoar`s not llovs
voro positivo.
Each soctor has a lasic incomo llov - vagos lor housoholJs, taxos lor
govornmonts, salos lor lusinossos, invostmont incomo lor all. This incomo
is thon spont, vith part ol tho monoy going to covor curront oxponsos
(liko looJ anJ ront lor housoholJs, or rav matorials anJ salarios lor lusi-
nossos) anJ part to long-torm invostmonts.` Thoso invostmonts may oi-
thor lo in tangillo assots (cars anJ housos lor housoholJs, or computors
anJ ollico luilJings lor lusinossos) or linancial onos (stocks, lonJs, lank
Joposits). ln tho lol vorlJ, lorroving is consiJoroJ a nogativo linancial
invostmont, so tho not linancial invostmont lor oach soctor consists ol vhat
it savos loss vhat it lorrovs.
Concoptually, all thoso accounts must lalanco: noithor pooplo nor lusi-
nossos can sponJ moro than thoy tako in through incomo anJ lorroving.
ln practico, tho accounts novor ouito lalanco, locauso it`s noarly impos-
sillo to account lor ovory transaction - somothing tho lol accountants
tako caro ol ly throving in Jiscropancy` torms. Thoso aro usually ouito
tiny, anJ can lo saloly ignoroJ. Concoptually anJ practically, tho lol ac-
counts aro an oxtraorJinary achiovomont in tho vastly unJorratoJ liolJ ol
social statistics.
who owes what to whom
DocaJos ol linancial innovation asiJo, most linancial markot activity still
involvos somo variation on lorroving anJ lonJing, anJ this soction lo-
cusos mainly on thoso traJitional aroas.
A chart noarly shovs that most soctors havo loon lusily tapping tho
croJit markots. Whilo tho U.S. govornmont spont tho lirst hall ol tho post-
WorlJ War ll yoars paying Jovn its var Jolt, housoholJs voro oxploring
consumor anJ mortgago croJit, nonlinancial lirms voro graJually ratchoting
up thoir lovorago, anJ linancial lirms vont rathor vilJ.
3
All this lorroving
PLAYERS
59
ly tho main oconomic soctors pushoJ up tho total JoltGDP ratio, graJu-
ally lrom tho 1950s through tho lato 190s, vith an accoloration loginning
arounJ 1982 - tho yoar tho Poagan loom roally got unJorvay, along
vith tho lull markot in stocks. Though tho paco ol nov croJit-making
slovoJ a lit in tho oarly 1990s, it vasn`t throvn into rovorso ovorall: noto
that tho only major soctor to rothink its rolation vith Jolt vas nonlinan-
cial lusinoss - though it looks liko tho U.S. govornmont vill lollov suit
in tho lato 1990s, shoulJ tho luJgot actually romain in lalanco altor 1998.
This continuoJ upvarJ riso in tho aggrogato Jolt lino contraJicts tho
clichoJ picturo ol tho 1990s as a solor corroctivo to tho vickoJ inJul-
goncos ol tho 1980s.
ln ollicial mythology, tho croJit markots oxist to colloct tho savings ol
housoholJs in orJor to lonJ to lusinossos that nooJ othor pooplo`s monoy
in orJor to mako proJuctivo invostmonts that allov thom, anJ tho vholo
oconomy, to grov. ln somo Joop sonso, this may lo truo: Jolts aro claims
on luturo grovth in incomos, anJ unJor capitalism, tho principal ongino
ol grovth is invostmont ly nonlinancial corporations. But vhilo such Joop
truths aro not irrolovant, roality is a lot mossior. Nonlinancial lusinoss ac-
countoJ lor just 22/ ol outstanJing croJit markot Jolt in 199, voll unJor
tho 26/ sharo ovoJ ly housoholJs, anJ just a lit alovo tho 19/ sharo
ovoJ ly tho U.S. govornmont. Thoso Jolts aro not claims on luturo prol-
its, lut on luturo vagos anJ taxos. Unliko lusinoss Jolts, thoro aro no roal
incomo-proJucing capital assots ollsotting thoso olligations.
lt must lo acknovloJgoJ that it`s a lit misloaJing to locus on Jolts
vithout taking noto ol assots. On Jolts alono, housoholJs, lor oxamplo,
aro Joop in tho roJ - lut housoholJs also havo assots liko Jurallo gooJs,
housos, mutual lunJs, anJ stock in unincorporatoJ lusinossos. Businossos
credit market debt of all sectors,
percent of GDP, 1952-97
credit market debt by major sector,
debt, total and by sector, relative to GDP
!25'
!50'
!75'
200'
225'
250'
275'
!952 !962 !972 !932 !992
0'
!0'
20'
30'
40'
50'
60'
70'
!952 !962 !972 !932 !992
U.S. govl
households
linancial
lirns
nonlinancial
lirns
WALL STREET
60
who owes, who's owed
US$ billion percenl
owed by
lolal $2!,!!3.9 !00.0'
doneslic nonlinancial !5,!94.! 7!.9
US governnenl 3,304.9 !3.0
nonlederal !!,339.3 53.9
household 5,57!.5 26.4
business 4,532.9 2!.5
noncorporale !,250.! 5.9
corporale 3,232.3 !5.5
slale & local governnenl !,!23.7 5.3
olher !56.2 0.7
loreign 553.3 2.6
linancial 5,366.0 25.4
CSEs/lederal norlgage pool 2,32!.7 !3.4
banks 309.7 !.5
lhrills !60.3 0.3
linance conpanies 554.5 2.6
ABS issuers 993.4 4.7
olher 52!.5 2.5
heId by
lolal $2!,!!3.9 !00.0'
doneslic nonlinancial 2,955.! !4.0
US governnenl 20!.4 !.0
doneslic nonlederal nonlinancial 2,753.7 !3.0
household !,326.9 3.7
business 335.3 !.6
noncorporale 39.! 0.2
corporale 296.3 !.4
slale & local governnenl 59!.5 2.3
resl ol world 2,270.0 !0.7
linancial !5,393.3 75.3
CSEs/lederal norlgage pool 2,734.4 !2.9
Federal Feserve 43!.4 2.0
banks 4,03!.9 !9.!
lhrills 925.5 4.4
credil unions 304.2 !.4
insurance conpanies 2,239.3 !0.3
pension lunds !,409.2 6.7
nulual lunds 394.3 4.2
ABS issuers 359.5 4.!
olher !,446.4 6.3
PLAYERS
61
havo sulstantial physical assots as voll. Thoro`s no lovol ol Jolt that`s
magically latal: Jolts only locomo insupportallo vhon tho incomos or
assots unJorlying thom aron`t sulliciont to covor intorost anJ principal.
lor ovory lorrovor, thoro must lo a lonJor. A chart ol vho holJs thoso
Jolts voulJ lack tho visual Jrama ol tho lorrovors` charts. lt voulJ mainly
shov a riso in tho linancial soctor`s holJings that tracks tho ovorall riso in
Jolt - not surprising, roally, sinco tho manulacturo ol Jolt is ono ol tho
linancial soctor`s main rolos in lilo. Socially, though, linancial institutions
aro moroly intormoJiarios: tho ultimato croJitors anJ Joltors aro human
loings - or housoholJs, as Jomographors call thom. This is vhy tho Jis-
trilution ol housoholJ assots JiscussoJ lolov mattors - that is tho truost
picturo ol vho ovos, anJ vho is ovoJ, altor all tho institutional mystilica-
tions aro strippoJ avay.
That, ol courso, is Jomostically spoaking. ln orJor to consumo moro
than it proJucos, anJ invost moro than it savos, tho U.S. has gono Jooply
into hock alroaJ: anothor vay ol looking at this is that tho U.S. oconomy
hasn`t gonoratoJ onough ol a linancial surplus to satisly all its lorrovors,
so it`s turnoJ to countrios that havo, liko Japan. ln 1952, tho U.S. holJ
claims on loroignors ooual to 4.2/
ol GDP: in 199, that numlor haJ
rison a lit, to 6./. But loroign
claims on Amorican lorrovors ox-
ploJoJ, lrom 1.4/ ol GDP in 1952
to 26.8/ in 199. As tho graph
shovs, on croJit markot Jolts
alono (loaving out Jiroct invost-
mont anJ stock positions), tho
U.S. vont lrom a not croJitor po-
sition ol 2.8/ ol GDP to a not
Joltor liguro ol 20.2/. Tho U.S. haJ loon a not croJitor intornationally
sinco Britain loll into tho roJ altor WorlJ War l. ln loth mainstroam anJ
Varxist thoory, intornational political povor - call it imporialism il you
liko - is insoparallo lrom linancial povor, anJ an orosion in intorna-
tional position liko that soon ly tho U.S. coulJ lo tantamount to tho top-
pling ol a hogomon - typically a porioJ ol groat intornational JisorJor.
So lar, U.S. military, political, anJ cultural povor has largoly lailoJ to lol-
lov tho croJit lino into tho alyss, lut ghouls anJ possimists avait tho
Jropping ol tho othor shoo.
U.S. net credit market
debt position with
rest of world,
25'
20'
!5'
!0'
5'
0'
5'
!952 !962 !972 !932 !992
WALL STREET
62
Iot`s look at oach ol tho major soctors - vho thoy aro, hov much thoy
lonJ anJ lorrov, anJ vhy.
households
ln tho national incomo accounts, housoholJs aro tho ultimato claimants in
tho linancial systom: tho catogory not intorost,` vhich appoars through-
out tho accounts, rolors to tho amount that lusinossos hanJ ovor to houso-
holJs altor all cross-paymonts aro nottoJ out. On ono hanJ, this makos
intuitivo sonso: though thoy aro unJoultoJly social actors, corporations
aro ultimatoly logal lictions, institutions that sorvo tho pooloJ intorosts ol
inJiviJuals. ln tho llov ol lunJs systom, though, thoro is no linal rosting
placo: housoholJs aro ooual citizons in tho ropullic ol linanco, along vith
tho 33 othor major soctors.
HousoholJs got alout tvo-thirJs ol thoir incomo lrom vagos, salarios,
anJ lringo lonolits, vith tho lalanco alout ooually JiviJoJ lotvoon in-
vostmont incomo (intorost anJ JiviJonJs) anJ translor paymonts (liko
ponsions, alimony, anJ vollaro).
4
lrom this incomo, taxos aro paiJ anJ
tho nocossitios anJ inJulgoncos ol lilo aro lought. ll anything olso is lolt
ovor, it can lo savoJ.
AccorJing to tho lol, housoholJs savoJ anJ invostoJ $1.13 trillion in
199, vith arounJ 95/ ol that total going to physical invostmont in hous-
ing anJ Jurallo gooJs liko cars anJ appliancos, anJ tho lalanco going
into linancial assots. But that not linancial invostmont liguro, romomlor,
consists ol tho oxcoss ol saving ovor nov lorroving: in 199, housoholJs
took on $404 lillion in nov Jolt at tho samo timo thoy aJJoJ $491 lillion
to thoir stock ol savings. Sinco tho not liguro is positivo, housoholJs can
lo thought ol as not proviJors ol lunJs to tho linancial markots: thoy put
in moro than thoy tako out.
5
BohinJ thoso lottom-lino liguros, hovovor, lurk somo oJJ convontions.
To tako ono important oxamplo, unliko tho national incomo accounts, tho
lol troats purchasos ol consumor Jurallos as invostmonts rathor than cur-
ront consumption. AccorJing to tho loJ`s llov ol lunJs hanJlook (loJ-
oral Posorvo BoarJ 1993), thoro aro throo major roasons lor this: (1) liko
capital gooJs, consumor Jurallos aro long-lasting: (2) consumor Jurallos
proviJo sorvicos that othorviso voulJ lo proviJoJ ly lusinossos through
thoir purchasos ol oouipmont,` anJ (3) Jurallos purchasos aro usually
linancoJ ly Jolt, anJ tho logic ol lol accounting roouiros somo assot to
ollsot this Jolt.
PLAYERS
63
Ol tho throo, only tho longovity argumont is romotoly convincing: cars
anJ computors last lor yoars, ovon though tho NlPAs troat thom as loing
usoJ up in tho ouartor thoy voro lought. But tho othor argumonts soom to
lo motivatoJ ly iJoology anJ convonionco moro than anything olso.
Though thoy may mako lilo oasior or happior, consumor Jurallos, unliko
roal capital assots, Jo not proJuco a stroam ol cash in roturn. Consumor
Jolts, ospocially Jolts unsocuroJ ly assots liko housos or cars, aro moroly
a vago oarnor`s promiso to pay: thoy capitalizo lalor incomo, olton at
vory high ratos ol intorost. Businoss lialilitios capitalizo luturo prolits (in
tho caso ol tho stock markot) or paymonts maJo out ol luturo prolits (in
tho caso ol Jolt): thoy capitalizo capital incomo.
As oJJ as this may soom, tho national incomo accounts troat ovnor-
occupioJ housing ovon moro surroally. Housing purchasos aro JolinoJ as
invostmonts, lut sinco ly U.S. Jolinitions only lusinossos can invost, in-
torost paymonts on rosiJontial mortgagos aro listoJ in tho lusinoss rathor
than tho housoholJ accounts. Ovnor-occupiors aro troatoJ as lanJlorJs
vho pay thomsolvos ront, anJ JoJuct upkoop, mortgago, anJ proporty
tax paymonts as lusinoss` oxponsos. Tho not roturn on housing invost-
monts is imputoJ to housoholJs as tho consumption ol housing sorvicos.
Ollicial statisticians arguo that thoy aro trying to soparato tho consumption
anJ invostmont aspocts ol housing: though pooplo Jo spoculato in pri-
mary rosiJoncos, hoping to mako a killing on a voll-timoJ purchaso or
salo, most ol thoso gains aro rolloJ into tho acouisition ol a nov houso.
lol accountants, lroo ol tho projuJico that only lusinossos invost, con-
tinuo to troat housing purchasos as invostmont, lut shilt most activity to
tho housoholJ soctor. Ono practical aJvantago ol this is to oxposo tho
sharp incroaso in mortgago Jolt rolativo to tho unJorlying valuo ol tho
housing. ln 1945, homo mortgagos outstanJing voro 14/ ol tho valuo ol
all ovnor-occupioJ housing: this roso stoaJily to 34/ in 1965, loll gontly
into tho high 20s in tho lato 190s anJ oarly 1980s, anJ thon roso vith
harJly a pauso to a rocorJ 43/ in 199. Almost cortainly, this long riso
holpoJ lring alout tho stoaJy inllation in housing pricos - though rising
houso pricos aro, in mainstroam Jiscourso, takon as a sign ol a hoalthy
markot: in tho vorJs ol tho lato lNN croJit markot analyst EJ Hart, hous-
ing inllation is tho Amorican national roligion.` lt also moant that mort-
gago croJitors voro taking an ovor-incroasing sharo ol porsonal incomo.
This rising tronJ ol mortago Jolt vas aiJoJ ly tho invontion ol tho
homo oouity loan, vhich allovoJ pooplo to lorrov against tho valuo ol
thoir houso to linanco collogo tuition, vacation oxponsos, or vhatovor.
WALL STREET
64
But unloss pooplo aro villing to soll thoir housos, or turn thom ovor to tho
lank, that oouity is ovon moro puroly lictitious than a stock option, ospo-
cially il houso pricos aro stagnant or Joclining. ll tho ovnor-occupior losos
his or hor jol, tho inaJoouacy ol tho homo as capital assot comos ouickly
cloar: it JomanJs cash vithout proJucing any in roturn. \ou can`t pay tho
mortgago lankor vith imputoJ ront. Or as tho loJ puts it, tho incroaso in
mortgago Jolt has loon unrolatoJ to nov capital lormation` (loJoral
Posorvo BoarJ 1980, p. 31), a lormulation that il carrioJ to tho oxtromo
suggosts inllation, insolvoncy, or somo unploasant comlination ol loth as
its ultimato rosolution. CarrioJ short ol that apocalyptic rosolution, it sug-
gosts strains on porsonal housing luJgots lor all lut tho most allluont.
Anothor ollicially JolinoJ assot ol tho housoholJ soctor that looks loss
improssivo on closor scrutiny is privato ponsion lunJs. lol accountants
troat thoso as loing holJ in trust lor housoholJs, vhich is concoptually
accurato lut politically misloaJing: liko chilJron, luturo lonoliciarios havo
littlo or no say in hov thoir trust lunJs aro managoJ. AnJ only a minority
- alout 40/ anJ lalling - ol vorkors aro in ponsion plans. AccorJing to
EJ Wolll`s (1996) oxamination ol loJ`s Survoy ol Consumor linancos (SCl),
tho lottom 90/ ol tho population holJ just 38/ ol ponsion assots in 1992.
lor all thoir virtuos, tho lol accounts Jo oraso all Jistinctions among tho
momlors ol a soctor. This is alvays a Jangor vith aggrogato Jata, lut it`s
ospocially Jangorous vith housoholJs. Whilo it is truo, lor oxamplo, that
housoholJs aro not proviJors ol lunJs to to othor soctors, not all houso-
holJs koop thoir loJgors in llack ink.
6
AccorJing to tho 1992 SCl
(Konnickoll anJ Starr-VcCluor 1994), 30/ ol lamilios vith incomos unJor
$10,000 haJ no linancial assots at all, as JiJ 12/ ol thoso in tho $10-
25,000 rango: ovorall, almost ono in 10 Amorican lamilios haJ nothing in
tho lank, ligurativoly spoaking. Tho moJian assots ol all lamilios having
assots vas $13,100 - comparoJ to a moJian ol $1,600 in Jolts, lor tho
throo-ouartors ol all housoholJs carrying Jolts.
Back in tho 1980s, you usoJ to roaJ alout tho rising Jolt lurJon on
housoholJs: lor somo roason, you Jon`t roaJ alout it much in tho 1990s
anymoro, ovon though tho lurJon has continuoJ to grov. \ou Jo still
roaJ alout tho concontration ol voalth. Tho tvo phonomona aro raroly
soon as linkoJ. But locauso ol tho Joclino in roal hourly vagos, anJ tho
stagnation in housoholJ incomos, tho miJJlo anJ lovor classos havo lor-
rovoJ moro to stay in placo: thoy`vo lorrovoJ lrom tho vory rich vho
PLAYERS
65
havo gotton richor. Tho rich nooJ a placo to oarn intorost on thoir surplus
lunJs, anJ tho rost ol tho population makos a juicy lonJing targot.
Just hov this vorks out can lo soon in Jata lrom tho 1983 survoy: un-
lortunatoly, tho loJ JiJn`t pullish tho 1995 survoy Jata in sulliciont Jotail.
ln 1983, loaving asiJo tho primary rosiJonco anJ mortgago Jolt on it, ovor
hall ol all lamilios voro not Joltors, anJ lovor than 10/ accountoJ lor
85/ ol tho housoholJ soctor`s not lonJing (Avory ot al. 1984). As William
GroiJor (198, p. 39) put it, tho lov lonJ to tho many.
At tho onJ ol 199, U.S. housoholJs spont $1 trillion, or 1/ ol thoir
altor-tax incomos, on Jolt sorvico - just a smiJgon lolov 1989`s rocorJ
ol 1.4/ (unpullishoJ loJoral Posorvo stall ostimatos). This roprosonts a
massivo upvarJ roJistrilution ol incomo. Tho sharo voulJ havo loon
highor haJ not intorost ratos JoclinoJ sharply ovor tho porioJ. But this
lorroving has loon a tromonJous stimulus to consumor JomanJ: lotvoon
1950 anJ 199, tho grovth in consumor croJit (oxcluJing mortgagos) li-
nancoJ 23/ ol tho grovth in consumption: lotvoon 1991 anJ 199, tho
liguro vas 29/, tho highost ol any post-WorlJ War ll oxpansion.
8
Why Jo pooplo lorrov? Polort Pollin (1990) concluJoJ lrom a stuJy
ol tho SCl that tho lottom 40/ ol tho incomo Jistrilution lorrovoJ to
componsato lor stagnant or lalling incomos (vhat Pollin calloJ nocossi-
tous` or componsatory` lorroving), vhilo tho uppor 20/ lorrovoJ
mainly to invost (or spoculato, il you prolor). Pollin`s linJings aro ochooJ
in British oxporionco: a survoy ol that country`s housoholJs concluJoJ
that |ClroJit lullils tvo Jilloront rolos in housoholJ luJgots. Pooror lami-
lios, on tho vholo, uso croJit to oaso linancial Jillicultios: thoso vho aro
lottor-oll tako on croJit commitmonts to linanco a consumor lilo-stylo.
Both voulJ uso it to improvo thoir lot: ono to roJuco thoir povorty: tho
othor to incroaso thoir prospority` (BorthouJ anJ Kompson 1992, p. 64).
9
household debts,
percent of after-ta
income, 1950-97
household debt service,
percent of after-ta
income, 1960-97
household debt and debt service
!3'
!4'
!5'
!6'
!7'
!3'
!9'
!960 !967 !974 !93! !933
30'
40'
50'
60'
70'
30'
90'
!00'
!952 !960 !963 !976 !934 !992 !995
WALL STREET
66
Economically, thon, consumor croJit can lo thought ol as a vay to
sustain mass consumption in tho laco ol stagnant or lalling vagos. But
thoro`s an aJJitional social anJ political lonus, lrom tho point ol viov ol
tho croJitor class: it roJucos prossuro lor highor vagos ly alloving pooplo
to luy gooJs thoy coulJn`t othorviso allorJ. lt holps to nourish loth tho
appoaranco anJ roality ol a miJJlo-class stanJarJ ol living in a timo ol
polarization. AnJ Jolt can lo a groat consorvatizing lorco: vith a largo
monthly mortgago anJor VastorCarJ lill, strikos anJ othor lorms ol
troullomaking look loss appoaling than thoy voulJ othorviso.
Though tho housoholJ soctor as a vholo has a stooply positivo not vorth,
tho lialilitios aro lounJ Jisproportionally at tho lovor onJ, anJ assots at
tho high onJ ol tho Jistrilution. Sultract lialilitios lrom assots, anJ you
linJ not vorth to lo concontratoJ lar moro Jonsoly than incomo. ln 1995,
tho richost 1/ ol housoholJs claimoJ 11/ ol total incomo - lut haJ 31/
ol all assots, 35/ ol all not vorth, anJ 43/ ol not vorth il you JisrogarJ
tho principal rosiJonco, vhich is tho lion`s sharo ol most miJJlo-class
voalth. TI~ ::cI~:I I2% Iuu u Iu:~: :Iu:~ J IIuI uu:~::u~uI:uI u~I
u:II IIuu II~ IIIu U% J II~ jjuIuI:u (4% :: 22%. II~ ::cI~:I
IU% uccuuI~u J: 73% J uu:~::u~uI:uI u~I u:II
10
Povisions to olJor ostimatos shov that Jospito tho JocaJo`s roputation,
thoro vas no groat concontration ol voalth in tho 1980s: tho roal concon-
tration has happonoJ in tho 1990s, vith tho sharo ol tho top 1/ rising ly
noarly livo porcontago points. That gain camo mostly at tho oxponso ol tho
noxt 9/: tho sharo ol tho lottom 90/ continuoJ its long orosion. Woalth is
nov tho most concontratoJ it`s loon sinco tho 1920s. AccorJing to EJ-
varJ Wolll (1995, pp. 28, 62-63), this tronJ is prolally tho rosult ol sov-
oral things, among thom tho incroasing Jisporsion` ol vagos anJ salarios
- oconomists prolor this morally noutral torm to tho moro valuo-laJon
inoouality` - vhich has JoprossoJ saving among tho miJJlo class anJ
loostoJ it among tho rich, anJ also tho rolativo stagnation ol houso pricos
(tho main ropository ol miJJlo-class voalth) along vith tho phonomonal
riso in stock anJ lonJ pricos lrom tho oarly 1980s into tho lato 1990s.
Ovnorship ol tho most valuallo linancial assots - roal claims, liko
stocks anJ lonJs - is Jonsoly packoJ in tho uppor crust. ln 1995, tho
richost 1/ ol housoholJs - alout 2 million aJults - ovnoJ 42/ ol tho
stock ovnoJ ly inJiviJuals, anJ 56/ ol tho lonJs (Konnickoll anJ
WooJlurn 199): tho top 10/ togothor ovn noarly 90/ ol loth.
11
Sinco
housoholJs ovn alout hall ol all corporato stock, that posh 1/ ovns a
ouartor ol tho proJuctivo capital anJ luturo prolits ol corporato Amorica:
PLAYERS
67
tho top 10/, noarly hall. Thoso stockholJors aro ovorvholmingly vhito:
lovor than 6/ ol llack anJ Hispanic housoholJs ovnoJ any stock in 1991
(U.S. Buroau ol tho Consus 1995, p. 513).
Thoso numlors aro lasoJ on sorting housoholJs ly thoir not vorth: il
you sort housoholJs ly thoir stock ovnorship, tho concontration is ovon
moro intonso. ln 1992 (tho most rocont yoar availallo), tho top 0.5/ ol
stockovnors holJ 58.6/ ol all pullicly traJoJ stock: tho noxt 0.5/, 11./:
tho noxt 4/, 24.2/: aJJ thoso togothor anJ you Jiscovor that II~ Ij 5%
uu: 45% J uII :Ic I~Iu I) :uu:::uuuI: (Potorla anJ Samvick 1995).
Dospito tho omniprosonco ol stock novs in tho papors anJ on TV, os-
pocially pullic` TV, tho activo invostor population, prosumally tho targot
ol all thoso pitchos, is tiny. ln 1983, only 19/ ol housoholJs ovnoJ any
stock at all, anJ ol thoso almost hall ovnoJ just ono: 4/ ovnoJ tvo to
distribution of wealth, debts, and income, 1995
lop !0', percenlile breakdown
bollon 90' lop !0' 90-93.9 99-99.4 99.5-!00
PERCENT OF TOTALS
lanilv incone 63.9' 3!.! !9.6 3.4 3.!
assets 37.9 62.1 31.0 6.9 24.2
principal residence 66.4 33.6 25.7 2.7 5.2
olher real eslale 20.2 79.7 43.9 3.3 27.!
slocks !5.6 34.4 42.2 !0.7 3!.5
bonds 9.7 90.2 34.5 9.2 46.5
lrusls !3.! 36.3 42.6 !0.4 33.3
lile insurance 55.0 45.0 27.3 6.! !!.0
checking accounls 57.7 42.3 26.0 4.6 !!.6
lhrill accounls 43.! 56.9 40.9 3.2 7.3
olher accounls 37.9 62.! 35.2 7.0 !9.3
business 7.7 92.2 20.3 !!.5 59.9
aulos 77.6 22.4 !7.3 !.9 2.6
olher 29.3 70.6 39.2 4.3 26.6
IiabiIities 70.9 29.1 19.3 3.0 6.7
principal residence 73.4 2!.6 !7.2 !.3 2.6
olher real eslale 25.2 74.7 4!.0 !0.2 23.5
olher 30.6 !9.4 9.6 !.5 3.3
net worth 31.5 68.4 33.2 7.6 27.5
nonresidenlial 22.5 77.5 34.2 9.! 34.2
DOLLAR VALUES
incone $33,273 !34,933 94,690 293,565 700,677
nel worlh 72,654 !,4!3,022 765,622 3,!63,956 !!,4!5,294
nonresidenlial 39,252 !,2!7,375 596,974 2,344,934 !0,757,046
WALL STREET
68
lour, anJ only 4/ ovnoJ livo or moro. Tho sharo vho traJoJ stock vas
ovon smallor: only 6/ lought or solJ a sharo ol stock that yoar, anJ only
2/ maJo livo or moro traJos (Avory anJ Elliohauson 1986). Whilo moro
rocont SCl Jata havo not loon pullishoJ, tho Nov \ork Stock Exchango`s
1990 sharoholJor survoy (Nov \ork Stock Exchango 1990) shovoJ a moJ-
ost uptick in tho porcontago ol tho population ovning sharos, to 21/,
vith tvo-thirJs ol thom mon. This incroaso looks liko a lit ol an anticli-
max, consiJoring tho granJ lull markot ol tho 1980s. TraJing pickoJ up
somovhat moro, vith 12/ making at loast ono stock purchaso or salo, anJ
4/ making livo or moro traJos. Dospito tho oxpansion ol thoso numlors,
tho stockholJing anJ traJing sharo ol tho population is ouito small - lut
tho amount ol voalth thoy control is not: almost $1.5 trillion in stocks anJ
lonJs alono in 1989.
12
EJvarJ Wolll`s analysis ol tho loJ`s 1962, 1983, anJ 1989 Survoys ol Con-
sumor linancos shovoJ that 0-5/ ol tho grovth in voalth ovor tho
long torm is lrom tho approciation ol assots, anJ only 20-25/ lrom nov
savings - anJ tho voalthy aro alout tho only pooplo vho havo appro-
ciallo amounts ol sparo monoy to savo (Wolll 1992, citoJ in Vishol anJ
Bornstoin 1994, p. 246). Elsovhoro, Wolll (1996) roports that lotvoon
1983 anJ 1992, 5/ ol tho incroaso in linancial voalth vont to tho richost
1/, 39/ to tho noxt 19/, anJ just 4/ to tho lottom 80/.
Things voro a lit loss lopsiJoJ lotvoon tho 1962 anJ 1983 survoys: tho
uppor miJJlo class (tho 90th to 99th porcontilos) JiJ notally lottor anJ
tho lottom 80/ ovon gainoJ voalth rathor than losing it. Evon so, voalth
concontratoJ lotvoon 1962 anJ 1983. lt sooms to lo in tho vory naturo ol
voalth to concontrato, much as intorost compounJs ovor timo.
Dospito myths ol allirmativo action anJ upvarJ molility, tho tonJoncy
ol voalth to concontrato, lor aJvantago to lrooJ aJvantago, makos it harJ
on pooplo vho start vith nothing. Ouito surprisingly, oconomists Jon`t
roally havo a vory soliJ iJoa ol vhat sharo ol porsonal voalth comos lrom
savings Juring inJiviJuals` lilotimos, anJ vhat sharo is inhoritoJ. This is in
sharp contrast to tho roams ol stuJios on tho intorgonorational transmis-
sion ol vollaro JoponJoncy.` Estato taxos, a possillo sourco ol inlorma-
tion, aro viJoly ovaJoJ: also, survoys ol tho voalthy aro raro, anJ any
ansvors thoy olicit voulJ havo to lo takon vith a grain ol salt. Economists
havo usoJ a varioty ol tochniouos to simulato inhoritanco. Daphno Groon-
vooJ anJ EJvarJ Wolll (1992), lor oxamplo, using ago group Jata lrom
PLAYERS
69
various yoars ol tho Survoy ol Consumor linancos lounJ that youngor
lamilios haJ highor not vorths, anJ olJor lamilios, lovor, than thoir saving
lohavior voulJ suggost: attriluting tho Jilloronco to intorgonorational
translors oithor Juring lilo or at Joath, thoy ostimatoJ that 50-0/ ol tho
voalth ol housoholJs unJor ago 50 vas inhoritoJ. Iauronco Kotlikoll anJ
Iavronco Summors (1981), using a varioty ol simulation tochniouos, osti-
matoJ that as much as 80/ ol porsonal voalth camo oithor lrom Jiroct
inhoritanco or tho incomo on inhoritoJ voalth. lranco VoJigliani (1988),
ono ol tho invontors ol tho lilo cyclo hypothosis (ICH) ol savings - that
pooplo savo in thoir oarly yoars to linanco rotiromont, implying that thoir
voalth approachos zoro as thoy stumllo tovarJs tho gravo - camo up
vith rosults that voro a mirror imago ol Kotlikoll anJ Summors: only 20/
ol porsonal voalth, ly his ostimato, vas tho rosult ol inhoritanco. Tho
major roason lor his lov ostimato vas that ho countoJ incomo on inhor-
itoJ voalth as lilotimo savings rathor than as an inhoritanco, rathor a con-
coptual strotch, lut ono ossontial to prosorvo tho ICH, somothing ho
unJorstanJally lools a porsonal attachmont to.
During tho 1980s, alout hall tho lortunos in tho 1:I~: 400 voro tho
rosult ol inhoritanco, ly tho magazino`s classilication: this inoxplically loll
to unJor a ouartor in tho oarly 1990s. But tho magazino vas prolally
Jolining things too strictly. A stuJy ol tho 1995 anJ 1996 oJitions ly tho
Boston-lasoJ group UnitoJ lor a lair Economy (1996) shovoJ that 43/
voro lorn vith onough voalth to mako it onto tho olito list: anothor /
haJ inhoritoJ $50 million or moro - not onough to mako it onto tho list,
lut nothing to snoozo at: 6/ haJ inhoritoJ at loast $1 million or a lamily
lusinoss: anJ 14/ voro lorn into tho uppor miJJlo class. Just 30/ ol tho
400 plutocrats voro soll-maJo` - lut thoy controlloJ only 25/ ol tho
list`s total voalth, making thom tho olito`s poor rolations.
Putting all tho oviJonco togothor, a cautious guoss is that alout hall ol
all porsonal voalth can lo tracoJ to inhoritanco (Galo anJ Scholz 1994),
though ono is porloctly justilioJ at lolioving throo-ouartors.
`Nonvhito` Amoricans - tho SCl ollors no linor Jistinction than that
- sullor laJly in a voalth comparison vith vhitos.
13
ln 1992, nonvhitos`
moJian incomo vas 58/ ol vhitos`, lut thoir moJian not vorth vas only
20/ ol vhitos`: looking at only linancial assots, nonvhito voalth vas a
moro 1/ ol vhito lovols. (Wolll 1996). Tho racial voalth gap is vast ovon
lor housoholJs at tho samo incomo lovol. ln 1989, tho poorost vhitos,
thoso vith incomos unJor $10,000, haJ lour timos tho not vorth ol non-
vhitos in tho samo incomo class: vhitos vith incomos ovor $50,000 voro
WALL STREET
70
tvico as voalthy as nonvhitos in tho samo class. Nonvhito singlo-mothor
housoholJs haJ only ono-lilth tho voalth ol vhito onos. Olviously this
loavos nonvhito housoholJs much moro vulnorallo to oconomic crisos
(sicknoss, jol loss) anJ much loss capallo ol taking aJvantago ol oppor-
tunitios (movos, schooling, ontropronourship) than vhito onos.
ln mainstroam spooch, saving` raroly travols vithout a moralizing
sultoxt, ono that apologizos lor vast inooualitios ly arguing that tho poor
aro prolligato, livo in tho otornal prosont, anJ aro unallo to control thoir
impulsos, vhilo tho rich aro tho virtuous opposito ol all thoso things. Or as
Toxas Sonator Phil Gramm puts it in his homoy vay, socioty consists ol
thoso vho pull tho vagon (his rich Dallas anJ Houston constituonts) anJ
thoso vho riJo in it (tho shiltloss poor). Tho miJJlo classos, olviously, lall
somovhoro lotvoon vico anJ virtuo. lrom this llack-is-vhito promiso, it
lollovs that tho rich shoulJ lo lightly taxoJ, anJ tho poor, soakoJ: this is
tho rationalo lohinJ consumption taxos, liko salos taxos anJ VATs, vhich
sparo tho savor anJ punish tho consumor.
But accorJing to SCl Jata, only 5/ ol housoholJs - 61/ ol vhito
non-Hispanics` anJ 44/ ol Nonvhitos or Hispanics` (Konnickoll anJ Starr-
VcCluor 1994) - savoJ in 1989. Vost pooplo roportoJ saving lor liouiJ-
ity` purposos, liko illnoss anJ unomploymont: noxt camo rotiromont anJ
oJucation. ln Amorica, privato savings sulstituto lor a vollaro stato, to tho
groat JisaJvantago ol tho nonvoalthy.
Anothor look at savings comos lrom tho Buroau ol Ialor Statistics Con-
sumor ExponJituro Survoy (CES). Thoso linJings must lo rogarJoJ as vory
rough approximations ol actual oxporionco. Whilo somo pooplo in tho
lovost incomo lrackot aro just tomporarily Jovn on thoir luck, anJ aro
allo to Jrav on savings or lamily holp, most pooplo cannot consumo moro
than tvico thoir incomo lor vory long. Tho tallo`s roport that thoy Jo is
prolally vrong. Poor pooplo vork oll tho looks, anJ hiJo it lrom Con-
sus onumorators. Pich pooplo aro almost cortainly unJorsamploJ, anJ thoso
vho aro survoyoJ hoavily unJorstato thoir incomo. Tho U.S. has a lov
savings rato, lut it`s not 0./ ol incomo. lncomos aro prolally unJor-
statoJ at tho lottom anJ tho top, moaning that lov-onJ Jissaving` is
smallor anJ high-onJ saving, highor than thoy appoar.
Still, tho ovorall pattorns aro unJoultoJly corroct, though ol courso
loilorplato cavoats alout oxcoptions to ovory rulo apply. On avorago, poor
pooplo consumo all thoir incomo anJ thon somo: miJJlo-incomo pooplo
como out moro or loss llat: anJ only tho voll-oll savo signilicant amounts.
\oung pooplo usually start out lorroving hoavily, accumulato savings into
PLAYERS
71
miJJlo ago, anJ sponJ thom in rotiromont. But Consus Jata shovs that
thoro is no oviJonco that not vorth JocroasoJ among tho olJost ago groups
vithin any incomo group,` at loast in 1991 (U.S. Buroau ol tho Consus
1994l, pp. x-xi): in lact, thoro`s somo oviJonco that olJor housoholJs con-
tinuo to savo (Vonchik anJ DaviJ 1983). Tho Amorican Jroam, il you lo-
liovo ostato schomor Barry Kayo`s TV aJs, is to Jio rich anJ tax-lroo.
consumption and savings, 1991
incone
belore lax aller lax expendilures saving assels
doIIars
lolal $33,90! $30,729 $30,437 $ 242
pooresl lillh 5,93! 5,643 !3,464 7,3!6
second lillh !4,32! !4,303 !3,936 4,673
niddle lillh 26,073 23,973 26,!44 2,!7!
lourlh lillh 40,363 37,237 36,!5! !,036
richesl lillh 3!,594 72,332 57,597 !4,735
under 25 !4,3!9 !3,52! !6,745 3,224
25-34 34,032 30,363 29,230 !,533 $ 2,500
35-44 4!,37! 37,533 36,446 !,!37 !!,200
45-54 43,4!3 43,323 33,!37 5,69! !4,500
55-64 33,235 34,40! 3!,945 2,456 20,000
65+ 20,004 !3,5!5 !9,692 !,!77
65-74 22,723 2!,339 22,564 !,225 !3,200
75+ !6,247 !4,6!2 !5,732 !,!70 2!,000
percent of
pretax income
lolal 90.6' 39.9' 0.7'
pooresl lillh 94.4 225.! !30.7
second lillh 96.5 !23.! 3!.6
niddle lillh 9!.9 !00.3 3.3
lourlh lillh 9!.! 33.5 2.7
richesl lillh 33.6 70.6 !3.!
under 25 94.4 !!6.9 22.5
25-34 90.7 36.0 4.7 7.3'
35-44 39.3 37.0 2.7 26.7
45-54 90.5 73.3 !!.3 30.0
55-64 39.9 33.4 6.4 52.2
65+ 92.6 93.4 5.9
65-74 93.9 99.3 5.4 30.!
75+ 39.9 97.! 7.2 !29.3
Figures are lron lhe BLSs Consuner Expendilure Survev. Age relers lo relerence
person, lhe person nenlioned bv lhe respondenl when asked who owns or renls
lhe hone. Saving is allerlax incone less expendilures.
WALL STREET
72
nonfinancial business
Iiko housoholJs, lusinossos havo incomos, vhich thoy Jovoto to curront
oxponsos anJ to invostmonts. ll thoy nooJ oxtra, thoy can lorrov, liko
housoholJs, or soll stock to outsiJo invostors. Tho nooJ to lorrov anJ
soll stock is saiJ to lo a Jisciplino` on corporato lohavior: poor manag-
ors vill linJ it Jillicult anJor oxponsivo to lorrov monoy or soll stock,
vhilo sharp managors vill linJ oagor invostors camping on thoir Joor-
stops. Thoso altornativos vill prosumally rovarJ gooJ managors anJ Jisci-
plino laJ onos, lorcing tho haploss or incompotont to improvo porlormanco
or linJ thomsolvos shut out ol tho linancial markots.
Whilo thoso inlluoncos Jo oporato on somo lovol, tho signilicanco ol
oxtornal linancing is groatly oxaggoratoJ, as tho tallo on pago 5 shovs.
14
Eithor tho U.S. linancial markots lunction vory laJly, anJ gooJ invost-
monts aro not maJo locauso oxtornal linanco is vanting, or nonlinancial
lusinossos Jon`t vant to mako tho invostmonts. Capital oxponJituros -
capox, in Wall Stroot jargon - roso as a sharo ol GDP Juring tho GolJon
Ago anJ ovon into tho troulloJ 190s, poaking lato that JocaJo anJ oarly
tho noxt, anJ thon Jrilting JovnvarJ through tho Poagan loom anJ Bush
slump. Things porkoJ up in tho Clinton ora, lut not ly much.
Almost all ol this invostmont - alout 92/ ol tho total lotvoon 1952
anJ 199 - vas paiJ lor ly tho lirms` ovn cash. Or to turn that notion
upsiJo Jovn, tho linancing gap - tho Jilloronco lotvoon tho nonlinan-
cial corporato soctor`s capital oxponJituros (liko luilJings, machinory, anJ
invontory) anJ its ovn intornal lunJs (prolits plus Joprociation allov-
ancos), vhich has to lo lunJoJ ly outsiJo lorroving or stock salos - has
avoragoJ arounJ 8/ ol capox. Evon at tho linancing gap`s viJost chasm,
tho oarly 190s, corporations still managoJ to lunJ almost 0/ ol thoir
gross invostmont vith intornal lunJs. During tho 1980s anJ 1990s, it`s loon
common to hoar ol largo inJustrial corporations vith sovoral lillion Jol-
lars in cash anJ no iJoa ol vhat to Jo vith tho monoy.
AnJ tho stock markot contrilutos virtually nothing to tho linancing ol
outsiJo invostmont. Botvoon 1901 anJ 1996, not llotations ol nov stock
amountoJ to just 4/ ol nonlinancial corporations` capox. That avorago is
inllatoJ ly tho oxporionco ol tho oarly yoars ol tho contury, vhon corpo-
rations voro going pullic in largo numlor: nov stock ollorings voro ooual
to 11/ ol roal invostmont lrom 1901 through 1929. Givon tho vavo ol
takoovors anJ luylacks in rocont yoars, lar moro stock has loon rotiroJ
than issuoJ: not nov stock ollorings voro -11/ ol capox lotvoon 1980
anJ 199, making tho stock markot, surroally, a nogativo sourco ol lunJs.
PLAYERS
73
But il you oxcluJo that porioJ, anJ look only at 1946-199, stocks linancoJ
just 5/ ol roal invosmont. This is truo ol most othor lirst WorlJ countrios:
in tho ThirJ WorlJ, tho liguros aro moro liko thoso ol tho oarly 20th con-
tury in tho U.S., lut again, that`s locauso lirms aro going pullic lor tho
lirst timo, not locauso oxisting onos aro raising lunJs through lrosh stock
ollorings (intornational anJ pro-1952 U.S. Jata aro lrom Vullin 1993: U.S.
liguros sinco 1952 aro lrom tho llov ol lunJs accounts).
That hugo nogativo numlor lor stock-linancoJ invostmont altor 1980 is
part ol a largor phonomonon ol svolling rontior claims. Nonlinancial lirms
havo loon Jistriluting ovor moro ol thoir prolits to outsiJo invostors, vho
typically contriluto no capital to roal lirms, lut simply luy thoir lonJs or
stocks lrom provious holJors. Start vith tho lasic Jistrilution, JiviJonJs.
lrom tho oarly 1950s through tho miJ-190s, lirms paiJ out 44/ ol thoir
altor-tax prolits in JiviJonJs. That sank a lit in tho lato 190s, anJ thon
roso sharply: lrom 1990-199, nonlinancial corporations paiJ 60/ ol thoir
altor-tax prolits out as JiviJonJs. Prosumally thoy sav no alluring oppor-
tunitios lor invosting tho cash in thoir ovn lirms, at loast at a prolit rato that
voulJ satisly sharoholJors. Wall
Stroot vants cash toJay, not prom-
isos alout tomorrov. But Jivi-
JonJs aro not all. lirms aro also
paying lots ol intorost to thoir
croJitors. What might lo calloJ
tho rontior sharo ol tho corporato
surplus - JiviJonJs plus intorost
as a porcontago ol protax prolits
anJ intorost - has rison sharply,
lrom 20-30/ in tho 1950s to 60/
in tho 1990s.
15
lar lrom turning to
Wall Stroot lor outsiJo linanco,
nonlinancial lirms havo loon
stulling Wall Stroot`s pockots vith
monoy.
But corporato Amorica lor-
rovoJ hoavily in tho 1980s: Jolt
lovols zoomoJ upvarJ (soo chart,
p. 4), though thoy`vo como Jovn ouito a lit sinco, thanks to lankrupt-
cios, Jolt roschoJulings, anJ hoalthy prolits. Why all tho lorroving, il not
to linanco invostmont? To lunJ stock luylacks anJ takoovors.
Oulside inveslors are laving clain lo a lar
larger share ol lhe corporale nonev nachine
lhan 20 or 30 vears ago. This shows inler
esl plus dividends as a percenlage ol lhe
prelax prolils and inleresl ol nonlinancial cor
poralions. nleresl is added back inlo lhe de
noninalor because il is deducled belore
prolils are conpuled, dividends, on lhe olher
hand, are paid oul ol prolils.
rentier share of
corporate surplus,
1945-97
in!eres! dividends
pre!ax pro!i!s in!eres!
0'
!0'
20'
30'
40'
50'
60'
70'
30'
!945 !952 !959 !966 !973 !930 !937 !994
WALL STREET
74
lirms havo lought lack immonso ouantitios ol thoir ovn stock - $864
lillion lotvoon 1984 anJ 199 (Socuritios Data Corp., unpullishoJ Jata).
That amount is largor than total mutual lunJ luying ovor tho porioJ, anJ
tvico as largo as stato anJ local govornmont ponsion lunJ luying ovor tho
porioJ - tho tvo largost stock-luying soctors. ln tho 1980s, lirms lought
lack thoir stocks vith lorrovoJ
lunJs (Pomolona 1990): in tho
1990s, thoy`vo usoJ thoir happily
rising prolits rathor than Jolt, lut
thoy`vo continuoJ to luy thoir
ovn stock vith loth hanJs. Thoy
also lorrovoJ locauso having
lots ol Jolt vas soon as a possillo
Jolonso against takoovor - not
only voulJ its lurJon lo somo-
thi ng an acouiri ng company
voulJ havo to Joal vith, lut il tho lorrovoJ monoy voro usoJ to support
tho sharo prico, stockholJors voulJ lo happy, anJ proJators lar loss likoly
to lo on tho provl.
Thoy also lorrovoJ to Jo morgors anJ acouisitions (V8A). Botvoon
1980 anJ 199, U.S. nonlinancial lirms spont $3 trillion luying oach othor,
38/ ol vhat thoy spont on capital oxponJituros ovor tho porioJ. Iiko
luylacks, thoy havo continuoJ to Jo this throughout tho 1990s, lut again
vithout lorroving, just vith lountilul prolits (anJ inllatoJ stock).
16
With
V8A loos, accorJing to Socuritios Data Corp., running lrom 1-2/ ol tho
valuo ol a Joal, lankors anJ lavyors rakoJ in somo $20-40 lillion lrom
comlinations alono ovor tho porioJ.
ll you put all tho cash-liko paymonts togothor - JiviJonJs, intorost,
V8A, anJ luylacks - thon lotvoon 1985 anJ 199, nonlinancial lirms
translorroJ to rontiors an amount alout 5/ groator than thoir capital ox-
ponJituros. Thoso lunJs voro thon plovoJ into tho stock markot, vhoro
thoy`vo contrilutoJ to its vonJrous riso.
A linal point: just locauso tho nonlinancial soctor, on avorago, linancoJ
invostmont intornally, Joosn`t moan all lirms JiJ. Smallor anJ novor lirms
almost cortainly voulJ invost moro il outsiJo linanco voro availallo, lut
this unmot Josiro Joosn`t shov up in a lol coll. Cash-rich corporations
pull Jovn tho avoragos, too. Both thoso oxtromos suggost that tho capital
markots aron`t channoling social capital too voll.
At a linor lovol ol Jotail, U.S. Consus Data, analyzoJ ly lazzari ot al.
credit market debt, percent of
after-ta profits, nonfinancial
corporations, 1952-1997
0'
500'
!000'
!500'
2000'
2500'
!952 !962 !972 !932 !992
PLAYERS
75
nonfinancial corporations: financing investment
capex inlernal linancing gap dividends, &A, slock
' ol lunds, ' ' ol ' ol ' posllax ' ol buvbacks,
CDP ol capex capex CDP prolils capex ' ol capex
!952-54 9.!' 93.9 6.! 0.5 43.3
!955-59 3.9 94.5 5.5 0.5 43.4
!960-64 7.3 !00.5 0.5 0.0 47.2
!965-69 3.3 37.! !2.9 !.! 44.4
!970-74 6.4 76.6 23.4 2.0 44.5
!975-79 7.5 36.7 !3.3 !.2 32.5
!930-34 5.2 35.6 !4.4 !.3 53.5 20.!
!935-39 4.3 93.! !.9 0.2 7!.5 47.5 3.3
!990-94 4.5 99.7 0.3 0.0 77.3 30.3 3.5
!995-97 6.2 94.5 5.5 0.4 6!.4 67.! !3.2
average 6.3 9!.5 3.5 0.7 52.0 35.0 9.5
Capex is capilal expendilures, bolh on lixed assels and invenlories.
(1988) shov that lrom 190 throuh 1984 (a porioJ ol rolativoly high roli-
anco on oxtornal lunJs ovorall), manulacturing corporations linancoJ an
avorago ol 1.1/ ol invostmont vith rotainoJ oarnings, vith much loss
variation ly lirm sizo than ono might imagino. PotainoJ oarnings - thoso
not JistrilutoJ as JiviJonJs or taxos - lor lirms vith loss than $10 million
in assots covoroJ 5.9/ ol lunJing nooJs: lirms in tho $50-100 million
catogory, 8./: lirms in tho ovor $1 lillion catogory, 6.9/ - a variation
ol loss than 11/ arounJ tho avorago. Thoso liguros oxcluJo Joprociation
allovancos, tho othor major sourco ol intornal lunJs, vhich voulJ lo
roughly ooual to rotainoJ oarnings - moaning that lirms ol all sizos lunJ
most ol thoir invostmonts vithout having to rosort to markots or lanks.
Tvo things that Jo vary groatly ly sizo aro tho portion ol prolits a lirm
koops rathor than paying out as JiviJonJs to sharoholJors (tho rotontion
ratio) anJ tho importanco ol lanks as a sourco ol linanco. Potontion ratios
rangoJ lrom 9/ lor tho smallost lirms to 52/ lor tho largost. lirms vith
assots unJor $100 million rolioJ on lanks lor arounJ 0/ ol thoir long-
torm Jolt (though romomlor that all lorms ol oxtornal sourcos accountoJ
lor voll unJor a thirJ ol all lunJing): thoso vith assots lrom $250 million
to $1 lillion, 41/: anJ thoso vith ovor $1 lillion in assots, 15/. Bank
linanco is gonorally moro oxponsivo than lonJ intorost ratos, anJ lankors
aro gonorally moro inouisitivo, ovon intorvontionist, than lonJholJors, vho
gonorally koop thoir Jistanco in non-critical timos. AnJ much ol tho non-
lank linanco raisoJ ly small lirms is in tho lorm ol privato placomonts
Jono Jiroctly vith institutional invostors, usually vith rostrictions on lor-
rovor lohavior (vorking capital roouiromonts, minimum oouity lovols,
WALL STREET
76
limits on JiviJonJ payouts anJ capital sponJing) strictor than pullic lonJ
covonants. That`s not to say that strict conJitions aro unvarrantoJ: lanks
tako risks ly lonJing to smallor, loss-ostallishoJ lirms, anJ may ovon Jo
tho vorlJ at largo a lavor ly roining in tho onthusiasms ol ontropronours,
vho can tonJ tovarJs a Panglossian viov ol lilo.
Salos ol nov stock aro insignilicant lor smallor lirms, conlirming tho
lig-picturo liguros prosontoJ alovo lrom a vorm`s-oyo viov. lazzari ot al.
cito rosoarch ly Philip Vasan shoving that manulacturing corporations
vith unJor $100 million in assots raisoJ only 2/ ol thoir total linanco lrom
nov sharo issuos lotvoon 1960 anJ 1980. lt is vory oxponsivo lor small
lirms to proparo tho logal anJ linancial Jocumonts lor a pullic stock ol-
loring, anJ, outsiJo ol lullly timos, it can lo Jillicult to soll olscuro namos
to invostors. Smallish ontropronours may chalo at tho snoopinoss ol out-
siJo invostors, tho pross, anJ Wall Stroot analysts - unploasantrios that
havo to lo aJJoJ to tho costs ol going pullic.
Ol courso, small lirms Jo occasionally got linanco lrom stock salos at
momonts that may lo crucial in thoir ovolution, moaning that thoso aggro-
gato numlors may unJorstato tho importanco ol tho socuritios markots in
lringing togothor ontropronours anJ rontiors Evon il it voro possillo to
aJjust lor tho timolinoss ol a cash injoction, it`s harJ to imagino any multi-
plior that voulJ turn Vasan`s 2/ into somothing signilicant.
ln sum, lig corporations, tho onos vith oasy accoss to tho pullic (non-
lank) capital markots, havo moro monoy than thoy knov vhat to Jo vith:
small onos, vho invost most ol vhat thoy oarn, Jon`t linJ a gonorous
rocoption in tho capital markots.
financial institutions
ln thoory, tho linancial soctor oxists to gathor a socioty`s savings anJ Jiroct
thom tovarJs thoir vorthiost, vhich moans most prolitallo, invostmont
pursuits. Whothor it accomplishos this or not, linanco is vory hanJsomoly
rovarJoJ lor its ollorts. Thoro aro sovoral vays ol making this point.
ln 1991, linanco, insuranco, anJ roal ostato, colloctivoly nicknamoJ
llPE,` surpassoJ manulacturing`s contrilution to GDP, anJ viJonoJ thoir
loaJ in sulsoouont yoars: as rocontly as 1985, llPE vas 15/ smallor. ln 1996,
manulacturing accountoJ lor $1.3 trillion ol output, anJ linanco lor $1.4
trillion. That yoar, invostmont vas $1.1 trillion - moaning llPE proJucoJ`
30/ moro than tho savings it thoorotically channoloJ into invostmont.
Tho noarly chart shovs tho tako ol vhat mainstroam oconomists call
tho tvo major lactors ol proJuction, capital (vhoso rovarJ is prolit) anJ
PLAYERS
77
lalor (vhoso rovarJ is vagos anJ salarios) lor tho llPE soctor, calculatoJ
as a porcontago ol gross privato Jomostic invostmont (GPDl).
1
Altor all, il
llPE`s social task is to allocato invostmont, this is prolally tho most rol-
ovant moasuro ol hov choaply or oxponsivoly it Joos its vork. Poal ostato
is incluJoJ along vith linanco anJ insuranco locauso rosiJontial invost-
mont (housoluilJing) accounts lor ovor a ouartor ol total invostmont, anJ
nonrosiJontial structuros anothor ouartor.
Tho most striking loaturo ol tho chart is tho oxtraorJinary ascont sinco
tho oarly 1980s, lrom just unJor 20/ in 1981 to poak at 4/ in 1991, thon
lalling lack gontly to 40/ in 1996. This spoctacular oxplosion, vhich oc-
curroJ locauso ol a simultanoous stagnation in invostmont (anJ a Joclino
in its sharo ol GDP) along vith a sharp grovth in llPE incomo, throatons
to ovorvholm tho mossago ol tho rost ol tho chart: ovon in lygono yoars,
linanciors, Jovolopors, lrokors, roaltors, anJ tho rost ol tho gang pock-
otoJ rovarJs ooual to 20-25/ ol gross invostmont - rathor a largo tako
lor a supposoJ noutral intormoJiary. Tho 1990-94 avorago ol 43/ is a
granJ rovarJ inJooJ.
HaJ tho chart logun in 1929, vhon tho national incomo accounts lo-
gin, tho graph voulJ lo much harJor to roaJ, lut its story voulJ lo no
loss compolling. ln 1929, llPE`s
rovarJs voro 28.4/ ol gross in-
vostmont, a lit alovo tho 24.1/
avorago lor tho 1950-9 porioJ.
But tho liguro oxploJoJ in tho
1930s, as invostmont collapsoJ
lut tho prolits ol linanco JiJn`t,
hitting 228/ in 1932 - moaning
that tho allocators oarnoJ ovor
tvico as much as tho invostmont
lunJs thoy voro allocating! lt vas
not until tho rocovory ol invost-
mont at tho onJ ol tho var that tho ratio roturnoJ to moro normal` lovols.
With tho grovth ol consumor croJit sinco tho 1920s, it might lo arguoJ
that consumor Jurallo gooJs, liko cars anJ appliancos, shoulJ lo aJJoJ
to tho Jonominator ol tho calculation, sinco thoso, too, aro linancoJ
(though, ol courso, thoy proJuco no monotary roturn to thoir ovnors -
unloss thoy`ro taking in thoir noighlors` launJry). Whilo this aJjustmont
proJucos slightly loss oyo-popping liguros, tho tronJ romains tho samo:
llPE`s incomo as a porcont ol GPDl plus oxponJituros on Jurallo con-
FlRE profits and
salaries, percent
of gross
investment,
1950-1996
!5'
20'
25'
30'
35'
40'
45'
50'
!950 !960 !970 !930 !990
WALL STREET
78
sumor gooJs roso lrom tho 1950-9 avorago ol 1/ to a poak ol 28/ in
1991, loloro rotroating to a moro moJost 26/ in 1996.
ln 1992, llPE corporations liloJ 1/ ol all corporato tax roturns, ro-
porting 16/ ol total rovonuos, lut 3/ ol prolits (U.S. Buroau ol tho Con-
sus 1994, p. 539). llPE`s prolit sharo has rison stoaJily, lrom 14/ ol tho
corporato total in 1980, to 25/ in 1985, anJ upvarJs to 1992`s liguro.
Vanulacturing`s sharo vas almost a mirror imago, lalling lrom 53/ ol prolits
in 1980 to 36/ in 1992.
PovarJs to inJiviJual llPE vorkors aro usually ouito gonorous. As part
ol tho national incomo accounts, tho Buroau ol Economic Analysis roports
avorago vago anJ salary liguros lor 85 Jilloront occupational catogorios.
At tho vory top aro routinoly tho olito monoyspinnors ol tho liolJ, socurity
anJ commoJity lrokors,` vho oarnoJ on avorago $108,60 in 1996. (No
Joult tho lrokors voulJ havo Jono a lot lottor il thoir socrotarios anJ
clorks voron`t Joprossing tho inJustry avorago.) That Jisparity is tho viJ-
ost sinco tho accounts logan in 1929, lroaking tho provious rocorJ, sot in
1993. ln tho momorallo yoar ol tho Groat Crash, lrokors oarnoJ a lit ovor
tvico as much as tho avorago vorkor: thoy pickoJ up a lit on avorago in
tho 1930s, anJ thon logan losing grounJ lrom tho onJ ol tho var until tho
lato 1960s: in 190, omployoos ol lrokors oarnoJ just 58/ moro than tho
avorago vorkor. Tho lrokorago promium has climloJ, almost vithout in-
torruption, ovor sinco. llPE vorkors as a vholo Jo somovhat loss voll
than lrokorago omployoos. Avorago oarnings lor all llPE vorkors voro
39/ alovo tho national avorago in 1996 - up sharply lrom tho 1960s anJ
190s, vhon thoy louncoJ arounJ tho national moan.
Thoso high numlors aro a lit Jocoptivo. Hourly pay lor nonsuporvisory
vorkors in all ol llPE vas just 9/ alovo tho privato soctor avorago in
Docomlor 199, anJ oarnings at Jopository institutions (liko lanks anJ
thrilts), 16/ lolov. Tollors anJ chock procossors Jon`t lunch anyvhoro
noar as granJly as invostmont lankors.
Though thoy aro oxcooJingly voll-paiJ, thoro aron`t that many pooplo
omployoJ at lrokorago housos - just 616,000 in January 1998, or 0.5/ ol
total omploymont, though this is a consiJorallo incroaso lrom 1950`s 0.1/
sharo. Brokors aro ovorvholmingly vhito mon - tvo-thirJs ol tho total,
accorJing to 1990 consus Jata. UnJor 2/ ol all lrokors voro llack vomon:
25/ voro vhito vomon. Womon occupy only alout 5-10/ ol tho top
jols at tho high-onJ invostmont lanks (Passoll 1996l). Ioss olito linancial
jols shov groator Jivorsity: almost 90/ ol all lank tollors voro vomon,
anJ 8/ voro llack vomon - moro than tho / vho voro vhito mon.
PLAYERS
79
This Jomographic mix comports ouito proJictally vith tho salary rankings
roportoJ in tho provious paragraph. All in all, llPE omploymont grov lrom
4.3/ ol tho total in 1950 to 6.0/ in 1996 - signilicant grovth, lut no-
vhoro noar as signilicant as tho grovth in llPE`s monotary haul.
ln ono ol tho intorosting analytical articlos lasoJ on tho 1983 Survoy ol
Consumor linancos - part ol an analytical oxorciso that tho loJ hasn`t
roplicatoJ vith lator survoys - it vas roportoJ that 31/ ol lamilios vith
incomos ovor $200,000 a yoar voro hoaJoJ` ly somoono in lanking,
insuranco, or roal ostato, ovon though thoy roprosontoJ only 2/ ol tho
population (Avory anJ Elliohauson 1986): llPE`s roprosontation among
tho voll-hooloJ vas tho most ol any soctor.
18
llPE has croatoJ a strango oconomy in its hoaJouartors city, Nov \ork.
ln tho vorJs ol Nov \ork loJ apologist Pao Poson (1993, p. 23), on a por
capita lasis, oach jol in tho llPE soctor gonoratos 24 I:u~: u: uucI uI-
juI u: uII II~: :~cI:: Tho vagos anJ salarios that aro paiJ in tho llPE
soctor rolloct this Jogroo ol proJuctivity.` Poson`s roasoning is Jizzily cir-
cular. Hov Jo you moasuro tho output` ol llPE? By its rovonuos, vhich
aro a lunction ol its costs. What aro its costs? Tho salarios anJ prolits ol
llPE. What Poson`s numlors moan is that llPE croatos a city vith a small
olito anJ a mass ol oxcluJoJ. This is vhat makos Nov \ork Jilloront lrom
many othor citios, vhich havo only tho oxcluJoJ vithout tho olito. lt`s also
vhat makos Vanhattan tho most incomo-unooual county in tho U.S. altor
ono in Havaii that usoJ to lo tho sito ol a lopor colony, accorJing to
Ouoons Collogo prolossor AnJrov BovoriJgo (porsonal communication).
Iost vo closo this soction vith tho implication that Wall Strootors aro
vithout roJooming social valuo, horo`s a kinJ vorJ lor thom lrom tho
Nov \ork call-girl-turnoJ-vritor Tracy Ouan (porsonal communication):
Wall Stroot guys gonorally liko vorking girls anJ voro among my svootost
clionts vhon l vas activo. On tho vholo, thoy aro nicor to Jo lusinoss vith
than Joctors (vho aro olton ouito vain, nourotic anJ sollish) - anJ thoy
aro olton moro giving than lavyors (vho priJo thomsolvos on thoir nogoti-
ating skills). Wall Strootors tonJ to lo vory inJulgont - onco thoy loavo tho
ollico or tho pit, anJ ontor tho loJroom.. Also, thoy lasically soo thom-
solvos as hookors soo thomsolvos, vhich colors thoir humor.
19
So lar in this soction l`vo contoroJ my attontion on linanco, tho l in llPE.
Tho rost ol this look vill sustain that lias, lut a lov vorJs alout lPE aro
WALL STREET
80
in orJor. Poal ostato is lasoJ on milking voalth lrom lanJ anJ tonants,
vith tho holp ol govornmont sulsiJios (in tho lorm ol tax lroaks anJ in-
lrastructuro Jovolopmont) vhonovor possillo. lts connoction vith con-
struction anJ inlrastructuro puts it a mito closor to tho physical vorlJ than
puro linanco, lut to many linancial invostors, luilJings aro just stroams ol
rovonuos - ronts - that can lo capitalizoJ just liko a lonJ or a stock.
20
As an inJustry, roal ostato accounts lor only alout 13/ ol tho total llPE
Jollar payroll, lut 20/ ol omploymont, moaning roal ostato vorkors aro
tho poor rolations ol linanco.
Thoro`s also littlo horo alout insuranco as an inJustry in itsoll, though
insuranco companios aro major playors in tho major markots, anJ thoy
control hugo lumps ol capital - $3.4 trillion in assots at tho onJ ol 199.
Tho inJustry is largoly oxompt lrom loJoral rogulation - tho statos hanJlo
it - lut it carrios plonty ol voight in Washington, as tho lailuro ol Clinton`s
hoalth insuranco schomo shovoJ. lnsuranco companios aro hoavily rop-
rosontoJ on tho loarJs ol major nonlinancial lirms: ovoryono vants to
romain on gooJ torms vith thoso rich sourcos ol capital. Corporations
olton tap insuranco companios through privato placomonts` - custom
loans that aron`t pullicly traJoJ.
ln gonoral, insuranco is tho privato socialization ol risk.
21
Pooplo luy
insuranco to protoct thomsolvos against Jovastating things that happon
raroly. Pisks aro pooloJ across a largo population, anJ tho lossos aro paiJ
lrom tho common pool. ll tho pool is largo onough, tho risks aro lairly
proJictallo, moaning that insurors can invost most ol thoir promium in-
como in tho linancial markots, ospocially in lonJs. Vost ol tho timo it is
highly prolitallo, as long as thoy can koop prico vars unJor control anJ
koop thoir paymonts to policyholJors to a minimum, though thanks to
Joxtorous accounting, tho inJustry can mako prolits look liko lossos.
Prico vars aro conlinoJ mainly to tho proporty-casualty sulspocialty,
vhoro thoro sooms to lo a pricing cyclo. lirms unJor-prico insuranco in
orJor to tako in cash lrom promiums, vhich is thon invostoJ. Thoy hopo
invostmont prolits vill oxcooJ payout on claims, lut il tho pricing is too
lov, thoy onJ up unJor vator, anJ thoy`ro curoJ ol tho tomptation to un-
Jor-prico lor a vhilo. Proporty-casualty insurors koop thoir rosorvos in
much shortor-torm papor than Jo lilo insurors: Jisastors anJ acciJonts can
happon at any timo, lut pooplo tonJ to Jio on a proJictallo schoJulo.
Piots anJ natural Jisastors, maJo vorso ly glolal climatic tromors, havo
rocontly hammoroJ proporty insurors, hovovor, anJ JisturloJ thoir olJ
risk moJols. Ono coulJ think ol this as social anJ onvironmontal crisis
PLAYERS
81
taking a linancial lorm - an oxamplo ol Jamos O`Connor`s (1988) soconJ
contraJiction ol capitalism - lut liko tho classic contraJiction, it hasn`t
provon systomically latal yot.
lnsuranco companios havo lost somo markot sharo in tho provision ol
croJit, lalling lrom arounJ 16/ total croJit markot Jolt in tho oarly 1950s
to arounJ 11/ in 199. Still, thoy aro vast luyors ol papor assots: lilo insur-
anco companios ovnoJ almost a thirJ ol all corporato lonJs outstanJing
in 199. Thoy voro major lunJors ol corporato luyouts anJ takoovors
Juring tho miJJlo anJ lato 1980s, though on roviov, a luyout spocialist
lor a lranJ-namo insuranco company tolJ mo his lirm coulJ havo Jono
lottor invosting in Troasury lills, so lousy vas tho roturn on his Joals.
As linancial popstar AnJrov Tolias (1982) onco arguoJ, tho insuranco
inJustry thrivos on its roputation lor Jullnoss, vhich koops prying oyos
avay lrom oxamining its voalth. So-calloJ mutual lilo insuranco compa-
nios, vhich aro ovnoJ ly thoir policyholJors, aro ospocially lat anJ ol-
scuro, locauso lov small policyholJors havo tho moans or vill to chock
out vhat thoir` lirm is up to vith thoir` monoy. Exocutivos ol such lirms
aro among tho most cossotoJ ol a cossotoJ class, though linancial Jorogu-
lation is loginning to lito at tho inJustry.
AnJ nov to tho playors that attract tho most attontion - commorcial anJ
invostmont lanks anJ othor star institutions that aro synonymous vith
Wall Stroot. A striking loaturo ol tho gonoral croJit scono is that olJ-stylo
lanking has takon a lacksoat to tho markots.` This is a mattor ol loth
numlors anJ stylo. lrom tho 1950s through tho miJ-190s, lanks holJ an
avorago ol 28/ ol total croJit markot Jolt: at tho onJ ol 199, thoir sharo
haJ lallon to 19/. Thrilts havo lost ovon moro markot sharo than tho lanks.
Thoy holJ 18/ ol croJit markot Jolt in 19, a noar-Joulling lrom 1952,
lut that sharo oroJoJ throughout tho 1980s anJ oarly 1990s, lalling to
unJor 5/ in 199. What lanks anJ thrilts lost vas gainoJ in part ly pon-
sion lunJs, vho havo moro than JoulloJ thoir sharo ovor tho last 40 yoars,
anJ mutual lunJs, vho haJ 0.2/ ol all croJit markot Jolt in 1952, anJ
.6/ in 199.
Thoso assot liguros aro misloaJing, sinco lanks still havo a hanJ in most
linancial transactions - it`s harJ to soll a stock or traJo a curroncy vith-
out ono - anJ also sinco tho llov ol lunJs liguros oxcluJo lanks` oll-
lalanco-shoot` activitios - unsuporvisoJ, unJor-roportoJ aJvonturos in
lovorago in Jorivativos markots anJ anyvhoro olso thoir invontivo minJs
WALL STREET
82
might tako thom. At tho onJ ol 1993, tho 20 largost lanks haJ oll-lalanco-
shoot oxposuros ooual to 39/ ol assots anJ 53/ ol thoir coro capital`
(rotainoJ prolits plus tho procooJs ol past stock salos), moaning that il all
holl lroko looso many voulJ lo logally insolvont. AJJitionally, many lanks
havo oxtonsivo propriotary traJing accounts (lor thoir ovn accounts rathor
than clionts`), in vhich thoy turn ovor loroign oxchango, govornmont lonJs,
anJ othor lictitious claims: tho 20 largost lanks haJ traJing accounts ooual
to 45/ ol assots anJ 49/ ol coro capital (computoJ lrom Shoshunoll
Jata roportoJ in Schlosingor 1995). Vany ol thoso activitios aro not only
oll lalanco shoots, thoy`ro oll tho mainlanJ as voll, in IonJon or tho Cay-
man lslanJs.
22
But tho contral lanks voulJ not allov all holl to lroak
looso, moaning that a pullic saloty not has loon placoJ unJor a markot no
ono roally unJorstanJs or can ovon accuratoly moasuro.
23
loar-mongoring asiJo, vhatovor tho virtuos ol oll-lalanco-shoot linanc-
ing anJ propriotary traJing, it has littlo in common vith J.P. Vorgan`s char-
actor` lanking - making a loan lasoJ on a juJgmont ol porsonal charactor
rathor than a lalanco shoot - or classic croJit scrutiny. Olton, lanks aro
ouick to synJicato loans - larm lits ol a Joal out to othor lanks - or to
socuritizo thom (to packago a lunch ol similar loans anJ soll thom as lonJs
on tho opon markot). AnJ tho liggost commorcial lanks aro rapiJly lo-
coming socuritios lirms, so thoir lounJing uniouonoss - making com-
morcial loans vhilo loing prohilitoJ lrom unJorvriting nov socuritios -
no longor oxists. Vonoy-contor lanks - tho giants lasoJ in Nov \ork,
Chicago, anJ Calilornia - Jorivo largo portions ol thoir prolits lrom traJ-
ing oporations: moroly paying your Jopositors loss than you chargo your
lorrovors sooms a vory rotro approach to tho lusinoss.
24
Big lanks no
longor nurturo long-torm tios vith lig corporations: tho lig corporations
can lorrov lor thomsolvos in tho commorcial papor markot, anJ tho lank-
ors liJ on tho rost ol tho corporato lusinoss liko traJors juggling stock.
Banking is nov largoly an allair ol transactions, not rolationships.
Nov vo got to tho rich hoart ol vhat pooplo moan ly Wall Stroot.`
Commorcial lanks, though unJoultoJly major prosoncos in tho linancial
vorlJ - anJ vhich aro locoming moro liko invostmont lanks ovory Jay
- aro still lookoJ Jovn on ly invostmont lankors as Jull anJ incompo-
tont. Tho poak ol tho Wall Stroot hiorarchy, moasuroJ ly loth prostigo anJ
monoy - anJ monoy, ol courso, is vhat roally mattors - aro tho lulgo
lrackot` unJorvriting anJ traJing monstors liko Vorgan Stanloy anJ
GolJman Sachs. Thoy lring lorth nov socuritios issuos to thoir customors,
anJ traJo thom lor thoir ovn anJ thoir customors` accounts.
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83
Tho sociology ol moJorn Wall Stroot is vorth a look in itsoll. lt`s no-
tallo hov lov high-llyors lrom tho 1980s mania maJo it into tho ruling
class. Honry Kravis, tho major liguro ol tho lovoragoJ luyout mania, JiJ
mako it to tho chair ol Nov \ork City`s pullic TV station anJ tho loarJ ol
tho Votropolitan Vusoum, tho lattor an innor sanctum ol tho Estallish-
mont - lut Kravis` lathor vas rich anJ voll-connoctoJ on Wall Stroot,
ovon il ho vas lrom Oklahoma (Bartlott 1991). Vany 1980s hotshots havo
JisappoaroJ lrom tho hoaJlinos: ono, Kirk Korkorian, maJo a pass at
Chryslor in tho spring ol 1995, lut vasn`t takon soriously, locauso thoro
vas no longor any Droxol Burnham Iamlort arounJ to lloat junk lonJs in
his namo. Boono Pickons` lirm, Vosa Potroloum, is in torrillo shapo, anJ
his sharoholJors lootoJ him out. Alumni ol tho linancing arm ol tho up-
starts, tho nov-JoaJ Droxol, aro scattoroJ arounJ Wall Stroot, lut thoy`ro
no longor linancing a Nov Class`s claims to povor.
ln tho olJ Jays, invostmont lanking vas much moro alout connoc-
tions - vho roomoJ vith vhom at AnJovor coulJ Jotormino loth part-
norships anJ cliont rolationships. During tho 1950s anJ 1960s, invostmont
lankors raisoJ monoy lor anJ olloroJ counsol to tho managors ol tho
Amorican Contury, anJ lixoJ loos anJ gontlomanlinoss kopt compotition
lrom gotting out ol control. AnJovor connoctions still mattor, ol courso,
though not as much, lut tho rost is uttorly translormoJ. loos anJ commis-
sions aron`t lixoJ, anJ noithor aro customor rolationships.
Wall Stroot Joos lusinoss vith loth linancial institutions anJ tho gon-
oral pullic, vith tho gonoral pullic ranging lrom lillionairos Jovn to oJJ
lottors` (litorally pooplo vho traJo stocks in units smallor than a rounJ lot
ol 100 sharos, lut moro colloouially tho nals vho loso monoy locauso
thoy`ro in ovor thoir hoaJ). Somo lirms, liko Vorrill Iynch, Joal vith tho
gonoral pullic, lrom oJJ lottors upvarJs to rich inJiviJuals anJ institu-
tions, vhilo somo, liko Vorgan Stanloy, Joal vith only institutions anJ tho
vory rich. Sinco lixoJ commissions voro alolishoJ in 195, an inJustry ol
Jiscount lrokors has sproutoJ, Joaling mainly vith tho gonoral pullic.
Thoy ollor littlo or no rosoarch lrom prolossional analysts, anJ thoir lro-
kors Jon`t givo invostmont aJvico. At tho lottom ol tho hoap aro luckot
shops, loilor rooms, anJ havkors ol choap ponny stocks. Thoso opora-
tions rango lrom tho nogligontly optimistic to tho outright criminal, anJ
shov a spocial lonJnoss lor locating in placos liko Iong lslanJ, lloriJa,
anJ Vancouvor.
This survoy oxcluJos tho lovlilos vho tako in $200-300 lillion a yoar
ly proying on tho poor anJ Josporato - lrokors vho JomanJ 20/ on a
WALL STREET
84
soconJ mortgago, pavn shops vho chargo 240/ on loans, linanco com-
panios vho chargo 300/, chock-cashing sorvicos that chargo 2,000/ lor
ouick payJay` loans, layavay artists anJ ront-to-ovn schomors (HuJson
1996). Whilo thoy`ro unJoultoJly part ol tho linancial inJustry, l`ll ignoro
thom: tho point ol this look is to tar tho lolks vith tho gooJ roputations, il
only to proompt tho laJ applo` Jolonso.
lnJiviJuals vho Joal vith lrokors can traJo stocks, lonJs, options, anJ
othor oxotic instrumonts, lut many also turn to mutual lunJs anJ othor
managoJ invostmont vohiclos to Jo tho rosoarch anJ traJing vork lor thom.
Vutual lunJs havo grovn stoaJily sinco Wall Stroot rocovoroJ its roputa-
tion altor tho Doprossion - 11/ a yoar on avorago through tho 1960s anJ
190s, anJ alout tvico that ovor sinco. Tho 1990s havo loon notallo not
only lor tho continuoJ rush ol Jollars into mutual lunJs as pooplo Jo-
spairoJ ol lov intorost ratos - vith many ol thom plunging into lonJ anJ
loroign stock markots complotoly unavaro ol tho risks involvoJ, though
vith Jroams ol 20-30/ roturns in porpotuity - lut also tho shoor prolil-
oration ol ontitios. As ol lolruary 1998, thoro voro 6,86 U.S. mutual lunJs
(lar moro stocks than aro listoJ on tho Nov \ork Stock Exchango), moro
than Joullo 1990`s numlor, a lirthrato ol almost tvo lunJs por lusinoss
Jay. lrom 1991 to 199, $992 lillion llovoJ into mutual lunJs, voll ovor
hall ol nov savings ovor tho porioJ, anJ ovon oxcooJing tho lrosh supply
ol savings in sovoral ouartors. lt is ono ol tho most romarkallo linancial
Jovolopmonts ol moJorn timos - assuming it lasts, anJ that it`s not a
lulllo ol sullimo proportions, liko tho Japanoso linancial markots voro
in 1989.
25
Vutual lunJs colloct monoy lrom pullic invostors, uso a lit ol it to hiro
managors vho soloct socuritios anJ traJo thom. (A lit` lrom tho lig pic-
turo porspoctivo, porhaps, lut consiJoring tho small stall it takos to man-
ago lig lucks, a thin slico ol a massivo pilo moans tho managors anJ
Jiroctors aro paiJ vory vory voll.) Stylos vary: somo lunJs aro aggrossivo,
somo consorvativo: somo invost only in lonJs, or stocks, or cortain kinJs
ol lonJs (municipal, Troasury) or stocks (moJical companios, nov or small
companios), or cortain rogions (Voxico, Asia). Thoro is a hugo inJustry
alout thom, too - TV shovs, soltvaro, volsitos, novslottors. Vutual lunJs
havo locomo tho lavorito inJoor sport ol tho uppor hall.
HoJgo lunJs` might lo thought ol as high-onJ mutual lunJs.
26
Though
thoro`s no strict Jolinition ol vhat thoy aro, in gonoral a hoJgo lunJ is tho
PLAYERS
85
pooloJ capital ol usually 100 or lovor partnors (rich inJiviJuals or institu-
tions), loJ ly a singlo managor or a small toam. Thoy`ro laroly rogulatoJ,
il at all: many aro rogistoroJ in ollshoro havons, ovon though thoy`ro olton
managoJ lrom placos liko Nov \ork anJ IonJon: anJ can Jo protty much
vhatovor thoy liko vith thoir monoy, lrom U.S. lonJs to Turkish stocks to
silvor luturos to Voscov roal ostato. Sinco thoro`s no strict Jolinition, anJ
sinco thoy nooJ lilo no roports - ovon tho partnors aron`t alvays inlormoJ
ol thoir invostmonts - ono can only guoss at thoir sizo. As ol 1994, lost
ostimatos voro that thoro voro 800 to 900 hoJgo lunJs vith total capital ol
$5-100 lillion: a small lunJ voulJ lo ono vith $5 million unJor man-
agomont, anJ a largo ono, as much as $10 lillion. Sinco hoJgo lunJs lor-
rov aggrossivoly, thoy can tako positions anyvhoro lrom 5 to 20 timos
thoir paiJ-in capital, moaning that thoy can control anyvhoro lrom $35
lillion to $2 trillion in socuritios (GolJstoin ot al. 1994, pp. 6-9). Not only
aro thoso lig numlors, ovon ly tho stanJarJs ol toJay`s capital markots,
lut thoy movo vory ouickly in anJ out ol invostmonts. Thoy voro rospon-
sillo lor much ol tho turlulonco in tho Europoan Vonotary Systom in 1992,
anJ lor tho U.S. lonJ markot Jolaclo ol 1994 (tho vorst yoar in tho moJ-
orn history ol that markot), anJ lor tho Voxican crisis ol that yoar as voll.
Whilo many hoJgo lunJ stars lost lig monoy in 1994, thoir porlormanco in
tho yoars loaJing up to that plaguo yoar vas improssivo: an avorago yoarly
roturn ol almost 20/ lotvoon 198 anJ 1993, comparoJ vith only` 13/
lor mutual lunJs anJ tho U.S. stock markot (moasuroJ ly tho S8P 500),
anJ vith much groator consistoncy as voll. Such suporior roturns com-
pounJ miraculously ovor timo: $1 million placoJ vith tho avorago hoJgo
lunJ in 1986 voulJ havo grovn to $3.5 million at tho onJ ol 1993, com-
paroJ vith a moro $2.4 million in tho avorago stock or mutual lunJ (Po-
pullic Nov \ork Socuritios Jata, prosontoJ in GolJstoin ot al., p. 8).
Dospito thoso roturns lor tho lucky lov, hoJgo lunJs aro not vithout
Jangors lor tho rost ol us. Sinco thoy lorrov so hoavily lrom lanks, a
roally Jisastrous yoar lor tho spoculators coulJ Jo sorious Jamago to tho
lroaJ linancial systom - moaning that contral lankors anJ rogulators
may laco tho choico ol a lailout or systomic collapso. Thoro is also tho
vorry that thoy incroaso tho volatility ol tho markots, though it may also
lo that thoir villingnoss to troaJ vhoro othors loar may holp put a lloor
unJor voak markots. Anothor vorry is that hoJgo lunJ oporators coulJ
manipulato markots, oithor through calculatoJ luying anJ solling JosignoJ
to misloaJ tho gonoral pullic - slovly liJJing up tho prico ol somo as-
sot, say, anJ thon unloaJing a largo position on gullillo luyors, or using
WALL STREET
86
calculatoJ loaks to tho pross to croato a mania or panic prolitallo to tho
voll-positionoJ. Tho authoritios play Jovn tho Jangors ol manipulation,
lut that`s vhat authoritios aro paiJ to Jo.
A highly romanticizoJ cornor ol linanco is tho vonturo capital inJustry,
vhich supplios lunJs to small, nov lirms, prominontly though not oxclu-
sivoly in high-toch. Typically, monoy is pooloJ ly institutions anJ rich
inJiviJuals into partnorships unJor tho managomont ol a small oxport toam.
Tho lailuro rato is high, lut tho succossos can mako it all vorthvhilo: ov-
oryono vants to hit tho noxt Compao. Patos ol roturn run lotvoon 0/ in
laJ yoars (liko 1984 anJ 1990) to 60/ in gooJ onos (liko 1980 anJ 1995),
avoraging arounJ 20/ sinco 1980 (Vonturo Economics Jata, roportoJ in
Vohta 1996). Vany initial pullic ollorings (lPOs) aro JosignoJ to cash out
tho original invostors: though somo vonturo capitalists koop thoir monoy
anJ ovon a managomont prosonco at companios onco thoy go pullic, tho
iJoa is not to nurturo a largo portlolio ol maturo oporating companios, lut
to proviJo linanco anJ guiJanco at tho omlryonic stago.
As important as that sounJs, tho vonturo capital inJustry is surprisingly
small. ln 1995, vonturo pools totaloJ $34 lillion, Jovn a lit lrom 1990`s
$36 lillion, anJ JvarloJ ly tho stock markot`s $8.4 trillion capitalization.
lnllovs ol $4.4 lillion oxcooJoJ nov commitmonts ol $3.9 lillion - voll
unJor 1/ ol that yoar`s nonrosiJontial invostmont - suggosting that tho
vonturo inJustry isn`t going vanting lor lunJs (!~uIu:~ uj:IuI {u:uuI,
various issuos). This looks liko lurthor prool that tho outsiJo linancing ol
roal invostmont, Wall Stroot`s aJvortisoJ social rolo, is actually a rathor tiny
part ol vhat tho rackot is all alout.
the thrift disaster
No look on moJorn linanco voulJ lo comploto vithout a look at ono ol tho
groatost monotary Jisastors ol all timo, tho savings 8 loan (S8I) Jolaclo ol tho
1980s. Whilo hotshot S8Is voro among tho most onthusiastic makors ol
tho groat loom, thoy collapsoJ at a cost ol $200 lillion to tho U.S. govorn-
mont, to lo paiJ lor voll into tho noxt contury. S8Is, also knovn as thrilts,
aro Jisappoaring: thoy`vo protty much lost thoir rationalo lor loing.
S8Is havo thoir roots in 19th contury mutual savings lanks, coopora-
tivo institutions that pooloJ tho savings ol vorkors to linanco homo mort-
gago loans.
2
PattornoJ altor Europoan croJit cooporativos, thrilts olloroJ
croJit to customors vhoso custom vas rolusoJ ly snollish commorcial
lanks. Sinco a mutual`s Jopositors aro also its lorrovors anJ sharoholJ-
PLAYERS
87
ors, 19th contury thrilts olloroJ protoction lrom tho proJations ol tho mon-
ioJ classos` - usurious intorost ratos, spoculativo lulllos, anJ lank lail-
uros (O`Hara 1992). Somo moro convontional stockholJor-ovnoJ thrilts
poppoJ up, lut a spato ol lailuros in tho 1890s loJ sovoral statos, notally
Nov \ork, to roouiro that all thrilts lo structuroJ as mutuals. As lato as
194, only 11 statos pormittoJ stockholJor-ovnoJ S8Is.
Noarly 2,000 S8Is lailoJ in tho Doprossion, anJ a thirJ ol Joposits voro
vipoJ out, though cooporativo associations survivoJ illiouiJity anJ toch-
nical insolvoncy ly rostricting vithJravals. Tvo Nov Doal institutions
translormoJ tho inJustry, tho loJoral Savings anJ Ioan lnsuranco Corp.
(lSIlC) anJ tho loJoral Homo Ioan Bank BoarJ (lHIBB). Tho lirst pro-
viJoJ Joposit insuranco, anJ tho soconJ vas a contral lank, to ovorsoo
tho inJustry anJ proviJo croJit to troulloJ institutions. Thrilts` invostmonts
voro limitoJ largoly to mortgago loans at lixoJ ratos. No othor inJustrial
country olloroJ lixoJ-rato loans, sinco thoy put all tho linancial risk ol
highor intorost ratos onto tho lonJor: vith lloating-rato or aJjustallo loans,
tho lorrovor loars all tho risk (Iomax 1991: U.S. Congrossional BuJgot
Ollico 1993). Thrilts voro insulatoJ lrom compotition ly limits on com-
morcial lank Joposits
Thrilts prosporoJ Juring tho housing loom that lollovoJ WorlJ War ll.
Doposits anJ mortgago loans soaroJ, though capital ratios sank as prolits
laggoJ grovth. Groving compotition lrom lanks lor loth Joposits anJ
mortgago loans in tho 1960s anJ monoy markot lunJs lor Joposits in tho
190s Jrov customors avay lrom thrilts. Worso, tho inllation anJ high
intorost ratos ol tho lator 190s oxposoJ tho S8Is` tragic llav, lorroving
short to lonJ long: Jopositors tomptoJ ly highor ratos in tho unrogulatoJ
vorlJ voro lroo to vithJrav on a vhim, lut thoir lunJs haJ loon com-
mittoJ ly thrilt managors to 30-yoar mortgagos. As ratos roso, tho valuo ol
outstanJing mortgagos sank (liko lonJs, loan valuos movo in tho oppo-
sito Jiroction ol intorost ratos). Balanco shoots anJ incomo statomonts
turnoJ Joop shaJos ol roJ.
Dorogulation vas tho ansvor. ll thrilts coulJn`t mako monoy tho olJ-
lashionoJ vay, thoy voulJ lo liloratoJ lrom tho anciont stricturos anJ
allovoJ to ontor tho playpon ol high linanco. Tho Dopository lntormoJi-
ary Dorogulation anJ Vonotary Control Act ol 1980 - passoJ ly a Domo-
cratic Congross anJ signoJ ly a Domocratic prosiJont, roluting popular
associations ol tho Jisastor vith Poaganism` - romovoJ all intorost rato
coilings, anJ tho Garn-St. Gormain Act ol 1983 lot thrilts got out ol hous-
ing anJ into vhatovor thoy likoJ. Tho lavs anJ rogulations govorning
WALL STREET
88
thrilts haJ long loon vritton ly inJustry lollyists, anJ thoir rogulators
voro in thrall to tho S8Is as voll, lut this cozy rolationship locamo par-
ticularly Jangorous as thoy voro lroo to go vilJ. That vilJnoss, as ovory-
ono knovs ly nov, incluJoJ shovoring monoy on suporlluous shopping
contors in tho miJJlo ol novhoro, vinJmill larms, prostitutos, spoculativo
housing, spoculativo ollico luilJings, cocaino, junk lonJs, art lor tho CEO`s
houso, tho Nicaraguan contras, anJ yacht partios on tho Potomac. Hot lor
lunJs to got into thoso pursuits, anJ sulsoouontly hottor lor lunJs to covor
lossos, thrilts pushoJ up intorost ratos to attract Joposits lrom Wall Stroot.
lt usoJ to lo saiJ that noloJy got rich in tho thrilt inJustry anJ noloJy
vont lust: Juring tho lrooplay ol tho 1980s, pooplo JiJ loth.
Consorvativos lovo to point to tho vol ol porvorso incontivos that
spavnoJ tho allair. Doposit insuranco romovoJ all incontivo lor Joposi-
tors to scrutinizo tho thrilt`s portlolio (a situation lankors anJ thoir lrionJs
call moral hazarJ`). Tho mutual structuro roinlorcoJ this, sinco inJiviJual
Jopositor-sharoholJors havo noithor timo nor intorost nor oxportiso to
scrutinizo managomont. Alolish Joposit insuranco, saiJ tho right raJicals,
or roin it in, saiJ tho contrists. Ol courso, vithout Joposit insuranco, tho
ontiro linancial systom voulJ prolally havo collapsoJ in a climactic run
somotimo lotvoon 198 anJ 1990. ll you`ro going to insuro Joposits, you`J
lottor suporviso lankors protty closoly: tho prico ol tho S8I lailout voulJ
havo lunJoJ tho prosonco ol 10 lull-timo lank oxaminors in ovory thrilt in
tho country lor closo to 200 yoars.
linancial raJicals shoulJ pay attontion to tho losson alout JisporsoJ
cooporativo ovnorship: thoro`s littlo incontivo lor smallish Jopositors, or
tho ovnors ol any largo cooporativo, to pay attontion to tho managomont
ol tho ontorpriso thoy logally ovn. Unloss thoro`s somo institutionalizoJ
ovorsight, a sorious anJ roprosontativo suporvisory loarJ, managors can
oasily commanJoor tho institution lor thoir ovn intorost. But unlortunatoly
lor thoso vho vant to Jamn cooporativo ovnorship ontiroly, sharoholJ-
ors in non-mutual thrilts JiJ littlo lottor. Ono ol tho crucial junk lonJ
luyors in Vichaol Vilkon`s notvork vas a pullic thrilt, Columlia Savings.
SharoholJors can lo as JisporsoJ anJ inattontivo as small Jopositors.
Economists havo thoir ovn unJorstanJing. Thrilt punJit Polort Iitan
(1992) rojoctoJ popular oxplanations ol tho crisis, vhich contor on vonal-
ity, grooJ anJ incompotonco,` out ol prolossional Jiscomlort. lnstoaJ, Iitan
prolorroJ tho torrain ol convontional oconomics - inllation, intorost rato
volatility, moral hazarJ, roal ostato slump, anJ tho rost - anJ, liko a loyal
oconomist, vas oagor to got Jorogulation oll tho hook.
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Ol courso inllation anJ tho rost aro to llamo. But it voulJ lo impovor-
ishing to stop thoro. Iitan`s lollov oconomists assuroJ us that linancial
Jorogulation vas supposoJ to roloaso untolJ onorgios ly lilorating tho
soll-aJjusting mochanisms ol tho capital markots. lnstoaJ, it roloasoJ im-
pruJonco, incompotonco, anJ lrauJ throughout tho ontiro systom. As a
WuII I:~~I {u:uuI pioco on tho thrilt Jisastor notoJ, tho list ol malolac-
tors is so long that somo olsorvors concluJo thoro is somothing prolounJly
vrong vith tho country`s political anJ linancial systoms, vhich appoar
oasily unJono ly lockloss anJ rockloss lohavior. ln lact, thoy say, tho
lohavior ol this logion calls into ouostion tho porlormanco ol this nation`s
prolossional class itsoll` (VcCoy ot al. 1990). Tho calls into ouostion` is a
littlo ouphomizing, anJ tho somo olsorvors concluJo` a classic journalist`s
JoJgo lor olloring tho lorliJJon controvorsial opinion, lut tho {u:uuI s
analysis is a lino corroctivo to Iitan`s. Unlortunatoly, tho papor JiJ not go
into tho sorry porlormanco ol tho moJia, tho {u:uuI incluJoJ, Juring tho
1980s, as tho thrilts anJ ovorything olso voro spinning out ol control.
Evory institution that vas supposoJ to vatch tho S8Is lotchoJ tho task.
Topping tho rostor ol lailuros aro tho rogulators, loJoral anJ stato, in tho
grip ol tho oarly-Poagan-ora ouphoria, vho lailoJ to suporviso tho institu-
tions - olton run ly Jim provincials - that thoy haJ just sot lroo to ontor
lusinossos thoy`J novor loon in loloro. Congross haJ long loon in tho
inJustry`s pockot. Evon a prosiJont`s son, Noil Bush, holpoJ Jrivo an S8I
into tho grounJ, Donvor`s SilvoraJo (Wilmson 1991). Tho aJministration,
vith tho complicity ol an uncurious pross, succosslully kopt SilvoraJo out
ol tho 1992 campaign, no Joult holpoJ ly ooual Domocratic political anJ
linancial collusion in tho Jisastor.
But it`s vrong to llamo only tho govornmont, Jospito tho Amorican
halit ol Joing so. Virtually ovory high-onJ prolossion arounJ vas involvoJ
(a point maJo voll ly Vartin Vayor |1990l). AuJitors ropoatoJly cortilioJ
lictitious linancial statomonts, lavyors arguoJ on lohall ol con artists anJ
incompotonts, invostmont lanks lilkoJ navo S8I managors, anJ consult-
ants tostilioJ as charactor vitnossos lor lolons. Ono ol thoso charactor vit-
nossos vas Alan Groonspan, thon an unJistinguishoJ oconomist lrom
vhom you coulJ orJor tho opinion you nooJoJ` (Vayor 1990). Groonspan
praisoJ thrilt-killor Charlos Koating`s soasonoJ anJ oxport` managomont
toam lor roscuing a laJly lurJonoJ` thrilt through sounJ anJ prolit-
allo` invostmonts. Evory vorJ ol this vas untruo. Groonspan`s roputa-
tion, hovovor, survivoJ intact (just as it JiJ his oarlior JomontoJ jottings
lor Ayn PanJ`s I~cI::::I novslottor).
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90
ln its inlinito gonorosity, Washington camo to tho roscuo. Ol courso it
haJ no choico: no moJorn govornmont voulJ Jaro lot a linancial crisis
turn into a gonoral collapso. \ot tho situation is rich vith irony. ln tho
oarly 1990s, Groonspan voulJ cralt tho loJoral Posorvo`s lailout ol tho
1980s mania. AnJ tho lrainJoaJ carotakor aJministration ol Goorgo Bush
craltoJ tho groatost socialization ol privato loss in history, tho S8I lailout.
AnJ, romarkally, almost noloJy has sulloroJ sorious criminal ponaltios
or political Jisgraco lor this rampant aluso ol trust. Hugo ouantitios ol
pullic monoy - somo $200 lillion, though Jolinitivo accountings aro harJ
to como ly - voro spont vith littlo Jiscussion or analysis, anJ tho allair is
nov largoly lorgotton. Tho chanco to uso tho inJustry`s partial liouiJation
as an opportunity to Jovolop nov pullic anJ cooporativo linancial insti-
tutions vas llovn. Within a couplo ol yoars ol tho crisis` passing, no
ono paiJ it any minJ any longor. lt`s as il it novor happonoJ.
government, especially the Fed
Tho S8I crisis oxhilits sovoral rolos ol govornmont in linanco: to look tho
othor vay Juring a riot on tho upsiJo, anJ thon pay lor tho roscuo vhon
it`s Jono. But ol courso that`s not tho only rolo ol govornmont on Wall
Stroot. Govornmonts aro hoavy playors in tho linancial markots - not
moroly as Joltors, though cortainly tho pullic lonJ markots aro ouito
important. But govornmont is moro than a Joltor: it is a hoavy sponJor
anJ rogulator. ln tho JocontralizoJ U.S. linancial systom, loth stato anJ
loJoral govornmonts suporviso anJ rogulato linanco: thoro is virtually no
loJoral rogulation ol insuranco, vhich is mainly a stato-ly-stato allair.
At tho loJoral lovol, many agoncios rogulato linanco. Tho issuanco anJ
traJing ol socuritios is mainly tho provinco ol tho Socuritios anJ Exchango
Commission (SEC): lirms vishing to soll stocks or lonJs to tho pullic
must rogistor thom vith tho SEC, Jisclosing a roasonally largo amount ol
inlormation alout tho socuritios anJ tho lirm poJJling thom. Pullic lirms
must also lilo thoir annual anJ ouartorly roports vith tho SEC: such ro-
ports, along vith moro tochnical annoxos knovn as proxios anJ 10-Ks,
incluJo lots ol inlo alout ollicors` anJ Jiroctors` pay, lusinoss rolation-
ship lotvoon tho lirm anJ its loarJmomlors, as voll as linancial stato-
monts.
28
Tho SEC also suporvisos traJing on organizoJ stock oxchangos
anJ, to a lossor oxtont, koops an oyo on ovor-tho-countor traJing. Tho
SEC, anJ its Jisclosuro roouiromonts, voro tho croation ol tho Nov Doal,
an attompt to provont a rocurronco ol tho lunacios ol tho 1920s - markot
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manipulations, tho issuanco ol lrauJulont socuritios, anJ tho liko. Though
plonty ol hypo anJ con artists still porvaJo tho socuritios markots, lrokors
routinoly clip thoir customors in pricing traJos, anJ insiJors prolit lrom
knovloJgo ol vhat thoir customors anJ tho gonoral pullic aro up to, tho
markots aro protty cloan - asiJo, that is, lrom thoir systomic parasitism.
Whilo lirms Jon`t alvays toll tho truth, anJ Jo thoir lost to put tho most
positivo spin on thoir roports, U.S. corporato Jisclosuro roouiromonts aro
strict ly vorlJ stanJarJs: it`s amazing hov many junk lonJs that vont
laJ Juring tho 1980s containoJ oxplicit varnings in thoir prospoctusos ol
just hov risky thoy roally voro. lnlormation anJ unJorstanJing aro appar-
ontly vory Jilloront things.
To avoiJ gotting loggoJ Jovn in Washingtonia, l`ll aJJ only a lov
moro vorJs alout rogulators. CommoJitios anJ luturos markot aro rogu-
latoJ ly tho much novor CommoJitios luturos TraJing Commission
(ClTC). Tho commorcial lanking systom is rogulatoJ ly tho tho Comp-
trollor ol tho Curroncy (part ol tho Troasury Dopartmont), tho loJoral Do-
posit lnsuranco Corp. (vhich also insuros Joposits), anJ tho loJoral
Posorvo systom. Stato lanking Jopartmonts aro also important, ospocially
tho Nov \ork Stato authoritios, sinco tho liggost commorcial lanks aro
hoaJouartoroJ thoro. As vith tho U.S. linancial systom - tho vholo soci-
oty, it`s tompting to say - tho rogulators aro vory lragmontoJ.
Ouasi-loJoral agoncios aro also important linancial intormoJiarios. lor
oxamplo, tho loJoral National Vortgago Association (lannio Vao) anJ
tho loJoral Homo Ioan Vortgago Corp. (lroJJio Vac), aro monstors in
tho mortgago markot: thoy loJ its translormation lrom a sloopy, localizoJ
lusinoss into a hot, liouiJ national anJ ovon glolal ono. ln tho olJ Jays,
thrilts anJ lanks maJo mortgago loans anJ kopt thom on thoir looks,
olton lor tho lull 30 yoars ol thoir Juration. Nov, thoy`ro moro likoly to soll
tho loans to lannio Vao or its much smallor cousin lroJJio Vac, vho tako
tho loans anJ packago thom into lonJs lor salo to institutional invostors
anJ rich inJiviJuals (a procoss knovn as socuritization): thoy voro lo-
hinJ $1 trillion in oustanJing socuritios in 1996 (Calmos 1996). lannio
Vao, onco a pullic ontity croatoJ Juring tho Nov Doal, anJ lroJJio Vac,
a 190 croation, havo loth loon partly privatizoJ - though ovoryono on
Wall Stroot corroctly loliovos that thoy aro implicitly guarantooJ against
lailuro ly tho U.S. govornmont, ovon though thoir stock traJos on tho N\SE
as il thoy voro privato lirms.
That implioJ guarantoo allovs thom to lorrov choaply, lovorago up
thoir lalanco shoots, anJ luy loans on moro lavorallo torms than thoir
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92
truly privato compotitors. Thoso compotitors, as voll as tho liscally pru-
Jont, arguo that tho corporations` implicit guarantoos aro a lorm ol corpo-
rato vollaro, lor vhich tho govornmont shoulJ lo paiJ, anJ that thoir
ovor-lovoraging oxposos tho govornmont to tho risk ol a lailout moro ox-
ponsivo than tho S8I oxtravaganza. To protoct thoir privilogoJ status,
lannio anJ lroJJio Joploy tho usual voapons vith unusual skill. ln 1996,
lor oxamplo, lannio Vao sav its ox-chair movo on to Jiroct Clinton`s luJ-
got ollico, anJ lont a voluntoor PP oxport to tho cash-starvoJ Dolo cam-
paign (vhilo ho continuoJ to Jrav his lannio Vao paychock). lts lollyists
incluJo lormor Sonators, Poprosontativos, anJ Whito Houso ollicials ol
loth partios, anJ it throvs arounJ campaign contrilutions vith groat vorvo.
lt makos lrionJs in acaJomia vith tho luro ol lat consulting contracts (a
soJuctivo trick also practicoJ ly tho loJ anJ tho WorlJ Bank). Tho U.S.
Congrossional BuJgot Ollico (1996) ostimatoJ that only tvo-thirJs ol tho
lonolits ol lovor intorost ratos lrom tho implioJ loJoral guarantoo aro
passoJ through to lorrovors: tho rost is skimmoJ ly managors anJ stock-
holJors.
29
lannio Vao oarnoJ $2.1 lillion in prolits in 1995, anJ its sharo-
holJors havo Jono ouito voll. Who says govornmont Joosn`t havo tho
knack lor lusinoss?
Tho most important govornmont agoncy in tho roalm ol monoy is unJoult-
oJly tho loJoral Posorvo. ll somothing as JocontoroJ as a linancial systom
has a contor, it`s tho contral lank, anJ sinco tho Jollar romains tho vorlJ`s
contral curroncy, tho loJ is tho most important ol all contral lanks. All
oyos aro on it, anJ tho tono ol loth linancial anJ roal lusinoss is hoavily
JoponJont on its stanco. Whon a contral lank is in an oxpansivo mooJ,
linanco lulllos: vhon it`s tight, things sag.
Tho loJoral Posorvo is a stuJy in hov monoy anJ tho monioJ consti-
tuto thomsolvos politically. lronically, though it`s nov an anathoma to
populists ol tho lolt anJ right, its croation porvorsoly lullilloJ ono ol tho
JomanJs ol 19th contury populists: lor an olastic` curroncy - ono aJ-
ministoroJ ly tho govornmont that coulJ proviJo omorgoncy croJit vhon
a linancial implosion soomoJ imminont - as an altornativo to tho inllox-
ilility ol tho golJ stanJarJ. lnstoaJ ol locoming tho lloxillo, inJulgont
institution tho populists JroamoJ ol, tho loJ ouickly ovolvoJ into Wall
Stroot`s vory ovn lourth lranch ol govornmont (GroiJor 198, chaptor 8).
Thoro voro a couplo ol attompts in tho oarly anJ miJ-19th contury to
croato an Amorican contral lank, lut thoy voro allovoJ to Jio locauso ol
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Jollorsonian-Jacksonian oljoctions to concontratoJ linancial povor. That
lolt tho anarchic, volatilo U.S. linancial systom vithout any kinJ ol lonJor
ol last rosort, lut in looms all kinJs ol lunny monoy passoJ.
30
Canonically, it vas tho panic ol 190 that loJ to tho loJ`s croation. ln
tho lroouont panics ol tho lato 19th contury, a calal ol Nov \ork lankors
voulJ typically lanJ togothor to organizo liloloat oporations in omorgon-
cios: in tho panic ol 1895, J.P. Vorgan anJ his cronios lailoJ out tho U.S.
Troasury itsoll vith an omorgoncy loan ol golJ. Tho panic ol 190, hov-
ovor, provoJ too much lor thoso privato arrangomonts: that timo, tho Troa-
sury haJ to lo calloJ in to lail out tho calal. Altor that lrush vith Jisastor,
Wall Stroot anJ its lrionJs in Washington camo arounJ to thinking that tho
U.S. coulJ go no longor vithout a contral lank (GroiJor 198, chaptor 9:
Carosso 198, pp. 535-549).
Galriol Kolko (1963) tracoJ tho loss ol tho Wall Stroot circlo`s povor to
sovoral things - tho aging ol porsonalitios liko Vorgan anJ Stillman (tho
Pockolollor roprosontativo): tho grovth ol tho oconomy anJ linancial mar-
kots, anJ tho ovolution ol linancial contors outsiJo Nov \ork: anJ tho
shilt ol inJustry tovarJs intornal linanco, vhich lossonoJ Wall Stroot`s in-
lluonco. Tho loss ol rav linancial povor, hovovor, vas componsatoJ lor
ly tho croation ol tho loJ, an institution that has loon JominatoJ ly Wall
Stroot sinco its lirth in 1913. To Kolko, tho loJ vas an oxamplo ol an
intorost group using tho stato to rovorso its laJing markot lortunos. This
lino rosonatos in populist Jiscourso toJay.
That canonical story, hovovor, Joosn`t comport vith tho convincing
oviJonco massoJ ly Jamos Iivingston (1986). To Iivingston, tho strugglo
lor a U.S. contral lank haJ a much longor history, anJ ono contral to tho
croation ol tho moJorn corporato-Wall Stroot ruling class loginning in tho
1890s. Iivingston shovoJ that tho campaign lor a moro rational systom ol
monoy anJ croJit vas not a movomont ol Wall Stroot vs. inJustry or ro-
gional linanco, lut a lroaJ movomont ol olito lankors anJ tho managors
ol tho nov corporations as voll as acaJomics anJ lusinoss journalists.
Tho omorgonco ol tho loJ vas tho culmination ol attompts to Jolino a
stanJarJ ol valuo that logan in tho 1890s vith tho omorgonco ol tho moJ-
orn prolossionally managoJ corporation ovnoJ not ly its managors lut
ly JisporsoJ pullic sharoholJors.
Though tho U.S. haJ locomo a national markot Jooply involvoJ in glo-
lal traJo anJ linanco in tho JocaJos lolloving tho Civil War, in tho oarly
1890s it vas still JominatoJ ly small proJucors anJ lanks. As any Varx-
ian or Koynosian crisis thoorist can toll you, tho soparation ol purchaso
WALL STREET
94
anJ salo is ono ol tho groat llashpoints ol capitalism: an oxpoctoJ salo that
goos unmaJo can Jrivo a capitalist unJor, anJ unravol a chain ol linancial
commitmonts. Vultiply that ly a thousanJ or tvo anJ you havo groat po-
tontial lor mischiol. This is ono roason tho last thirJ ol tho 19th contury
vas charactorizoJ ly violont looms anJ lusts, in noarly ooual moasuro,
sinco almost hall tho porioJ vas ono ol panic anJ Joprossion. ln panics,
tho thousanJs ol JocontralizoJ lanks voulJ hoarJ rosorvos, thus starving
tho systom lor liouiJity procisoly at tho momont it vas most laJly nooJoJ.
But tho up cyclos voro also oxtraorJinary, povoroJ ly looso croJit anJ
kinky curroncios (liko privatoly issuoJ lanknotos). Thoro vas no contral
stanJarJ ol valuo, unliko tho vay vo think ol assots ol all kinJs, lrom cash
to invorso lloators, as JonominatoJ in tho samo lunJamontal unit, tho Jol-
lar. Progrossivo` corporato thought, vhich haJ mastoroJ tho rhotoric ol
moJornization, vantoJ a contral lank that voulJ control inllationary li-
nanco on tho upsving - vhich in tho minJ ol largor intorosts, moant
kooping small oporators lrom ovorinvosting` anJ laying tho grounJvork
lor a Jollationary panic - anJ oxtonJ crucial support in a crunch.
Trusts voro ono attompt ly loaJing inJustrialists anJ lankors to man-
ago tho systom`s instalilitios, lut thoso voro prohilitoJ ly tho Shorman
Act ol 1890. Tho corporation, arguoJ Iivingston, vas a rosponso to tho
outlaving ol trusts. By intornalizing lots ol tho tho compotitivo systom`s
gaps - ly lringing moro transactions vithin tho samo institutional valls
- corporations groatly stalilizoJ tho oconomy.
With tho omorgonco ol tho moJorn lirm at tho turn ol tho contury camo
a lroaJor rothink ol tho lusinoss systom. Writing in 1905, Charlos Conant,
a cololrity lankor-intolloctual, oxplicitly citoJ Varx (anJ anticipatoJ
Koynos) in omphasizing that tho prosonco ol monoy as a storo ol valuo,
tho possilility ol kooping voalth in linancial lorm rathor than sponJing it
promptly on commoJitios, alvays introJucos tho possilility ol crisis. ln
othor vorJs, tho possilility assortoJ ly Varx lut JonioJ ly classical oco-
nomics, tho possilility ol an oxcoss ol capital lacking a prolitallo invost-
mont outlot, anJ an oxcoss ol gooJs that coulJn`t lo solJ prolitally on tho
opon markot, haJ provoJ all too roal in practico. A systom lor rogulating
croJit vas ossontial - ono that vhilo oporating through tho stato voulJ
lo takon out ol politics: tho rogulation ol monoy anJ croJit voulJ lo
turnoJ ovor to oxports,` that is, croJitors, inJustrialists, anJ tochnocrats
vho thought liko thom.
Tho strugglo arounJ tho Jolinition ol monoy, Iivingston shovoJ, markoJ
tho omorgonco ol corporato anJ Wall Stroot ligvigs as a truo ruling class:
PLAYERS
95
onorgizoJ, conliJont, highly conscious ol its mission - capallo ol pro-
moting its caso to a lroaJor pullic using PP anJ lrionJly oxportiso, anJ to
Congross vith Jolt lollying. Univorsitios locamo rich sourcos ol oxpor-
tiso lor tho nov class, anJ thoy onJovoJ institutos anJ lounJations to act
as a markoting anJ Jistrilution mochanism lor tho nov iJoas.
Tho light lor sounJ monoy vas also consciously oxpansivo, ovon im-
porial: tho oconomic thoory ol tho Jay holJ that chronic ovorsupplios ol
capital anJ gooJs coulJ lo alloviatoJ ly conouoring loroign markots. ln-
Justrialists vith glolal amlitions vantoJ thoir lankors to lo intornational,
anJ vantoJ tho Jollar to lo lirm against tho British pounJ rathor than a
junk curroncy. Thoy vantoJ thoir papor accoptoJ in IonJon monoy mar-
kots in Jollars, not pounJs, anJ that roouiroJ a contral lank.
Tho panic ol 190, rathor than loing tho catalyst it`s somotimos pro-
sontoJ as, vas takon as tho oviJonco that valiJatoJ conclusions |tho cor-
porato-linancial ostallishmontl haJ alroaJy roachoJ` (Iivingston 1986, p.
12). Tho olito haJ loon agitating lor stornor monoy lor a JocaJo. Tho PP
campaign hoatoJ up, as JiJ tho political campaign: in 1908, Congross
lormoJ a monotary commission loJ ly tho lluo-chip Sonator Nolson
AlJrich, anJ tho noxt yoar, tho WuII I:~~I {u:uuI ran a 14-part oJitorial
on its lront pago (vritton ly Conant) arguing tho caso lor a contral lank.
This institution voulJ rogulato tho oll anJ llov ol capital,` anJ stalilizo
tho oconomy. Among tho olito thoro vas a groat loss ol laith in tho soll-
rogulating povors ol tho lroo markot: a contral lank vas just tho sort ol
oxport anJ Jispassionato intorvontion roouiroJ to lrako its lroouont ton-
Joncy tovarJs Jorailmont.
This history holps oxplain tho alsonco ol a linanco-inJustry split, mi-
nor lamily ouarrols oxcoptoJ, ovor contral lank policy in tho U.S. anJ
olsovhoro. Thoro vas romarkallo rogional anJ soctoral agroomont on tho
nooJ to rationalizo tho lanking systom, loth lor roasons ol stalilizing tho
oconomy anJ to promoto ovorsoas commorcial anJ imporial intorosts. This
history also holps oxplain populist thinking in tho U.S. toJay, vith a simi-
lar analysis olton sharoJ ly lolt anJ right, groons anJ lilortarians. Thoir
opposition to contral lanks, contralizing corporations, anJ glolal ontanglo-
monts in lavor ol a JocontoroJ, small-scalo systom rollocts tho historical
procossos ly vhich thoso moJorn institutions lormoJ oach othor. Thoy
typically lorgot tho volatilo, panic-riJJon history ol tho lato 19th contury
in thoir Jroams ol simplor timos.
lrom its lounJing, tho loJ has consistoJ ol tvolvo Jistrict lanks scat-
toroJ arounJ tho country - a concossion to tho JocontralizoJ traJitions
WALL STREET
96
ol Amorican linanco anJ politics - anJ a contral govorning loarJ in Wash-
ington. Tho Jistrict loJoral Posorvo lanks aro tochnically ovnoJ ly tho
privato lanks in thoir rogions, vhich chooso six ol oach Jistrict lank`s
nino Jiroctors. Ol tho Nov \ork Jistrict`s nino sorving in 1996, throo voro
lankors (lrom tho Bank ol Nov \ork, anJ smallish lanks on Iong lslanJ
anJ in Bullalo): tvo voro CEOs ol giant companios (AT8T anJ Plizor).
Tho lalanco: consorvativo Nov \ork City toachors` union loaJor, SanJra
lolJman:
31
privato invostor John WhitohoaJ, lormorly ol GolJman, Sachs
anJ tho Cartor calinot: invostmont lankor Poto Potorson ol Tho Blackstono
Group, lormorly ol tho Nixon aJministration, anJ svorn onomy ol Social
Socurity: anJ tho hoaJ ol a giant ponsion lunJ, Thomas Jonos ol TlAA-
CPEl. Pocont alumni incluJo tho CEO ol a largo insuranco company, a
small lusinoss-ovnor, anJ tho hoaJ ol an olito lounJation. Ol all thoso,
only tvo voro outsiJo tho Big BusinossBig linanco orlit - throo il you`ro
gonorous, anJ vant to count tho lounJation oxocutivo, lut lounJations
havo lig linancial holJings, anJ aro politically anJ socially intimato vith
tho corporato class. So vhilo tho loJoral Posorvo Systom is tochnically an
agoncy ol tho loJoral govornmont, an important part ol tho systom is Ji-
roctly ovnoJ anJ controlloJ ly privato intorosts.
Dospito tho original Jocontralizing intont ol tho Jistrict structuro, povor
ouickly gravitatoJ tovarJ tvo contors - Washington, vhoro tho loJ is
hoaJouartoroJ, anJ Nov \ork, tho sito ol tho most important ol tho ro-
gional lanks locauso ol its location just llocks lrom Wall Stroot. Day-to-
Jay monotary policy is carrioJ out, lasoJ on lroaJ instructions lrom
Washington, at tho Nov \ork loJ`s traJing Josk. Tho systom`s oxocutivo
loJy is a BoarJ ol Govornors, consisting ol sovon momlors nominatoJ ly
tho ProsiJont anJ conlirmoJ ly tho Sonato, vho sorvo lor a torm ol lour-
toon yoars. That long torm is supposoJ to insulato tho govornors lrom
political prossuros: in roality, it insulatos thom almost complotoly lrom
anything liko Jomocratic accountalility. lrom tho sovon loarJ momlors,
tho ProsiJont nominatos, suljoct to Sonato conlirmation, a chair anJ a vico
chair, vho sorvo lour-yoar torms. Tho loarJ has in practico loon protty
voll JominatoJ ly tho chair: altor loaving tho vico chairship in 1996, Alan
BlinJor complainoJ pullicly alout his Jilliculty in ovon gotting inlorma-
tion out ol tho stall oconomists. lrom tho chair Jovn to tho vico prosi-
Jonts anJ Jiroctors ol tho Jistrict lanks, tho loJ`s sonior stall is
ovorvholmingly malo, vhito anJ privilogoJ (Vlumo 1993).
Unliko orJinary govornmont agoncios, tho loJ is ontiroly soll-linanc-
ing: it nooJ novor go to Congross, hat in hanJ. Almost all its incomo comos
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lrom its portlolio ol noarly $400 lillion in U.S. Troasury socuritios. lt`s not
Jillicult to luilJ up a hugo piggy lank vhon you can luy lonJs vith
monoy you croato out ol thin air, as tho loJ Joos. ln lact, at tho onJ ol
ovory yoar, tho loJ roturns a prolit ol somo $20 lillion to tho Troasury -
altor JoJucting vhat it consiJors to lo roasonallo` oxponsos. Salarios aro
lar moro gonorous anJ vorking conJitions lar moro comlortallo, than in
moro munJano lranchos ol govornmont - anJ thoro`s not much that moro
civilians can Jo to challongo its Jolinition ol roasonallonoss.
Vonotary policy is sot ly a loJoral Opon Varkot Committoo (lOVC),
vhich consists ol tho sovon govornors plus livo ol tho Jistrict lank prosi-
Jonts, vho sorvo in rotation -livo ol tho tvolvo votos aro cast ly tho
hoaJs ol institutions ovnoJ ly commorcial lanks, a strango loaturo in a
nominally Jomocratic govornmont. lmagino tho outcry il almost hall tho
soats on tho National Ialor Polations BoarJ voro rosorvoJ lor unionists.
Tho lOVC moots in socrot ovory livo to oight vooks to sot tho tono ol
monotary policy - rostrictivo, accommoJativo or noutral, in loJ jargon.
Until vory rocontly, tho committoo JiJn`t announco policy Jocisions until
six to oight vooks altor thoy`J loon maJo. ln a Joparturo lrom almost
oighty yoars ol history, tho soouonco ol tightonings startoJ in lolruary
1994 voro announcoJ immoJiatoly, a lrank attompt to stoal somo ol tho
populist rolormors` thunJor. Until oarly 1995, thoso rolormors voro loJ ly
Toxas Poprosontativo Honry Gonzaloz, vho spont his lov yoars as chair ol
tho Houso Banking Committoo Joliciously torturing tho loJ in ovory vay
possillo. Tho throat ol sulpoonas lrom Gonzaloz causoJ a suJJon lout
ol rocovoroJ momory synJromo at tho loJ: lor 1 yoars, it haJ JonioJ that
it ovon took JotailoJ minutos at lOVC mootings: in lact, it haJ loon tap-
ing anJ transcriling thom all along. Tho Popullican takoovor ol Congross
in 1994, hovovor, onJoJ Gonzaloz` roign ol torror.
Still, Jospito this vhill ol Iu:u:I, tho loJ romains an intonsoly socro-
tivo institution. This opaouonoss has spavnoJ an ontiro loJ-vatching in-
Justry, a traJo rominiscont ol Kromlinology, in vhich ovory institutional
tvitch is scrutinizoJ lor cluos to policy changos. loJ vatchors oarn` sala-
rios voll into tho six liguros lor such vork: groator oponnoss at tho loJ
voulJ roJuco thoir importanco, il not put thom out ol lusinoss, a raro
lorm ol unomploymont that voulJ lo ontiroly volcomo. Tho loJ also
manipulatos tho moJia ally: roportors, oagor lor a loak lrom a contral lank
insiJor, vill print anything vhisporoJ in thoir oars, vhothor or not it`s truo
- loaks somotimos JosignoJ to misloaJ or onlighton tho markots, anJ
othor timos tho proJuct ol somo intornal strugglo.
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Evon though lOVC momlors voulJ no Joult invont all sorts ol clovor
ouphomisms to oxpross tho Jangors ol oxcossivoly lov unomploymont,
tolovising tho lOVC`s procooJings on C-SPAN voulJ still proviJo an on-
lightoning glimpso into tho montality ol povor.
Sinco this soction is alout tho stato, somo vorJs alout Wall Stroot`s poli-
tics. As Jo most plutocrats, linanciors tako thoir ovn, usually cruJo,
thoughts ouito soriously, anJ aro also rich onough to pay lots ol othor
pooplo to think lor thom. Thoir opinions rango lrom ostallishmont liloral
(ospocially on social issuos) to ravingly right ving: tho rightvingors, all
lans ol Iu:::~z-Ju::~, can lo sulJiviJoJ into thoso vhoso lilortarianism
oxtonJs to social toloranco, anJ thoso vho aro lulminant ligots. (Not all
tho ligots aro on tho right. AccorJing to somoono vho usoJ to vork lor
ono ol Wall Stroot`s moro prominont liloral` Domocrats, ho vas ouito tho
racist in privato.) Prolally 95/ ol Wall Stroot - anJ that incluJos similar
outposts in Chicago anJ Calilornia - voulJ agroo vith tho mantra, mar-
kots gooJ, govornmont laJ` - ovon thoso vho traJo govornmont lonJs
lor a living. Dospito thoir roputation lor sophistication, most Wall Strootors
holJ to a rav, sollish viov ol tho vorlJ.
linanco, loth U.S. anJ intornational, is hoavily roprosontoJ on tho
loarJs ol Washington thinktanks, lrom hotloJs ol contrism liko tho
Brookings lnstitution to right-ving outposts liko Cato anJ Horitago. Buyout
artist ToJ lorstman, a man laroly capallo ol articulating ovon his ovn
primitivo lilortarian philosophy vhon not supportoJ ly a script, is a ma-
jor supportor ol tho right-ving .u~::cuu j~cIuI: linanciors aro ouito
hoavy political givors. llPE`s political action committoos (PACs) invostoJ
lar moro.Jollars in tho `94 campaign than any othor group ol lusinoss
intorosts,` vith tho socuritios inJustry tilting hoavily tovarJs tho Domo-
crats, ovon in that Popullican yoar (GolJstoin 1995). Whilo it may lo soon
as a sign ol onlightonmont that Wall Stroot contains moro Domocrats than
Jo most othor lusinoss soctors, in lact linanco is a hoavily consorvatizing
inlluonco on tho supposoJ party ol tho pooplo. Voro rocontly, hoJgo lunJ
hotshots omorgoJ as major supportors ol tho 1994 Novt Gingrich Popul-
lican countorrovolution. AnJ again in 1996, roports tho Contor lor Pospon-
sivo Politics, tho llPE soctor vas tho hoaviost political givor ol all.
Evon though thoir vorlJviov olton sooms lormoJ ly nothing Joopor
than tho onJloss play ol hoaJlinos that scroll ly on thoir computor scroons,
Wall Stroot analysts anJ oconomists aro lavoroJ sourcos lor roportors to
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turn to vhon thoy nooJ a ouoto. lor a somovhat moro scholarly tako,
roportors call oxports at tho thinktanks Wall Stroot supports. AnJ so Joos
monoy oxpross itsoll iJoologically.
information: "refleively fellative"
No survoy ol tho cast ol charactors voulJ lo comploto vithout a look at
tho various linancial moJia. PunJits anJ oconomists aro lonJ ol pointing
out that tho markots aro alout inlormation,` a chic anJ spongy vorJ that
olton sorvos as an unoxaminoJ ouphomism lor monoy anJ povor, anJ
not just in linanco.
32
But just locauso punJits anJ oconomists say somo-
thing ropoatoJly Joosn`t moan that it isn`t at loast partly truo. Thoro aro,
hovovor, many Jilloront kinJs ol inlormation.
Vost procious ol all is insiJo inlormation, vhich comos in many lorms.
Tho most lamous kinJ is novs alout somo Jramatic lusinoss Jovolop-
mont, liko an unoxpoctoJ Jrop in prolits, or a takoovor attompt, or an
imminont inJictmont. Olviously, vhoovor knovs this loloro tho pullic
can mako lig monoy vhon tho novs hits tho Stroot. But that`s not tho only
kinJ ol insiJo inlo that can lo turnoJ into roaJy monoy. Novs that a lro-
kors` rosoarch Jopartmont is alout to rocommonJ lntol, or that a cliont is
alout to placo an orJor lor a million sharos ol lBV, can lo valuallo to tho
lirm`s traJing Josk, vhich can tako a position ahoaJ ol tho ovont anJ
prolit lrom tho onsuing prico thrust as tho novs sproaJs. Tho traJing Josk
is supposoJ to lo insulatoJ lrom tho rost ol tho lirm through a so-calloJ
Chinoso vall,` lut thoso valls aron`t alvays poroloss. As a votoran linan-
cial journalist tolJ mo in tho miJst ol all tho insiJor scanJals ol tho lato
1980s, pooplo havo loon coming to Wall Stroot lor gonorations to mako
monoy oll insiJo inlo: Boosky 8 Co. just got too piggy lor thoir ovn gooJ.
Or as a cololrity traJor onco put it, Whoovor Joosn`t knov somothing
ovoryono olso Joosn`t knov is a lucking chump.`
Wall Stroot is avash in loss soxy lorms ol inlormation, too, ranging lrom
gossip that traJors pass along to oach othor on tho phono, to sorious-
sooming linancial anJ oconomic analysis pullishoJ ly lrokorago lirms
anJ rosoarch loutiouos, to tho Jaily novs that appoars in tho papors anJ
on tho viros. Tho linancial viro sorvicos - Poutors, Dov Jonos, Bloomlorg
- havo computor torminals scattoroJ all ovor tho linancial vorlJ, pouring
livo novs into tho oyos ol oasily JistractoJ playors, anJ olloring a rango ol
markot pricos, historical inlormation, anJ analysis as voll.
Ono shoulJn`t ovorostimato tho ouality ol a lot ol that novs proJuct.
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Whilo tho novs pagos ol tho WuII I:~~I {u:uuI contain somo ol tho lost
Jaily journalism in Amorica, tho markot novs in that anJ othor major pa-
pors is olton ouito suporlicial, an uncritical ropackaging ol tho llathor com-
ing out ol tho lig lrokorago housos. Tho rosoarch proJucoJ ly thoso
lrokors is typically littlo moro than an aJjunct to tho salos ollort. Analysts
raroly say anything unkinJ alout companios thoy covor: lirms Jon`t vant
to alionato potontial invostmont lanking clionts, anJ tho analysts Jon`t
vant to alionato thoir sourcos in managomont, lor loar thoy`ll stop taking
thoir phono calls.
33
As a rosult, you almost novor soo a soll` rocommonJa-
tion: tho nastiost thing most analysts vill say alout a stock is to call it a
holJ` rathor than a luy.`
Tho most lamous oxamplo ol tho prossuros at vork vas vhon Varvin
Pollman, a gamlling analyst thon in tho omploy ol Jannoy Vontgomory
Scott, JaroJ toll tho WuII I:~~I {u:uuI in 1990 that DonalJ Trump`s lright-
oning Taj Vahal casino in Atlantic City vas a Jolt-hoavy houso ol carJs
that von`t mako it.` Trump throatonoJ to suo Jannoy, anJ tho lirm ouickly
liroJ Pollman (vho turnoJ out, as ol 1996, to lo vrong, alas).
That`s an oxtromo caso. Tho moro normal prossuros voro JoscriloJ ly
John Koolo, lormorly a lanking analyst vith Droxol Burnham Iamlort
vho nov runs his ovn rosoarch shop in Nov \ork. AccorJing to Koolo,
sinco tho sorvicos lrokors ollor to clionts aro protty unJillorontiatoJ, it`s
harJ lor a lirm, loyonJ a lasic lovol ol compotonco, to stanJ out at ox-
ocuting luy anJ soll orJors. So, tho rosoarch a lirm ollors clionts is vhat`s
supposoJ to Jistinguish it lrom its rivals.
But, in lact,` Koolo notos, analysts sponJ most ol thoir timo solling`
thoir iJoas to thoir clionts, anJ vory littlo ol thoir timo rosoarching.` Whon
ho vas at Droxol, Koolo saiJ ho vas oxpoctoJ to pay tvo or throo por-
sonal visits a yoar to major clionts, anJ ono a yoar to lossor clionts. AsiJo
lrom tho porsonal sit-Jovns, analysts aro oxpoctoJ to mako a loast 100
phono calls a month to clionts, vith somo ol tho moro olsossivo (anJ
succosslul)` onos making as many as 300 calls a month - or 15 a vork
Jay. Olviously, thoro isn`t much timo lolt ovor altor tho clionts aro sor-
vicoJ to Jo sorious corporato anJ inJustry rosoarch.
Ono thing analysts raroly Jo is soconJ-guoss tho numlors that lirms
roport to thoir sharoholJors, vhich aro cortilioJ ly outsiJo auJitors, typi-
cally a lranJ-namo glolal accounting lirm. Accountancy may havo a ropu-
tation lor Jullnoss, lut it can lo tho scono ol groat croativity. Accountants
aro notoriously oagor to say kinJ things alout tho companios thoy auJit:
altor all, tho suljoct ol tho auJit pays tho loos. Notorious lankrupts ol tho
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1980s, lrom Droxol Burnham Iamlort to BCCl to sovoral hunJroJ
S8Is, voro ropoatoJly givon cloan lills ol hoalth ly prominont account-
ing lirms - tho vory outsiJo auJitors vho aro supposoJ to proviJo an
oxtornal chock on a lirm`s numorical soll-roprosontation. Voro poJostrian
companios aro translormoJ through croativo arithmotic anJ logal intor-
protations into Jazzling grovors.
Sluttish accountancy is a long-stanJing practico. During tho 1960s, John
Brooks (193, pp. 160-162) roportoJ, accountants paintoJ a gloving pic-
turo in numlors that morgor promotors vantoJ. lnvostors, many ol thom
nals, oagorly lought papor that only a lov yoars lator voulJ turn out to
lo noar vorthloss. By lolloving consorvativo practicos anJ thoir con-
scioncos, accountants coulJ havo provontoJ this jiggory-pokory: thoy JiJ
not.` \ou coulJ say oxactly tho samo thing alout tho linancial Jisastors ol
tho last 15 yoars. HaJ Wall Stroot analysts, vho aro prosumally compotont
to Jo so, givon tho accountants` numlors a sorious soconJ look, much
rocont jiggory-pokory might havo loon JotoctoJ.
34
Evon oconomic analysis must sorvo tho salos ollort. Ono oconomist
vho`J loon making accuratoly lullish lorocasts alout U.S. oconomic
grovth in 1993 anJ 1994, vhon tho rost ol Wall Stroot vas unanimous in
projocting sluggishnoss, vas calloJ in ly his suporiors anJ tolJ to rothink
his lorocasts. (Strong oconomic grovth is usually laJ lor lonJs, anJ tho
lirm haJ lots ol lonJs to soll.) Tho oconomist JiJ as tolJ, anJ markoJ
Jovn his lorocasts. Wall Stroot`s lavorito oconomist, EJ Hyman, vinnor ol
tho 1u:I:IuI:uuI 1u:~:I: poll lor a Jozon yoars running, vas ono ol thoso
(vrongly) proJicting sluggishnoss in 1993 anJ 1994: ly coinciJonco, his
lirm not only solls lonJs, lut ho also managos a largo lonJ portlolio.
As Koolo saiJ, il tho markots aro tho casino that Koynos lamously saiJ
thoy voro, thon tho analysts aro liko loungo singors. Altor all, tho casinos
all ollor tho samo gamos anJ tho samo oJJs: tho only Jilloronco among
thom is tho ontortainmont anJ Jocor. Whilo thoro aro many analysts vho
tako thoir vork ouito soriously,` Koolo concluJoJ, many timos tho com-
potition among thom Jogonoratos into a contost to soo vho can got tho
most attontion vith tho most Jaring lorocast.` Othor timos, hovovor, loss
llamloyant analysts simply tuno thoir lorocasts to tho consonsus, so as not
to stanJ out, anJ thoroly avoiJ potontial omlarrassmont. ln oithor caso,
llamloyant or shrinking, tho lorocast is Jrivon ly tho consonsus rathor
than tho lacts ol tho caso.
Thoso analysts anJ oconomists proviJo tho rav matorial lor linancial
roportors. Horo`s a viov ol hov that traJo is plioJ, lrom a long-timo prac-
WALL STREET
102
titionor, John Iiscio, a lormor 1u::u: columnist vho nov pullishos his
ovn high-pricoJ novslottor:
linancial vritors aro nothing moro than glorilioJ rocorJing socrotarios.
Unliko thoir colloaguos in othor liolJs liko thoatro, cinoma, looJ, sports,
politics, anJ lashion, linancial vritors anJ ovon columnists roluso to think
lor thomsolvos. Bocauso thoy chorish accoss to highly-placoJ sourcos, thoy
sorvo as nothing moro than conJuits lor tho rocoivoJ visJom, vhich is
almost alvays vrong.. Whatovor tho moron oconomists anJ analysts toll
tho linancial pross gots smoaroJ across tho pago. Thoro`s no liltor.
lmagino hov riJiculous it voulJ lo il a sports vritor, assignoJ to a poron-
nial also-ran, porsistoJ in printing tho alsurJly optimistic rantings ol tho
managors, ovnor, anJ aging pitching stall, anJ littlo or nothing olso. Or il a
looJ critic`s roviov ol a rostaurant vas luilt arounJ tho opinion ol tho mas-
tor chol anJ matro J`. Asking a Wall Stroot hack his opinion on tho oconomy
is liko asking a proJucor hov ho lools alout a play ho just mountoJ, or a
runvay moJol vhat sho thinks alout tho nov lino. \ot that`s oxactly hov
tho linancial pross plays it: rolloxivoly lollativo.
Historically, tho linancial pross has sorvoJ a Jooply iJoological rolo. As
Wayno Parsons (1990) shovoJ, tho Jissomination ol prico anJ proJuct
inlormation vas crucial to tho Jovolopmont ol national markots in Britain
anJ Amorica lrom tho 1th through tho 19th contury. Iiko toJay, somo ol
that inlormation vas gooJ, lut somo ol it vas littlo moro than shilling lor
tho touts ol tho Jay: tho South Soa Bulllo, lor oxamplo, prolally novor
voulJ havo inllatoJ vithout tho holp ol tho IonJon pross.
But moro than pricos voro circulatoJ - so voro iJoas. TI~ Ecuu::I,
unJor oJitor Waltor Bagohot, vas crucial to tho sproaJ ol tho lroo-traJo
anJ Iu:::~z-Ju::~ roligion through tho British olito. As Bagohot saiJ, TI~
Ecuu::I, tho magazino that mystoriously calls itsoll a novspapor, vas a
groat loliol proJucor` lor tho nov lourgooisio. As Parsons (1990, p. 41)
put it, tho historical importanco ol tho linancial pross Joos not lio so much
in its contrilution to tho Jovolopmont ol a litorary lorm as in its rolo in
Jolining a capitalist languago anJ culturo: lroo markots, inJiviJualism, prolit
anJ spoculation. Not only JiJ tho pullication ol inlormation lacilitato tho
grovth ol tho intornationalization ol markots, it also assistoJ in no small
vay in tho promotion ol capitalist culturo` (Parsons 1990, pp. 2, 41).
That culturo haJ a vory narrov concoption ol oconomic novs: it vas
that vhich impactoJ on tho stato ol tho markot anJ City opinion. Tho
oconomic conJition ol tho pooplo.vas not somothing vhich.groatly
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prooccupioJ tho attontion ol linancial journalists anJ novspapor oJitors`
(Parsons 1990, p. 31).
Parsons vas spoaking ol tho 19th contury, lut much tho samo can lo
saiJ toJay, vith callo TV channols running tho stock tickor all Jay, tho
1:uuuc:uI T:u~: anJ WuII I:~~I {u:uuI pullishing oJitions on oach othor`s
homo turl, anJ TI~ Ecuu::I tolling yuppios anJ sonior luroaucrats
arounJ tho vorlJ vhat to think, vith a hoavy Joso ol British attituJo that
insocuro Amoricans linJ intoxicating. Economic novs is largoly conlinoJ
to tho lusinoss` soction, vith all tho liasos that implios: nooJloss to say,
no Jaily papor has a lalor` soction.
lurthor, Parsons arguos, tho translormation ol oconomics into a largoly
olscuro lranch ol mathomatics anJ tho rotroat ol oconomists into tho acaJ-
omy havo lolt a groat vacuum in tho Jissomination ol oconomic iJoas, a
vacuum that has loon lilloJ ly tho lusinoss pross. Tho convorsion ol TI~
Ecuu::I lrom a Koynosian shoot to an anti-Koynosian ono Juring tho
190s vas ol groat importanco in tho ropuJiation ol tho postvar Koynosian
consonsus.
Supply-siJo oconomics, a luJicrous lut onriching Joctrino that locamo
national policy in tho U.S. in tho oarly Poagan yoars, vas JovolopoJ in
largo part on tho oJitorial pago ol tho WuII I:~~I {u:uuI ly JuJo Wanniski
anJ Polort Bartloy. Wanniski lolt tho papor to locomo an oconomic con-
sultant (lamous lor his lorviJ scrooJs promoting a roturn to tho golJ stan-
JarJ), lut Bartloy anJ his minions still push tho oarly Poagan yoars as an
oconomic moJol lor all timo, vith ovor-incroasing JisrogarJ lor lact, roa-
son, anJ opposing viovs. Vany {u:uuI roportors aro omlarrassoJ ly
Bartloyism, lut tho chair ol Dov Jonos, Potor Kann, anJ his vilo, Karon
Elliott Houso, a liro-lroathing vico prosiJont ol tho company, aJoro it.
Kann is saiJ to havo JonouncoJ Jamos Stovart, tho papor`s pago ono oJi-
tor in tho lato 1980s, lor loing too liloral.` Tho liloral` Stovart vont on
to vin tho Pulitzor prizo lor his look on Droxol anJ tho insiJor scanJals ol
tho 1980s (Stovart 1991), anJ lrom thoro vont on to locomo a lig chooso
at uu:I Mu~), a joint vonturo lotvoon Dov Jonos anJ Hoarst. At uu:I
Mu~), a slick anJ ompty porsonal linanco magazino, Stovart ovorcamo
his ignoranco ol tho stock markot anJ vroto storios naming tho ton stocks
you Iu:~ to ovn - namos supplioJ ly a monoy managor, Jamos Cramor,
vho just happonoJ to ovn many ol tho stocks ho rocommonJoJ to Stovart.
Ono might think that tho scaJs ol inJoponJont novslottors, vith sul-
scription pricos ranging lrom sovoral hunJroJ to thousanJs ol Jollars a
yoar, might lo a lottor sourco ol invostmont analysis, lut thoy raroly aro.
WALL STREET
104
Tho long-torm porlormanco ol popular novslottors is littlo Jilloront lrom
a guoss, lut ovon tho high-onJ onos aro not too improssivo oithor.
Tho consulting sorvico Johnson Smick, vhich chargos up to $100,000
lor sulscriptions to its tout shoots, is a caso in point. Tho Johnson is Vanuol
Johnson, lormor vico chair ol tho loJoral Posorvo. Whon Johnson vas at
tho contral lank, tho lirm, thon Smick VoJloy, shovoJ an uncanny alility
to lorocast loJ policy changos: vhon Johnson lolt tho loJ, tho lirm lo-
camo Johnson Smick VoJloy - anJ thoir proscionco alout loJ policy
soomoJ to loso somo ol its oJgo. ln 1994, tho lirm roportoJ to its clionts
that tho Whitovator scanJal vas alout to tako a spoctacular turn that voulJ
lo vory Jamaging to ProsiJont Clinton: tho stock anJ lonJ markots
svoonoJ on tho roport, vhich turnoJ out to lo complotoly untruo (Kurtz
1994: lromson 1994). So vhy voulJ pooplo pay $100,000 a yoar lor such
laJ journalism? Bocauso it movos tho markots vhon it sproaJs loyonJ
tho circlo ol sulscrilors: il you hoar it lirst, you can mako monoy on it,
vhothor it`s truo or not. This is aJmittoJly an oxtromo oxamplo, anJ a
novslottor that ropoatoJly vas vory vrong voulJ stop moving markots,
lut vhilo a sorvico is hot - anJ somotimos lor long altor - pooplo vill
pay lig to lool tho lirst varmth.
Iovor-graJo tout shoots olton Jisguiso thoir poor porlormanco ly ma-
nipulating history. AccorJing to Iiscio, vho roaJs tons ol tho stull, ono ol
tho most amlitious rovritors is Jamos Dalo DaviJson, vho mixos right-
ving politics vith linancial aJvico in his I:uI~:c 1u:~:I:u novslottor.
BaJ picks - anJ thoro`s no shortago ol thoso - simply Jisappoar lrom
tho rocommonJoJ portlolio lrom ono issuo to tho noxt. Passionatoly anti-
Clinton, DaviJson has rocommonJoJ shorting stocks ol Arkansas-lasoJ
companios simply locauso ol somo imaginoJ connoction to tho prosiJont.
At tho timo ol his Joath, lormor ClA Jiroctor William Colly vas vriting lor
a DaviJson 1 spinoll, promoting talos ol Clintonian criminality: tho con-
spiracy viros hoatoJ up altor Colly mot his onJ in tho Chosapoako.
styles of play
This isn`t a manual ol invostmont tochniouo, though it voulJ prolally
soll a lot moro copios il it voro. But a lov vorJs on hov pooplo sling
arounJ thoir cash voulJn`t lo oxcossivo panJoring to commorco. Pooplo
vho traJo linancial assots can lo JiviJoJ into sovoral catogorios. Ono com-
mon Jistinction is lotvoon traJors anJ invostors, that is, lotvoon pooplo
vho tako a position vith an oyo to gotting out ol it in a timo moasuroJ in
PLAYERS
105
units somovhoro lotvoon soconJs anJ vooks, as opposoJ to thoso vho
intonJ to holJ it lor months or ovon, on occasion, yoars.
Anothor Jistinction is lotvoon lunJamontal anJ tochnical traJors.
Though Jotails vary ly markot, pooplo vho traJo on lunJamontals look
at tho roalitios unJorlying prico movomonts - lroaJ oconomic Jovolop-
monts, govornmont policios, Jomography, corporato stratogios. A lunJa-
montal analyst in tho stock markot, lor oxamplo, might oxamino a
company`s linancos in Jopth, or talk to managors, customors, anJ rivals.
Tochnical traJors coulJn`t caro loss alout such ophomora - all thoy caro
alout is tho movomont ol socurity pricos, vhich thoy traco to unJorlying
supply anJ JomanJ pattorns in tho markots thomsolvos.
To a tochnical stock traJor, it Joosn`t mattor vhothor a lirm makos po-
tato chips or momory chips. Somo tochnical analysts Jo lairly rigorous
statistical vork, tracking changos in traJing volumo or prico momontum,
looking lor possillo cluos ol imminont tronJ rovorsal. Othors, littlo lottor
than haruspicos, try to Jivino pattorns in prico graphs that supposoJly
portonJ Jramatic upvarJ or JovnvarJ movos. Such chartists` spoak
onthusiastically ol ponnants, rising voJgos, hoaJ anJ shoulJors, saucor
lottoms. Thoro is littlo oviJonco that chart-roaJing vorks at all: tho pat-
torns soon aro prolally littlo Jilloront lrom tho luttorllios anJ gonitalia
that ono soos in a Porschach tost. Tho oconomist Burton Valkiol, author ol
tho popular invostmont toxt . Ruuuu WuI 1uu WuII I:~~I, haJ his
stuJonts construct mythical stock prico charts ly llipping coins. Whon
Valkiol shovoJ thoso to practicing chartists, thoy JiscovoroJ thoir lavor-
ito pattorns lurking in tho ranJom souigglos (Valkiol 1990, pp. 135-136).
Vost markot participants uso somo comlination ol tochnical anJ lun-
Jamontal analysis, lut that Joosn`t moan thoir porlormanco is torrilly suc-
cosslul. AccorJing to Norm ZaJoh, vho ratos tho porlormanco ol monoy
managors, only alout 1-2/ ol all monoy-slingors havo a consistont anJ
sulstantial rocorJ ol gooJ porlormanco. Vost Jo a littlo loss voll than tho
markot avoragos, vhich isn`t surprising, sinco thoy u:~ tho markot, anJ
locauso loos anJ commissions shavo a lit oll thoir roturns. Truly out-
stanJing porlormancos - tho 1,239/ roturns you soo trumpotoJ in aJs -
aro almost alvays llukos.
What`s tho socrot ol consistont vinnors, tho housoholJ namos (at loast
in allluont housoholJs)? AccorJing to ZaJoh, it olton involvos markot
manipulation, lrilory to got insiJo inlormation, anJ clovor uso ol tho pross:
thoy viov invosting as var,` anJ in var, all is lair. lnvostors vith Joop
pockots can movo markots simply ly moving lots ol monoy arounJ: strong
WALL STREET
106
movomonts in ono Jiroction or anothor vill attract attontion lrom tho
lroaJor pullic, moving pricos in a lavorallo Jiroction. Star invostors -
namos aro omittoJ to avoiJ lavsuits - vill olton lot it Jrop that thoy think
tho yon is ovorvaluoJ, or that thoy`vo just lought golJ: vhon tho massos
act on this inlormation, tho position, vhatovor its initial visJom, locomos
a vinnor. No unknoving chumps horo.
capital unbound
So lar, this roviov has concontratoJ on tho U.S. Whilo this simplilios things,
it`s harJly a lair roprosontation ol hov vo invost toJay. Capital anJ com-
moJitios travorso tho glolo vith romarkallo lrooJom. Though casual ol-
sorvors troat this lorJorloss vorlJ as a rocont invontion, it`s moro than a
littlo rominiscont ol lilo loloro WorlJ War l. That iJyllic vorlJ vas nicoly
ovokoJ ly John VaynarJ Koynos (1988, pp. 11-12), no Joult ono ol thoso
onco-charmoJ IonJonors ho vroto alout:
Tho inhalitant ol IonJon coulJ orJor ly tolophono, sipping his morning
toa in loJ, tho various proJucts ol tho vholo oarth, in such ouantity as ho
might soo lit, anJ roasonally oxpoct thoir oarly Jolivory upon his Joorstop:
ho coulJ at tho samo momont anJ ly tho samo moans aJvonturo his voalth
in tho natural rosourcos anJ nov ontorprisos ol any ouartor ol tho vorlJ,
anJ sharo, vithout oxortion or ovon troullo, in thoir prospoctivo lruits anJ
aJvantagos: or ho coulJ JociJo to couplo tho socurity ol his lortunos vith
tho gooJ laith ol tho tovnspooplo ol any sulstantial municipality in any
continont that lancy or inlormation might rocommonJ. Ho coulJ socuro
lorthvith, il ho vishoJ it, choap anJ comlortallo moans ol transit to any
country or climato vithout passport or othor lormality, coulJ Jospatch his
sorvant to tho noighloring ollico ol a lank lor such supply ol tho procious
motals as might soom convoniont, anJ coulJ thon procooJ alroaJ to lor-
oign ouartors, vithout knovloJgo ol thoir roligion, languago, or customs,
loaring coinoJ voalth upon his porson, anJ voulJ consiJor himsoll groatly
aggriovoJ anJ much surpisoJ at tho loast intorloronco. But, most important
ol all, ho rogarJoJ this stato ol allairs as normal, cortain, anJ pormanont,
oxcopt in tho Jiroction ol improvomont, anJ any Joviation lrom it as alor-
rant, scanJalous, anJ avoiJallo. Tho projocts anJ politics ol militarism anJ
imporialism, ol racial anJ cultural rivalrios, ol monopolios, rostrictions, anJ
oxclusion, vhich voro to play tho sorpont to this paraJiso, voro litlo moro
than tho amusomonts ol his Jaily novspapor, anJ appoaroJ to oxorciso al-
PLAYERS
107
most no inlluonco at all on tho orJinary courso ol social anJ oconomic lilo,
tho intornationalization ol vhich vas noarly comploto in practico.
This attituJo ol ontitlomont anJ pormanonco ooually charactorizos capital`s
sonso ol itsoll toJay. AsiJo lrom tho occasional traJo skirmish, olton
vhippoJ up ly politicians oagor to oxcito Jomostic auJioncos, lurthor glo-
lal oconomic intogration, ol vhich lroo capital llovs aro tho avant garJo,
is thought to lo inovitallo. Wo`ll soo il it is.
Tho vorlJ Koynos JoscriloJ lirst camo apart Juring WorlJ War l, though
tho glolal ovorprivilogoJ JiJ thoir lost to put it lack togothor again in tho
1920s. Whilo Europoan oconomios harJly thrivoJ in tho 1920s - British
unomploymont vas alovo 10/ lor almost tho ontiro JocaJo, anJ Gor-
many spont tho Poaring Tvontios in crisis - it still soomoJ as il parts ol
tho provar orJor haJ loon rostoroJ, anJ tho U.S. spont most ol tho Jo-
caJo in a loom that markoJ tho loginning ol moJorn consumor capital-
ism. Capital logan lloving across lorJors again, anJ lolJ Jolts voro
contractoJ. But tho olJ orJor linally loll apart lor gooJ vith tho 1929 crash.
Hov laJly that vorlJ camo unstuck in tho Doprossion can lo soon in
tho oxporionco ol sovoroign Jolault` - countrios that vont lust. Ol 58
countrios that issuoJ intornational lonJs in tho 1920s, 25 JolaultoJ lo-
tvoon 1929 anJ 1935. ln Jollar torms, 0/ ol all loroign Jolt issuoJ in tho
U.S. lotvoon 1926 anJ 1929 (oxcluJing CanaJa) vont laJ - comparoJ
vith a Jolault rato ol only` 30/ on corporato Jolt issuoJ in tho lato 1920s.
Vost ol tho sovoroign Jolaultors, ly tho vay, haJ gooJ ratings lrom
VooJy`s (Cantor anJ Packor 1995).
But nov thoso Jolaults aro a Jistant momory, anJ toJay`s capital mar-
kots look soamloss. Statistics conlirm tho Jocroasing importanco ol lor-
Jors lor tho linancial markots.
35
ln tho 190s, tho corrolation coolliciont
lotvoon intorost ratos on 10-yoar U.S. govornmont lonJs anJ Gorman
lonJs ol similar maturity vas 0.191, lut lrom 1990 to 1994, it vas 0.934:
Japan anJ tho U.S., 0.182 anJ 0.965, rospoctivoly: anJ tho U.S. anJ tho
U.K., 0.590 anJ 0.949 (Bank ol EnglanJ Jata, roportoJ in GolJstoin ot al.
1994, p. 5).
36
Whilo it voulJ lo an oxaggoration to say that thoro`s nov a
singlo glolal croJit markot, vo`ro Jolinitoly moving in that Jiroction.
Though all this sooms as natural as tho sunriso, this incarnation ol
glolalism isn`t all that olJ. Vost countrios imposoJ oxtonsivo capital con-
trols voll into tho 190s. Evon nov, tho lVl Articlos ol Agroomont (Articlo
Vl, Soction 3) allov momlors to oxorciso such controls as aro nocossary
to rogulato intornational capital movomonts,` as long as thoy Jon`t unJuly
WALL STREET
108
intorloro vith routino paymonts that go vith traJo. Though ollicial opin-
ion ol tho 1950s urgoJ a liloral rogimo, lalanco ol paymonts imlalancos
in tho 1960s loJ to a tightoning ol controls, vith tho U.S. trying to rostrict
capital outllovs anJ sovoral surplus countrios trying to limit inllovs.
As Philip Turnor (1991), an oconomist vith tho Bank lor lntornational
Sottlomonts, notoJ, capital llovs havo tonJoJ to oxaggorato imlalancos in
traJo. Cross-lorJor movomonts ol privato capital voro Jrivon to an im-
portant oxtont ly oxpoctations ol oxchango rato roalignmonts,` thomsolvos
Jrivon largoly ly curront-account consiJorations. Dolicit countrios, thon,
typically lacoJ outllovs, as capital trioJ to loat a coming Jovaluation:
surplus countrios lacoJ inllovs, as invostors hopoJ to lonolit lrom tho
likoly rovaluation. With tho aJvont ol lloating oxchango ratos in 193, thoso
tonJoncios voro only roinlorcoJ.
Vargarot Thatchor`s prompt romoval ol oxchango controls upon hor
asconsion in 199 sot tho tono lor tho 1980s. Ton yoars lator, nono ol tho
major anJ lov ol tho minor rich inJustrial countrios signilicantly rostrictoJ
tho right ol thoir citizons to holJ loroign proporty.
As Turnor notoJ, things voro vory Jilloront tho last timo capital roamoJ
tho glolo so lrooly. Ono Jilloronco is ovokoJ ly Koynos` momoir - coinoJ
voalth.` Contrary to tho myths
prolloroJ ly moJorn golJlugs,
curront-account imlalancos (anJ
tho consoouont capital llovs) ol
tho pro-1914 golJ stanJarJ -
vith storling sorving as a gooJ-
as-golJ sulstituto - voro loth
largo anJ porsistont. lrom 1880 to
1914, Britain`s curront account
surplus vas 4
1
2/ ol GNP, vhich
yiolJoJ a not loroign invostmont
position ol 130-140/ ol GNP in
1914. Poturns on loroign invost-
mont voro 5/, tvico tho roturn availallo lrom U.K. govornmont lonJs.
By contrast, Japan`s surplus ol 19/ ol GDP looks moJost (soo chart) com-
paroJ to Britain at its poak, anJ 5/ roturns aro rogarJoJ as minimal toJay.
Sinco almost all thoso llovs voro JonominatoJ in golJ, thoro vas no
curroncy risk - unloss somo country vas lolJ onough to tako tho vickoJ
stop ol ronouncing golJ. Ol courso, tho llip siJo ol curroncy risk - tho
opportunity to spoculato in curroncios thomsolvos (moro than in tho un-
net foreign assets, percent of GDP
source. Bank o! ng|and (!994), F
!5' !0' 5' +0' +5' +!0'+!5'+20'
U.S.
France
U.K.
Cernanv
(!995
Japan
!93!
!996
PLAYERS
109
Jorlying assots JonominatoJ in thoso curroncios), vhich locamo ono ol
tho primo movors lohinJ glolal capital llovs in tho 1980s - vas roJucoJ.
What inspiroJ capital to movo alout thon vas intorost rato Jillorontials.
AsiJo lrom golJ, Turnor notoJ tvo othor loaturos ol tho pro-1914 po-
rioJ, a limitoJ rango ol vohiclos anJ tho prominonco ol long-torm invost-
monts in roal assots. Bocauso ol tho stalility ol tho golJ-storling systom,
thoro vas no nooJ lor toJay`s hoJging instrumonts liko options, svaps,
anJ luturos - anJ it`s harJ to imagino a Joop markot in such alchomy in
a computorloss ago. Thoro voro stocks, lonJs, Jiroct invostmonts - many
ol thoso ouphomisms lor imporial claims - anJ not much olso.
Voro stunning to tho moJorn olsorvor is hov much ol lorJor-crossing
capital took tho lorm ol proJuctivo invostmont, oithor through tho Jiroct
Europoan ovnorship ol railroaJs in tho colonios or through holJings ol
railroaJ lonJs. This haJ, as Turnor (1991, pp. 13-20) pointoJ out, tvo
oconomically lortunato soouolao (loaving asiJo tho social ouostions ol
colonial Jovolopmont`). lirst, roal assots voro croatoJ, assots that coulJ
sorvico thoir Jolts. AnJ soconJ, tho inllov typically lounJ its vay lack to
capital oxporting countrios in tho lorm ol JomanJ lor capital oouipmont.
Unliko tho 19th contury, tho lroo capital llovs in tho 1980s largoly ly-
passoJ tho so-calloJ ThirJ WorlJ, stanJing tho logic ol convontional oco-
nomics on its hoaJ. Ono voulJ think that potontial prolit ratos voulJ lo
highor in vhat aro optimistically calloJ Jovoloping countrios,` lut asiJo
lrom a hanJlul ol lavoroJ novly inJustrializing countrios (NlCs), capital
largoly shunnoJ tho Southorn Homisphoro until tho omorging markots`
loom ol tho oarly 1990s. (Evon thon, llovs voro concontratoJ in a hanJ-
lul ol countrios - anJ still, llovs among lirst WorlJ countrios proJomi-
natoJ.) Govornmonts anJ ouasi-pullic institutions liko tho WorlJ Bank
proviJoJ tvo-thirJs ol tho linanco to tho poor countrios Juring tho 1980s.
But, as Turnor (1991, p. 25) pointoJ out, tho classical lunction ol intorna-
tional capital markots` - allocating lunJs to aroas ol tho highost roturn -
has locomo ovon loss oviJont in rocont capital llovs ovon among inJus-
trial nations.` Ho continuoJ:
ln tho 1950s, tho UnitoJ Statos (high capitallalour ratio) oxportoJ capital
to Europo (lovor capitallalor ratio), a procoss that contrilutoJ to lastor
grovth in Europo than in tho UnitoJ Statos anJ a narroving ol vago
Jillorontials. Within Europo, SvitzorlanJ (high capitallalour ratio) vas
tho largost por capita oxportor ol capital. ViovoJ in this light, it appoars
somovhat anomalous that tho UnitoJ Statos has loon tho largost importor
WALL STREET
110
ol capital lor much ol tho 1980s: thoro is littlo oviJonco that tho US rato ol
roturn on roal assots vas highor in tho 1980s than that in othor countrios.
3
Turnor surmisos that this inllov vas largoly a lunction ol tho Jopth ol U.S.
capital markots. Woll-JovolopoJ markots, it sooms, can porvort tho alloca-
tion ol capital as voll as lulricato it. Tho incroasing sophistication ol tho
capital markots is a roaction to tho post-Brotton WooJs instalility ol tho
glolal systom. Turnor concluJos that tho J:uuuc:uI u::~:::J:cuI:u uuu
:uI~:u~u:uI:u lunction ol intornational capital markots has como to oclipso
tho classical allocation ol capital lunction.` Joan Polinson vas right vhon
sho saiJ that tho linancial markots aro mainly convonionco lor rontiors.`
Things changoJ somovhat arounJ 1990, hovovor, as Turnor`s papor
vas pullishoJ. Tho Joclino in U.S. intorost ratos oasoJ tho stross on Iatin
Amorican lorrovors as much as it JiJ in tho U.S., lut thoso lovor ratos
lolt invostors hungry lor yiolJ. Thoy ovorcamo thoir momorios ol tho Jolt
crisis anJ logan ploving monoy into tho ThirJ WorlJ. Ollicial Jovolop-
mont linanco grov just 28/ lotvoon 1989 anJ 1994 - lut privato linanco
svolloJ ly 313/, loJ ly stock markot invostmont, vhich oxploJoJ ly 1029/.
Vuch ol this llovoJ into privatizoJ lirms, particularly in Iatin Amorica. OlJ
190s anJ 1980s Jolts voro convortoJ into oouity in thoso Jo-statilioJ
lirms, giving loroign invostors anJ Jomostic political cronios lig stakos,
olton at gonorous pricos, in monopoly or noar-monopoly lusinossos. Pri-
vato Jolt llovs, mainly lonJs rathor than lank loans, grov 33/, anJ
Jiroct invostmont - taking a position in oxisting roal ontorpriso or tho
ostallishmont ol a nov ono - roso 203/. As a rosult, tho ollicial sharo ol
long-torm linanco loll lrom ovor hall in 1989 to a thirJ in 1994.
Voxico vas tho postor country ol tho omorging markots lulllo. Tho
vavo ol privatization, Jorogulation, anJ capital markot oponing loJ to a
rush ol capital - $68 lillion in portlolio capital lotvoon 1991 anJ tho lirst
hall ol 1994, comparoJ to a not outllov ol $3.6 lillion lrom 1988 through
1990. Voxican linancial markots, a lraction ol tho sizo ol tho U.S. markot,
loomoJ. Tho roal Voxican oconomy, hovovor, vas porlorming poorly,
turning in topiJ grovth ratos anJ lov roal invostmont lovols, vhilo avor-
ago Voxicans sulloroJ only tho milJost ol rocovorios lrom tho ravagos ol
tho 1980s. Whon tho lulllo lurst, tho roal oconomy loll apart unJor tho
prossuro ol tho austority program JosignoJ to calm tho linancial markots,
anJ living stanJarJs collapsoJ onco again (HonvooJ 1995).
Tho ThirJ WorlJ`s sharo ol total glolal Jiroct invostmont roso lrom un-
Jor 15/ in 1990 to noarly 40/ in 1993 (WorlJ Bank 1994, volumo 1, chap-
PLAYERS
111
tor 1). That incroaso in Jiroct invostmont in tho ThirJ WorlJ lollovoJ on a
romarkallo incroaso in cross-lorJor holJings among tho lirst WorlJ coun-
trios Juring tho 1980s, vhich JoulloJ or triploJ lrom tho lovols ol tho
190s (Turnor 1991, p. 32). AccorJing to tho UN Contro on Transnational
Corporations (UNCTC 1991), unliko tho 190s anJ oarly 1980s, vhon Ji-
roct invostmont grov roughly in lino vith traJo, in tho lato 1980s, cross-
lorJor Jiroct invostmont grov at tvo to throo timos tho paco ol traJo.
But Jiroct invostmont llovs to tho ThirJ WorlJ voro concontratoJ in
only a hanJlul ol countrios, mainly in East Asia anJ Iatin Amorica: tho
ViJJlo East, Alrica, anJ South Asia voro laroly in tho picturo. ln lact,
that`s truo ol all privato capital llovs in gonoral - portlolio (stock anJ
lonJ) as voll as Jiroct. Just livo countrios - China, Voxico, Argontina,
ThailanJ, anJ Koroa - accountoJ lor hall tho privato capital llov total
lotvoon 1989 anJ 1993: aJJ anothor oight (Brazil, Portugal, Valaysia,
Turkoy, Grooco, lnJia, lnJonosia, anJ Chilo), anJ you`ro ovor 80/. Pri-
vato markots aro not knovn lor sproaJing tho voalth.
As a sorios ol annual W:Iu 1u:~:Iu~uI R~j:I: pullishoJ ly tho UnitoJ
Nations has arguoJ, thoso invostmont llovs aro Jrivon ly tho proJuction
stratogios ol multinational corporations (VNCs).
38
Though loroign invost-
mont is olJ, tho truly glolal corporation is a rolativoly rocont Jovolop-
mont. lor conturios, Jiroct invostmont vas mainly tho mochanism ly vhich
tho lirst WorlJ corporations roliovoJ ThirJ WorlJ countrios ol thoir oil,
tin, anJ rullor. Starting in tho 1960s, hovovor, vith a lig push ly U.S.
consumor proJucts lirms into Europo, tho moJorn VNC logan to tako
shapo. As tho 1960s anJ 190s progrossoJ, U.S. multinationals continuoJ
to oxpanJ ovorsoas, choosing to sorvo loroign markots vith local opora-
tions rathor than oxporting lrom tho U.S. Europoan VNCs soon lollovoJ
suit, anJ Juring tho 1980s - ospocially as tho yon roso in valuo altor 1985,
making Japanoso oxports moro oxponsivo on vorlJ markots - Japanoso
lirms hoppoJ on tho glolalization lanJvagon.
Tho UNCTC (1991) calls tho throo groat goographical sourcos ol Jiroct
invostmont - tho U.S., Wostorn Europo, anJ Japan - tho TriaJ. AnJ Jo-
spito tho rocont upsurgo in Jiroct invostmont in tho ThirJ WorlJ, as thoir
stuJy says, in torms ol loth loroign Jiroct invostmont anJ in torms ol
traJo, intoractions u:II:u tho TriaJ havo outpacoJ intoractions in tho rost
ol tho vorlJ, anJ lotvoon tho TriaJ anJ tho rost ol tho vorlJ, inJicating a
lastor rato ol intogration among tho TriaJ than lotvoon tho TriaJ anJ tho
rost ol tho vorlJ.` Sinco tho throo polos ol this trilatoral vorlJ colloctivoly
account lor tvo-thirJs ol glolal proJuct, it`s not surprising that VNCs aro
WALL STREET
112
gravitating to vhoro tho markot action is. As glolal compotition continuos
to intonsily, oliminating tho voak anJ incroasing tho stakos lor tho survi-
vors, it von`t lo surprising to soo ovon lurthor concontration ol capital
anJ markots as tho JocaJo voars on.
At tho samo timo, hovovor, tho UNCTC spioJ a pattorn vhoroly host
countrios IcuI~u :u II~ :uu~ ~:ujI:cuI :~:u |omphasis in originall
aro clustoroJ arounJ a singlo TriaJ momlor.` Though tho Contro voulJn`t
phraso it this vay, oach momlor ol tho TriaJ has gathoroJ unJor itsoll a
rolativo hanJlul ol poor countrios to act as svoatshop, plantation, anJ
mino: tho U.S. has Iatin Amorica, particularly Voxico: tho Europoan Union
has Eastorn anJ Southorn Europo anJ Alrica: anJ Japan, Southoast Asia.
ln a lov casos, tvo TriaJ momlors sharo a country - Taivan anJ Singaporo
aro split lotvoon Japan anJ tho U.S.: Argontina, lotvoon tho U.S. anJ tho
EU: Valaysia, lotvoon tho EC anJ Japan: anJ lnJia is sharoJ ly all throo.
AccorJing to tho UNCTC, tho numlor ol countrios JominatoJ ly U.S. capital
JoclinoJ somovhat Juring tho 1980s, ospocially in Asia, anJ thoso Jomi-
natoJ ly Japan anJ tho EU incroasoJ.
Only alout 25 countrios lit into this clustoring alout tho TriaJ, loaving
arounJ 100 mainly small anJ poor countrios on tho margins. Though lo-
ing a momlor ol ono ol thoso clustors is no guarantoo ol prospority, loing
lolt out is prolally an ovon vorso lato.
So lar, l`vo talkoJ a lot alout Jiroct invostmont, anJ rathor promiscu-
ously so lor a look moro concornoJ vith tho linancial soctor than tho
roal. Thoro`s a gooJ roason lor this. Stophon Hymor (199) arguoJ that tho
intogration ol national linancial markots into a singlo glolal systom - a
procoss that vas only loginning vhon ho vroto this in 192 - JovolopoJ
in symliosis vith tho grovth ol tho VNC. Tho multinational corporation`s
nooJ lor short-torm loans anJ invostmont arising lrom tho continuous in-
llov anJ outllov ol monoy lrom all nations, novor ouito in lalanco, has
oncouragoJ intornational lanking anJ has holpoJ intograto short-torm
monoy markots: its long-torm linancial roouiromonts.havo lroaJonoJ
tho JomanJ lor intornational lonJ anJ oouity capital` (Hymor 199, p.
82). ProJuction must lo linancoJ, anJ il all goos voll, it throvs oll prolits
in monoy lorm, anJ glolalizoJ proJuction is no oxcoption, moaning that
VNCs inovitally croato linancial llovs alongsiJo thoir proJuctivo activi-
tios.
39
Whilo tho glolal markots that surrounJ thom may soom monstrously
lloatoJ noxt to thoir roal-vorlJ laso, much tho samo can lo saiJ ol tho
U.S. national linancial systom, vhich has loon groving lar loyonJ its tan-
gillo laso lor JocaJos.
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Just as national capital markots join togothor lragmontoJ surplus anJ
Jolicit units vho may lo milos apart, this glolal markot joins croJitors
anJ Joltors arounJ tho vorlJ. AnJ just as sharoholJor-ovnoJ, prolos-
sionally managoJ, nation-sizoJ lirms omorgoJ lrom lamily-ovnoJ anJ -
run local units ol tho 19th contury, tho VNC omorgoJ lrom tho national
corporation. SharoholJors anJ croJitors voulJ, Hymor rightly imaginoJ,
Jovolop an intorost in tho glolal lunction ol tho systom, not thoir national
pioco ol it, just as thoy haJ JovolopoJ an intorost in thoir national systom
moro than any spocilic corporato pioco ol it.
Tvo pungont ouotos givo tho llavor ol this glolal soliJarity. A sonior
oxocutivo ol Colgato-Palmolivo tolJ tho N~u : T:u~: in 1991: Tho
UnitoJ Statos Joos not havo an automatic call on our rosourcos. Thoro is
no minJsot that puts this country lirst` (ouotoJ in Poich 1991, p. 141). Not
only Amoricans aro so lroo ol patriotic sontimont. To lo in lusinoss,` saiJ
lrank Stronach, chair ol Vagna lntornational, a CanaJian auto-parts makor
that has shiltoJ its proJuction to Voxico, your lirst manJato is to mako
monoy, anJ monoy has no hoart, soul, conscionco, homolanJ` (ouotoJ in
Bilollo 1992). This is vory lar lrom tho constraints on capital llovs imag-
inoJ ly DaviJ PicarJo (1911198, chaptor ), tho lounJing lathor ol moJ-
orn lroo traJo thoory:
Exporionco, hovovor, shovs that tho lancioJ or roal insocurity ol capital,
vhon not unJor tho immoJiato control ol its ovnor, togothor vith tho
natural Jisinclination vhich ovory man has to ouit tho country ol his lirth
anJ connoctions, anJ intrust himsoll, vith all his halits lixoJ, to a strango
govornmont anJ nov lavs, chock tho omigration ol capital. Thoso
loolings, vhich l shoulJ lo sorry to soo voakonoJ, inJuco most mon ol
proporty to lo satislioJ vith a lov rato ol prolits in thoir ovn country,
rathor than sook a moro aJvantagoous omploymont lor thoir voalth in
loroign nations.
40
PicarJo`s sontimontal patriotism is a long vay lrom tho hoartloss, lanJ-
loss sontimonts ol Stronach anJ tho Colgato oxoc. lt romains to lo soon
vhothor this lorJorloss vorlJ is moro pormanont than tho ono JoscriloJ
ly Koynos, or vhothor var, Joprossion, anJor political rolollion vill
smash tho iJyll onco again.
Pocalling Koynos, though, shoulJ caution against tho common halit ol
troating tho glolalizoJ prosont as somothing uttorly nov. Tho sharo ol
oxports in Britain`s GDP vas only a lit highor in 1992 than it vas in 1913,
anJ tho U.S. ol 1996 is no match lor oithor. By that samo moasuro, Voxico
WALL STREET
114
vas moro intornationalizoJ in 1913 than it vas in 1992 (VaJJison 1995).
Capitalism has lrom its lirth loon a Jooply intornational, anJ intornation-
alizing, systom. ln many vays, tho glolalization charactoristic ol tho lato
20th contury rosomllos tho vorlJ ol 100 yoars ago, vith gooJs anJ capital
crossing lorJors vith a lrooJom unknovn sinco tho olJ vorlJ lroko apart
in 1914. l loavo it to soothsayors to ansvor tho ouostion ol vhothor an-
othor 1914 - or 1929 - is in our luturo.
notes
1. Hov lig is institutional linanco? ln 1991, 1,291,000 tax roturns voro liloJ ly inJiviJual
propriotorships claiming oithor linanco, insuranco, or roal ostato (llPE) as thoir main
lino ol lusinoss, 804,000 partnorships, anJ 618,000 corporations (U.S. Buroau ol tho
Consus 1995, tallo 84, p. 543).
2. Tho NlPAs also havo littlo to say alout U.S. rolations vith tho outsiJo vorlJ: thoso aro
covoroJ in tho lalanco ol paymonts (BoP) accounts, vhich, liko tho NlPAs, aro com-
piloJ ly tho Commorco Dopartmont`s Buroau ol Economic Analysis. Tho UN`s Systom
ol National Accounts covors all thoso lasos - NlPAs, BoP, anJ lol - in a unilioJ vay,
lut tho U.S. is only slovly moving tovarJs complianco vith tho SNA stanJarJ.
3. Not shovn is stato anJ local govornmont Jolt, vhich haJ a short lurst in tho 1950s, loll
lack in tho oarly 1980s, anJ thon roso somo in tho lato 1980s: 1995`s liguro ol 14.9/ ol
GDP is littlo Jilloront lrom 1962`s 14.0/.
4. This ignoros soll-omploymont incomo, part ol vhich is a roturn to lalor anJ part to
capital: it accounts lor voll unJor a tonth ol porsonal incomo.
5. 1994 liguros aro usoJ locauso tho 1995 lalanco shoot liguros voro JolayoJ ly tho
lonchmark rovisions ol tho national incomo accounts. linancial accounts voro pul-
lishoJ lor 1995, lut Jata on tangillo assots anJ capital stocks voro unavailallo as this
look vas proparoJ lor pullication.
6. Noto that in torms ol croJit markot lonJing alono, housoholJs aro not lorrovors - lut
housoholJs havo many othor kinJs ol assots, lrom housos to mutual lunJs, that Jon`t
shov up as croJit markot assots. As a vholo, tho housoholJ soctor has a highly positivo
not vorth.
. Tho SCl is tho most JotailoJ anJ accurato survoy ol tho linancial stato ol tho population
that oxists, cortainly lor tho U.S. anJ ouito prolally tho vorlJ, lut locauso ol lunJing
shortagos, it is Jono only ovory throo yoars. Dospito its Jotail anJ lroaJth - tho intor-
viov on vhich it`s lasoJ is an hour long, involving roviovs ol actual linancial rocorJs
anJ not just sums Jono lrom momory, anJ it catchos lar moro rich pooplo in its not than
routino Consus survoys - it isn`t porloct. AccorJing to vork ly EJvarJ Wolll (1994),
tho SCl numlors Jon`t roally match tho lol. Pooplo roport thoir housos anJ privatoly
ovnoJ lusinossos to lo vorth almost a thirJ moro than tho accountants ostimato thom
to lo vorth, vhich isn`t surprising, locauso tho lol liguro is an ostimato lasoJ on
historical invostmont liguros, anJ pooplo roport curront markot pricos (inllatoJ, no Joult,
ly an optimism promium). Thoy unJorstato thoir socurity holJings ly hall. Pooplo also
roport lovor Jolts to SCl survoyors than tho lol`s sums, moaning that SCl not vorth is
sulstantially highor than lol not vorth ostimatos.
8. Thoso liguros aro computoJ ly JiviJing tho annual Jollar chango in consumor croJit
ly tho annual chango in porsonal consumption oxponJituros.
9. Pooplo vho got Jooply into Jolt aro signilicantly moro likoly` to havo roportoJ a
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sharp Jrop in incomo, as aro thoso vho ultimatoly lilo lor lankruptcy - most prol-
ally locauso ol jol loss or moJical omorgoncy (Sullivan ot al 1989, pp. 95-102, 185-
18). CroJit sooms again to lo a privato sulstituto lor a civilizoJ pullic vollaro stato.
10. Ono vay ol moasuring tho (in)oouality ol incomo or voalth Jistrilution is vith tho Gini
inJox, vhich rangos lrom 0 (porloct oouality) to 1 (porloct inoouality, i.o., ono porson
has all tho monoy). Gini inJoxos on voalth aro astonishing. ln 1989, tho Consus Buroau`s
housoholJ incomo Gini vas .431: on tho SCl, it vas .505: lor voalth, it vas .93 ovorall,
anJ oo ~.cIuu:u Iu:~: uuu cu:: (Woichor 1995).
11. Tho loJ has latoly loon Joing its lost to lury thoso numlors. DotailoJ roports on tho
1983 Survoy ol Consumor linancos voro pullishoJ in its main journal, tho 1~u~:uI
R~:~::~ 1uII~I:u. only a vory gonoral roport vas pullishoJ on tho 1989 survoy, anJ tho
voalth Jistrilution Jata vas circulatoJ only in tho lorm ol an unpullishoJ vorking
papor, lurioJ unJor 36 pagos ol tochniouo. Tho loJ also sat on tho voalth Jata lor
month, Jolaying tho roloaso ol tho computor tapos until altor tho 1992 prosiJontial
campaign oloction - lor ostonsilly tochnical roasons, lut tho ollicial oxplanation must
lo mot vith somo skopticism. Whon tho Domocrats von, tho lorcos intorostoJ in Joing
tho voalth arithmotic lost somo ol thoir zoal. Tho 1992 survoy rocoivoJ similarly cur-
sory troatmont.
12. Who knovs hov unJorroporting allocts this? lt may lo that Jospito tho SCl`s lost ol-
lorts, rich pooplo aro still lalling through tho not, or it may moan that nonrich pooplo
aro unJorroporting thoir holJings. Tho lost ono can Jo is say, il it`s gooJ onough lor
tho loJ, it`s gooJ onough lor mo.
13. Tho SCl`s catchall nonvhito` is as misloaJing as it is callous. lt incluJos Asians anJ
Hispanics, vho aro notally lottor oll than llacks, anJ sinco thoir numlors aro incroas-
ing lastor than Alrican Amoricans, thoy`ro loosting tho nonvhito avorago.
14. Othor paths ol inlluonco - Jiroct onos liko takoovor throats anJ sharoholJor rolol-
lions, or inJiroct onos liko stock pricos anJ intorost ratos - aro moro important than
tho rogulation ol markot accoss, anJ vill lo takon up lator.
15. Tho rationalo lor tho lormula is givon in tho graph`s caption.
16. Whon stock pricos aro high, ono lirm can tako ovor anothor vithout sponJing cash, lut
just ly olloring sharos ol its ovn stock as paymont.
1. lor Jilloront roasons, Post-Koynosian anJ Varxist oconomios oljoct to making capital
into a lactor ol proJuction on a par vith lalor, lut thoso oljoctions, as accurato as thoy
aro, Jon`t roally loar on tho point loing maJo horo.
18. Iator survoys lumpoJ llPE vorkors into inlrastructuro, vholosalo traJo, anJ llPE,`
mixing lus Jrivors in vith lonJ traJors.
19. Elsovhoro, a sourco lamiliar vith tho Nov \ork gay S8V vorlJ saiJ that most ol tho
Wall Strootors ho`s mot havo loon lottoms. As ono oxplainoJ to him, Tho moro
povor l havo, tho groator my nooJ to lo humiliatoJ.`
20. A luilJing is thought to lo vorth . timos its ront roll, vith tho . varying vith intorost
ratos, tho prosont stato ol tho roal ostato markot, invostors` gonoral optimism or possi-
mism alout tho luturo, anJ various tax consiJorations. That . is tho invorso ol tho
luilJing`s yiolJ. ll intorost ratos aro 5/, thon a roal ostato invostor might vant annual
rontal incomo to ooual 10/, sinco roal ostato is riskior than a sounJ govornmont or
corporato lonJ - so tho luilJing voulJ lo pricoJ at ton timos tho ront roll. But roal
ostato is a gamo usually playoJ vith lorrovoJ monoy, so tho intorost rato on that lor-
rovoJ monoy voulJ havo to lo sultractoJ lrom tho ront to got tho luilJing`s not yiolJ.
ll tho luilJing approciatos ovor timo, so much tho lottor: ront can covor tho mortgago,
vith tho prico approciation almost all gravy.
21. lnsuranco companios olton manago ponsion lunJ assots, lut in Joing so thoy`ro acting
moro as portlolio managors than insurors in tho narrov sonso.
WALL STREET
116
22. IonJon may look onshoro, lut it`s largoly unrogulatoJ. Ollshoro` is roally moro a stato
ol minJ than a placo, anyvay: tho ultimato lonoliciarios ol ollshoro transactions aro
usually vory rich citizons ol vory rich countrios.
23. ln April 1995, tho Bank lor lntornational Sottlomonts (BlS), tho Basol-lasoJ contral
lankors clul, proposoJ alloving lanks to uso thoir ovn intornal computor moJols lor
juJging tho riskinoss ol thoir oxposuro to Jorivativos anJ oll-lalanco-shoot itoms, sul-
joct to tho approval ol national rogulators. Tho BlS, normally a lairly consorvativo insti-
tution, is horo shoving groat laith in loth tho moJols` accuracy anJ tho lanks` honosty
(Basol Committoo on Banking Suporvision 1995).
24. ln tho 1950s anJ 1960s, it vas saiJ that a gooJ Joal ol lanking lollovoJ tho 3-6-3 rulo:
lorrov monoy lrom your Jopositors at 3/, lonJ it to anothor sot ol customors at 6/,
anJ lo at tho goll courso ly 3.
25. l havo locomo vory shy alout proJicting tho luturo. But it I: liko a lulllo ol sul-
limo proportions.
26. Tho namo hoJgo lunJ` originally camo lrom tho lact that unliko most institutional
invostors, thoy voro lroo to soll short anJ play vith options, supposoJly to protoct
(hoJgo`) thoir positions. HoJging is rogarJoJ as a consorvativo thing to Jo, lut hoJgo
lunJs aro anything lut consorvativo.
2. Thoso voro not ontiroly spontanoous lormations: thoy voro guiJoJ ly uppor-class ro-
lormors anJ philanthropists oncouraging tho moral Jovolopmont ol tho lovor orJors
(Kristov anJ OlmstoaJ 1992). lt sooms that saving anJ lorroving aro alvays intimato
companions ol virtuo, ospocially il thoy mako tho rich richor anJ tho poor ouioscont.
28. lor tho momont - larring privatization - SEC lilings aro availallo on tho WorlJ WiJo
Wol, at vvv.soc.gov. Thoy aro a rich sourco ol inlormation alout corporato Amorica,
il you can hack through tho jargon.
29. SnippoJ lrom tho CBO stuJy, tho WuII I:~~I {u:uuI roportoJ, vas math shoving that tho
$2 lillion that goos annually to lannio`s anJ lroJJio`s managors anJ sharoholJors coulJ
proviJo a 10/ Jovn paymont on homos lor 250,000 lov-incomo lamilios.`
30. Vost Europoan countrios haJ contral lanks, somo ol thom going lack hunJroJs ol
yoars. Tho vorlJ`s lirst vas SvoJon`s Pikslank, lounJoJ in 1668: tho Bank ol EnglanJ,
tho vorlJ`s soconJ, vas lounJoJ (as a privato lankor to tho govornmont) in 1694.
31. That union loaJor, SanJra lolJman, rolusoJ to appoar at a lalor-lackoJ tax tho rich`
rally in Nov \ork City in 1993, locauso, hor spokosporson tolJ mo, sho voulJn`t sharo
a platlorm vith avovoJ Communists.`
32. As, lor oxamplo, vith patont protoction lor Jrugs anJ microchips, vhoro inlormation`
is roally alout tho prosorvation ol monopoly povor anJ prolits.
33. An articlo in tho PuII:c R~IuI:u: {u:uuI (Sholl 1990) saiJ that invostor rolations`
stallors - corporato PP spocialists vhoso auJionco is Wall Stroot - shoulJn`t stono-
vall`: instoaJ thoy shoulJ proviJo moro` inlormation.` Tho uso ol ouotos arounJ
moro` - thoy`ro in tho original - suggosts that tho provision ol moro inlormation
shoulJ novor lo conlusoJ vith tolling tho truth.
34. Ono chock on this conloJoracy ol optimists aro prolossional shorts - pooplo vho look
lor companios vith inllatoJ roputations anJ stock pricos, Jig out tho inlo, short tho
stock, anJ thon loak tho laJ novs to roportors oagor lor a hot tip. ll tho novs takos,
thon tho stock vill sullor Jamago. Somotimos it Joosn`t mattor vhothor tho laJ novs is
truo: il tho short can tako a position anJ unJortako a succosslul Jisinlormation cam-
paign, ho or sho can prolitally covor tho short.
35. lor tho roal` soctor, hovovor, lorJors still mattor, anJ tho glolal assomlly lino` is a
lit ol an oxaggoration.
36. Tho corrolation coolliciont is a moasuro ol hov tightly tvo sots ol numlors aro rolatoJ
to oach othor, ranging lrom -1 (a porloct mirror imago) through 0 (no rolation at all) to
PLAYERS
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+1 (porloct lockstop). A corrolation coolliciont unJor 0.2 marks a lairly cacophanous
rolation, lut liguros ovor 0.9 signily groat intimacy.
3. ln lact, many loroign invostmonts maJo in tho U.S. Juring tho 1980s havo haJ
apparontly Jismal ratos ol roturn. Tho Jollar`s Joclino has savagoJ linancial
invosmonts, anJ roal invostmonts havon`t Jono much lottor. AccorJing to ollicial U.S.
liguros lor 1993 (U.S. Dopartmont ol Commorco, Buroau ol Economic Analysis 1994),
loroignors oarnoJ a roturn ol 1.4/ (incomo JiviJoJ ly tho total valuo ol assots) on
thoir Jiroct invostmonts in tho U.S., vhilo U.S. lirms oarnoJ 10.3/ on thoir invost-
monts alroaJ. Japan ran in tho roJ - a roturn ol -2.4/. Thoso liguros aro aJmittoJly
only vory rough approximations: it`s vory harJ to valuo tho capital stock proporly,
anJ companios schomo anJ choat to roJuco roportoJ prolits. But thoso numlors lit
voll vith anocJotal oviJonco that Japanoso invostors took a lath on thoir invost-
monts in tho U.S. Juring tho 1980s.
38. Tho agoncy that pullishos tho W:Iu 1u:~:Iu~uI R~j:I: vas onco knovn as tho UN
Contro on Transnational Corporations (UNCTC). Though this vas onco a milJly sul-
vorsivo institution Juring tho 190s, vhon calls lrom tho South lor a nov intornational
oconomic orJor voro popular - moaning a moro oouitallo Jistrilution ol glolal voalth
anJ povor - tho UNCTC grov tamo along vith ovoryono olso ly tho 1980s. Still, tho
Poagan anJ Bush aJministrations rogarJoJ tho Contro as a nost ol Bolshoviks, anJ
prossuroJ tho UN into roJucing its status to tho point vhoro it is nov a sul-spock
vithin UNCTAD, tho UN Conloronco on TraJo anJ Dovolopmont. lor tho sako ol con-
sistoncy, l`m calling it tho UNCTC anyvay, ovon though tho Contro no longor oxists.
39. Again, it must lo omphasizoJ that tho glolalization ol proJuction shoulJn`t lo oxag-
goratoJ. Vost multinational lirms mako proJucts in tho country or rogion ol thoir linal
salo: tho amount ol shipmont ol parts anJ somilinishoJ gooJs arounJ tho vorlJ is
novhoro noar as groat as is somotimos thought (WhicharJ anJ Iovo 1995).
40. lronically, though lorn in IonJon, PicarJo vas ol Dutch origin, anJ ho vas oJucatoJ
in HollanJ.
118
3 Ensemble
Though it olton sooms liko Wall Stroot inhalits a vorlJ ontiroly ol its ovn
imaginativo making, it is connoctoJ to tho roal vorlJ, in olton inJiroct anJ
mystorious vays. So too tho inJiviJual markots: though thoy olton soom
to Janco to thoir ovn music, vhat happons in ono can alloct anothor, or
sots ol markots may simultanoously roact to tho samo novs. Having out-
linoJ tho piocos, lot`s nov try to lit thom togothor.
Mother Credit
ll thoro is a mothor ol all linancial markots it is tho ono lor croJit.
1
Changos
in tho torms on vhich somo pooplo lot othor pooplo uso thoir monoy movo
loth tho linancial markots anJ tho roal oconomy. Whon croJit is oasily
gotton, anJ vhon intorost ratos aro lov anJor lalling, tho linancial mar-
kots typically sizzlo: vhon croJit is scarco, anJ ratos aro high anJor ris-
ing, linancial markots Jo laJly.
Why is this? Sovoral roasons, tho simplo onos lirst. Tho locus horo is on
stocks, vhich aro typically tho locus ol spoculators` most arJont atton-
tions, lut tho roasoning can lo applioJ vith only slight moJilications to
othor assots, liko roal ostato, art, anJ ovon lasolall carJs.
- :I J jIu):u u:II II~: j~jI~: uu~) Spoculators - anJ in this
instanco tho vorJ is usoJ in a morally noutral sonso to moan anyono
vho luys a linancial assot in tho hopo ol solling it at a highor prico in
tho noar or Jistant luturo - typically oporato on lorrovoJ monoy.
Any incroaso in tho cost ol lunJs incroasos thoir costs ol Joing lusi-
noss, vith olvious ollocts on loth thoir onthusiasm anJ luying povor.
Somoono vho lorrovs monoy at 5/ nooJs to mako voll ovor 5/ to
justily tho groat risks ol holJing stocks or luturos - say, just lor tho
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119
sako ol argumont, 10/ or moro. ShoulJ ratos riso to /, tho margin ol
saloty at a hopoJ-lor 10/ roturn voulJ lo roJucoJ, moaning that a
roturn ol 12/ voulJ lo roouiroJ. AnJ roturns ol 12/ aro much raror
than 10/, raro as thoso aro. Consoouontly, spoculativo onthusiasm
Jampons, anJ pricos ol spoculativo assots typically sag, vhon intor-
ost ratos riso.
- EJJ~cI: u :~uI:u~uI Whon intorost ratos riso or lall a nontrivial amount,
it`s usually vith tho consont or ovon tho intontion ol tho contral lank.
Whon contral lanks lovor ratos, thoy`ro trying to stimulato tho roal anJ
linancial oconomios: vhon thoy raiso ratos, thoy`ro trying to slov thom
Jovn. Sano spoculators novor lot against contral lanks, tho contor ol
tho ontiro linancial univorso: thoy croato monoy, rogulato croJit, anJ
olton JociJo vhothor troulloJ privato lanks vill livo or Jio. Whilo not
almighty, contral lanks olton got vhat thoy vant, so thoy alloct spocu-
lators` sonso ol tho luturo vory povorlully. (Vajor contral lanks, that
is: tho loJ anJ tho BunJoslank aro mighty, lut tho Bank ol Voxico is
voak anJ tho Bank ol Zaro littlo moro than a joko.) Sinco linancial
assot pricos aro luilt largoly ol oxpoctations alout tho luturo, stimuli or
Joprossants to thoso oxpoctations loar vory Jiroctly on thoir pricos.
Optimism loosts pricos, anJ possimism Joprossos thom.
- R~IuI::~ uII:ucI::~u~:: J uII~:uuI::~ :u:~:Iu~uI: Whon intorost ratos
aro lov or lalling, pooplo Jospair ol tho oarnings on thoir Troasury
lills, lank Joposits, or monoy markot lunJs: thoy soarch lor juicior
prolits, anJ plungo into stocks or long-torm lonJs, vhich typically
pay highor intorost ratos than short-torm instrumonts. But vhon ratos
aro rising, tho rolativo attractivonoss ol short-torm invostmonts risos. ll
you can oarn / on a CD, it may not lo vorth taking tho oxtra risk ol
holJing stocks: lut at 2/ intorost ratos, stocks soom much loss intimi-
Jating - irrosistillo ovon.
- !uIuuI:u This is a lit moro complicatoJ: it JoponJs on tho luturo
valuo ol monoy, ono ol tho olomontary concopts ol linancial analysis.
What is tho valuo ol $10,000 in 10 yoars? lt`s tho amount you`J havo to
sot asiJo toJay, at curront intorost ratos, to havo that $10,000 in 10 yoars.
ll you voro guarantooJ to oarn a 5/ intorost rato ovory yoar lor tho
noxt 10, you`J hit $10,000 il you maJo a lank Joposit ol $6,139, or
lought a lonJ ol that valuo. That $6,139 voulJ grov to $6,446 in a
yoar (tho original amount plus 5/ intorost, $6,68 in tho soconJ
yoar.anJ so on, until yoar 10, vhon tho $10,000 targot voulJ lo hit.
ln linancial jargon, tho prosont valuo (PV) ol $10,000 at 5/ ovor 10
WALL STREET
120
yoars is $6,139. But vhat voulJ happon il intorost ratos voro to riso to,
say, 10/? \ou`J nooJ to sot asiJo a lot loss, locauso oach yoar`s intorost
oarnings voulJ lo tvico as high - anJ sinco you`J lo oarning intorost
on intorost, that olloct is groatly magnilioJ. At 10/, tho PV ol $10,000 in
10 yoars is $3,855, a lot loss than tho PV at 5/. This is illustratoJ graphi-
cally noarly.
Hov Joos this alloct assot
pricos? Tho valuo ol a stock, lun-
Jamontally spoaking - loaving
asiJo all inlluoncos ol optimis-
tic or possimistic psychology -
is a lunction ol tho prolits that
its issuor vill oarn ovor timo, or
tho JiviJonJs it vill pay to
sharoholJors out ol thoso prol-
its.
2
ln a normal vorlJ, thoso prolits or JiviJonJs can lo assumoJ to
grov vith tho oconomy ovory yoar. Somo yoars, ol courso, vill lo lot-
tor than othors, lut ovor timo, it`s not unroasonallo to assumo that tho
joys ol ovnorship vill grov ly 5-10/ a yoar. Tako, lor oxamplo, a
corporation that oarns $10 in prolits lor ovory sharo ol stock outstanJ-
ing. Assumo lurthor that that amount vill grov ly .5/ ovory yoar lor
tho noxt 20. What is its stock vorth? ln thoory, its prico shoulJ lo somo
lunction ol tho PV ol that luturo stroam ol prolits, JiscountoJ at pro-
vailing intorost ratos. ln this oxamplo, tho stock that oarns` $10 toJay,
groving .5/ a yoar to $39.51 at tho onJ ol 20 yoars, vill throv oll
$433.05 in prolits ovor tho 20-yoar porioJ. At 5/ intorost ratos, tho PV
ol that stroam is $240.39: at 10/, $14.43. So ovon il tho luturo pros-
pocts ol a corporation romain unchangoJ, a riso or lall in intorost ratos
groatly changos tho arithmotic usoJ to valuo stocks. AnJ il tho chango
in ratos changos ono`s ostimatos ol luturo grovth prospocts - il, say,
highor intorost ratos loaJ tho prospoctivo stockholJor to mark Jovn
ostimatos ol luturo prolit grovth, locauso ol a loss lrionJly oconomic
onvironmont - thon thoso simplo arithmotic changos aro magnilioJ.
- Ecuu:c cuu:I:u: Stock pricos riso vhon invostors anticipato an
incroaso in prolits anJ lall vhon thoy anticipato a Jocroaso, anJ prolits
movo vith tho lusinoss cyclo, rising in oxpansions anJ lalling in con-
tractions. l`ll havo moro to say alout this in a lit, lut on tho mattor ol
immoJiato rolovanco, highor ratos olton portonJ a slump anJ lovor
ratos a rocovory. Consoouontly, movomonts in intorost ratos color in-
$2,000
$4,000
$6,000
$3,000
$!0,000
0 2 4 6 3 !0
5'
!0'
vears
the growth of money
at different interest
rates
ENSEMBLE
121
vostors` ostimation ol tho luturo courso ol prolits.
With assots othor than stocks, tho oconomic onvironmont counts
loss Jiroctly. ln a rocossion, spoculators assumo that othor playors vill
lo or at loast lool loss llush, making tho prospocts lor unloaJing an
assot - vhothor it lo a Pothko or 1,000 sharos ol Vicrosolt - at a
highor prico loss lrionJly. WorJs ol caution aro in orJor horo too: no
ono knovs lor suro vhon a rocossion vill hit, so spoculators may lot
that thoro vill alvays lo somo groator lool` to tako a raro lasolall
carJ oll thoir hanJs, or that things aro Jilloront this timo anJ highor
ratos von`t lring alout a rocossion.
Thoso aro somo ol tho roasons vhy intorost ratos havo such a prolounJ
impact on tho pricos ol stocks anJ othor spoculativo linancial assots. Sinco
many ol tho samo tochniouos usoJ to valuo stocks aro applioJ to roal-
vorlJ assots as voll - liko an ongoing lusinoss that may lo up lor salo,
or tho villingnoss ol a lirm to unJortako a nov projoct or oxpanJ an oxist-
ing ono - ratos aro a povorlul inlluonco on roal activity as voll. AnJ l
havon`t ovon montionoJ tho ollocts that changos in intorost ratos havo on
tho linancos ol loth Joltors anJ croJitors.
finance and the economy
Changos in intorost ratos Jo alloct tho linancos ol housoholJs anJ lusi-
noss: rising intorost ratos vill Jivort lunJs avay lrom roal sponJing anJ
tovarJs Jolt sorvico, vhilo lalling ratos can Jolivor a vinJlall. Ono
shoulJn`t mako too much ol this: in a strong oxpansion, rising omploy-
mont, incomos, anJ prolits vill prolally outvoigh a moJost incroaso in
intorost ratos, anJ in a Joop slump, lov ratos can lo only a voak antiJoto
to tho gonoral oconomic Jospair. To tako tvo notorious historical oxamplos,
microscopic T-lill ratos ol 0.28/ in 1934 voro not onough to onJ tho Do-
prossion, anJ it took a sustainoJ lout ol 15-20/ short-torm ratos in 1980
anJ 1981 to shut Jovn tho U.S. oconomy unJor tho Volckor roprossion.
But in loth casos, thoso voro oxtraorJinary timos.
lnstoaJ, lot`s look at tho lohavior ol tho major markots in moro normal
timos. Shovn noarly aro iJoalizoJ - iJoalizoJ ly avoraging, not ly imagi-
nation - roprosontations ol tho lohavior ol tho stocks anJ intorost ratos
arounJ lusinoss cyclo poaks anJ troughs. lntorost ratos lall sharply as a
rocossion maturos: locauso tho avorago post-WorlJ War ll rocossion has
lastoJ alout nino months, you can say that short-torm ratos login Jrop-
WALL STREET
122
ping only a lov months into a slump, vith long ratos acting a lit moro
stickily. Altor a lov months ol Joclining ratos - usually oncouragoJ ly
tho loJoral Posorvo - tho stock markot logins roponJing to ono ol its
lavorito stimuli, lovor ratos. At lusinoss cyclo poaks, tho procoss is throvn
into rovorso goar, vith intorost ratos stoaJily rising anJ tho stock markot
llattoning anJ linally sinking. Noto that short-torm ratos movo lar moro
Jramatically in loth Jiroctions than long-torm ratos: tho yiolJ curvo nor-
mally llattons or ovon goos nogativo as tho oconomy approachos rocos-
sion, thon turns stooply positivo as tho slovJovn onJs. ln lact, tho yiolJ
curvo signilicantly outporlorms othor linancial anJ macrooconomic inJi-
cators in proJicting rocossions tvo to six ouartors ahoaJ` (Estrolla anJ
Vishkin 1996) - anJ not only in tho U.S., lut in most ol tho rich inJustrial
countrios (BornarJ anJ Gorlach 1996). lt outJoos tho stock markot anJ
composito loaJing inJicators at this Jistanco, vith stocks anJ tho com-
positos having a lorvarJ vision ol only alout a singlo ouartor.
3
Tho lonJ markot`s loar ol oconomic strongth, anJ its lovo ol voaknoss,
usoJ to lo somothing ol a Wall Stroot socrot, at loast until arounJ 1993,
vhon it locamo a moro opon socrot. Though it olton shocks pooplo vhon
thoy lirst hoar alout it, tho roasoning isn`t that harJ to lollov. CroJitors
hato inllation, sinco it oroJos tho valuo ol thoir stock-in-traJo, monoy it-
soll. ll tho oconomy grovs too last anJ unomploymont gots too lov, thon
inllation vill almost inovitally riso. Tho roal valuo ol thoir lonJs vill Joto-
riorato vith tho pickup in pricos, anJ tho intorost rato agrooJ to in tho Jays
These charls show lhe behavior ol inleresl rales and slock prices around business
cvcle peaks and lroughs, based on lhe average ol nine U.S. business cvcles be
lween !943 and !995, wilh eilher lhe peak or lrough nonlh indexed lo !00. Bills
are lhreenonlh U.S. Treasurv bills, bonds are longlern U.S. Treasurv bonds (na
lurilv grealer lhan !0 vears, and slocks are lhe Slandard & Poors 500 average, all
as reporled bv lhe Federal Feserve.
35
90
95
!00
!05
!!0
!!5
!20
!25
!30
!35
9 6 3 T +3 +6 +9
troughs
bills
bonds
slocks
30
35
90
95
!00
!05
!!0
9 6 3 P +3 +6 +9
peaks
bills
bonds
slocks
financial markets and the business cycle
ENSEMBLE
123
vhon inllation vas lovor vill soom much loss satislying vhon tho con-
sumor prico inJox is hoaJing northvarJs.
Thoro aro sovoral roasons lor this. At tho highost lovol ol alstraction,
grovth loyonJ tho oconomy`s prosumoJ capacity limits vill strain human
anJ physical rosourcos, rosulting in an ovorhoating.` ll lolt unchockoJ,
this vill turn into a runavay loom, to lo lollovoJ ly a stunning collapso.
Voro concrotoly, il markots got too tight, thon shortagos anJ lottlonocks
vill Jovolop, rosulting in prico risos anJ orJor lacklogs rathor than hoalthy
grovth. What is truo ol markots lor gooJs anJ sorvicos is also truo lor
markots in human lalor: il tho pool ol skilloJ vorkors runs Jry, thon vagos
vill riso, as omployors liJ lor tho scarco rosourco anJ vorkors lool thoir
povor anJ turn moro JomanJing. Consoouontly, vhon tho oconomy looks
too strong, Wall Stroot JomanJs that tho loJ tighton in orJor to slov tho
oconomy Jovn to a cravl - anJ to push tho unomploymont rato signili-
cantly highor.
Vany lilorals anJ populists Jismiss such roasoning as paranoiJ. Though
tho history ol actual oconomios shovs that thoro`s no simplo rolationship
lotvoon grovth anJ inllation, linanciors aro noar-unanimous in thoir lo-
liol that a strong oconomy moans rising pricos, anJ is somothing to lo
loaroJ. AnJ painlul as it is to aJmit it, tho linanciors havo a point - vithin
tho limitations ol tho convontional vorlJviov. Whilo thoro may lo no noat
mathomatical triggor point vhon strongth translatos into inllation, tight
markots - vhothor moasuroJ ly tho porcontago ol total lactory capacity
that`s in uso, or tho porcontago ol tho vorklorco unomployoJ ly tho (in-
aJoouato anJ misloaJing) ollicial moasuro, or tho ratio ol actual GDP to
its long-torm tronJ grovth rato - tonJ to loaJ to a highor inllation rato.
Tho rovorso is also truo, vhich is vhy tho long anJ Joop rocossion ol tho
oarly 1980s - much longor anJ Joopor than policymakors haJ toloratoJ
in tho 190s - lroko tho lack` ol inllation, as tho clicho runs. lt also
lroko moro than a lov vorkors, lut to Wall Stroot, that vas moro collat-
oral Jamago in a holy var lor prico stalility.
Iilorals anJ populists olton soarch lor potontial allios among inJustri-
alists, roasoning that ovon il linancial intorosts sullor in a loom, lirms that
traJo in roal, rathor than lictitious, proJucts voulJ thrivo vhon grovth is
strong. ln gonoral, inJustrialists aro loss than sympathotic to thoso argu-
monts. Employors in any inJustry liko slack in tho lalor markot: it makos
lor a pliant vorklorco, ono unlikoly to mako JomanJs or rosist spooJups.
ll a sizoallo portion ol inJustry oljoctoJ lunJamontally to contral lank
policy - not only in tho U.S., lut in tho rost ol tho rich vorlJ - thon
WALL STREET
124
contral lanks voulJn`t oporato tho vay thoy Jo.
4
Whilo rontiors might
liko a slightly highor unomploymont rato than inJustrialists, tho Jilloroncos
aron`t lig onough to inspiro a lig political light.
BonJ markots may hato oconomic strongth, lut vhat alout stocks?
Stroot-lovol visJom - Vain Stroot, not Wall Stroot - usually holJs that a
loom is gooJ lor stocks, lut this isn`t tho caso. Vost ol tho gains in a lull
markot aro maJo in tho lato rocossion-oarly rocovory porioJ. Stocks gon-
orally lohavo laJly just as tho roal oconomy is at its strongost. Sinco tho
oarly 1950s, roportoJ invostmont aJvisor Jamos Stack in tho August 19,
1994, issuo ol his 1u:~:T~cI novslottor, annual stock roturns havo avor-
agoJ +20.1/ vhon capacity utilization vas lolov 82/, anJ +6.0/ vhon it
vas alovo: +16.9/ vhon tho Columlia Univorsity Contor lor lntornational
Businoss Cyclo Posoarch`s loaJing inJox ol inllation vas lolov 0/, anJ
+8.3/ vhon it vas alovo: anJ +1./ vhon tho annual chango in spot
rav matorials pricos vas lolov 0/, anJ -0./ vhon it vas alovo. Othor
vork ly Stack, inspiroJ ly Vartin Zvoig anJ roportoJ in tho April 28,
1995, issuo ol 1u:~:IT~cI, shovoJ that convontional thinking, vhich soos
tho lost timo to luy stocks as vhon corporato prolits aro soaring anJ tho
vorst timo vhon thoy aro collapsing, is oxactly vrong. Botvoon 1938 anJ
1994, Stack roportoJ, oxcitoJly, tho most prolitallo porioJ to lo invostoJ
(u:II uIu:I u 2U% uuuuuI:z~u :~Iu:u vas vhon tho S8P 500`s lour-
ouartor oarnings voro IuuII:u at ovor a -25/ annual rato!` Noxt lost vas
Juring a prolit Joclino ol -10/ to -25/, anJ so on, up to tho vorst porioJ,
vhon prolits voro groving at ovor a 20/ annual rato, vhon roturns voro
laroly positivo. Stocks thrivo on a cool oconomy, anJ vithor in a hot ono.
That apparont contraJiction may lo rosolvoJ ly timing: tho stock mar-
kot, lolloving intorost ratos, tonJs to loaJ tho roal oconomy, as vork ly
AhmaJ A. KaJor (1985) shovs - though KaJor aptly points out that tho
markot`s loaJing rolo shoulJ not lo conlusoJ vith causation, sinco loth
stocks anJ tho roal oconomy olton rosponJ similarly to tho samo stimuli
(notally, lovor intorost ratos aro typically manna to loth vorlJs). KaJor
roportoJ that lrom 1963 to 1983, stock markot changos voro most highly
corrolatoJ vith GNP grovth tvo ouartors lator.
But that corrolation is lar lrom porloct. Tho markot gavo lalso signals in
1966 anJ 196, Jropping sharply vith no sulsoouont rocossion. KaJor
concluJos that though tho corrolation is high, it is still not as strong as
ono might oxpoct,` anJ shoulJ only lo usoJ vith caution` as a loaJing
oconomic inJicator. Tho 198 markot crash haJ no oconomic ollocts -
lut unJoultoJly locauso ol prompt, aggrossivo salvago oporations
ENSEMBLE
125
launchoJ ly tho vorlJ`s contral lanks: vithout thoso, tho collapso voulJ
prolally havo sproaJ, 1929-stylo. Tho markot must lo soon as a somo-
vhat unroliallo narrator: it gots lost in its ovn storios as it trios to Jivino
tho noar luturo. AnJ alout tho Jistant luturo, it thinks harJly at all.
Stopping into tho viJor vorlJ loyonJ tho U.S. anJ loyonJ tho moroly
cyclical makos tho picturo ovon llurrior. John Vullin, an oconomist vith
tho loJoral Posorvo Bank ol Nov \ork, marshalloJ a samplo ol 13 coun-
trios, six ol thom inJustrializoJ anJ sovon ol thom Jovoloping` (Vullin
1993). Ovor tho 15-yoar porioJ lrom 196 to 1991, Vullin`s Jata shov that
long-torm stock markot porlormanco can lost lo oxplainoJ ly JiviJonJ
grovth - lut ovon this is not tho tightost ol rolations, sinco only 31/ ol
tho variation in stock pricos can lo oxplainoJ` ly variations in JiviJonJ
grovth.
5
On soconJ glanco, this statistical rolation is ovon loss satislying
than it may soom: tho oouation JolivoroJ up ly tho rogrossion suggosts
that vith an annual rato ol 0/ JiviJonJ grovth, tho avorago stock markot
among tho Vullin 13 voulJ nonotholoss go up ly 16.6/ a yoar. Stock
markot invostors aro invotorato optimists. A loss omotional oxplanation
might lo that in a vorlJ vhoro tho rich tonJ to got richor, anJ park a lot ol
thoir ovor-oxpanJing voalth in stocks, tho markot can riso Jospito a gon-
oral oconomic torpor.
lor tho Vullin 13, tho rolationship lotvoon oconomic grovth anJ stock
markot porlormanco is as gooJ as ranJom. Whothor you uso roal GDP
liguros in national curroncy, as roportoJ in 1uI~:uuI:uuI 1:uuuc:uI
IuI::I:c:, or U.S. Jollar GDP por capita liguros, as roportoJ in tho WorlJ
Bank`s W:Iu TuII~:, tho rolationship lotvoon stock porlormanco anJ
oconomic grovth is ossontially pattornloss.
6
Back to tho U.S. oconomy, anJ moro rigorous statistical vork than oi-
thor Stack`s, KaJor`s, or mino. Nai-lu Chon (1991), lolloving up on somo
oarlior rosoarch (Chon, Poll, anJ Poss 1986), linJs that stock roturns can
lo proJictoJ ly sovoral inJicators, notally tho yiolJ curvo (tho stoopor tho
curvo, tho lottor stocks anJ tho oconomy vill Jo ovor tho noxt sovoral
ouartors): JiviJonJ yiolJs (high rolativo to stock pricos vhon tho markot is
poisoJ to Jo voll, anJ lov vhon tho markot is likoly to lo voak): anJ
inJustrial proJuction grovth (vhich movos invorsoly to tho markot -
that is, tho markot Joos voll vhon tho oconomy Joosn`t anJ vico vorsa).
Thoso rolations aro mostly looso anJ noisy. lt is intorosting, though,
that Chon`s Jata shovs that tho roal oconomy can also lo thought ol as
proJicting tho stock markot (vith roal voaknoss portonJing linancial
strongth), turning tho convontional notion ol tho stock markot as tho loaJor
WALL STREET
126
anJ tho roal vorlJ as tho lollovor on its hoaJ. Whon things movo in op-
posito Jiroctions, it`s aJmittoJly harJ to say vhich is tho causo anJ vhich
is tho olloct.
allocation
A gooJ Joal ol Wall Stroot timo is JovotoJ to assot allocation - liguring
out vhoro to put monoy. Analysts aro JoployoJ, loth on tho luy (cus-
tomor) anJ soll (lrokor) siJos, to scrutinizo tho hoalth ol tho national ocono-
mios, inJustrial soctors, anJ classos ol assots. Though lots ol institutional
invostors aro rostrictoJ in vhat thoy can luy - managors ol high-toch
mutual lunJs can`t luy auto stocks, anJ insuranco companios Jon`t luy
ponny stocks - ovon tho most tightly spocilioJ havo to liguro out just
vhat to luy, soll, anJ holJ. Tho loss rostrictoJ havo an array ol choicos to
mako: linancial assots vs. roal commoJitios, Jomostic vs. loroign assots, il
loroign thon Iatin Amorican vs. Alrican, stocks vs. lonJs, various kinJs ol
stocks (ly inJustrial soctor, ly sizo ol unJorlying company, ly various
linancial moasuros liko pricooarnings ratios) or lonJs (govornmont vs.
corporato, high-ouality corporato vs. lov-, long-torm vs. short-), anJ so
on. Ovor tho vory long torm stocks groatly outporlorm any othor assot
class, lut most pooplo Jon`t caro alout tho long torm: thoy vant to lo in
toJay`s hot soctor, tho Jay altor tomorrov lo JamnoJ.
Whilo stocks Jo outporlorm ovor tho vory long torm, it`s not roally cloar
vhy: thoir porlormanco can`t lo oxplainoJ ly most convontional linancial
moJols (Vohra anJ Proscott 1985: Siogol 1992). This is knovn as tho ~a-
u:I) j:~u:uu juzzI~ in tho traJo. Vany ingonious attompts havo loon
maJo to solvo tho puzzlo - liko nonaJJictivo halit lormation`
(ShrikhanJo 1996), vhatovor that moans - lut nono havo Jono so Jolini-
tivoly. Whon moasuroJ against long-torm oconomic grovth - anJ Siogol`s
vork covors tho U.S. lrom 1802 through 1990, alout as long-torm as an
anlysis can got - stock roturns soom too high anJ lonJ roturns too lov.
Ol courso, tho unJorlying moJols may lo nonsonso, lut il orthoJox oco-
nomics can`t oxplain tho stock markot, ono ol tho contral institutions ol
moJorn capitalism, vhat cuu tho Jisciplino oxplain?
But no ono on Wall Stroot caros alout such lunJamontal ouostions.
lnstoaJ, tho gamo is to play tho cyclo anJ tho microcyclo. Wall Stroot apolo-
gists might point to attompts to riJo omorging long-torm tronJs - liotoch,
tho lntornot - vith loth groat risk anJ promiso, lut tho Stroot is olton
vrong alout thoso things: thoy`ro lar moro passions ol tho momont than
ENSEMBLE
127
thoy aro sorious, JotachoJ prognostications. Talk ol structural translorma-
tions is olton just part ol tho salos rhotoric, a vay to havk a lrosh assot
class or JolonJ a lavoroJ olJ ono. lov pooplo pay as much attontion to
tho lusinoss cyclo as Wall Strootors - unJorstanJallo, givon tho chart
pattorns arounJ cyclical turning points. But unJorstanJing tho cyclo isn`t
onough: it`s also tompting to catch Joviations lrom tho cyclo - grovth
rocosssions,` solt lanJings,` anJ tho liko. Groat ollort goos into proJict-
ing important numlors: moaningloss lactoiJs liko in lour ol tho last livo
Aprils, omploymont camo in unJor tho consonsus` circulato, assortions
that aro olton vrong, lut aro nonotholoss loliovoJ anJ solomnly ropoatoJ.
But il onough pooplo loliovo thom, anJ tho markot movos in accorJanco
vith loliol, vhat Joos it mattor? Truth is vhat makos you monoy.
a trading week
Iot`s tako a look at a vook`s traJing in tho linancial markots to soo hov
thoy play against oach othor anJ tho roal vorlJ. l choso, part ly chanco
anJ part ly Josign, tho lirst vook ol Vay 1994. lt vas an intorosting vook
locauso sovoral signilicant oconomic roports voro Juo, notally tho ro-
port on omploymont lor April. ln this instanco, Wall Stroot vas actually
intorostoJ in an important thing, sinco tho stato ol tho lalor markots is,
asiJo lrom loing tho most humanly important ol all tho proJucts ol tho
loJoral Jata mills, tho lost contomporanoous inJicator ol tho gonoral stato
ol tho oconomy.
What lollovs vas vritton in roal timo` - vhich oxplains, anJ l hopo
oxcusos, tho uso ol tho historical prosont - to capturo tho sontimonts, as
ophomoral as thoy aro, that movoJ tho markots, anJ to avoiJ rotrospoctivo
visJom. TraJors, analysts, anJ somo acaJomics lroouontly arguo that tho
markots olton Janco to thoir ovn loat, anJ novsy oxplanations ol thoir
choroography aro simply altor-tho-lact rationalizations. UnJoultoJly thoro`s
somo truth to that, lut lor tho momont this Jiary is olloroJ in an agnostic
spirit. This is vhat happonoJ, anJ hov Wall Stroot roprosontoJ itsoll to
itsoll anJ tho outsiJo vorlJ.
lor somo timo nov, analysts havo loon prooccupioJ vith trying to Jivino
tho strongth anJ Juralility ol tho oconomic rocovory that logan lormally
in Varch 1991, lut vhich oualilioJ as prolally tho voakost anJ most
tontativo post-rocossion upsving in moJorn U.S. history.
WALL STREET
128
Wall Stroot has como to lovo this sluggishnoss - voak onough to koop
inllation at lay, lut just strong onough to stillo political prossuros lor lis-
cal stimulus, anJ vith jol grovth topiJ onough to koop lalor appropri-
atoly JisciplinoJ. \ot this spato ol lair voathor nov soomoJ a ploasant lut
laJing momory. Tho roal oconomy logan picking up stoam in lato 1993,
to tho alarm ol tho linancial markots, anJ tho monthly count ol nov jols
vas avoraging arounJ 200,000. ll that paco ol omploymont grovth con-
tinuoJ, tho unomploymont rato ol 6.5/, stullornly high lor tho thirJ yoar
ol an oconomic oxpansion, might Joclino. Though tho jol liguros lor Janu-
ary anJ lolruary voro JoprossoJ ly unusually nasty vintor voathor, thoro
vas a sharp rolounJ in Varch. ShoulJ April also shov a lrisk paco, thon
all holl coulJ lroak looso in tho markots on lriJay.
Tho languago usoJ to Joscrilo this oconomic strongthoning voulJ soom
surroal to ono untrainoJ in tho sultlo visJom ol Wall Stroot. Phrasos liko
Jark clouJs` anJ throat ovorhanging tho markot` havo loon throvn
arounJ lor tho last six months or so to Joscrilo a situtation that might
soom liko gooJ novs to tho outsiJo vorlJ. Wall Stroot has locomo con-
vincoJ that GDP grovth ovor 2.5-3.0/ anJ unomploymont ratos lolov
6.5/ aro nov unsustainally strong,` anJ must lo roinoJ in ly tightor
loJoral Posorvo policios.
Altor noarly lour yoars ol lalling intorost ratos, tho loJ logan rovorsing
tho tronJ in oarly 1994. As ol this vook, tho contral lank haJ tightonoJ
policy in throo notchos, starting on lolruary 4, anJ vas oxpoctoJ to con-
tinuo to Jo so ovor tho noxt sovoral months. With that tightoning camo tho
lirst signs ol sorious troullos in tho U.S. linancial markots - anJ tho vorlJ`s
- sinco lrao`s hostilo takoovor ol Kuvait in 1990. Varkots thrivo on lovor
intorost ratos anJ svoon on highor onos. BonJ pricos havo lallon alout
20/ lrom thoir 1993 poaks, anJ stock pricos alout 10/. Evoryono`s lavor-
ito omorging markot,` Voxico, has also solJ oll sharply, locoming a sul-
morging markot,` anJ tho vholo miraclo` - or lulllo,` il you prolor
- sooms on tho vorgo ol coming unstuck. Tho rocont Joclinos voro lairly
viJosproaJ: a Salomon Brothors roport roloasoJ oarly in tho vook shovoJ
that ol all tho vorlJ`s major lonJ markots, only Japan`s shovoJ gains in
prico (anJ Joclinos in yiolJ) Juring April.
Thoso oarly cracks voro shoving in linancial markots that voro among
tho most ovorvaluoJ in history. Though tho U.S. stock markot, anJ most
othor vorlJ markots, oxporioncoJ a massivo crash in 198, anJ a mini-
crash in 1989, thoy haJn`t oxporioncoJ a sustainoJ loar markot liko tho
ono ol tho miJ-190s in 20 yoars. But Jospito thoso cracks, tho gonoral
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129
mooJ vas ono ol conliJonco: vhilo tho markots might stumllo, most play-
ors voro convincoJ that tho unploasantnoss voulJ lo no moro than tran-
sitory. As tho lrokorago houso Whoat lirst saiJ in a commontary roportoJ
on CNBC, tho markots voro oxporioncing no moro than an inlroouont
porioJ ol oxtranoous volatility.`
Muuu), Mu) 2, I4 At 10 AV, tho National Association ol Purchasing
Vanagomont (NAPV) roloasoJ its April survoy ol tho oxocutivos vho luy
things lor largo corporations. lnstoaJ ol lalling slightly, it roso slightly.
Tho NAPV inJox has locomo ono ol Wall Stroot`s curront lavos, sinco it`s
supposoJ to lo a gooJ guiJo to tho stato ol tho manulacturing oconomy,
anJ ono that comos out moro
ouickly than ollicial govornmont
numlors. Whothor this is actually
tho caso has novor loon provoJ,
lut tho markots loliovo it to lo,
so no ono can ignoro tho ovont.
BonJ pricos loll on tho novs that
tho oconomy vas Joing lottor
than tho consonsus allovoJ.
Stocks shruggoJ oll tho voak
lonJ markot, anJ roso, though
not vi th an ovorpovori ng
strongth. Tho markot vas loJ
highor ly novs that tho Sviss
Jrug company Pocho voulJ luy
tho Calilornia-lasoJ Jrugmakor
Syntox lor $5.3 lillion, croating
tho vorlJ`s lourth-largost Jrug company. Syntox, onco a high-llying stock,
haJ crashoJ rocontly locauso many ol its most important patonts haJ loon
oxpiring, anJ it haJ nothing in its P8D pipolino to match tho olJ hits.
Othor Jrug stocks roso in sympathy vith Syntox`s: sinco hoalth rolorm
anJ cost-containmont prossuros haJ loon prossing tho consoliJation ol
tho inJustry, it JiJn`t soom outlanJish to lot on tho possilility ol othor
morgors. AnJ ovon il thoy JiJn`t happon, voll, it vas toJay`s story. Who
knovs vhat tomorrov`s vill lo?
Tu~:uu) At 8:30 AV, tho Commorco Dopartmont roportoJ that its inJox
ol loaJing oconomic inJicators (IEl), so-calloJ not locauso ol thoir promi-
All values are al narkel closes. Slocks are
lhe S&P 500, bonds, lhe near lulures con
lracl in U.S. Treasurv bonds, and lhe dollar,
lhe Feds index ol !0 currencies againsl lhe
U.S. dollar. All are indexed so lhal lhe clos
ing value on April 29, !994, equals !00. on
dav is av 2, !994.
93
99
!00
!0!
!02
Fri on Tue ved Thu Fri
the first week of May 1994
bonds
dollar
slocks
Fri Apr 29, !994 = !00
WALL STREET
130
nonco lut locauso ol thoir tonJoncy to loaJ changos in tho roal oconomy
ly 6 to 9 months, roso 0./ in Varch, anJ tho roaJing lor lolruary vas
rovisoJ lrom Jovn 0.1/ to unchangoJ.
8
Both voro a hair alovo oxpocta-
tions. Tho mossago is that tho oconomy survivoJ tho vintor anJ is lounc-
ing lack strongly in tho spring. Sinco this mossago is nov ouito lamiliar,
anJ sinco tho numlors camo in moro or loss in lino vith oxpoctations, anJ
sinco most ol tho compononts ol tho inJox aro knovn in aJvanco ol tho
lormal announcomont, tho markots shruggoJ oll tho novs, anJ somo lo-
gan spoculating alout noxt month`s numlor.
Tho U.S. Jollar vas voak on tho loroign oxchango markots, continuing
a multivook sliJo that Jolios short-torm oconomic logic. Europoan intor-
ost ratos havo loon tonJing lovor, thanks to tho gruJging oasing ly tho
Gorman BunJoslank, anJ U.S. ratos tonJing highor, Jovolopmonts that
shoulJ arguo lor a highor Jollar (Jovolopmonts that shoulJ attract capital
to tho U.S., thoroly pushing up tho curroncy). Tho only immoJiato ratio-
nalo vas political - tho Clinton aJministration voulJ liko to soo a highor
valuo lor tho yon to pross Japan into making traJo concossions. But that
Joosn`t oxplain vhy tho Jollar shoulJ lall against Europoan curroncios. A
longor-torm oxplanation - that tho U.S. is a Joltor country vhoso oxport
inJustrios aro aJJictoJ to tho stimulus ol a choap curroncy - is attractivo,
lut tho timing is a lit harJ to oxplain.
Though tho loJ anJ othor contral lanks camo to tho Jollar`s Jolonso
lato last vook, it coulJ lo that curroncy spoculators lounJ tho intorvon-
tions hall-hoartoJ, anJ thoy might lo tosting tho authoritios` rosolvo. ll
contral lanks JolonJ a sickly curroncy vith only hall moasuros, thon thoso
Jolonsos can lo littlo moro than a gilt to traJors.
9
ln this oxamplo, tho
contral lanks lought Jollars vith marks anJ yon to prop up tho U.S. unit`s
valuo. But lrom tho traJors` point ol viov, tho contral lankors voro just
luying a Joprociating assot vith approciating onos vithout having any
lasting olloct on tho markot`s tronJ. A casino oporator vho playoJ ly thoso
rulos voulJ ouickly lo out ol lusinoss.
BonJ pricos voro JoprossoJ ly tho voak Jollar, locauso, shoulJ intor-
vontion lail, tho loJ vill lo lorcoJ to hiko intorost ratos ovon moro than
thoy vant to othorviso, anJ moro than tho markots haJ loon oxpocting.
Stocks, Jospito tho voaknoss in lonJs, staggoroJ inJocisivoly, vith
lroaJor inJoxos Jovn moJostly anJ tho lluo-chip Dov up, loJ highor ly
Eastman KoJak, vhich announcoJ that it voulJ spin oll its Storling Jrug
Jivision. Stock jockoys onJorsoJ tho movo as oviJonco that KoJak voulJ
nov lo lroo to locus on its coro lusinossos: only a lov yoars ago, tho
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131
acouisition ol Storling vas chooroJ as a Jivorsilication avay lrom its stoJgy
olJ lilm lusinoss, viJoly thought to lo a tochnology in Joclino in thoso
Jays ol oloctronic imaging. ln othor morgor novs, tho soltvaro lirms
BroJorlunJ anJ Eloctronic Arts calloJ oll thoir marriago, saying that tho
markot`s nogativo juJgmont, oxprossoJ in Joclining sharo pricos sinco tho
announcomont, maJo tho union look unviso. Thus Jo markot gyrations
alloct tho roal vorlJ.
W~uu~:uu) Tho Nov \ork morning lrought novs ol hoavy contral lank
intorvontion to prop up tho sagging U.S. Jollar, vhich roachoJ sovon-
month lovs in yostorJay`s traJing. ln a statomont to tho pross, Troasury
Socrotary IloyJ Bontson, vho is in chargo ol tho Jollar - curroncy markot
intorvontion is tho only instanco vhoro tho loJ is logally roouiroJ to Jolor
to oxocutivo lranch vishos - saiJ that tho aJministration soos no aJ-
vantago to an unJorvaluoJ curroncy,` anJ that tho intorvontion vas Jo-
signoJ to countor rocont movos in oxchango markots |thatl havo gono
loyonJ vhat is justilioJ ly oconomic lunJamontals.` By Jay`s onJ, tho
contral lanks ol 1 countrios lought $3-5 lillion to prop up tho curroncy`s
valuo - tho most massivo curroncy oporations in a JocaJo - vith tho
loJ alono intorvoning 1 timos. But in a markot vhoro traJing avoragos
arounJ $1 trillion a Jay, it`s unlikoly that intorvontion alono vill rovorso
tho tronJ: shoulJ tho groonlack rosumo its sliJo altor tho smoko cloars,
thon tho loJ might lo lorcoJ to raiso intorost ratos il it roally vants to
JolonJ tho Jollar`s valuo. Tho U.S. lonJ markot`s voaknoss in tho laco ol
tho intorvontion loJ to markot gossip that a loJ tightoning - spocilically,
an incroaso in tho Jiscount rato - vas imminont.
loroign oxchango traJors suspoct that tho Clinton aJminstration voulJ
lo happy to soo tho Jollar lall somo moro, suspicions that voro roinlorcoJ
ly Ialor Socrotary Polort Poich`s romark that tho Jollar`s svoon vasn`t
inllationary, locauso curroncy valuations aro rolativoly short-torm pho-
nomona.` Tho Ialor Dopartmont ouickly issuoJ a clarilication` ol Poich`s
romark, saying that it vas not intonJoJ as a commont on oxchango rato
policy. As tho vook progrossoJ, aJminstration ollicials rolusoJ to uttor a
vorJ alout tho Jollar, rolotically saying that only Bontson vas autho-
rizoJ to mako such statomonts. Evon altor tho intorvontion, suspicions lin-
goroJ that Clinton 8 Co. voulJ lo happy to soo tho Jollar Joclino somo
moro - just not too ouickly, anJ as long as it JiJn`t throaton tho stalility
ol U.S. linancial markots.
At noon, tho loJ roloasoJ its loigo look` - or tan look,` JoponJing
WALL STREET
132
on your proloroncos - a compilation ol roports alout oconomic conJi-
tions arounJ tho country issuoJ ovory six vooks in aJvanco ol tho policy-
sotting loJoral Opon Varkot Committoo`s (lOVC) mooting. (Tho namo
comos lrom tho lact that tho copy prosontoJ to lOVC momlors has a
loigo covor: markot participants soo mainly viro sorvico accounts ol tho
volumo, anJ tho vorsion mailoJ to moro civilians has only a vhito papor
covor anJ vory lov proJuction valuos.) Tho roport is lasoJ on vork at tho
tvolvo rogional loJoral Posorvo Banks, oach ol vhich has a lormiJallo
intolligonco notvork in its Jistrict, lasoJ on intorviovs vith oxocutivos,
lankors, roal ostato Jovolopors, tax colloctors, anJ othor inhalitants ol
vhat linancial playors call tho roal soctor.`
lor yoars, loigo looks havo loon roporting topiJ oconomic conJitions,
vith rogional or soctoral pockots ol strongth amiJst a lairly tontativo ro-
covory. This issuo, hovovor, roportoJ soliJ` grovth ovoryvhoro lut Cali-
lornia, anJ ovon tho lirst signs ol a pickup thoro. Sovoral important soctors
- autos, stool, anJ luilJing matorials - voro saiJ to lo noar capacity.`
ln loJcoJo, this moans that lottlonocks anJ prico risos aro prolally not
lar lohinJ, conJitions vhich must lo aJJrossoJ through anothor tighton-
ing. Sinco tho oconomy`s grovth vas JoscriloJ as soliJ,` this must lo
takon as oviJonco that tho loJ thinks tho tightoning can lo Jono vithout
much Jamago. That tho at-capacity soctors aro vory intorost-rato sonsitivo
- tho strongth ol tho auto anJ housing markots corrolatos strongly vith
tho oxponso or choapnoss ol auto anJ mortgago loans - no Joult roin-
lorcos loJ rosolvo to tighton, il not nov, than at tho Vay lOVC mooting.
ln tho stock markot, Jrug anJ othor hoalth caro stocks romainoJ hot,
thanks to tho spillovor lrom tho Syntox anJ Storling novs, anJ to contin-
uoJ luzz that inJustry consoliJation vas inovitallo.
TIu::uu) Varkots voro lairly ouiot toJay, as tho Just sottloJ in tho lorox
markots, anJ stock anJ lonJ playors avaitoJ tomorrov`s omploymont
roport. At 8:30, tho BIS roportoJ a Jrop in tho numlor ol vorkors apply-
ing lor unomploymont insuranco last vook: this vas takon as a sign that
tomorrov`s omploymont roport voulJ lo on tho strong siJo. lor somo
roason, Wall Stroot takos this so-calloJ initial claims sorios as a picturo ol
tho prosont omploymont picturo: in roality, it`s a lottor proJictor ol tho
noar luturo, vhich is vhy it`s ono ol tho compononts ol tho ollicial loaJing
inJicators inJox.
Entortainmont vas proviJoJ ly Domocrats on tho housing sulcommit-
too ol tho Sonato Banking Committoo, vhich olloroJ a lorum lor
ENSEMBLE
133
homoluilJors to complain alout tho loJ`s groving stinginoss. An inJus-
try lollyist ostimatoJ that highor ratos havo alroaJy trimmoJ construction
payrolls ly 80,000 jols, anJ anothor 100,000 voro at risk voro tho risos
not to lo rovorsoJ. Sonator Paul Sarlanos, tho sulcommitoo chair, saiJ ho
vas puzzloJ` anJ Jooply concornoJ` ly tho loJ`s tightoning, vhich is
lairly harJ to loliovo, sinco Sarlanos isn`t stupiJ ly Sonatorial stanJarJs
anJ tho loJ`s lohavior is porloctly consistont vith vhat it anJ Wall Stroot
soo as its mission - kooping tho oconomy slack onough to provont inlla-
tionary prossuros lrom Jovoloping. Congrossional posturing, somo ol it
sincoro, is littlo moro than stoam-vonting, sinco no rospoctallo logislator
voulJ ovor soriously challongo tho primacy ol monoy capital: in lact, poli-
ticians aro olton happy to havo tho loJ tako tho hoat lor thom.
Stocks, lonJs, anJ othor major assot markots closoJ noarly unchangoJ,
as thoy olton Jo ahoaJ ol important novs: only tho lravost mako lig lots
16 hours loloro an announcomont that may provo thoir guossos vory vrong.
Tho only oxcoption vas tho Dov Jonos Utility Avorago, vhich saggoJ,
suggosting unJorlying voaknoss in conliJonco anJ an upvarJ lias to in-
torost ratos lurking lohinJ tho apparont calm.
1::uu) AccorJing to a survoy takon a vook ago ly VVS lntornational, a
rosoarch loutiouo, tho markot`s avorago oxpoctations aro that tho U.S.
oconomy aJJoJ 15,000 jols in April, or moro procisoly, that tho Buroau
ol Ialor Statistics vill roport that as tho ostimato ol tho month`s jol grovth.
Whilo tho BIS`s monthly survoy ol omployors is tho largost monthly sam-
pling oporation in tho liolJ ol social statistics,` as tho Buroau`s loilorplato
in ovory issuo ol EujI)u~uI uuu Eu:u:u: roaJs, it is still only an osti-
mato, anJ is suljoct to numorous rovisions, as aro most oconomic num-
lors. Still, vhat roally mattors lor tho markots is tho numlor that prints on
tho novs tickor an oyollink altor tho roport is roloasoJ: sorious analysts
may scrutinizo tho roloaso lor cluos to tho truth lohinJ tho hoaJlinos, lut
il you`ro slinging papor arounJ, vhat mattors moro than anything olso is
vhothor a numlor comos in moaninglully alovo or lolov tho consonsus.
lor tho vorking class, April turnoJ out to lo a lottor month than Wall
Stroot imaginoJ: omploymont grov ly 26,000, anJ tho provious tvo
months` ostimatos voro rovisoJ up lairly sharply. (Connoissours somo-
timos viov rovisions as a cluo to an unJorlying tronJ: upvarJ rovisions
suggost a strong unJorlying tronJ, anJ ono that ollicial numlors may lo
unJorostimating: JovnvarJ rovisions suggost tho rovorso. Not that thoro`s
any sorious oviJonco this is tho caso, though.) BonJ pricos instantly loll
WALL STREET
134
ovor a lull point, a moJoratoly Jramatic movo, ignoring novs olsovhoro
in tho statistical roloaso shoving that avorago hourly oarnings grov only
throo conts, to $11.06 - an annual rato ol just ovor 3/, in lino vith inlla-
tion. lor U.S. vorkors, vho`vo oxporioncoJ 20 yoars ol Joclining roal hourly
vagos, ovon this strong omploymont grovth has loon unallo to Jolivor
any vago improvomont. To Wall Stroot oyos, hovovor, that`s gooJ novs:
vago inllation` is unJor control lor nov. Thoro`s nothing tho lonJ ghouls
hato moro than roal vago incroasos lor anyono lut thomsolvos.
Dospito that vago sluggishnoss, anJ tho gooJ lohavior ol tho gonoral
prico inJoxos, tho consonsus is that tho loJ vill tighton again loloro long.
This supposition vas conlirmoJ ly loJ govornor Iavronco IinJsoy, vho
saiJ that monotary policy vas not ouito in noutral.` Noutral, in loJspoak,
is a ouphomism lor moJoratoly tight: lor months tho contral lank`s lino
has loon that its lov intorost rato policios, vhich haJ savoJ tho linancial
systom lrom tho inJiscrotions ol tho 1980s, voro oxcossivoly stimulativo
nov that tho linancial systom haJ hoaloJ, anJ that it vas moroly shilting
policy lack to noutral` ly pushing up ratos.
W~~~uu Tho loaJ hoaJlino in SunJay`s N~u : T:u~: Joclaros U.S.
Shilts Stanco ln Ellort To Slov Economic Grovth,` anJ its lirst sontonco
roaJs: Altor a yoar anJ a hall ol sooking lastor oconomic grovth, tho
Clinton AJministration has nov roluctantly changoJ courso, putting tho
stalility ol linancial markots ahoaJ ol rapiJ oconomic oxpansion.` Doopor
into tho story, tho author Koith BraJshor notos that this shilt coulJ lo
unpopular vith liloral Domocrats.|llut it is in kooping vith Vr. Clinton`s
political goal ol positioning himsoll as a Domocrat vho is not loaroJ on
Wall Stroot.` Grovth must lo throttloJ lack to no moro than 2.5/, or maylo
3/ tops - lolov lovols that might mako possillo sharpor roJuctions in
unomploymont, strongthon lalor`s largaining position, anJ maylo ovon
rovorso, hovovor tomporarily, tho 20-yoar Joclino in roal vagos.
This story may lo a plant, an attompt to calm tho markots through loak-
ing: BraJshor is a roportor vho has haJ no troullo sorving as a lrictionloss
conJuit lor aJministration or loJ propaganJa. But it Joos lit vith ovonts:
challonging tho Wall Stroot JomanJ lor slovor grovth voulJ lo political
Jynamito - just tho kinJ ol light a not-loaroJ-on-Wall-Stroot Domocrat
voulJ shy avay lrom. Tho lonJ-markot vigilantos havo von.
P:I:c::jI This look is loing proparoJ lor pullication tvo-anJ-a-hall yoars
altor that Jiary vas vritton. Grovth continuoJ to lo strong lor tho rost ol
ENSEMBLE
135
1994, consistontly surprising Wall Stroot, vhich vas touting an imminont
slovJovn, anJ tho loJ tightonoJ sovoral moro timos. 1994 turnoJ out to
lo tho lonJ markot`s vorst yoar in moJorn history, anJ porhaps ovor:
highor U.S. intorost ratos holpoJ throv Voxico into crisis. lor a momont, it
lookoJ liko a loar markot anJ maylo ovon a rocossion vas in orJor, lut
tho loJ, apparontly loaring that it haJ ovorJono tho tightoning, lackoJ oll
a lit, pushing Jovn loJ lunJs lrom thoir spring 1995 poak. Grovth slovoJ
consiJorally - vhothor locauso ol tho loJ`s tightoning, tight liscal policy,
or tho oconomy`s immanont torpor - to tho 2.0-2.5/ rango, lolov tho
targots montionoJ in BraJshor`s T:u~: articlo, lut still alovo rocossion
lovols. Dospito tho slov grovth, tho lalor markot tightonoJ ovor tho noxt
tvo yoars, vith unomploymont lalling ly a porcontago point. Tho Jollar
continuoJ its Joclino into tho summor ol 1995, stalilizoJ, anJ thon ro-
gainoJ alout hall its lossos ly miJ-1996. Tho lonJ markot rotracoJ a lit
moro than hall its Joclino, anJ tho stock markot, alroaJy granJly ovorval-
uoJ, roso 46/ ovor tho noxt tvo yoars. Though prosumally loJ tighton-
ing voulJ lo in orJor somoJay, 1995 anJ 1996 voro vonJorlul yoars to
ovn stocks.
notes
1. Tho allusion is not only to SaJJam Hussoin, lut to Karl Varx (1981, p. 596): |llntorost-
loaring capital alvays loing tho mothor ol ovory insano lorm, so that Jolts, lor ox-
amplo, can appoar as commoJitios in tho minJ ol tho lankor..`
2. DiviJonJs aro gonorally moro stallo than prolits, lut JoponJ ultimatoly on thom, so lor
tho purposos ol this oxorciso, thoy aro protty voll intorchangoallo. AcaJomics prolor
looking at JiviJonJs, anJ Wall Strootors, prolits.
3. This voak proJictivo valuo ol tho stock markot vas conlirmoJ in a stuJy ol lanks that
lailoJ or voakonoJ in tho 1980s. Katorina Simons anJ Stophon Cross (1991) lounJ that
stock pricos lail|oJl to anticipato lank JovngraJos ly oxaminors.` Stock traJors loarnoJ
vhon ovoryono olso JiJ that a lank vas in troullo. Dospito this rocorJ, Wall Stroot lolk
visJom attrilutos almost mystical lortuno-tolling povor to linancial markots: somo
partisans ovon arguo that agricultural luturos markots aro lottor at lorocasting tho voathor
than motoorologists.
4. Thoro is tho aJJitional lact that many nonlinancial corporations havo hoavy linancial
intorosts: GE, an iJoal typo ol tho largo U.S.-lasoJ inJustrial ontorpriso, JorivoJ 24/ ol
its 1994 prolits lrom linancial sorvicos (S8P Onlino).
5. That is, in a linoar rogrossion ol stock markot roturn on JiviJonJ grovth, tho aJjustoJ
r
2
is .31, vith p-.0282. lirms tonJ to smooth JiviJonJ payouts ovor tho oconomic cyclo
(that is, JiviJonJs aro loss volatilo than prolits or oconomic grovth), so somo ol this
corrolation may lo spurious. Thanks to Vullin lor sharing tho Jata lohinJ his articlo.
6. That is, a linoar rogrossion rolating loth to roal stock roturns, p-.3 anJ p-.521,
rospoctivoly.
. lor tho sako ol oconomy, JotailoJ roloroncos aro omittoJ. This Jiary vas compiloJ
WALL STREET
136
using tho lolloving sourcos: N~u : T:u~:, 1:uuuc:uI T:u~:, WuII I:~~I {u:uuI,
Wu:I:uIu P:I, Poutors, AssociatoJ Pross, Dov Jonos, VVS lntornational, CNBC (tho
callo TV linancial novs channol), as voll as phono chats vith markot olsorvors anJ
participants.
8. This inJox, along vith tho lagging anJ coinciJont inJicators, vas privatizoJ in 1996:
tho Commorco Dopartmont turnoJ ovor its proJuction anJ pullication to tho lusinoss-
lunJoJ Conloronco BoarJ. Sinco tho inJoxos aro compiloJ lrom proviously roportoJ
Jata, almost all ol it lrom tho govornmont, tho Dopartmont JoomoJ it a lov-priority
itom in tho laco ol still luJgot cuts. Still, tho inJoxos anJ thoir compononts aro usolul,
anJ until lato 1995 voro pullishoJ in tho yollov pagos` ol tho Dopartmont`s llagship
oconomic journal, u::~) J u::~uI 1u::u~:: Thoso pagos voro a rosiJuo ol anothor
casualty ol luJgot constraint, tho 1u::u~:: uu:I:u: 1:~:I, snulloJ in 1990: tho 11s
yollov pagos voro lolJoJ into tho u::~). (Tho 11 vas origianlly knovn as tho
1u::u~:: )cI~ 1:~:I, lut in tho optimistic Jays ol tho lato 1960s, vhon it vas thought
tho lusinoss cyclo haJ loon conouoroJ ly aJopt Koynosian managomont, tho )cI~
vas changoJ to uu:I:u:) Thoy join in Joath tho u::~)s lluo pagos,` anothor
componJium ol usolul inJicators, snulloJ in 1994. No Joult, tho Conloronco BoarJ
vill Jo a lino jol in assomlling anJ Jistriluting tho inJicators. But thoy apparontly lool
no sonso ol pullic Juty in pricing thoir nov sorvico, 1u::u~:: )cI~ 1uu:cuI::. a yoar
vill go lor $95 anJ up. A sulscription to tho u::~) J u::~uI 1u::u~::, hovovor, vas
$41 in 1996, anJ tho journal also contains hugo amounts ol original inlormation.
9. Though intorvontion is lar lrom tho suiciJal thing it`s thought to lo lor tho contral
lanks, as vo sav in Chaptor 1. ln this caso, tho U.S. Jollar continuoJ to sink, vith tho
loJ`s Jollar inJox losing alout 5/ ol its valuo through tho onJ ol 1994, anJ alout that
much again in 1995. Still, tho contral lank maJo $06 million in prolits on loroign
oxchango intorvontion in all ol 1994.
137
4 Market models
So lar, this has largoly loon a Wall Stroot vulgato. What has tho Jismal
scionco Jono vith linanco on a moro rigorous lovol?
ln (noo)classical oconomics, monoy is holJ to lo noutral - a moro lu-
lricant to traJo, lut not a lorco in itsoll. lronically, though, thoorios lrom
that traJition voro part ol tho intolloctual lounJation as voll as tho mar-
koting garl lor tho linancial oxporimonts ol tho 1980s.
Tho placo ol linanco - lumping togothor monoy anJ croJit in Jisro-
garJ ol all Jistinctions lotvoon thom
1
- in oconomics is ouito oJJ. As
ClauJio Borio (1995, p. 3), an oconomist vith tho Bank lor lntornational
Sottlomonts, put it:
lt sooms lair to say that contral lankors, accustomoJ to tracing tho ollocts ol
thoir actions through tho linancial systom, havo prolally laiJ moro ompha-
sis on croJit than acaJomics, vho aro moro usoJ to thinking in torms ol
simplo paraJigms vhoro croJit may not ovon appoar oxplicitly. Similarly,
croJit has traJitionally loon moro prominont in policy Jiscussions in sov-
oral continontal Europoan countrios than in somo Anglo-Saxon onos, ospo-
cially in tho UnitoJ Statos, partly locauso ol a loss porvasivo monotarist
traJition..
Borio is right that contral lankors, anJ oconomists vorking lor contral
lanks, aro olton much moro intorosting than acaJomics on tho suljoct ol
hov linanco anJ tho concroto rolato to oach othor. His simplo paraJigms`
aro tho noat mathomatical moJols that oconomists luilJ to roprosont so-
cial roality, or at loast to convoy somo thoory alout social roality, para-
Jigms that olton ignoro monoy anJ linanco complotoly, or troat it as an
altorthought. (Tho irony ol monotarism` loing partly rosponsillo lor this
strango inJilloronco to monoy anJ croJit is ono l`ll roturn to.) Thoso Amori-
can oconomists vho havon`t ignoroJ linanco havo luilt thoir ovn para-
WALL STREET
138
Jigms, simplo anJ complox, that roturn tho lavor ly olton troating tho
roal` soctor as an altorthought.
A vol ol linancial thoorios, spun lrom tho 1950s onvarJ, locamo tho
orthoJoxy ol lusinoss schools anJ oJitorial loarJs in tho 190s onvarJ.
Thoso thoorios holJ that tho markots aro olliciont anJ rational, that thoy
optimizo tho allocation ol social capital, anJ that tho capital structuro ol
lirms (hov much Jolt anJ hov much oouity aro on tho lalanco shoot)
harJly mattors. linanco locamo capital`s mastor control panol: liloratoJ
lrom tho lottors ol rogulation, it coulJ spontanoously Jrain capital lrom
Joclining soctors anJ llooJ moro promising onos vith cash - vithout
introJucing any mischiol ol its ovn. To arguo this, oconomists anJ prolos-
sors ol linanco luilt many lovoly moJols.
2
the technique of economics
Charlos Plossor (1984) listoJ somo ol tho lasic assumptions on vhich moJ-
orn linancial thoory is lasoJ:
Vost ol tho lunJamontal contrilutions to linancial oconomics, incluJing
portlolio thoory, tho VoJigliani-Villor Thoorom, olliciont markots, anJ vir-
tually all ol tho assot-pricing moJols, havo loon JovolopoJ unJor tho as-
sumption ol a j~:J~cI uu:~I ly vhich l moan (1) no transaction costs, (2)
comploto anJ costloss inlormation, anJ (3) compotition.
As Plossor notoJ, thoorists, ospocially ol tho Koynosian varioty, aro ouick
to assumo tho oxistonco ol arlitrary constraints anJor markot lailuros,`
such as institutional anJor vago-prico rigiJitios, nonmarkot cloaring,
oxogonously JotorminoJ long-torm contracts, anJ tho monoy illusion, to
vhich you may aJJ your lavoritos.` But, arguoJ Plossor, vo nooJ puro
moJols ol markot lunction so vo may lottor unJorstanJ tho Joparturos
lrom purity. ln oconomics, roality is olton troatoJ not as tho starting point
ol analysis, lut as a sot ol unlortunato constraints on or oxcoptions to tho
thoorotical utopia ol porloct markots.
ll you roaJ nooclassical - or vhat usoJ to lo calloJ lourgoois - oco-
nomics, tho markot porlorms its magic lor lroo. Pricos lloat gontly to thoir
natural lovol, gooJs anJ capital aro loJ magnotically to thoir most lruitlul
rolos, anJ matorial proJuction anJ human happinoss aro thoroly maxi-
mizoJ. But markots aro oxponsivo to croato anJ maintain, anJ ovon il tho
aJjustmonts` promotoJ ly lroo-lloving markots voro olliciont, thoro`s
no guarantoo tho ollicioncy gains oxcooJ tho costs ol tho markot. Tho con-
MARKET MODELS
139
sumor sphoro, lor oxamplo, is povoroJ ly a massivo rogimo ol psycho-
motricians anJ imago morchants. AnJ linanco, as vas shovn in Chaptor
2, is vory oxponsivo. lnlormation gathoring is harJly costloss: loth con-
sumors anJ inJustrialists sponJ plonty ol timo anJ monoy rosoarching tho
stull thoy luy. Nor aro all participants ooually inlormoJ: vhat small sharo-
holJor coulJ unJortako tho rosoarch a hugo invostmont lunJ can, or oavos-
Jrop on tho socrots that loak through Chinoso valls?
A nonacaJomic conlronting tho acaJomic oconomics litoraturo is con-
lrontoJ vith a largoly torrillo thing. Vuch ol it consists ol luilJing olalo-
rato moJols, anJ ompirical vork consists in litting Jata to tho moJol.
3
linancial thoory is ono ol tho most mathomatizoJ lranchos ol oconomics.
Economics vas onco knovn as political oconomy: class, povor, insti-
tutions, anJ ovon a vision ol hov tho vorlJ shoulJ lo mattoroJ at loast as
much as numlors. Politics logan to Jisappoar in tho 19th contury, anJ
mathomatics camo to Jominato in tho miJ-20th. Economics, at loast in tho
English-spoaking vorlJ, has locomo moro anJ moro a mattor ol ocono-
motrics. As Potor KonnoJy (198, p. 1) notoJ in his oxcollont primor on
tho suljoct, strango as it may soom,` thoro is no gonorally accoptoJ Joli-
nition ol oconomotrics. KonnoJy saiJ his guiJo to oconomotrics vas Jo-
votoJ to tho Jovolopmont ol statistical tochniouos appropriato to tho
ompirical prolloms charactorizing tho scionco ol oconomics.` KonnoJy
usoJ tho vorJ scionco` vithout any ouotation marks.
As ono ol tho liolJ`s major aJopts, GorarJ Dolrou (1991) notoJ in his
1990 prosiJontial aJJross to tho Amorican Economic Association (AEA),
in 1940, ono only nooJoJ lasic collogo math to lollov tho traJo: in 1990,
graJuato training in mathomatics is nocossary.` To Dolrou, tho liolJ has
loon holpoJ ly groator alstraction,` though Jotails on tho naturo ol this
claimoJ improvomont aro sparso in his toxt. But Dolrou Joos concoJo
ono prollom vith this numorical turn - that it has promotoJ an insularity
in tho prolossion, so that mathomatical sophistication itsoll, rogarJloss ol
its roloront, is rovarJoJ, anJ so that its vory incompohonsilility to a gon-
oral auJionco is part ol tho thrill. Sinco its mossagos cannot lo JociphoroJ
ly oconomists vho Jo not havo tho propor koy, thoir ovaluation is on-
trustoJ to thoso vho havo accoss to tho coJo.` AnJ so oconomics has
valloJ itsoll oll lrom tho othor social scioncos, intoxicatoJ ly lantasios ol
its ovn rigor.
Economic numlors aro Jirty statistics - not locauso ol Joviousnoss or
incompotonco on tho part ol tho Jata gathorors, lut ly tho vory naturo ol
tho animal. National incomo accounting is carrioJ out to tho noarost hun-
WALL STREET
140
JroJ million Jollars, lut tho liguros aro only ostimatos, imporloctly col-
loctoJ anJ imporloctly organizoJ. GDP ostimatos can novor lo as accurato
as llooJ counts. Pun tvo or throo timo sorios, ostimatos all, through your
statistical soltvaro anJ you may oithor compounJ orrors or lall proy to
spurious corrolations. lnvostmont is harJ onough to moasuro (is soltvaro
capital?), anJ Joprociation is ovon harJor, lut thoso ostimatos in turn lorm
tho lasis ol moasuring grovth, prolitalility, anJ proJuctivity. lncomo anJ
proJuction liguros aro olton oxtrapolatoJ lrom omploymont ostimatos, so
any link JiscovoroJ lotvoon can lo loss than rovoaling. Economotricians
uso ovor moro sophisticatoJ tochniouos to try to outvit tho Jolicioncios in
thoir Jata, lut all lall proy to GooJhoart`s Iav, namoly that all oconomot-
ric moJols lroak Jovn vhon usoJ lor policy` (KonnoJy 198, p. 6).
Though tho machinory has gotton consiJorally moro complicatoJ ovor
tho yoars, oconomotricians ossontially comparo tvo or moro variallos vith
oach othor to linJ somo pattorn among thom - or to linJ it missing, il
thoy`ro trying to Jisprovo somothing. An analyst might Joviso a moJol in
vhich changos in monoy grovth, intorost ratos, privato invostmont, anJ
govornmont sponJing voro tostoJ soparatoly anJ togothor lor thoir ca-
pacity to anticipato changos in GDP grovth. ln such a moJol, GDP voulJ
lo tho JoponJont, anJ tho othors tho inJoponJont, variallos. KonnoJy
(198, p. 69) olloroJ this aJvico on hov to chooso tho variallos lor your
moJol:
Tho lirst anJ most important ingroJiont in such a soarch is oconomic thoory.
ll oconomic thoory cannot JolonJ tho uso ol a variallo as an oxplanatory
variallo, it shoulJ not lo incluJoJ in tho sot ol potontial inJoponJont vari-
allos. Such thoorizing shoulJ tako placo I~J:~ any ompirical tosting ol tho
appropriatonoss ol potontial inJoponJont variallos: this guarJs against tho
aJoption ol an inJoponJont variallo just locauso it happons to oxplain` a
signilicant portion ol tho variation in tho JoponJont variallo in tho particu-
lar samplo at hanJ.
This takos hypothosis tosting - hypothosos prosumally loing JorivoJ
lrom tho inlormoJ olsorvation ol roality - into a puroly iJoal roalm. Ol-
sorvation anJ oxporionco aro JistrustoJ, anJ thoory instoaJ is tho loJo-
star. Givon tho lias ol most thoorists anJ thoorios, thon, this stylo ol
oconomics can gonorally lo trustoJ to proJuco rosults proving unlottoroJ
markots to lo tho linost principlo ol social organization.
Thoro`s ono storling oxamplo ol that JoponJallo lias, tho minimum
vago, almost univorsally rogarJoJ ly oconomists to lo a jol-killor. Thoir
MARKET MODELS
141
roasoning is puro Econ 101 - raiso tho prico ol somothing (anJ a vago is
tho prico ol lalor), anJ you Jopross JomanJ lor it. Thoroloro, loosting
tho minimum vago Iu: to rosult in an omploymont Joclino lor lov-onJ
vorkors. But in survoys ol omployors takon just loloro anJ altor changos
in tho minimum vago, DaviJ CarJ anJ Alan Kruogor (1995) shovoJ that
this just isn`t truo. Thoy pausoJ lor a lov pagos in tho miJJlo ol thoir
look, M)II uuu M~u:u:~u~uI, to roviov somo roasons vhy tho acaJomic
litoraturo has almost unanimously lounJ tho minimum vago guilty as
chargoJ. Thoy surmisoJ that oarlior stuJios shoving that highor vagos
roJucoJ omploymont voro tho rosult ol pullication lias` among journal
oJitors. Thoy also surmisoJ, vory Jiplomatically, that oconomists havo loon
avaro ol this lias, anJ playoJ thoso notorious scholarly gamos, spocili-
cation soarching anJ Jata mining` - lonJing tho numlors to oltain tho
JosiroJ rosult. Thoy also notoJ that somo ol tho oarly stuJios voro lasoJ
on soriously llavoJ Jata, lut sinco tho rosults voro Josirallo lrom loth
tho political anJ prolossional points ol viov, thoy vont unJiscovoroJ lor
sovoral yoars.
ln its lorocasting, math-happy oconomics oxposos its limits to tho vorlJ,
proving Wassily Ioontiol (191) too kinJ in his romark that in no othor
liolJ ol ompirical inouiry has so massivo anJ sophisticatoJ a statistical
machinory loon usoJ vith such inJilloront rosults.` Tvo oxamplos ol soll-
criticism como to minJ. ln a roviov ol tho lorocasting accuracy ol tho
lVl`s W:Iu Ecuu:c uII anJ that ol tho Organization lor Economic
Cooporation anJ Dovolopmont, lunJ stall oconomist V.J. Artis (1988)
lounJ thom roughly comparallo, vith a Jocont rocorJ il you go no lur-
thor than ono yoar out, lut likoly to miss turning points. ln othor vorJs, il
noxt yoar is protty much liko this yoar, tho lorocast vill lo accurato.
Economists lrom tho U.S. Buroau ol Ialor Statistics (lullorton 1992,
SaunJors 1992, Posonthal 1992) roviovoJ tho Buroau`s ovn omploymont
projoctions anJ lounJ similar lailings. Tho 193 lorocast lor 1990 groatly
unJorostimatoJ tho continuing surgo ol vomon into tho vorklorco. Pro-
joctions ol tho lomalo lalor lorco participation rato (IlPP) in 1990 maJo
in 198, 1980, 1983, anJ 1985 voro a lot closor to tho mark, lut ly 198,
vomon`s IlPP haJ alroaJy rison sharply onough to lo noticoallo. ln its
macrooconomic projoctions, tho 198 anJ 1981 GNP lorocasts lor 1990
voro too optimistic - tho 198 lorocast ly a margin ol 11.5/, a not incon-
siJorallo $386 lillion. Though tho orror got smallor as timo vont on, thoro
vas a porsistont tonJoncy to ovorostimato tho grovth ol lalor proJuctiv-
ity. lorocasts lor tho composition ol GNP voro ovon vorso than tho ag-
WALL STREET
142
grogato numlors: tho consumption sharo projoctoJ lor 1990 in 198 vas
too high: that proJictoJ in 1981 vas too lov: 1983 anJ 1985 projoctions
voro much closor to tho markot - lut all missoJ tho lall in sponJing on
nonJurallo gooJs anJ tho riso in sponJing on moJical anJ linancial sor-
vicos. Tho BIS also missoJ JoinJustrialization anJ tho ovorluilJing ol
commorcial roal ostato - tronJs that unhappily shapoJ tho U.S.
macrooconomy ol tho oarly 1990s. ln tho vorJs ol tho Buroau`s ovn sum-
mary ol its roviov, tho projoctions improvo tho noaror to tho targot yoar
thoy aro maJo.: tho JovnsiJo is that thoy olton lail to lorsoo major struc-
tural shilts in tho U.S. oconomy` (SaunJors 1992, p. 15). ln othor vorJs,
lorocasts aro loast accurato vhon thoy aro most nooJoJ - vhon tho vorlJ
is alout to chango. Thoy aro lost at proJicting tho prosont anJ tho noar
luturo, assuming tho status ouo isn`t ovorturnoJ.
Tho point ol this littlo roviov is not just to omlarrass ollicial visJom,
though cortainly that is alvays lun, lut to unJormino conliJonco in tho
ontiro ontorpriso ol convontional mathomatizoJ oconomics. AnJ lov sul-
liolJs aro as math-Jonso as linanco. A lot ol noat thoorios grov up in tho
1950s, 1960s, anJ 190s, only to lo challongoJ ly somo noator thoorios in
tho 1980s anJ 1990s, lut tho ontiro projoct ol clovor, inlluontial, anJ largoly
ompty thoorizing alout capital markots anJ tho invisillo hanJ has yot to
lo sovoroly ouostionoJ. Evon tho oxtonsivo ompirical vork ly a numlor
ol linancial oconomists, olton lasoJ on thousanJs, ovon millions, ol Jata
points, lails to proviJo any signilicant onlightonmont, locauso it asks such
soll-containoJ, ovon puorilo, ouostions.
4
As Ioontiol arguoJ - in tho prosiJontial aJJross to tho AEA givon 20
yoars loloro Dolrou`s - that soll-containoJ ouality is a signilicant roason
lor tho lailings ol oconomotric analysis.
Tho samo voll-knovn sots ol liguros aro usoJ again anJ again in all possillo
comlinations to pit Jilloront thoorotical moJols against oach othor in lormal
statistical comlat. lor olvious roasons a Jocision is roachoJ in most casos
not ly a knock-out, lut ly a lov points. Tho orJorly anJ systomatic naturo
ol tho ontiro procoJuro gonoratos a looling ol comlortallo soll-sullicioncy.
5
Poal progross, ho continuoJ, voulJ roouiro crossing Jisciplinary lounJ-
arios - tovarJs onginooring (or, ho might havo aJJoJ, inJustrial organi-
zation) to unJorstanJ tho procoss ol proJuction, or anthropology anJ
Jomographics (or psychology) to unJorstanJ consumption. But in tho hor-
motic vorlJ ol convontional analysis, pricos aro oxplainoJ vith rogarJ to
othor pricos, output vith rogarJ to othor outputs, anJ so on - a circular,
MARKET MODELS
143
almost onanistic procoss ol analysis. Tho intorosting stull - OPEC`s riso
in tho 190s, lor oxamplo, anJ its lall in tho 1980s - is typically rologatoJ
to tho roalm ol oxogonous shocks.` Somo thoorios ol tho lusinoss cyclo
oxplain rocossions as puroly oxogonous phonomona - an intolloctual con-
vonionco, sinco it allovs tho thoorist to avoiJ tho lalor ol oxplaining looms
anJ lusts, anJ an iJoological ono as voll, sinco it oxonoratos markot pro-
cossos thomsolvos as tho sourco ol instalility.
StuJying oconomics also sooms to mako you a nastior porson. Psycho-
logical stuJios havo shovn that oconomics graJuato stuJonts aro moro
likoly to lroo riJo` - shirk contrilutions to an oxporimontal pullic gooJs`
account in tho pursuit ol highor privato roturns - than tho gonoral pullic.
Economists also aro loss gonorous than othor acaJomics in charitallo giv-
ing. UnJorgraJuato oconomics majors aro moro likoly to Joloct in tho classic
prisonor`s Jilomma gamo than aro othor majors.
6
AnJ on othor tosts, stu-
Jonts grov loss honost - oxprossing loss ol a tonJoncy, lor oxamplo, to
roturn lounJ monoy - altor stuJying oconomics, lut not altor stuJying a
control suljoct liko astronomy (lrank, Gilovich, anJ Pogan 1993).
This is no surpriso, roally. Vainstroam oconomics is luilt ontiroly on a
notion ol soll-intorostoJ inJiviJuals, rational soll-maximizors vho can or-
Jor thoir vants anJ sponJ accorJingly. Thoro`s littlo room lor sontimont,
uncortainty, solllossnoss, anJ social institutions. Whothor this is an accu-
rato picturo ol tho avorago human is opon to ouostion, lut thoro`s no ouos-
tion that capitalism as a systom anJ oconomics as a Jisciplino loth rovarJ
pooplo vho conlorm to tho moJol.
Altor this ovorturo, lot`s oxamino throo ol tho most prominont thoorios
that linancial oconomists JovolopoJ ovor tho yoars - Tolin`s a, tho
VoJigliani-Villor thoorom, anJ tho olliciont markot hypothosis. Tho lirst
is a thoory ol hov linanco inlluoncos tho roal vorlJ: tho soconJ, a vision
ol hov linanco is largoly irrolovant to tho roal vorlJ: anJ tho thirJ, a Jooply
inlluontial story alout hov markots aro vonJrous instrumonts ol aJjust-
mont anJ allocation. Iiko all moJols, thoy trioJ to simplily tho vorlJ in
orJor to oxplain it. All aro vrong.
A lootnoto: high linanco thoory is olton associatoJ vith tho political
right (tho Univorsity ol Chicago loing virtually synonymous vith loth).
But VoJigliani anJ ospocially Tolin aro among tho most liloral` ol tho
mainstroam oconomists. Iiko Amorican loroign policy, moJoling markots
is a lipartisan allair.
ln lairnoss to Tolin, though, ho is critical ol tho linancial systom. Ho
lamously mournoJ tho proclivity ol his \alo stuJonts to hoaJ tovarJs Wall
WALL STREET
144
Stroot, to vasto human anJ linancial rosourcos on linancial activitios ro-
moto lrom tho proJuction ol gooJs anJ sorvicos.activitios that gonorato
high privato rovarJs Jisproportionato to thoir social proJuctivity` (Tolin
1984). Ho stooJ out among his poors in a Tvontioth Contury lunJ (1992,
p. 23) roport on markot spoculation anJ corporato govornanco` lor roc-
ommonJing a socuritios transaction tax. So lar right has tho contor movoJ
that this olJ-stylo Koynosian looks liko a rolol.
Tobin's q
Jamos Tolin anJ William BrainarJ lollovoJ up on a lov sontoncos lrom
Koynos`s ~u~:uI TI~:) to croato a thoory ol hov tho linancial markots
rogulato invostmont. Koynos (19361964, p. 151) saiJ:
|Thol Jaily rovaluations ol tho Stock Exchango, though thoy aro primarily
maJo to lacilitato translors ol olJ invostmonts lotvoon ono inJiviJual anJ
anothor, inovitally assort a Jocisivo inlluonco on tho rato ol curront invost-
mont. lor thoro is no sonso in luilJing up a nov ontorpriso at a cost groator
than that at vhich a similar oxisting assot can lo purchasoJ: vhilst thoro is
an inJucomont to sponJ on a nov projoct vhat may soom an oxtravagant
sum, il it can lo lloatoJ oll on tho Stock Exchango at an immoJiato prolit.
Boing moJorn oconomists, Tolin anJ BrainarJ (19) vantoJ to trans-
lato Koynos`s proso into numlors, roplacing his common sonso` vith sci-
ontilic rigor. ln thoir moJol, lirms invost moro il tho markot valuos thom
highly, anJ holJ lack il thoy aro assignoJ a lovly valuo. Koynos spoko
only ol tho stock markot, lut Tolin anJ BrainarJ aJJoJ Jolt. Spocilically,
thoy JolinoJ a as tho markot valuo ol a lirm`s sharos anJ long-torm Jolt
JiviJoJ ly tho valuo ol its roal capital. Whon a is alovo 1, lirms shoulJ
invost, locauso tho markot vill mark up thoir valuo ly moro than tho in-
vostmont. Whon it`s lolov 1, lirms vill soo thoir markot valuo - mainly
thoir stock prico, sinco Jolt pricos lluctuato lar loss - riso ly loss than tho
valuo ol invostmont. GooJ managors shoulJ lollov thoso signals.
Tolin, vriting vith anJ vithout BrainarJ, has claimoJ that changos in
a aro an important vay lor a contral lank to manipulato tho roal oconomy.
Whon intorost ratos aro lorcoJ Jovn ly tho loJ, stock anJ lonJ pricos
usually rally: vhon tightnoss roins, socurity pricos gonorally sink. Highor
markots vill thon inJuco roal corporato invostmont. Similar roasoning has
loon applioJ to housoholJs, vith changos in tho valuo ol linancial assots
stimulating or stilling tho lust lor housos, cars, anJ gaJgots.
MARKET MODELS
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Vost contral lankors agroo that changos in assot pricos - not only
stocks, lut also lonJs anJ roal ostato - havo somo inlluonco on porsonal
anJ lusinoss sponJing. But as tho BlS oconomist J.T. Knooshav (1995, p.
3) concoJoJ, tho mochanisms aro still not voll unJorstooJ,` Jospito a
contury ol oxporionco vith moJorn contral lanking. Tho Jorogulation anJ
linancial innovation ol tho last 20 yoars havo maJo things ovon murkior.
ln tho U.S., tho loJ assumos that hall tho impact ol monotary policy on
tho roal oconomy occurs through ollocts on housoholJ lalanco shoots:
incroasos or Jocroasos in papor voalth, ospocially changos in stock pricos,
inlluonco consumor sponJing. A policy-loJ Joclino in intorost ratos pushos
up stock pricos, anJ stockholJing housoholJs sponJ moro. Pocontly, hov-
ovor, that rolationship sooms to havo lrokon Jovn. Why this shoulJ lo
isn`t cloar: it coulJ lo that loth tho stock markot anJ consumor sponJing
voro inJoponJontly rosponJing to lovor intorost ratos, anJ that tho con-
clusion that stocks voro causing` tho sponJing changos aro a classic ox-
amplo ol conlusing corrolation vith causation. Or it may lo that tho
incroasing institutionalization ol tho markot has roJucoJ tho olloct ol stock
pricos on porsonal sponJing. Or it may havo loon that housoholJ lalanco
shoots voro in such torrillo shapo in tho oarly 1990s that a lull markot vas
ol littlo holp (StoinJol 1992). But vhatovor tho roason, this housoholJ ap-
plication ol a thoory isn`t ouito as improssivo as it onco vas.
But vo`vo strayoJ a lit lrom Tolin`s original lormulation, vhich vas
alout tho linancial inlluonco on roal corporato invostmont. Empirically
spoaking, tho lusinoss rolation lroko Jovn long loloro tho housoholJ
ono JiJ. But loloro vo look at tho rocorJ, a lov vorJs on hov oxactly to
computo a ln thoir numorator, Tolin anJ BrainarJ usoJ tho markot valuo
ol stocks plus tho markot valuo ol long-torm Jolt. Whilo gooJ ostimatos
ol tho markot valuo ol oouity aro availallo lor loth inJiviJual lirms anJ
tho ontiro corporato soctor, almost on a minuto-to-minuto lasis, tho mar-
kot valuo ol Jolt can only lo ostimatoJ, anJ rathor roughly. Koynos`s origi-
nal olsorvation montionoJ only tho stock markot, anJ that markot is tho
ono that is constantly valuing anJ ro-valuing corporato capital. Tho Jo-
nominator is tho valuo ol tho lirm`s capital stock at roplacomont cost, though
othor rosoarchors havo usoJ not vorth (assots minus lialilitios) in its placo.
ln practico, tho Jotails soom to mako littlo Jilloronco, vith Jilloront vor-
sions ol a all moving protty much in unison.
8
So lor vhat lollovs, it harJly
mattors vhich vorsion ol a you uso.
Tho Jata lor Tolin anJ BrainarJ`s 19 papor covors 1960 to 194, a
porioJ lor vhich a soomoJ to oxplain invostmont protty voll. But as tho
WALL STREET
146
This version ol lhe q ralio is lhe lolal narkel value ol lhe slocks ol non
linancial corporalions divided bv lhe value ol lhe langible assels (lixed
capilal plus invenlories, lron lhe Federal Feserves llow ol lunds ac
counls. Capilal expendilures, also lron lhe llow ol lunds accounls,
include lixed inveslnenl plus invenlorv inveslnenl. The S&P 500 is
lhe Slandard and Poors index ol 500 slocks, dellaled bv lhe consuner
price index. Charls cover dillerenl vears because lhe quarlerlv ligures
on capilal expendilures begin in !952, while lhe balance sheel dala
begins in !945. vhile il looks like inveslnenl is once again lraveling
along wilh lhe qralio, record qs have broughl aboul onlv a cvclical
expansion in inveslnenl, nol recordsnashing highs. Cash llow (lacing
page slill looks like lhe beller explanalion.
.capital ependitures as percent of GDP
.three-year real price change in the S&P 500
the q ratio and.
4'
5'
6'
7'
3'
9'
!0'
!952 !956 !960 !964 !963 !972 !976 !930 !934 !933 !992 !996
20'
40'
60'
30'
!00'
!20'
qralio
capex
qralio capex
60'
40'
20'
0'
20'
40'
60'
30'
!00'
!945 !950 !955 !960 !965 !970 !975 !930 !935 !990 !995
20'
30'
40'
50'
60'
70'
30'
90'
!00'
!!0'
qralio
S&P
qralio S&P
MARKET MODELS
147
nlernal lunds consisl ol prolils plus deprecialion allowance, aller laxes
and dividends. Capilal expendilures include lixed and invenlorv invesl
nenl. Fales ol change are noninal (uncorrecled lor inllalion. All lig
ures cone lron lhe llow ol lunds accounls, excepl lor CDP, which is
lron lhe nalional incone accounls. ole lhe lighl correlalion belween
inlernal lunds and inveslnenl, and lhe loose, sonelines inverse, rela
lion belween narkel values and inveslnenl. These charls lend greal
visual supporl lo lhe posilion lhal lirns invesl depending on lheir cash
llow, and nol slock narkel neasures like or share price changes. The
alleged power ol slock prices lo explain inveslnenl nav jusl be a re
sull ol lheir inperlecl relleclion ol corporale cash llows.
.market value of equity as percent of GDP, 1952-1997
.internal funds, two-year change, 1954-1997
capital ependitures of nonfinancial firms and.
30'
40'
50'
60'
70'
30'
90'
!00'
!952 !956 !960 !964 !963 !972 !976 !930 !934 !933 !992 !996
5'
6'
7'
3'
9'
!0'
capilal
expendilures
(righl scale
narkel
value
(lell scale
!0'
0'
!0'
20'
30'
40'
50'
60'
!954 !953 !962 !966 !970 !974 !973 !932 !936 !990 !994
30'
20'
!0'
0'
!0'
20'
30'
40'
50'
60'
70'
capex
(righl scale
inlernal
lunds
(lell scale
WALL STREET
148
chart on pago 148 shovs, things startoJ going avry ovon loloro tho papor
vas pullishoJ. Whilo a anJ invostmont soomoJ to movo togothor lor tho
lirst hall ol tho chart, thoy part vays almost at tho miJJlo: a collapsoJ
Juring tho loarish stock markots ol tho 190s, yot invostmont roso.
9
AnJ
as a roso vith tho lull markot ol tho 1980s, invostmont lailoJ to lollov. ln
lact, sinco 190, a high a has loon associatoJ vith lov invostmont, anJ a
lov a, vith high invostmont - oxactly tho opposito ol a thoory.
Tho Jivorgonco ol tho 190s is somotimos oxplainoJ ly tho riso in oil
pricos, vhich ronJoroJ a lot ol olJor capital oouipmont olsoloto, lorcing
lirms to invost in nov onorgy-olliciont tochnology. That points up a thoo-
rotical prollom at tho hoart ol a Tho thoory is alout nov invostmont, or
invostmont at tho margin, as oconomists say: a nov invostmont vill lo
unJortakon only il it vill lo applauJoJ ly tho stock markot. But vo can
only knov hov tho markots valuo oxisting assots: ono can only guoss at
marginal a ll managors voro invosting locauso thoy haJ to, thoy voro
apparontly Joing so vithout tho approval ol tho stock markot. Tho mar-
ginal rationalization may vork lor a short porioJ ol timo, lut il tho mar-
ginal a voro sulstantially highor than avorago a, sovoral yoars ol sustainoJ
invostmont shoulJ havo lrought up tho ratio`s valuo, anJ it JiJn`t. lt vasn`t
until tho lull markot that logan in tho oarly 1980s that a logan to tako oll.
Othor analysts havo arguoJ that vhilo a is a voak oxplanation ol roal
invostmont, changos in stock pricos Jo a lottor jol (Barro 1990). But it
may lo that tho stock markot is simply a loaJing inJicator ol tho lusinoss
cyclo, rosponJing ouickly to changos in intorost ratos anJ contral lank
policy, rathor than loing tho inJoponJont causo ol anything. PanJall Vorck,
AnJroi Shloilor, anJ Polort Vishny (1990) lounJ that ovor tho porioJ 1960-
198, tho stock markot oxplainoJ vory littlo ol tho chango in roal invost-
mont onco lunJamontals liko salos anJ prolit grovth voro controlloJ lor
- rolations that holJ lor tho stock markot anJ oconomy takon as a vholo,
anJ lor inJiviJual lirms oxaminoJ in Jotail.
10
lntroJucing oxtornal linanc-
ing - nov stock anJ Jolt issuos - aJJoJ a lit ol oxplanatory povor to
thoir oouations, lut not much, vith nov Jolt Joing a lottor jol than oo-
uity. Vorck 8 Co. thoorizo that this may lo locauso lirms lorrov to sus-
tain invostmont sponJing in loan prolit yoars. Thoir rosults aro conlirmoJ
ly BlancharJ ot al. (1993): lunJamontals liko prolits Jo a lar lottor jol ol
oxplaining changos in roal invostmont than stock markot Jovolopmonts.
Whilo it Joos a torrillo jol oxplaining invostmont, a sooms to proJict
tho stock markot anJ oxplain morgors. This isn`t surprising: a is anothor
vay ol Joing vhat Wall Stroot analysts call tho markot-to-look ratio - tho
MARKET MODELS
149
markot valuo ol a lirm`s stock comparoJ vith its not vorth. lirms solling
lolov thoir look valuo aro thought to lo largains, vhilo lirms solling
voll ovor look - voll ovor` loing an aJmittoJly spongy concopt - aro
ovorpricoJ. Tho soconJ ol tho a charts shovs that high a ratios havo por-
tonJoJ yoars ol poor porlormanco, anJ lov a valuos, yoars ol lulllinoss.
This conlirms tho notion ol so-calloJ valuo invostors` liko Bon Graham
anJ Warron Bullott that it pays to luy stocks vhon thoy`ro choap,` anJ
shun or soll thom vhon thoy`ro not.
lt`s also almost cortain that tho takoovor anJ rostructuring loom ol tho
1980s vas inspiroJ ly tho lov a ol tho 190s. lrom tho lato 190s through
tho miJ-1980s, it maJo linancial sonso to lorrov monoy, luy stock in
unJorvaluoJ lirms, anJ souoozo thom harJor. This JomanJ lor stock,
though, Jrovo pricos highor, anJ ly tho onJ ol tho 1980s, lovoragoJ luy-
ors voro taking on ovorvaluoJ assots, vhich is as gooJ an oxplanation as
any lor vhy tho loom collapsoJ.
Modigliani-Miller: almost nothing matters
Porhaps ono ol tho lovoliost linancial moJols vas ono ol tho oarliost, tho
VoJigliani-Villor thoorom, knovn as VV among connoissours. VV saiJ
that it JiJn`t roally mattor hov a lirm linancoJ itsoll, vith Jolt or oouity, it
vas all tho samo in tho onJ. Boloro tho thoorists got holJ ol tho mattor, it
vas rocoivoJ visJom that managors aro happiost to roly on intornal lunJs,
sinco, unliko outsiJo invostors or lonJors, your ovn monoy asks no om-
larrassing ouostions anJ makos no unploasant JomanJs. Noxt lavorito is
Jolt, though vithin roason. Ioan paymonts aro unlorgiving in harJ timos,
anJ lorroving shoulJ lo Jono vith caro. Vissing a singlo intorost pay-
mont can triggor cross-Jolault clausos in loan anJ lonJ contracts (an in-
jury to ono is an injury to all - soliJarity is still in lashion among tho
croJitor class), moaning tho lirm can lo throvn into involuntary lank-
ruptcy. But as long as you can oarn a saloly highor rato ol roturn on nov
invostmonts than you pay your croJitors on nov loans, lorroving can
raiso prolits, anJ vith it tho stock prico, tho critorion ol corporato porlor-
manco. Unliko othor countrios, lonJors usually havo littlo say in tho run-
ning ol a hoalthy lirm in tho U.S.: you got outsiJo monoy vith minimal
outsiJo suporvision.
Iast on tho list is solling nov stock to pullic invostors. Whilo JiviJonJs
aro not a lixoJ paymont - though markots Jo pummol a lirm`s stock vhon
it skips a JiviJonJ - solling nov stock moans a nov sot ol intrusivo al-
WALL STREET
150
sontoo ovnors. lt also moans that oxisting stockholJors soo thoir claims
JiminishoJ (JilutoJ,` in tho jargon) ly tho nov sharoholJors.
Along vith this pocking-orJor thoory vas tho supposition that thoro
vas an iJoal` lovol ol Jolt, that iJoal loing moasuroJ ly tho linancial
structuro that maximizos tho stock markot valuo ol a pullic corporation. ll
a lirm haJ an invostmont opportunity that olloroJ prolits groator than tho
intorost it voulJ pay on lorrovoJ monoy, it voulJ mako sonso to go into
Jolt to mako tho invostmont. But thoro aro only so many opportunitios to
oarn prolits voll alovo tho rato ol intorost: a lirm can only oxpanJ oxisting
oporations so lar loloro it saturatos its markot, anJ managors straying lar
lrom thoir usual lusinoss olton scrov up laJly. IonJors aro likoly to got
norvous vhon thoy soo lirms piling on Jolt, anJ vill chargo ovor highor
ratos ol intorost until thoy shut oll tho croJit llov. At somo point, tho prolit
rato on nov invostmonts vill lall lolov tho intorost rato on nov loans. At
that point, nov lorroving voulJ Jopross prolits, anJ vith it tho lirm`s
stock prico. So il you graphoJ tho Jolt lovol on tho vortical axis anJ tho
stock prico on tho horizontal, tho rosulting lino voulJ lo an upsiJo-Jovn
U - as Jolt incroasoJ, tho stock prico voulJ riso until tho iJoal Jolt lovol
haJ loon roachoJ, anJ thon turn Jovn again as tho lirm lookoJ incroas-
ingly risky. At loast that vas tho OlJ WisJom.
A 1958 articlo ly lranco VoJgliani anJ Vorton Villor rojoctoJ this or-
thoJoxy, assorting, scanJalously, that tho uu:~I :uIu~ J uu) J::u ::
:uu~j~uu~uI J :I: cuj:IuI :I:ucIu:~` anJ II~ u:~:u~ c:I J cuj:IuI I
uu) J::u :: cujI~I~I) :uu~j~uu~uI J :I: cuj:IuI :I:ucIu:~` (VoJigliani
anJ Villor 1958: italics in original).
11
Evon lor an unlovoragoJ lirm, Jolt is
no choapor than oouity, anJ managors cannot incroaso tho markot valuo
ol thoir lirm ly moving tovarJs somo iJoal point ol lovorago.
Thoir argumont vas highly alstract anJ lormal, lut loiloJ Jovn to tho
iJoa that invostors coulJ unJo tho supposoJ gains lrom lovorago ly soll-
ing tho stocks ol lirms that incroaso thoir inJoltoJnoss (sinco risk incroasos
vith lovorago), thoroly Joprossing tho sharo prico - or, convorsoly, in-
vostors can croato thoir ovn lovorago ly luying lonJs Jiroctly, proompt-
ing tho stratogios ol corporato managors. As VoJigliani anJ Villor put it,
tho gains lrom loing allo to tap choap, lorrovoJ lunJs aro moro than
ollsot lor tho stockholJors ly tho markot`s Jiscounting ol tho stock lor tho
aJJoJ lovorago assumoJ.` Or as Villor onco put it in an intorviov, you
can`t mako yoursoll richor ly moving monoy lrom ono pockot to tho othor.
VoJigliani vas actually initially skoptical alout thoir thoory, lut Villor,
a passionato loliovor in tho povor ol lroo markots to lorgo optimal anJ
MARKET MODELS
151
proJictallo outcomos, stooJ his grounJ. l I~I:~:~u it! l lolt lrom tho vory
loginning that this is right.`` (Bornstoin 1992, p. 14). Varxists havo olton
loon accusoJ ol practicing roligion rathor than scionco, lut Villor`s ro-
mark shovs that markot partisans also thrivo on lusloaJs ol laith.
Though VV arguoJ moro ly oouation than oxamplo, thoy JiJ prosont
somo ompirical oviJonco shoving littlo rolation lotvoon corporations` cost
ol capital anJ thoir linancial structuro. Thoir scattor Jiagrams plotting tho
cost ol capital vorsus lovorago ratios lor 43 oloctric utilitios anJ 42 oil com-
panios shovoJ no signilicant pattorn.
VV concluJoJ thoir papor vith a list ol thoir moJol`s shortcomings,
among thom its static ouality: its assumption ol porloct compotition, moan-
ing instantanoous anJ rational prico aJjustmont to nov inlormation: anJ
oaso ol accoss to tho capital markots. ln roality, timo lrustratos tho lost
plans: porloct compotition oxists novhoro, ovon in tho capital markots
vhoro it comos closost to roalization: anJ only giant corporations onjoy
choap, lrictionloss accoss to tho linancial markots. VoJol-luilJors pro-
cooJ vith tho laith that such shortcomings (that is, ossontial loaturos ol
actually oxisting capitalism) only complicato thoir vork vithout ronJor-
ing it pointloss.
VoJigliani anJ Villor, gooJ lourgoois suljocts, lookoJ most closoly at
inJiviJual lirms, not lothoring to consiJor vhat happons vhon inJiviJual
capitals aro aggrogatoJ. Tho possilility that a Jolt contraction coulJ choko
an oconomy, just as Jolt oxpansion can stimulato it, or signal ono in troullo,
or loth aro all convoniontly ovorlookoJ ly tho assumptions. So too tho
possilility that a highly inJoltoJ oconomy is moro vulnorallo to shock
than a milJly inJoltoJ ono, or that lirms vith high intorost oxponsos Jo
loss P8D than thoso vith lov onos. Nor JiJ VoJigliani anJ Villor con-
siJor tho Jilloront institutional arrangomonts anJ social pattorns lohinJ
tho vorJs Jolt` anJ oouity` - tho JisporsoJ pattorns ol U.S. linancial
markots, say, comparoJ to tho tightor vorlJs ol Gormany anJ Japan.
livo yoars lator, VoJigliani anJ Villor (1963) rovisoJ thomsolvos, con-
lossing that thoy haJ ignoroJ tho tax lonolits ol going into hock. Sinco
U.S. corporations can JoJuct intorost paymonts, lut not stock JiviJonJs,
lrom thoir taxallo incomo, an incroaso in lovorago is cortain to roJuco a
lirm`s tax rato. VV counsoloJ that this Joos not moan that corporations
shoulJ lorrov thomsolvos silly: lonJors got strictor as a lirm`s inJoltoJ-
noss risos, anJ managors voulJ novor vant to run up all thoir croJit linos
anJ loavo no rosorvo lor laJ timos.
Tho VV thosis, ovon vith its tax moJilications, locamo so viJoly ac-
WALL STREET
152
coptoJ in tho acaJomic litoraturo that intorost in tho rolation lotvoon li-
nanco anJ tho roal vorlJ laJoJ to noar-invisilility. ln tho vorJs ol a pa-
por that voulJ challongo this orthoJoxy 30 yoars lator, VV`s triumph
JominatoJ tho invostmont litoraturo until rocontly.largoly locauso ol
|itsl thoorotical appoal` (Cantor 1990). lt also maJo tho lilo ol moJol-
luilJing oconomists much oasior: as Vark Gortlor (1988) put it, Apart
lrom its lormal ologanco, tho VV thoorom vas attractivo locauso it pro-
viJoJ rosoarchors vith a rigorous justilication lor alstracting lrom tho com-
plications inJucoJ ly linancial consiJorations.` lor ono thing, you nooJoJ
lovor variallos in your oouations il you JiJ, anJ lor anothor, it lit in nicoly
vith tho orthoJox proloronco lor inJiviJualism: you coulJ locus only on
tho lirm or tho housoholJ as your unit ol analysis, anJ ignoro lroaJor
social institutions liko tho structuro ol linancial markots (or ovon tho stato).
Nooclassical thoorios ol invostmont, lor oxamplo, voro JovolopoJ vith-
out any rogarJ to linanco. UnJor tho inlluonco ol Vilton lrioJman, ocono-
mists paiJ attontion only to monoy lut not croJit - that is, tho moJium ol
oxchango usoJ to groaso immoJiato purchasos anJ salos, lut not tho longor-
torm olligations usoJ to linanco invostmont anJ consumption.
But VV`s inlluonco vont voll loyonJ tho acaJomy, as lovorago artists,
thoir lankors, anJ thoir apologists chantoJ a Jolt-Joosn`t-mattor mantra
throughout tho 1980s mania. lorgotting tho mossago in tho 1958 papor
alout hov Jolt can`t roally mako you lottor oll, anothor VV, Vichaol
Vilkon, usoJ tho thoory to convinco pooplo that Jolt Joosn`t hurt oithor,
anJ thanks to tax JoJuctilility, it roally can mako you lottor oll. Horo`s
hov 1u::u~:: W~~ (larroll anJ Nathans 1989) charactorizoJ tho popular
inlluonco ol tho VV thoory, just altor a vavo ol high-prolilo lovoragoJ
luyouts vont laJ in tho summor ol 1989:
Tho rationalo lor such linancings.Jatos lack to sominal vork in tho lato
1950s ly tvo ominont oconomists, Vorton H. Villor anJ lranco VoJigliani.
ln ossonco, tho oconomists roasonoJ that a company`s oarning povor, not
its linancial makoup, is vhat Jotorminos its markot valuo. So high lovorago
makos sonso, sinco tho tax coJo lots companios JoJuct tho intorost thoy
pay.. Dopito thoir lolJ logic - romomlor, Jolt vas anathoma lack thon
- it vas moro than tvo JocaJos loloro thoir iJoas took holJ, anJ that vas
largoly through Viko Vilkon`s canny nurturing ol tho markot lor loss-than-
invostmont-graJo |i.o., junkl lonJs.
Similar argumonts, vithout tho skopticism inspiroJ ly tho soouonco ol
lovorago Jisastors in tho summor ol 1989, voro common in tho lusinoss
MARKET MODELS
153
pross throughout tho 1980s. lor oxamplo, vriting just loloro tho Summor
ol Dolaults, Eu:uu~) (Thackray 1989) arguoJ that tho $200-400 lillion
in rocont corporato rostructurings voro not onough - that vork haJ only
just logun, anJ that a ouasi-Trotskyist Joctrino ol pormanont rostructur-
ing vas voll aJvisoJ ly tho riso ol moJorn corporato linanco thoory.`
Work that haJ originally saiJ that capital structuro JiJn`t mattor haJ
spavnoJ an inJustry, or at loast an apology lor that inJustry, lasoJ on tho
porpotual translormation ol thoso structuros.
Such olsorvations Jravn lrom moro journalism might lo JismissoJ as
hopolossly anocJotal ly acaJomics, lut tho notion that linanco mattors
logan lullling up to prominonco in tho lato 190s. lronically, ono ol tho
papors olton citoJ ly tho linanco rovisionists, Gurloy anJ Shav (1955),
vas ouickly oclipsoJ ly tho VV thoorom, laroly to rosurlaco lor moro
than 20 yoars. But Gurloy anJ Shav`s argumonts aro still important. Thoy
claimoJ that ono ol tho important Jilloroncos lotvoon JovolopoJ anJ
unJovolopoJ oconomios is tho Jopth ol tho linancial systom: in a youthlul
oconomy, lanks may play a primary rolo as a ropository lor savings anJ a
sourco ol croJit, lut in a moro aJvancoJ oconomy, a lar lroaJor array ol
institutional lorms connoct savors anJ lorrovors. So, in tho simplor
oconomy, tho lrioJmanito locus on monoy, JolinoJ as curroncy, chock-
ing accounts, anJ short-torm savings Joposits, is sonsillo, locauso it cap-
turos most ol tho linancial aspocts ol oxchango, lut in a complox ono,
linancial innovation loavos simplor lorms ol monoy vay lohinJ. AccorJ-
ing to Gurloy anJ Shav, vhat roally mattoroJ most in a complox oconomy
vas linancial capacity,` a moasuro ol lorrovors` alility to alsorl Jolt.
Thus linancial structuro mattoroJ a groat Joal to roal oconomic activity: an
oconomy populatoJ ly lirms anJ housoholJs lurJonoJ ly Jolt vas ono
that vas noar a lroaking point, lut ono populatoJ ly units light on Jolt
haJ plonty ol room to grov. A lov oconomists continuoJ this traJition
Juring tho 1960s anJ oarly 190s, lut tho VV orthoJoxy provailoJ - anJ
vas a staplo ol tho lusinoss school curriculum that shapoJ a gonoration ol
managors anJ linanciors.
Economics is raroly givon a chanco to lo tostoJ ly oxporimontation on
roal sociotios, lut linanco thoory unJorvont an oxhaustivo roal-vorlJ tost
Juring tho 1980s anJ oarly 1990s. Altor that oxporionco, it`s harJ to arguo
that linancial structuro Joosn`t mattor. lor oxamplo, a stuJy ly PicharJ
Cantor (1990) ol tho lohavior ol 586 companios ovor tho 1-yoar porioJ
WALL STREET
154
lrom 191 to 1986 shovoJ that highly inJoltoJ lirms shovoJ groator vola-
tility in invostmont anJ omploymont than thoso vith lov Jolt lovols. That
is, in gooJ timos, high-Jolt lirms voro likoly to oxpanJ ouickly, lut in
laJ timos, thoy tonJoJ to cut lack just as ouickly - a gonoralization that
cortainly lit tho U.S. oconomy in tho 1980s anJ oarly 1990s.
Cantor spoculatoJ that high lovorago may oncourago a risk-avorso atti-
tuJo on tho part ol managomont,` so that a Jrop in salos (ol tho sort ono
soos in a normal rocossion) may loaJ lirms to postpono invostmont anJ
stronuously avoiJ invontory luilJup, ovon il thoy aro oxporioncing ollsot-
ting improvomonts in intorost or othor oxponsos.` Tho nooJ to romain
curront in sorvicing ono`s Jolts may tako procoJonco ovor all olso in tho
managorial minJ.
Cantor vas inlluoncoJ ly tho vork ol Stovon V. lazzari, P. Glonn
HullarJ, anJ Bruco C. Potorson (1988), vho lounJ rich links lotvoon
linancial structuro anJ invostmont practicos. Vost invostmont moJols,
lazzari ot al. arguoJ, aro lasoJ on a roprosontativo lirm` that rosponJs to
tho cuos ol tho socuritios markots. ll tho roprosontativo lirm lacks tho lunJs
lor an invostmont that passos orthoJox linancial mustor, that shoulJ lo no
olstaclo: oxtornal lunJs aro a porloct sulstituto lor intornal lunJs. |Wlith
porloct capital markots, a lirm`s invostmont Jocisions aro inJoponJont ol
its linancial conJition.` Altor VV, classic notions that lirms havo a hiorar-
chy ol proloroncos in raising lunJs - intornal lunJs, Jolt, anJ stock, in
JosconJing orJor ol appoal - voro out ol lashion.
Vuch turns on hov you Jolino a roprosontativo lirm. Whilo largo, os-
tallishoJ corporations may onjoy oasy accoss to othor pooplo`s monoy,
small, youngish onos Jon`t. To moasuro tho importanco ol this Jistinction,
lazzari anJ his colloaguos lookoJ at 422 manulacturing lirms in tho Valuo
Iino Jatalaso that voro alivo lor tho ontiro porioJ lrom 1969 to 1984, sort-
ing thom into throo groups JoponJing on vhat portion ol thoir prolits
thoy paiJ out in JiviJonJs.
lazzari anJ colloaguos roasonoJ that il linancial constraints voro un-
important, invostmont voulJ lo largoly inJoponJont ol a lirm`s cash llov:
lirms lacing loan timos coulJ maintain thoir invostmont program simply
ly raising outsiJo monoy. Thoy usoJ JiviJonJ payout ratios (porcontago
ol prolits paiJ out in JiviJonJs) as a proxy lor linancial constraint. lirms
paying out loss than 10/ - 49 ol tho samplo 422 lirms - voro placoJ in
class 1: thoso paying moro than 10/ lut loss than 20/, class 2: anJ thoso
paying moro than 20/, class 3. As tho tallo shovs, salos grovth anJ in-
vostmont ratos Joclino as you mount tho class laJJor, as Joos tho corrola-
MARKET MODELS
155
tion lotvoon cash llov (mainly prolits plus Joprociation allovancos) anJ
invostmont. Sinco cash llov is volatilo, invostmont among tho constrainoJ
lirms is also moro volatilo than among unconstrainoJ lirms (as thoir ro-
spoctivo stanJarJ Joviation liguros shov).
At loast throo conclusions omorgo. lirst, lirms that coulJ most prolit-
ally uso oxtornal linanco soom to havo tho loast accoss to it, vhilo thoso
lirms vith tho loast promising invostmont prospocts aro sullusoJ vith sur-
plus cash. SoconJ, smallor, cash-constrainoJ lirms aro oxtromoly vulnor-
allo to changos in tho oconomic onvironmont: changos in intorost ratos
anJ salos grovth vill ouickly translato into rapiJ changos in invostmont.
12
An anti-inllation rogimo ol tight monoy vill loavo largo, maturo lirms mostly
unscathoJ, vhilo souoozing thoso vith tho lost prospocts. AnJ thirJ, thoo-
rizing asiJo, linancial structuro Joos mattor, anJ it mattors a lot.
Examplos Jravn lrom rocont oxporionco aro nothing comparoJ to thoso
Jravn lrom tho 1930s. Bon S. Bornanko (1983) arguoJ that tho Groat
Doprossion`s longth anJ sovority voro aggravatoJ ly tho incroasoJ costs
ol croJit intormoJiation, vhich is an oconomist`s vay ol saying that tho
lanking systom stoppoJ vorking as it`s supposoJ to - olliciontly match-
ing savors anJ lorrovors.
ln sovoroly alnormal timos, Bornanko arguoJ, this procoss ol intormo-
Jiation is JisruptoJ, as savors shun tho lanking systom anJ lankors hoarJ
vhat littlo lunJs aro ontrustoJ to thom. Though vo sav somo ol thoso
alnormal lohaviors Juring tho lato 1980s anJ oarly 1990s, tho rocont ovonts
voro nothing vhon comparoJ vith tho 1930s. lrom 1929 to 1933, almost
financial constraints and investment
FF CLASSFCATO
! 2 3
nunber ol lirns 49 39 334
relenlion ralio |'| 94 33 53
annual sales growlh |'| !3.7 3.7 4.6
inveslnenl/capilal ralio |'|
average 26 !3 !2
slandard devialion !7 9 6
cash llow/inveslnenl
correlalion .92 .32 .20
For explanalions ol classes, see lexl. Source: Fazzari el al. !933.
WALL STREET
156
10,000 lanks lailoJ: lotvoon lailuros anJ morgors, tho numlor ol lanks
vas roJucoJ ly noarly hall ovor thoso lour yoars. At tho samo timo, inJi-
viJual anJ lusinoss lorrovors voro going lust in unprocoJontoJ num-
lor. Ol 22 major citios survoyoJ in 1934, Jolault ratos on rosiJontial
proportios rangoJ lrom a lov ol 21/ in PichmonJ to 62/ in ClovolanJ,
vith tho majority clustoring arounJ 40/. A yoar oarlior, 45/ ol all U.S.
larmors voro Jolinouont on mortgagos. As ol Varch 1934, 3 ol tho 310
citios vith populations ovor 30,000 voro in Jolault, as voro throo statos.
Among lusinossos, hovovor, tho picturo vas unovon. Aggrogato cor-
porato prolits loloro taxos voro nogativo in 1931 anJ 1932, tho only yoars
tho lusinoss soctor as a vholo has loon in tho roJ sinco tho national in-
como accounts logan in 1929. But thoso lossos voro lorno mainly ly
small anJ miJ-sizoJ lusinossos: lirms vith assots ovor $50 million romainoJ
prolitallo throughout tho porioJ, vhilo thoso vith assots unJor $50,000
sulloroJ lossos ooual to 33/ ol thoir capitalization in 1932 alono.
13
ln thoso circumstancos, it`s not harJ to soo vhy tho procoss ol croJit
intormoJiation lrozo noarly soliJ. Customors vith sparo cash - an in-
croasingly raro spocios in tho oarly 1930s - avoiJoJ Jopositing it in lanks.
Simultanoously, lrightonoJ lankors calloJ in loans - thoso, ol courso,
that voron`t alroaJy in Jolault - anJ rolusoJ to mako nov onos, prolor-
ring instoaJ to stash thoir monoy in U.S. Troasury lills. Though lig corpo-
rations romainoJ largoly unscathoJ, tho shutJovn ol lank croJit hurt small
lusinossos, larmors, anJ housoholJs. No Joult tho cascaJo ol Jolaults,
insolvoncios, anJ lank lailuros loJ on itsoll, sinco croJit vas JonioJ ovon
to lorrovors vho coulJ havo put it to gooJ uso.
Though tho lanking crisis camo to an onJ in Varch 1933 vith Poosovolt`s
lank holiJay - tho vory month ollicially rocognizoJ as tho trough ol tho
1929-33 contraction - small lusinossos still lounJ it Jillicult to lorrov
monoy at loast through 1935, anJ possilly 1938, accorJing to a numlor ol
survoys citoJ ly Bornanko. Tho homo mortgago markot vas similarly lro-
zon: vhat lonJing took placo vas tho rosult ol Nov Doal croJit programs.
lroJoric S. Vishkin (198) arguoJ, in a papor nov soon as a milopost in
tho rovival ol intorost in linanco, that linancial mochanisms at tho houso-
holJ lovol voro also important in propagating tho Doprossion - not as
causos, roally, lut as part ol tho transmission mochanism ol tho oconomic
implosion. During tho 1920s, almost cortainly oncouragoJ ly tho stock
markot loom, housoholJs haJ takon on onormous lialilitios, vhich suJ-
Jonly locamo ouito omlarrassing,` in tho charming olJ lormulation, vhon
tho pricos ol stocks anJ roal ostato logan thoir collapso in lato 1929. Worso,
MARKET MODELS
157
tho gonoral Jollation - consumor pricos loll ly almost 25/ lotvoon 1929
anJ 1933 - sharply incroasoJ tho roal Jolt lurJon. lrom 1929 to 1935,
roal housoholJ not vorth loll almost 12/ (accorJing to Vishkin`s osti-
matos), a lunction ol simultanoously Joclining assot valuos anJ rising li-
alilitios. Tho situation improvoJ in tho miJ-1930s, lut tho rocossion anJ
stock markot Joclino ol 193-38 lrought a rorun, in loss Jramatic lorm, ol
tho 1929-33 horrorshov. Vishkin spoculatoJ that thoso lalanco shoot pros-
suros (anJ tho psychological prossuros thoy gavo riso to) causoJ solvont
consumors to Jolor major purchasos. linancial crisis, in othor vorJs, trans-
latoJ into a Joclino in JomanJ lor housing anJ Jurallo gooJs, purchasos
that typically roouiro loth lorrovoJ lunJs anJ laith that thoro vill lo
sulliciont incomo in tho luturo to sorvico tho loans.
ln a classic papor, lrving lishor (1933) arguoJ that linancial involvo-
mont maJo all tho Jilloronco lotvoon routino Jovnturns (not yot calloJ
rocossions) anJ lig-timo collapsos liko 183 anJ 1929. Typically, such a
collapso lollovoJ upon a croJit-povoroJ loom, vhich lolt lusinossos
oxcossivoly Jolt-lurJonoJ, unallo to copo vith an oconomic slovJovn.
Tho procoss, vhich ho laloloJ a Jolt Jollation, vas lairly simplo, anJ
makos groat intuitivo sonso, lut it vas an argumont largoly lorgotton ly
mainstroam oconomics in tho yoars altor WorlJ War ll. A milJ slovJovn,
causoJ porhaps ly somo shock to conliJonco, loavos Joltors unallo to
moot thoir olligations out ol curront cash llovs. To satisly thoir croJitors,
thoy liouiJato assots, vhich Joprossos tho pricos ol roal gooJs. Tho gon-
oral Jollation in pricos makos thoir curront proJuction unprolitallo, sinco
cost structuros voro proJicatoJ on olJor, highor salos pricos, at tho samo
timo it incroasos tho roal valuo ol thoir Jolt lurJon. So lirms cut lack on
proJuction, omploymont lalls anJ JomanJ lalls vith it, prolits turn into
lossos, tho Jolt lurJons lurthor incroaso, not vorths sink into nogativo
torritory - anJ so on into porJition. lishor arguoJ that thoro vas nothing
on tho horizon to stop tho procoss lrom continuing in 1933 - until
Poosovolt took ollico anJ JoclaroJ a lank holiJay on Varch 4. This stato
intorvontion lroko tho Jostructivo pattorn: othorviso, claimoJ lishor, tho
collapso voulJ havo takon out vholo nov roalms ol tho oconomy, loaJ-
ing inovitally to tho lankruptcy ol tho U.S. govornmont.
14
Tho implica-
tion, thon, is that such Jollations aro impossillo toJay, locauso
govornmonts vill intorvono at a lar oarlior stago (Vinsky 1982l).
Tho thoorotical mossago ol tho Doprossion oxporionco is that linanco
mattors a groat Joal to loth lusinossos anJ housoholJs, anJ is anything
lut noutral. Tho impact sooms to como loss lrom valuation (shovn ly tho
WALL STREET
158
irrolovanco ol a to invostmont sponJing anJ tho voak rolations lotvoon
assot pricos anJ consumor sponJing) than lrom tho lito ol intorost pay-
monts on curront incomos anJ tho availalility ol croJit (that is, tho alility
to roll ovor olJ Jolts anJ got lrosh loans). linanco is a povorlul stimulus
on tho vay up, anJ can lo a povorlul Joprossant on tho vay Jovn.
Thoso analysos ol tho linancial mochanisms lohinJ tho Groat Dopros-
sion aro illuminating lor rocont history as voll, particularly tho rocossion
ol tho oarly 1990s, vhich conlusoJ no loss an olsorvor than loJ chair
Alan Groonspan. No moJols can oxplain tho typos ol pattorns vo aro
having,` Groonspan saiJ on an Octolor 1992 visit to Japan. This is roally
a ouito oxtraorJinarily Jillicult typo ol onvironmont` (StorngolJ 1992). ln
his thoorizing, Groonspan vas a convontional oconomist schooloJ in tho
noutrality-ol-monoy laith - lut as a practical contral lankor, ho knov
that tho loJ haJ to Jrivo intorost ratos Jovn or tho oconomy voulJ havo
sunk into Joprossion. Ho JiJ just that, anJ it JiJn`t.
A tolophono-look-sizoJ componJium ol stuJios ly Nov \ork loJ
oconomists (loJoral Posorvo Bank ol Nov \ork 1994) conlirms tho thosis
that tho lovoroJ loom ol tho 1980s vas luoloJ ly an oxcoptionally hoavy
uso ol croJit - loJoral, lusinoss, anJ housoholJ - anJ that tho 1989-92
slump (a lroaJor porioJ ol sluggishnoss than tho ollicial rocossion ol July
1990 to Varch 1991) vas causoJ ly a lroakJovn in tho croJit machinory.
Whilo it`s Jillicult to spocily procisoly tho compononts ol that lroakJovn
- hov much coulJ lo ascriloJ to a loss ol Gurloy anJ Shav`s linancial
capacity, as Jolt-lurJonoJ lorrovors lounJ thomsolvos unvilling or un-
allo to lorrov moro: hov much to tho collapso ol tho S8Is anJ tho junk
lonJ markot, anJ tho rosulting shrinkago in tho supply ol nov croJit: anJ
hov much to tho roluctanco ol surviving lonJors to lonJ to risky clionts -
it`s almost cortain that all thoso olomonts contrilutoJ somothing to tho
slump. Tho loss ol lank croJit to small lusinoss sooms, lrom tho Nov
\ork loJ`s vork, to lo ol crucial importanco. Extrapolating lrom thoir
vork, it`s also virtually cortain that tho initially voak rocovory lrom tho
1991 rocossion lov vas in largo part a rosult ol tho crippling ol tho croJit
machinory. Evon tho oxtraorJinary liscal stringoncy ol rocont yoars can lo
soon in this light, as tho U.S. govornmont`s ovn linancial capacity vas
sovoroly strainoJ, anJ Jolicit roJuction kopt tho lrako on roal oconomic
activity lrom tho 1990 luJgot Joal onvarJs (tho mirror imago ol tho in-
tonsoly stimulativo Poagan Jolicits ol tho 1980s).
15
Whon tho oarly 1990s rocossion ollicially logan in July 1990, it vas not
unroasonallo to oxpoct tho lirst Jolt Jollation in 60 yoars. Total Jolts ol
MARKET MODELS
159
nonlinancial corporations (NlCs) voro almost 15 timos protax prolits, com-
paroJ vith unJor 11 timos in 1929. lntorost paymonts claimoJ 39/ ol protax
prolits, comparoJ vith 14/ in 1929.
16
Horo again, Bornanko anJ colloaguos (Bornanko anJ Camploll 1988:
Bornanko, Camploll, anJ WhitoJ 1990 - BCW) havo Jono illuminating
vork. BCW JiscovoroJ that tho incroaso in corporato Jolt avoragos vas
not across-tho-loarJ, lut vas instoaJ concontratoJ among a small num-
lor ol lirms. But tho Jolt loaJors haJ Jrivon thomsolvos into a hiJoous
linJ. Tho moJian lirm in tho BCW samplo ol alout 1,200 pullicly traJoJ
lirms JovotoJ 22/ ol its cash llov to intorost paymonts in 1988, up lrom
13/ in 1969, lut no incroaso lrom 1980`s 22/. At tho 90th porcontilo, hov-
ovor, lirms JovotoJ 186/ ol thoir cash llov to intorost in 1988, up lrom
34/ in 1969, anJ 56/ in 1980. Tho calculation is impossillo at tho 95th
porcontilo, sinco thoso lirms lost monoy - a situation that haJ porsistoJ
sinco 1982: in 1969, thoso lirms voro prolitallo, anJ paiJ 44/ ol cash llov
in intorost. Though BCW JiJ not say, it is salo to assumo that lirms at tho
0th anJ 80th porcontilo voro laroly oarning thoir intorost paymonts.
Using linancial Jata liko prolits, stock pricos, anJ intorost ratos running
through 1986, Bornanko anJ Camploll (1988) simulatoJ rocossions as so-
voro as thoso ol 193-5 anJ 1980-82: thoy projoctoJ that 10/ ol U.S.
corporations coulJ laco lankruptcy in a comparallo Jovnturn. UpJating
thoir vork in 1990, incorporating Jata lrom tho Jolt-maJ yoars 198 anJ
1988, BCW ostimatoJ that 20-25/ voulJ laco insolvoncy in a Joop rocos-
sion. Tho authors omphasizoJ that thoso voro moasuros ol linancial stross,
not litoral proJictions. NooJloss to say, il anything liko 10/ ol U.S. lirms
haJ gono unJor, tho crisis voulJ almost cortainly havo cascaJoJ into a
sovoro Joprossion.
Wo haJ a rocossion, lut no Joprossion. Whilo thousanJs ol lirms -
60,46 in 1990, 8,266 in 1991, anJ somo 90,000 in 1992 - vont lust,
oach yoar`s lailuros roprosontoJ lovor than 1/ ol all U.S. lusinossos. Ii-
alilitios ol lirms that lailoJ in 1991 totaloJ $108.8 lillion, a lot ol monoy,
lut loss than 2/ ol lusinoss Jolts.
Tho charts holp oxplain vhy things novor got vorso. Thoy shov tho
courso ol somo important linancial variallos ovor throo rocossions, 193-
5, 1980-82, anJ 1990-92. To lo suro, tho timing ol tho throo slumps isn`t
porloctly matchoJ: thoir ollicial lilospans aro Novomlor 193-Varch 195,
January 1980-July 1980 anJ again lrom July 1981-Novomlor 1982 (tvo
lack-to-lack JovnJralts that lolt liko ono long ono), anJ July 1990-Varch
1991 (though roal rocovory JiJn`t login until 1992). But all throo shov
WALL STREET
160
poaks in tho lirst yoar, anJ tvo ol thom shov troughs in tho thirJ, so this is
closo onough.
Scrutiny ol tho graphs shovs: in tho 1990-92 svoon, intorost ratos loll,
lut in tho othors thoy roso: prolits voro llat, unliko 1980-82, vhon thoy
loll 40/: anJ stock pricos roso 20/, instoaJ ol lalling, as thoy JiJ in tho
tvo prior rocossions. Consoouontly, tho avorago lusinoss vas allo to moot
its intorost lill, anJ tho valuo ol its oouity stayoJ alovo tho valuo ol its
Jolt, kooping it solvont. HaJ tho 1990-91 rocossion loon moro liko tho
oarlior tvo, avorago Joltoouity ratios voulJ havo loon 100/ (moaning
that hoavily inJoltoJ lirms voulJ havo loon unJor Joop vator) instoaJ
ol 60/, anJ intorost voulJ havo takon a liggor lito ol prolits - in tho
Charls show lhe course ol several inporlanl linancial neasures allecling nonlinancial
corporalions during lhree recessionarv periods, !973-75, !930-32, and !990-92.
For each indicalor, lhe value ol lhe lirsl vear (!973, !930, !990 is sel lo !00, and
values lor lhe second and lhird vears ol each period are expressed as an index
nunber relalive lo lhe lirsl. The absolule levels lor each period varv, lhe poinl ol lhis
exercise is lo exanine changes, nol absolules. n order, charls show inleresl rale
lor Baaraled corporale bonds (lirns raled Baa lie belween bluechip and junk slalus,
nel inleresl paid bv nonlinancial corporalions (FCs, prelax prolils ol FCs, lhe
ralio ol lhose inleresl pavnenls lo earnings |prolils| belore inleresl and laxes (EBT,
equilv |slock| values ol FCs, and lhe ralio ol lhose equilv values lo lhe debls ol
FCs. Assels and liabililies lron lhe llow ol lunds accounls, inleresl and prolils,
lron lhe PAs.
60
30
!00
!20
! 2 3
preta profits
!990-92
!930-32
!973-75
30
!00
!20
!40
! 2 3
Baa bond rate
!990-92
!930-32
!973-75
30
90
!00
!!0
!20
! 2 3
interest
!990-92
!930-32
!973-75
30
!00
!20
!40
!60
! 2 3
interestlEBlT
!990-92
!930-32
!973-75
60
30
!00
!20
!40
! 2 3
equity values
!990-92
!930-32
!973-75
60
30
!00
!20
!40
!60
! 2 3
debtlequity ratio
!990-92
!930-32
!973-75
financial measures in three recessions
MARKET MODELS
161
rango ol 42-55/, closo to tho lovols ol 1933-34 (though still lolov thoso
ol 1931 anJ 1932). BonJ ratos voulJ havo loon 12-13/, not 9/. BCW
havon`t upJatoJ thoir vork, lut it`s likoly that lirms at thoir 95th porcontilo
vont to tho vall lut thoso at tho 85th got ly, or somothing liko that.
Both lorrovors anJ lonJors got Jolt-shy in tho oarly 1990s. Altor rotir-
ing a not ol $641 lillion in stock lotvoon 1984 anJ 1990, mainly through
lovoragoJ luyouts, sharo ropurchasos, anJ takoovors (hostilo anJ othor-
viso), U.S. nonlinancial corporations linally usoJ tho stock markot lor its
allogoJ purposo lrom 1991 to 1993, raising a total ol $6 lillion total in not
nov oouity. Pathor than linancing nov invostmont, thoso stock issuos
mainly vont to pay oll olJ Jolts. Dolt issuanco slovoJ lrom $1.3 trillion
lrom 1984 through 1990, an avorago ol $185 lillion a yoar, to $ lillion
lrom 1991-93, or $26 lillion a yoar, an 86/ lall in tho annual paco ol Jolt
croation. Tho lov lovol ol not lorroving lor 1991-93 Jisguisos a hoavy
gross issuanco: lirms voro lusily oxchanging nov, lovor-intorost-rato Jolt,
lor olJ, high-rato Jolt, anJ short-torm Jolt lor long (Pomolona ot al. 1992-
93, pp. 15-19). By 1994, lirms` lalanco shoots voro signilicantly ropairoJ,
anJ tho Jolt sorvico lurJon vas consiJorally lightonoJ.
1
lt vasn`t luck that gavo us this turn ol ovonts, lut govornmont policy -
tho lank anJ S8I lailouts anJ sustainoJ inJulgonco ly tho loJ. Tho vol-
laro stato may havo loon shroJJoJ lor tho poor, lut not lor lig linanco,
vhich can scrov up granJly anJ still count on an oxponsivo roscuo.
efficient markets
Doos it mattor to a largor pullic vhothor tho stock markot is olliciont` or
not? Horo`s ono viov ol vhy it Joos, lrom somo convontional oconomists:
To rojoct tho Elliciont Varkot Hypothosis lor tho vholo stock markot.implios
lroaJly that proJuction Jocisions lasoJ on stock pricos vill loaJ to inolli-
ciont capital allocations. Voro gonorally, il tho application ol rational oxpocta-
tions thoory to tho virtually iJoal` conJitions proviJoJ ly tho stock markot
lails, thon vhat conliJonco can oconomists havo in its application to othor
aroas ol oconomics.? (Varsh anJ Vorton 1986, ouotoJ in lortuno 1991).
Tho ansvor to tho conliJonco ouostion, as vo`ll soo, is not much.
Porhaps tho oasiost vay to consiJor tho vast litoraturo on markot ollicioncy
is to locus on tvo roviovs ol tho stato ol tho art vritton ly Eugono lama ol
tho Univorsity ol Chicago, tho lirst in 190, vhon tho thoory vas in high
WALL STREET
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llovor, anJ tho soconJ in 1991, vhon it haJ takon sorious hits. lama oponoJ
his canonical 190 roviov ol tho olliciont markot thoory
18
as lollovs:
Tho primary rolo ol tho capital markot is allocation ol ovnorship ol tho
oconomy`s capital stock. ln gonoral torms, tho iJoal is a markot in vhich
pricos proviJo accurato signals lor rosourco allocation: that is, a markot in
vhich lirms can mako proJuction-invostmont Jocisions, anJ invostors can
chooso among tho socuritios that roprosont ovnorship ol lirms` activitios
unJor tho assumption that socurity pricos at any timo lully rolloct` all avail-
allo inlormation. A markot in vhich pricos alvays lully rolloct` availallo
inlormation is calloJ olliciont.`
19
Tho vorJs in ouotation marks carry hoavy laggago. lama acknovl-
oJgoJ that lully rolloct` is a protty mushy phraso, so vaguo as to lo statis-
tically untostallo. Stock pricos must alvays roprosont invostors` lost
opinions ol tho prospocts ol thoir unJorlying lirms: il this is tho caso, thon
tho allocation ol capital thoy symlolizo must lo optimal. To a puroly li-
nancial thoorist, olliciont pricos aro onos that rolloct all availallo inlorma-
tion. To an oconomist, an olliciont allocation is ono that proJucos tho
maximum output lor a givon sot ol inputs - a raro caso ol oconomics
ochoing colloouial usago. Unlortunatoly tho tvo moanings aro oasily con-
lusoJ, loaJing to much intolloctual anJ political mischiol.
lama JistinguishoJ among throo variotios ol tho EVH: tho voak, somi-
strong, anJ strong lorms. Tho voak lorm assorts that tho past courso ol
socurity pricos says nothing alout thoir luturo moanJorings. Tho somi-
strong lorm assorts that socurity pricos aJjust almost instantanoously to
signilicant novs (prolits announcomonts, JiviJonJ changos, otc.). AnJ tho
strong lorm assorts that thoro is no such thing as a hiJJon caJro ol smart
monoy` invostors vho onjoy privilogoJ accoss to inlormation that isn`t
rolloctoJ in pullic markot pricos.
EV thoory turns in part on vhat tho Jolinition ol tho right` prico ol a
stock or othor linancial assot shoulJ lo, sinco in an olliciont vorlJ, tho
markot prico shoulJ lo moro or loss iJontical to tho right ono. Hov, thon,
shoulJ a stock lo pricoJ?
20
Tho prolorroJ moJol that grov up alongsiJo
tho EVH holJs that tho koy to pricing any assot is its riskinoss. That has a
common-sonso appoal, lut tho prolossors ol linanco havo a spocial viov
ol risk. ln tho Sharpo-Iintnor-Black moJol (SIB, namoJ altor William
Sharpo, John Iintnor, anJ lishor Black), also knovn as tho capital assot
pricing moJol (CAPV, pronouncoJ cap-om), risk is JolinoJ as tho volatil-
ity ol an assot`s oxpoctoJ roturns - its varianco arounJ a norm - ox-
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prossoJ in comparison to somo lonchmark, usually a riskloss` invost-
mont liko Troasury lills. Pisk, thon, is not tho possilility ol loss in tho
colloouial sonso, lut tho likolihooJ ol Joviation lrom an oxpoctoJ roturn.
A socurity`s charactoristic risk is calloJ its lota (or , JoponJing on
your typographical proloroncos). Tho highor tho lota, tho highor tho ox-
poctoJ` roturn. ln tho CAPV, a riskloss invostmont liko a lank Joposit or a
Troasury lill sots tho lasolino roturn: tho lurthor up tho risk scalo you
movo, tho highor tho oxpoctoJ roturn. Stocks in gonoral aro riskior than T-
lills, so stocks in gonoral shoulJ ollor highor componsatory rovarJs: tho
stock ol a high-toch lirm is likolior to lo lar moro volatilo than a
soapmakors`s, so tho high-toch stock shoulJ ollor tho lottor roturn. ln tho
classic lormula, thon, tho roturn on an inJiviJual stock oouals tho riskloss
intorost rato plus a promium lor its rolativo volaility.
Woro thoso risk anJ roturn rolationships graphoJ, thoy voulJ yiolJ an
upvarJ-sloping lino, knovn as tho socurity markot lino (SVI), locauso
tho roturn JomanJoJ risos vith risk. ln an olliciont markot, assot pricos
shoulJ lall on tho lino. ShoulJ ono lall alovo it - inJicating a roturn
highor than varrantoJ ly risk - or lolov it, thon tho markot is inolliciont.
NooJloss to say, tho roal vorlJ is lar mossior than tho thoory, anJ lama
himsoll voulJ challongo it in a 1992 papor (JiscussoJ lolov). But ovor
tho long torm, tho rolationship lotvoon risk anJ rovarJ Joos moro or loss
holJ, ovon il not vith mathomatical porloction: vhilo yoar-to-yoar roturns
may vary vilJly, ovor JocaJos, stocks aro lar moro prolitallo than riskloss
invostmonts - though vhy this is has not loon convincingly oxplainoJ.
Vost thoory spoaks ol ~.j~cI~u roturns, vhich aro littlo moro than
guossos lasoJ on history. ln tho oarly Jays ol EV thoory, this vas largoly
ignoroJ, sinco oxpoctations voro assumoJ to lo rational, lut tho Jovils
hiJing in this assumption vill lo rovoaloJ lator on. lama acknovloJgoJ,
in his typically lair-minJoJ vay, that this notion ol oxpoctoJ roturns is a
mathomatical concopt that shoulJ not lo imluoJ vith any spocial impor-
tanco.` lnstoaJ, it is a mothoJological nocossity, tho unavoiJallo prico
ono must pay to givo tho thoory ol olliciont markots ompirical contont.`
No ono can soo an oxpoctoJ roturn: ono can only oxtrapolato lrom past
oxporionco. ln moro popular, moro iJoological vorsions ol olliciont mar-
kot thoory, oxpoctations aro imluoJ vith an almost mystical importanco:
tho colloctivo visJom ol tho markot` is troatoJ as il it voro omnisciont.
Notions ol markot ollicioncy havo thoir roots in a long-stanJing olsor-
vation that it`s Jamn harJ to loat tho markot, anJ that pricos soom to movo
in ranJom vays. Iouis Bacholior arguoJ in a 1900 stuJy (that vas ignoroJ
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164
lor 60 yoars) that ovor tho long torm, spoculators shoulJ consistontly oarn
no oxtraorJinary prolits: markot pricos, in othor vorJs, aro a lair gamo.`
Anothor procursor ol EV thoory vas AllroJ Covlos, vho shovoJ in tvo
stuJios (Covlos 1933: 1944) that a varioty ol lorocasts ly punJits anJ in-
vostmont prolossionals yiolJoJ rosults that voro at lost no lottor than tho
ovorall markot, anJ olton ouito vorso.
ln tho moro moJorn lorm, markot ollicioncy partisans holJ that tho
coursos ol pricos constituto somothing liko a ranJom valk,` moaning that
thoy cannot lo proJictoJ, sinco thoir Jay-to-Jay variations - oscillations
arounJ somo lunJamontal valuo, as JotorminoJ ly oxpoctoJ luturo ro-
turn - Jo not lollov a pattorn signilicantly Jilloront lrom vhat chanco
voulJ spocily. Almost no ono has accoss to spocial inlormation JonioJ
most markot participants. Tho practical implication is that puntors can`t
loat tho markot ly moving in anJ out ol tho stock markot as a vholo or
lrom ono sot ol stocks to anothor in accorJanco vith thoir ovaluations ol
tho markot`s prospocts: tho lost thing thoy can Jo is luy a lroaJ varioty ol
stocks anJ holJ thom pationtly through gooJ timos anJ laJ.
As lama notoJ, thoso notions ol ollicioncy all assumo: (1) thoro aro no
transaction costs in traJing socuritios: (2) inlormation is JissominatoJ
ooually among all markot participants: anJ (3) all participants holJ similar
intorprotations ol that inlormation. Elliciont pricos aro thoso lormoJ ly
tho lrictionloss luying anJ solling ol ooually onJovoJ participants.
Ol courso, nono ol thoso conJitions aro truo. Commissions anJ taxos
mako luying anJ solling rolativoly oxponsivo: institutional invostors om-
ploy a lovy ol pricoy analysts anJ sulscrilo to hunJroJs ol ooually pricoy
novs anJ analytical sorvicos, vhilo smallor lry JoponJ on instinct or ru-
mor: anJ intorprotations Jivorgo. As thoy say on Wall Stroot, pooplo luy a
stock locauso thoy think it`s going to go up, lut thoy usually luy it lrom
somoono vho thinks it`s likoly to go Jovn. ll ovoryono holJ iJontical
opinions, thoro voulJ lo no traJing. Thoso roal-vorlJ conJitions shoulJ
not lo latal to tho EV ontorpriso, lama arguoJ: roality is closo onough to
thoory to justily tho thoorotical pursuit.
Evon tho occasional anomalios that voro uncovoroJ in tho 1960s -
mainly thoso shoving sorial corrolations (that is, somo porsistonco in prico
changos lrom ono porioJ to tho noxt, or in plain English, tronJs) in stock
pricos ovor tho vory short torm, moaning a singlo Jay or just sovoral hours
- voro too small to lo traJoJ prolitally: ovon prolossionals vho traJo at
minusculo commissions coulJ not tako aJvantago ol thoso tronJlots. Othor
oviJonco citoJ ly lama shovoJ that largo prico changos aro likoly to lo
MARKET MODELS
165
lollovoJ ly largo prico changos, though thoro vas no pattorn to tho signs
ol tho succossor changos: a largo upvarJ chango ono Jay voulJ prolally
lo lollovoJ ly a largo chango tho noxt Jay, lut tho chango on tho soconJ
Jay vas as likoly to lo Jovn as up. NooJloss to say, such a Jiscovory is
not ol much holp to spoculators.
Tosts ol tho somi-strong lorm ol tho EVH Juring tho 1960s consistoJ ol
olsorvations ol stock pricos just loloro anJ altor important announco-
monts liko stock splits, JiviJonJ changos, anJ tho liko. Thoso proviJo sta-
tistical conlirmation ol tho Wall Stroot axiom to luy tho rumor anJ soll tho
novs: most ol tho chango in prico arounJ such announcomonts occurs
loloro thoir pullic roloaso, suggosting that a signilicant lraction ol invos-
tors aro romarkally prosciont, romarkally skilloJ at analyzing pullic in-
lormation, or romarkally voll-inlormoJ.
Evon in 190, tho strong lorm ol tho EVH vas ompirically tho voakost
ol tho throo vorsions. Ono 1966 stuJy citoJ ly lama shovoJ that stock
oxchango spocialists gonorally traJoJ prolitally ovor 80/ ol tho timo, a
sharp llov to tho iJoa that smart monoy invostors Jo not oxist. This lits
vith popular loliol that loing a spocialist is virtually a liconso to print
monoy (though spocialists, ol courso, Jony this). Othor stuJios Juring tho
1960s shovoJ that corporat o i nsi Jors - sonior managors anJ
loarJmomlors ol pullicly holJ lirms - voro also allo to luy anJ soll
vith lottor-than-avorago timing. This olsorvation concorns only logal in-
siJor traJing, vhich must lo roportoJ to tho SEC anJ vhich is not sup-
posoJ to lo lasoJ on accoss to spocilic juicy lits ol inlormation. lt voulJ
lo illogal lor a CEO to soll hor stock a vook in aJvanco ol a nasty an-
nouncomont that vill tako Wall Stroot ly surpriso - a Jisastrous loss,
porhaps, or an unlavorallo rogulatory Jovolopmont. But shoulJ sho soll
on tho lasis ol an inlormoJ juJgmont that tho lirm lacoJ a rocky yoar or
tvo, that voulJ not only lo ontiroly logal, lut also ouito voll-aJvisoJ.
Evon il thoy Jo havo accoss to privilogoJ inlormation on vhich thoy
can prolitally traJo, spocialists anJ corporato insiJors aro nonotholoss a
small class ol invostors. StuJios ol prolossional monoy managors, suppos-
oJly tho most sophisticatoJ invostors outsiJo Jonizons ol loarJrooms anJ
tho stock oxchango lloor, shov thom consistontly unallo to loat tho mar-
kot. Ol courso, as prolossionals havo como to Jominato traJing, roplacing
inJiviJual invostors, pros havo I~cu~ tho markot, anJ cannot roason-
ally lo oxpoctoJ to loat thomsolvos. Still, il most prolossional monoy
managors can Jo no lottor than markot avoragos, vhy Jo thoy Josorvo
thoso high salarios?
WALL STREET
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ln sum, tho voak lorm ol markot ollicioncy lookoJ ouito lirmly ostal-
lishoJ in 190, Jospito a lov minor anomalios. So too tho somi-strong
lorm. Evon tho strong lorm, vhich lama saiJ shoulJ lo lost viovoJ as a
lonchmark against vhich Joviations lrom markot ollicioncy.can lo
juJgoJ,` lookoJ rospoctallo, Jospito tho spocialist anJ insiJor oxcoptions.
lt is ouito a loap to say that locauso it is unproJictallo, tho stock markot
is olliciont, anJ anothor lroaJ loap to arguo that such ollicioncy moans
that tho stock markot`s inlluonco ovor tho allocation ol roal capital is olli-
ciont in tho oconomic sonso. But in 190, lama`s analysis soomoJ to lo
irrolutallo on its ovn torms.
Tvonty-ono yoars lator, lama (1991) roturnoJ to survoy tho stato ol olli-
ciont markot thoory, anJ lounJ it unJor challongo lrom sovoral ouartors.
lama logan ly Jolining ollicioncy as tho simplo statomont that socu-
rity pricos lully rolloct all availallo inlormation.` What is that inlormation?
Tho sum ol invostor oxpoctations alout tho luturo. But aro thoso stallo or
rational, anJ vhoro Jo thoy como lrom anyvay? ln tosting lor markot olli-
cioncy, lama pointoJ out, vo can only tost vhothor inlormation is prop-
orly rolloctoJ in pricos in tho contoxt ol a pricing moJol that Jolinos tho
moaning ol proporly.`` Tosts ol tho EVH, thon, aro simultanoously tosts ol
hov accuratoly invostors Jivino tho luturo anJ hov accuratoly stock pricos
roprosont that consonsus - moaning that tho EVH haJ a joint hypoth-
osis` prollom, in tho jargon ol tho traJo.
ll pricos rolloct laJ inlormation olliciontly, is that a gooJ thing? lnvos-
tors ovorvaluoJ U.S. corporations in tho oarly 190s, anJ unJorvaluoJ thom
lator in tho JocaJo: pricos corroctly rolloctoJ this consonsus, lut in loth
casos tho consonsus vas vrong` in rotrospoct. lama lrought up tho point
only to Jrop it, lut it Joos soom to havo rathor sorious implications lor tho
visJom anJ rolialility ol stock markot pricing anJ invostmont Jocisions
inlluoncoJ ly its signals.
Torminology, lama notoJ, haJ changoJ ovor tho tvo JocaJos sinco his
last roviov. Tho voak, somi-strong, anJ strong lorms ol tho EVH haJ
oarnoJ moro Joscriptivo namos: tosts lor roturn proJictalility, ovont stuJ-
ios, anJ tosts lor privato inlormation. lolloving lama, lot`s look at tho
stato ol tho art in tho oarly 1990s.
R~Iu:u j:~u:cIuI:I:I) Work in tho 1980s, using Jilloront - a skoptic on
oconomotrics hositatos to uso tho phraso moro povorlul` - statistical
MARKET MODELS
167
tochniouos, ropoatoJly lounJ moro pattorns in pricos than classic ranJom
valk thoory allovoJ, ospocially il you oxamino portlolios consisting ol a
numlor ol stocks. ln othor vorJs, inJiviJual sharos may lollov moro-or-
loss ranJom pattorns, lut tho markot as a vholo movos in tronJs (or, in
statistical languago, roturns aro autocorrolatoJ), ospocially ovor tho long
torm. |Plocont rosoarch,` lama concluJoJ, is allo to shov conliJontly
that Jaily anJ vookly roturns aro proJictallo lrom past roturns.`
Evon moro challonging to EVH orthoJoxy is rosoarch that goos loyonJ
prico history. A numlor ol stuJios Juring tho 190s anJ 1980s shovoJ
that stocks vith lov pricooarnings ratios anJor high JiviJonJ yiolJs -
choap` stocks, in slang - voulJ likoly outporlorm stocks that voro ox-
ponsivo ly thoso moasuros, a sophisticatoJ conlirmation ol olJ Wall Stroot
visJom. Othor rosoarch, incluJing lama`s ovn (lama anJ lronch 1989),
shovoJ that stocks aro a gooJ luy vhon tho long-torm intorost ratos aro
voll alovo short-torm onos, anJ vhon tho gap lotvoon intorost ratos on
risky anJ salo corporato lonJs is viJo, anJ a laJ luy vhon tho opposito
conJitions provail, though tho rolationship is lar lrom porloct. Tho lirst sot
ol circumstancos is usually associatoJ vith rocossion anJor linancial anxi-
oty, anJ tho soconJ sot vith gooJ timos - anothor vay ol saying that
stocks anticipato turns in tho lusinoss cyclo, though not vithout giving
ouito a lov lalso signals. Again, this looks liko a lancy conlirmation ol
Stroot visJom.
lama also roportoJ somo laJ novs lor tho Sharpo-Iintnor-BlackCAPV
pricing moJol. Tho oarly 190s, lama rocalloJ, voro a ouphoric timo lor
linancial thoorists: tho SIB thoory lor a momont soomoJ to havo solvoJ`
tho prollom ol pricing socuritios. Wo shoulJ havo knovn lottor,` lama
vroto. Tho SIB moJol is just a moJol anJ so suroly lalso.` lor a moJol
luilJing prolossion, this is an oJJ Jiscovory, lut lama vont on to JolonJ
SIB anJ moJol-luilJing in gonoral ly saying it vas usolul to Jiscovor tho
vays in vhich it is provoJ lalso, vhich might lo truo il tho moJol luilJors
haJ approachoJ tho vorlJ vith humility rathor than ouphoria.
Though it is still rovorontly taught to lusinoss school stuJonts, thoro
aro simply too many anomalios to sustain tho puro SIB lota moJol, most
importantly tho sizo olloct. Small` stocks, as moasuroJ ly markot capi-
talization (prico timos tho numlor ol sharos outstanJing) shov oxcossivoly
high roturns rolativo to thoir lotas, anJ lig` stocks, oxcossivoly lov ro-
turns. Also, tho rolation lotvoon lota anJ roturn (vith moro volatilo stocks
shoving highor roturns), vhich vas lirst positoJ in tho 1960s anJ 190s,
lroaks Jovn vhon applioJ to moro rocont prico history. Eithor tho lirst
WALL STREET
168
Jiscovory` vas anomalous, or it coasoJ to vork as tho invosting pullic
locamo avaro ol tho tochniouo.
A 1992 papor ly lama anJ Konnoth lronch that roportoJ vory Jamag-
ing oviJonco lor tho lota moJol - that lirm sizo anJ tho ratio ol markot
valuo to look valuo aro lottor proJictors ol roturn than rolativo volatility
- oxcitoJ tho iJoologists at TI~ Ecuu::I (1992c) to a Jolonso. ShoulJ
analysts stop using tho CAPV? Prolally not,` tho magazino JoclaroJ in its
lost ~. cuII~u:u tono. AnJ vhy not? Bocauso vhilo lama anJ lronch
havo proJucoJ intriguing rosults, thoy lack a thoory to oxplain thom.`
That is truo onough: lama anJ lronch voro uncortain vhothor thoy`J un-
covoroJ somothing rational or not rational. (lt`s ouito amazing to soo tho
190 partisan ol markot ollicioncy ovon ontortain tho notion ol irrational-
ity 22 yoars lator.) But as TI~ Ecuu::I put it, tho choico lor practitionors
anJ thoorists is vhothor to loliovo oviJonco vithout thoory, or stick vith
a thoory that, Jospito tho Jata, is luilt on impoccallo logic.` Tho magazino`s
proloronco, cloarly onough, vas lor thoory ovor oviJonco.
A small llooJ ol stuJios appoaroJ in tho yoars altor tho lama-lronch
papor, suljocting tho CAPV to lrosh scrutiny, somo JolonJing it against
tho horotics, anJ othors supporting tho horosy (lor oxamplo, Kothari ot al.
1995, anJ Cohon anJ Polk 1996). A roviov ol rocont vork (Jagannathan
anJ VcGrattan 1995) makos it cloar that ovaluations ol tho moJol aro highly
JoponJont on tho naturo ol tho oviJonco usoJ.
21
Dilloront timo porioJs, or
Jilloront sots ol stocks, or Jilloront moasuros ol roturn (monthly or an-
nual) proJuco vilJly Jilloront rosults. Tho mossago sooms to lo that, yos,
tho moro volatilo an assot, tho highor its likoly roturn ovor tho vory long
torm, lut tho rolation oscapos prociso ouanitilication ol tho sort most con-
vontional oconomists cravo. Sinco CAPV is not only usoJ to analyzo linan-
cial markots, lut is also usoJ ly corporato managors to JociJo on roal
invostmonts, tho moJol`s lato is ol moro than tochnical intorost.
Though CAPV still has its aJhoronts, ono ol tho moro inlluontial altor-
nativo approachos to stock valuation is arlitrago pricing thoory (APT) (Poss
196). ln APT, tho prico ol an assot JoponJs on tho pricos ol a numlor ol
rolatoJ assots, though tho numlor ol othor assots anJ thoir naturo isn`t
spocilioJ ly tho thoory. An APT moJol ol tho stock markot (Chon, Poll,
anJ Poss 1986), lor oxamplo, lounJ that tho lost proJictors ol luturo ro-
turn aro tho grovth rato ol inJustrial proJuction (vith luturo roturns high
vhon inJustrial proJuction has loon voak, anJ vico vorsa) anJ tho sproaJ
lotvoon intorost ratos on lov-graJo corporato lonJs anJ long-torm gov-
ornmont lonJs (vith luturo roturns high vhon tho sproaJ is viJo). This
MARKET MODELS
169
looks romarkally liko Wall Stroot common sonso: common sonso can ol-
ton lo stupiJ, lut not alvays.
Tho prollom, though, vith so-calloJ multilactor moJols liko APT is
that analysts can play vith tho Jata, aJJing anJ sultracting inlluoncos,
until thoy linJ a comlination that vorks. This Jangor is alvays prosont in
mathomatical oconomics: lama`s roviov is lull ol varnings alout tho Jan-
gors ol Jata larming anJ moJol JroJging. ln oconomics, ono raroly knovs
lor suro, Jospito all tho protonso ol scionco. AnJ, as alvays, ono usos his-
torical rolations to proJict luturo pricos - vhich is aJmittoJly all ono can
uso, lut it`s still a long vay lrom physics.
E:~uI :Iuu:~: Thoso stuJios aro rolativoly oasy to Jo, anJ can ollor moro
Jolinitivo rosults than most. Stock pricos vill oithor roact or not roact to an
announcomont: tho roaction vill oithor porsist or Jocay. So it`s no vonJor
that tho linanco litoraturo is lilloJ vith ovont stuJios.
Thoro`s littlo Joult nov that stocks Jo rosponJ ouickly to nov inlor-
mation, vith occasional oxcoptions. Tvo intorosting rocont Jiscovorios,
hovovor, Jothrono somo classic thoorotical notions. Tho lirst is that unox-
poctoJ changos in JiviJonJs tonJ to push stock pricos in tho samo Jiroc-
tion - up vhon tho JiviJonJ is loostoJ, Jovn vhon it`s cut. This violatos
VV thoory, vhich holJs that JiviJonJ policy shoulJ lo irrolovant to tho
stock prico. Thoro may lo sovoral roasons lor this. Ono possilility is that
invostors aro moro omotional than thooroticians allov lor, anJ thoir roac-
tion to JiviJonJ changos is a triumph ol gut roaction ovor rational analy-
sis. Anothor possilility is that corporato managors uso JiviJonJs to signal
major changos in tho long-torm prospocts lor tho lirm (or that invostors
porcoivo thom as such). A JiviJonJ cut is a vay ol saying tho corporation
is in Joop troullo: a loost, ospocially a largo, unoxpoctoJ ono, a vay ol
saying tho luturo is lrightor than anyono haJ roalizoJ.
Tho soconJ intorosting Jiscovory is that a nov issuo ol stock tonJs to
lo laJ novs lor luturo pricos. Tho classic assumption vas that a stock
issuo is a sign ol a lirm`s conliJonco in its luturo: aJJitionally, tho inlusion
ol lrosh capital shoulJ lo gooJ nourishmont lor luturo prolits. But this
sooms not to lo tho caso. Tho most roasonallo oxplanation is that manag-
ors issuo stock vhon thoy think it`s ovorvaluoJ - anothor sharp llov at
tho notion ol ollicioncy. Voro on loth thoso topics a littlo lator.
(uIj~:J:uuuc~ Horo, 20 yoars ol stuJios gonorally conlirm classic EV
thoory: it`s Jovilishly Jillicult to loat tho markot. Tho oxcoptions JiscussoJ
WALL STREET
170
alovo, stock oxchango spocialists anJ corporato insiJors, still provail. Evon
though inlormation on (logal) insiJor traJing is lairly viJoly availallo, tho
markot apparontly Joos not mako aJoouato uso ol it - though it`s harJ to
imagino this anomaly porsisting lorovor. Prolossional socurity analysts anJ
monoy managors aro largoly unallo to Jo lottor than tho markot, vith ono
notallo oxcoption, tho stock rankings pullishoJ ly tho !uIu~ 1:u~
1u:~:Iu~uI u::~)
Unlortunatoly, ovon tho Valuo Iino inlormation, vhilo thoorotically in-
torosting, is ol littlo practical importanco. Stock pricos aJjust spooJily to
Valuo Iino upgraJings, moaning that all lut tho nimllost or lost-connoctoJ
invostors aro JonioJ tho opportunity to prolit lrom tho inlormation: ly tho
timo most sulscrilors got tho novs, it`s alroaJy in tho prico.
Somo roaJors may havo noticoJ a contraJiction horo. On tho ono hanJ,
lama concoJoJ that roturns aro proJictallo,` at loast in tho statistical sonso,
lut on tho othor, it`s still noar-impossillo to loat tho markot. This appar-
ont contraJiction is oasily rosolvoJ. Tho kinJs ol proJictalility statisticians
talk alout aro vory Jillicult to translato into practical traJing aJvico. Things
that soom proJictallo` in rotrospoct aron`t oasy to soo in roal timo. Vortal
traJors, vho havo to vorry alout commissions, taxos, anJ othor vorlJly
complications, can`t oasily translato an anomaly announcoJ in tho {u:-
uuI J 1:uuuc~ into a prolitallo traJing systom. AnJ as soon as novs ol
tho anomaly circulatos, a traJors voulJ pounco on tho opportunity: onco
JiscovoroJ, anomalios can lo soll-unlullilling prophocios.
An oxcoption, though, aro longor-torm anomalios, particularly thoso
arounJ valuation. Buying unJorvaluoJ stocks, anJ avoiJing ovorvaluoJ
onos, might lo a vay to loat tho markot ovor tho long torm. Horo, tho
Jilliculty isn`t so much tochnical as psychological: it moans going against
tho consonsus, anJ sulloring tho scorn ol your colloaguos. lt also moans
moasuring porlormanco ovor yoars, ovon JocaJos, rathor than months anJ
ouartors - impossillo lor prolossional portlolio managors, vho aro un-
Jor constant short-torm roviov, anJ Jillicult ovon lor amatours, vho might
lo omlarrassoJ to Joscrilo thoir strango proloroncos at cocktail partios.
disinformation, noise, fads, and bubbles
Elliciont markot thoory JoponJs on tho univorsal, costloss Jissomination
ol accurato inlormation alout oconomic anJ corporato prospocts. Tho un-
critical stanco ol most Wall Stroot analysts anJ much ol tho linancial pross
roviovoJ in Chaptor 2 makos this a lit harJ to tako just on tho grounJs ol
MARKET MODELS
171
Jaily oviJonco. But ovon il analysts voro univorsally honost anJ viso,
thoro voulJ still lo sorious communications prolloms lotvoon managors
anJ stockholJors. lor oxamplo, accorJing to Joromy Stoin (1989), somo-
thing liko a prisonors` Jilomma provails in rolations lotvoon managors
anJ tho stock markot. Evon il participants aro avaro ol an upvarJ lias to
oarnings ostimatos, anJ ovon il thoy corroct lor it, managors still havo an
incontivo to try to lool tho markot. ll you toll tho truth, your accurato osti-
matos vill lo markoJ Jovn ly a skoptical markot. So, it`s ontiroly rational
lor managors to loost prolits in tho short torm, oithor through accounting
gimmickry or ly making only invostmonts vith ouick paylacks.
ll tho markots soo high costs as laJ, anJ lov costs as gooJ, thon lirms
may shun oxponsivo invostmonts locauso thoy vill lo takon as signs ol
managorial incompotonco. Throughout tho lato 1980s anJ oarly 1990s, tho
stock markot rovarJoJ lirms announcing vrito-olls anJ mass lirings - a
lulimic stratogy ol managomont - sinco tho cost-cutting vas soon as con-
triluting rathor ouickly to prolits. lirms anJ oconomios can`t got richor ly
starving thomsolvos, lut stock markot invostors can got richor vhon tho
companios thoy ovn go hungry - at loast in tho short torm. As lor tho
long torm, voll, that`s somoono olso`s prollom tho vook altor noxt.
Vanagors lacing a markot that is lamous lor its proloronco lor ouick
prolits toJay rathor than pationt long-torm grovth havo littlo choico lut to
Jo its liJJing. Othorviso, thoir stock vill lo markoJ Jovn, anJ tho lirm
vill lo ripo lor takoovor. Stoin citoJ survoys shoving that U.S. oxocutivos
rankoJ sharo prico incroasos as thoir soconJ most important oljoctivos
out ol nino choicos, ahoaJ ol such altornativos as improvoJ proJuct port-
lolio,
22
markot sharo, or company imago. ln contrast, Japanoso oxocutivos
rankoJ sharo prico incroasos as tho loast important ol tho nino oljoctivos.`
This is no moro cultural Jilloronco, lut a rolloction ol tho contrasting sys-
toms unJor vhich tho tvo nations` managors oporato.
Stoin`s analysis is rolatoJ to a lranch ol oconomics that sproutoJ Jur-
ing tho 1980s lrom sooJs plantoJ in tho 190s - tho stuJy ol inlormation
asymmotry. Sinco a party to a transaction can novor knov il tho othor is
tolling tho truth, oach has to lo at loast a littlo suspicious ol tho othor. But
protoctivo actions rosulting lrom such suspicions may loavo loth partios
vorso oll than thoy voulJ havo loon haJ loth partios loon honost anJ
trusting. What, lor oxamplo, Joos a lov prico moan? lt may moan a roal
largain - lut it may also lo a hint ol JamagoJ gooJs. (To tako an ox-
tromo oxamplo, an ollor ol hall-prico sushi might Jrivo avay moro cus-
tomors than it attracts.) A prico can convoy moro than is visillo on lirst
WALL STREET
172
glanco. This groatly complicatos tho mainstroam notion ol pricos as a sig-
naling mochanism lor lalancing supply anJ JomanJ: thoro may lo lots ol
noiso mixoJ in vith tho signals.
As thoy say on Wall Stroot, vhon somothing looks too gooJ to lo truo,
it prolally is. Or as ono ol tho major liguros in tho Jovolopmont ol inlor-
mation asymmotry thoory, Josoph Stiglitz, put it, ll it`s such a gooJ iJoa,
vhy aro you tolling mo, instoaJ ol invosting your ovn monoy?` (ouotoJ in
Kano 1993). This is a romarkally llunt statomont lor Stiglitz, vhoso nor-
mal moJo is tho symlols ol puro mathomatizoJ thoory.
lntorost in inlormation asymmotry` is usually tracoJ to Goorgo Akorlol`s
1969 papor on tho lomons` prollom - not tho lruit, lut lum autos. WoulJ-
lo luyors ol usoJ cars havo no vay ol knoving vhothor tho vohiclo thoy`ro
contomplating is any gooJ. So tho prico must rolloct tho j:::I:I:I) that it
is a lomon, moaning that tho sollors ol gooJ cars got an unlairly lov prico
- vhilo tho sollors ol laJ onos still got an unlairly high ono. ll tho lomon
Jiscount is Joop onough, it may koop tho sollors ol gooJ cars out ol tho
markot, locauso thoy can`t got tho prico thoy think thoy Josorvo. But sinco
toxtlook markots aron`t supposoJ to vork this vay, this has to lo countoJ
as a sorious llav, locauso so many participants, actual or potontial, aro
JissatislioJ vith tho rolation lotvoon prico anJ proJuct.
Stilgitz anJ AnJrov Woiss (1981) applioJ this principlo to tho croJit
markots, arguing, almost ontiroly in math, that at a givon intorost rato, lonJ-
ors vill oarn lovor roturns ly lonJing to laJ lorrovors (locauso ol Jo-
laults) than to gooJ lorrovors. ll lonJors try to jack up tho intorost rato to
componsato lor this risk, thoy may chaso avay gooJ lorrovors, vho aro
unvilling to pay a highor rato, vhilo porvorsoly not chasing avay incom-
potont, criminal, or malignantly optimistic lorrovors. Such a markot Joosn`t
cloar: thoro vill alvays lo unsatislioJ playors at a givon rato ol intorost.
Stiglitz anJ his collalorators (GroonvalJ anJ Stiglitz 1984: 198: Stiglitz
1988) arguo that inlormational prolloms oxplain croJit rationing, vhich
in turn can oxplain loth tho lusinoss cyclo anJ unomploymont.
23
Though oconomists troat tho lomons prollom as il it voro a rocont Jis-
covory, it`s roally as olJ as tho classics. AJam Smith (196, Book ll, Chap-
tor 4), in rocommonJing a logal coiling on tho rato ol intorost, olsorvoJ:
ll tho logal rato ol intorost in Groat Britain, lor oxamplo, vas lixoJ so high
as oight or ton porcont, tho groator part ol tho monoy vhich vas to lo lont
voulJ lo lont to proJigals anJ projoctors, vho alono voulJ lo villing to
givo this high intorost. Solor pooplo, vho vill givo lor tho uso ol monoy no
MARKET MODELS
173
moro than a part ol vhat thoy aro likoly to mako ly tho uso ol it, voulJ not
vonturo into tho compotition. A groat part ol tho capital ol tho country voulJ
thus lo kopt out ol tho hanJs vhich voro most likoly to mako a prolitallo
anJ aJvantagoous uso ol it, anJ throvn into thoso vhich voro most likoly
to vasto anJ Jostroy it.
24
This proviJos an intorosting gloss on tho junk lonJ ora. Or, as DaviJ PicarJo
(1911198, Chaptor 21), put it:
To tho ouostion, vho voulJ lonJ monoy to larmors, manulacturors, anJ
morchants, at 5 por cont. por annum, vhon anothor lorrovor, having littlo
croJit voulJ givo or 8?` l roply, that ovory pruJont or roasonallo man
voulJ. Bocauso tho rato ol intorost is or 8 por cont. thoro vhoro tho lonJor
runs oxtraorJinary risk is this any roason that it shoulJ lo ooually high in
thoso placos vhoro thoy aro socuroJ lrom such risks?
Vichaol Porolman, vho toachos oconomics at Calilornia Stato Univor-
sity-Chico, saiJ that vhon ho tolJ Stiglitz alout thoso classic proligura-
tions ol his argumont, Stiglitz, rogarJoJ as ono ol tho primo thoorists ol his
liolJ, roactoJ vith surpriso. To locomo a lamous oconomist, you nooJ not
lo lamiliar vith tho lounJing Jocumonts ol your Jisciplino.
25
BosiJos, Smith
anJ PicarJo usoJ vorJs, vorJs that anyono can unJorstanJ. lt`s much
moro sorious to uso math, vhich only a hanJlul ol pooplo can JocoJo:
ovon prolossional oconomists roport Stiglitz` vork harJ going.
Tho stock markot is also alllictoJ vith inlormational prolloms (Vyors
anJ Vajlul 1984: GroonvalJ, Stiglitz, anJ Woiss 1984). OutsiJo invostors
must JociJo vhothor a lirm solling lrosh oouity is logitimatoly trying to
raiso monoy lor a vorthy pursuit, or just trying to loavo outsiJors holJing
tho lag. Assuming managors knov thoir lirm`s prospocts lottor than out-
siJors, a lirm vith ovorvaluoJ` stock is moro likoly to issuo sharos than
ono vith a lov valuo rolativo to vhat managors think ol its possililitios, a
vory porvorso sot ol incontivos. ll tho markots roalizo this, thon it vill lo
vory Jillicult to got any Joals Jono. At tho oxtromo, say GroonvalJ, Stiglitz,
anJ Woiss, tho olloctivo` cost ol issuing oouity may lo so high as to lo
prohilitivo, locauso any lirm that issuos oouity oltains a laJ` lalol.` Ol-
viously, lirms u issuo oouity lrom timo to timo, lut raroly, anJ mainly in
ouphoric lull markots, vhon suspicions aro JulloJ (though such psychol-
ogy is uncapturoJ in tho moJols ol Stiglitz 8 Co.).
ln lact, ouphoric soll-Jocoption sooms to lo vhat makos nov oouity
ollorings possillo. Sovoral rocont stuJios shov convincingly that nov stock
WALL STREET
174
ollorings - vhothor ly lirms issuing stock lor tho lirst timo (initial pullic
ollorings - lPOs) or ly alroaJy-pullic lirms issuing lrosh holpings ol pa-
por (soasonoJ oouity ollorings - SEOs) - groatly unJorporlorm tho gon-
oral markot lor yoars (Ioughran anJ Pittor 1995: Chong 1996).
26
Ono prominont oxcoption to poor lPO porlormanco is that porsonally
onjoyoJ ly lavoroJ clionts ol tho lrokoragos vho unJorvrito tho ollor-
ings. During a hot lPO markot, pricos typically riso in tho oarly hours anJ
Jays ol traJing, olton ouito Jramatically, yiolJing ouick anJ lat prolits to
thoso gotting lirst Jils. lor ospocially hot ollorings, it can lo harJ to got a
pioco ol tho action - unloss, ol courso, you havo a lrionJly invostmont
lankor vho rosorvos a lat trancho lor you. Bost knovn aro tho svoot Joals
oarnoJ ly important politicans ol loth major partios - liko lormor Houso
Spoakor Tom loloy anJ Sonato Banking Committoo chair Allonso D`Amato
(Glassman 1994: Kuntz anJ Simpson 1996). Evon politicians vith storling
roputations play tho gamo: a lormor WuII I:~~I {u:uuI roportor tolJ mo
ho haJ conlirmoJ inlormation that a prostigious Sonator lolovoJ ol tho
punJit class haJ playoJ tho gamo - lut tho journalist rolusoJ to pullish
tho inlo locauso ho vas lonJ ol tho Sonator.
Vany rationalos havo loon olloroJ lor poor post-olloring porlormanco,
incluJing managors` taking aJvantago ol an ovorpricoJ` stock - con-
lirming tho asymmotry thoorists` spoculation - anJ managorial manipu-
lation ol roportoJ prolits. Vorck, Shloilor, anJ Vishny (1990) shov that
lPOs aro lar moro likoly vhon valuations aro high than vhon avorago or
lov - lormal prool ol somothing that olsorvors ol Wall Stroot knov in
thoir lonos. Tooh, Wolch, anJ Wong (1995) shov that accounting gamos
playoJ in aJvanco ol a stock olloring shoulJ lo visillo at tho timo ol tho
olloring. ll analysts voro Joing thoir jols, thoso manipulations shoulJ havo
loon noticoJ: lut most analysts aro in tho pay ol lirms in tho lusinoss ol
solling socuritios. Croativo lookkooping is a provon markoting tool.
2
Thoso prolloms may lo mitigatoJ through tho Jovolopmont ol long-
torm rolationships lotvoon lirms anJ thoir outsiJo linanciors. This is ono
ol tho aJvantagos ol lank, as opposoJ to lonJ or stock markot, linanco:
lankors got to knov thoir customors il thoy`ro togothor lor a long timo.
But vith tho markots, tho rolationship is olton tho linancial oouivalont ol a
ono-night stanJ: ocstasy is alvays possillo, lut so too is mortal Jisoaso.
Countrios liko Japan anJ Gormany that aro usually classilioJ as lank-
contoroJ - locauso lanks proviJo moro outsiJo linanco than markots,
anJ locauso moro lirms havo long-torm rolationships vith thoir lanks -
shov groator grovth in anJ stalility ol invostmont ovor timo than tho mar-
MARKET MODELS
175
kot-contoroJ onos, liko tho U.S. anJ Britain. Tho roason sooms to lo that
British anJ U.S. lirms aro moro JoponJont on thoir intornal lunJs lor li-
nancing invostmont, in contrast vith lirms in tho othor countrios, vhoro
outsiJo linanco is availallo lrom a lamiliar lankor. lurthor, stuJios com-
paring Gorman anJ Japanoso lirms vith tight lank tios to thoso vithout
thom also shov that lirms vith lank tios oxhilit groator stalility in invost-
mont ovor tho lusinoss cyclo (Corlott anJ Jonkinson 1993: Elston 1994).
lt locamo lashionallo in tho miJ-1990s to cololrato tho Amorican stock-
markot moJol as vinJicatoJ ly tho voak porlormanco ol tho Japanoso
anJ Gorman oconomios Juring tho Clinton yoars. Whilo it`s not cloar
vhothor that U.S. outporlormanco is a pormanont thing or just a shortor-
torm cyclical allair, it can`t lo JonioJ that tho olJ Axis povors oxpori-
oncoJ oxtraorJinary grovth in invostmont anJ incomo Juring tho lirst 45
yoars altor WorlJ War ll`s onJ. lt may lo that as capitalist oconomios ma-
turo, anJ liouiJ lalancos svoll, thoy may tonJ tovarJ a moro lluiJ stylo ol
linanco anJ ovnorship.
lnlormation asymmotry thoorists gonorally assumo that markot participants
aro tho rational soll-maximizors ol mainstroam thoory: thoy can just novor
lo cortain ol tho knovloJgo anJ motivos ol thoir countorparts. As Polort
GorJon saiJ ol tho closoly rolatoJ Nov Koynosian school, any attompt to
luilJ a moJol lasoJ on irrational lohavior or sulmaximizing lohavior is
viovoJ as choating` (ouotoJ in Dymski 1994).
Whilo it`s salo to loliovo that linancial playors aro soll-maximizors, thoir
rationality is anothor mattor. AcaJomic stuJonts ol linanco havo incroas-
ingly rocognizoJ that lots ol olJ-lashionoJ improssionistic notions alout
markot volatility may lo truor than rationalists coulJ imagino. Tho notion
that laJs anJ lulllos anJ panics Jrivo socurity pricos lar lrom thoir lun-
Jamontal valuo - Joviations that onJ not ly roturning to that lunJamon-
tal valuo lut typically ly ovorshooting it to tho othor oxtromo - nov
onjoys a scholarly rospoctalility that it JiJn`t 15 or 20 yoars ago.
ln an inlluontial sorios ol papors pullishoJ Juring tho 1980s, Polort
Shillor JovolopoJ a thoory ol linancial markot volatility povoroJ ly horJo
psychology. His 1981 papor, Do stock pricos movo too much to lo justi-
lioJ ly sulsoouont changos in JiviJonJs?` (roprintoJ in Shillor 1991) took
aim at tho EVH`s claim that stock pricos aro tho rational JiscountoJ prosont
valuo ol rationally anticipatoJ luturo JiviJonJs or prolits. On tho soconJ
pago ol his articlo, Shillor chartoJ tho valuo ol stock pricos against tho
WALL STREET
176
truo` valuo a porloctly rational markot shoulJ havo loon assigning stocks
lasoJ on hov JiviJonJs actually turnoJ out (a highly Jolonsillo uso ol
2020 hinJsight) lrom 181-199.
28
Tho lino roprosonting JiviJonJs is ro-
markally stallo, ovon through tho Groat Doprossion, lut tho lino ropro-
sonting stock pricos zigs anJ zags vilJly, romaining at oxtromos ol ovor-
anJ unJor-valuation lor yoars, ovon JocaJos.
Anothor porspoctivo on tho markot`s lalilo tomporamont is tho volatil-
ity paraJox,` tho onormous variations in volatility in stock pricos (Shillor
1988: Schvort 1989). This volatility loars no statistical rolation to tho vola-
tility ol roal-vorlJ phonomona liko inllation, monoy grovth, inJustrial
proJuction, intorost ratos, or lusinoss lailuros.
29
Voroovor, Jospito tho
aJvont ol computorizoJ traJing tochniouos such as portlolio insuranco
anJ inJox arlitrago Juring tho 1980s, Jay-to-Jay volatility Juring that Jo-
caJo vas littlo Jilloront lrom that ol tho 190s, though loth JocaJos voro
moro volatilo than tho 1950s anJ 1960s (Davis anJ Whito 198).
Schvort`s Jata roport stock volatility to havo loon lov Juring timos ol
groat oconomic Jistross, liko vars or tho oxtonJoJ Joprossion ol tho lato
19th contury, suggosting that in timos ol roal social stross, pooplo havo
moro important things to vorry alout than thoir portlolios. That spocula-
tion, hovovor, is uponJoJ ly tho lact that volatility Juring tho Groat Do-
prossion ol tho 1930s vas tho most oxtromo in linancial history, lar
outpacing tho incroaso in roal-vorlJ volatility. Schvort linJs only voak`
oviJonco that roal-vorlJ (inJustrial proJuction) volatility prosagos luturo
linancial volatility, anJ somovhat strongor` oviJonco that linancial vola-
tility prosagos tho roal-vorlJ kinJ, lut much ol tho timo, it sooms, tho
stock markot Jancos to its ovn tuno.
Why? Shillor (1984) points to various social phonomona to oxplain thoso
Joparturos lrom rationality. Elliciont markot onthusiasts Jony any rolo to
mass psychology: il, as thoy loliovo, markots aro unlorocastallo, thoro`s
no room lor psychological oxplanations ol prico lohavior. Shillor Jismissos
this as ono ol tho most romarkallo orrors in tho history ol oconomic
thought.` lnvosting is a social activity: loth amatour anJ prolossional in-
vostors sponJ lots ol timo gossiping, rosoarching, anJ comparing porlor-
manco. linancial markots aro not tho sum ol tho rational oxpoctations ol
roasoning invostors, lut tho colloctivo juJgmont ol a mol.
Thoro is gooJ oviJonco lrom oxporimontal psychology shoving that
roal pooplo Jon`t act in accorJanco vith tho assumptions ol most linancial
moJols (citoJ in Jo BonJt anJ Thalor 1985: Kahnoman anJ Tvorsky 199).
Spocilically, pooplo tonJ to ovorvoight nov inlormation, rathor than av-
MARKET MODELS
177
oraging it into a historical contoxt. Do BonJt anJ Thalor voro allo to uso
this inlormation to proJict stock pricos: a portlolio composoJ ol a lroaJ
array ol losors` - stocks that haJ loon morcilossly loaton Jovn ly tho
markot - outporlormoJ tho avoragos ovor tho sulsoouont throo yoars. ln
othor vorJs, tho initial lossos voro tho rosult ol ovorroactions that cor-
roctoJ thomsolvos, lut not vithout tho passago ol ouito a lit ol timo.
30
ln a sorios ol papors, Iavronco Summors anJ his colloaguos (Cutlor ot
al. 1989: Cutlor ot al. 1990: Cutlor ot al. 1991: Potorla anJ Summors 1986:
Potorla anJ Summors 1988: Summors 1986: thoso aro cloarly rocountoJ in
Shloilor anJ Summors 1990) JovolopoJ tho noiso traJor approach to li-
nanco.` ln tho vorJs ol Shloilor anJ Summors:
Our approach rosts on tvo assumptions. lirst, somo invostors aro not lully
rational anJ thoir JomanJ lor risky assots is alloctoJ ly thoir loliols or son-
timonts that aro not lully justilioJ ly lunJamontal novs. SoconJ, arlitrago
- JolinoJ as traJing ly lully rational invostors not suljoct to such sonti-
mont - is risky anJ thoroloro limitoJ. Tho tvo assumptions togothor imply
that changos in invostor sontimont aro not lully countoroJ ly arlitragours
anJ so alloct socurity roturns.
Arlitrago in this sonso rolors to tho olliciont markotoors` assumption
that shoulJ pricos got out ol lino vith thoir varrantoJ valuo, rational in-
vostors vill movo in ouickly anJ luy unJorpricoJ assots or soll ovorpricoJ
onos. Thus mispricing can only lo transiont, novor sustainoJ. This makos
sonso il you`ro Joaling vith tvo vory similar assots: voro golJ is solling lor
$350 an ounco in Nov \ork anJ $355 in IonJon, thon spoculators voulJ
immoJiatoly movo in anJ luy Nov \ork anJ soll IonJon. But vhat il tho
vholo U.S. stock markot sooms ovorpricoJ to a rational arlitragour? What
can sho luy anJ soll to Jrivo pricos lack into lino? What alout tho Jangor
that ovorpricoJ stocks may got ovon moro ovorpricoJ loloro roturning to
a moro rational` valuo? Hov Joos tho arl knov vhat tho rational prico
roally is? What il prolits aro alout to tako oll, anJ tho apparontly irrational
valuo isn`t so vacky altor all? AnJ vhat alout tho lact that a short-sollor
has to covor tho JiviJonJs on tho stock solJ short (to tho stockholJor tho
sharos voro lorrovoJ lrom): this isn`t costloss oithor.
Whilo markots may lo populatoJ ly tho rational souls assumoJ ly
thoory, as anyono lamiliar vith tho traJo knovs, thoy`ro also populatoJ
vith a lov loss than porloctly rational souls as voll. Tho irrationals traJo
on noiso` as voll as inlormation - psouJo-inlormation (Black 1986).
Woro noiso traJors all truly listoning to sounJs ol thoir ovn Jovising, thoy
WALL STREET
178
might cancol oach othor out, lut instoaJ juJgmont liasos alllicting invos-
tors in procossing inlormation tonJ to lo tho samo. Suljocts in psycho-
logical oxporimonts tonJ to mako tho samo mistako: thoy Jo not mako
ranJom mistakos` (Shloilor anJ Summors 1990). ln such oxporimonts, sul-
jocts tonJ to lo ovorconliJont, vhich makos thom tako on moro risk than
thoy shoulJ: thoy tonJ to oxtrapolato tho past into tho luturo, vhich loaJs
thom to chaso (somotimos spurious) tronJs: anJ thoy givo too much voight
to nov inlormation, at tho oxponso ol vhat thoy alroaJy knov.
31
Tochnical traJors - pooplo vho spot pattorns liko lroakouts anJ lroak-
Jovns on prico charts - sproaJ noiso. Thoy lroouontly luy stocks that
appoar to lo in strong uptronJs, or soll thoso that havo violatoJ` somo
porcoivoJ lovol ol support. Whilo thoso signals` aro almost cortainly moan-
ingloss in tho long torm, thoy can lo soll-lullilling in tho short torm.
Noiso traJors anJ laJJists aro tho culprits in a markot pattorn calloJ
moan rovorsion.` ln tho short torm, thoir traJing stratogios push pricos
lurthor than thoy might havo gono in a lully rational vorlJ, vhatovor that
is, lut vhon tho pricos got too lar avay, tho lulllo lursts, anJ pricos
rovort to somo lunJamontal valuo. But noiso oporatos on tho corroctivo
siJo too, moaning that pricos ovorshoot thoir targot, vhich sots up anothor
rovorsion. Tho statistics olloroJ ly Cutlor, Potorla, Summors, 8 Co. aro, as
lama notoJ, a povor lailuro` - tho pattorns thoy spot, vhilo signilicant
in tho statistical sonso, aro loss than ovorvholmingly so.
But his ovn vork vith his Chicago colloaguo Konnoth lronch (lama
anJ lronch 1988) Joos ollor long-torm support to tho pattorn ol moan
rovorsion, spocilically a throo- to livo-yoar timospan. Survoying stock pricos
ovor tho 60-yoar porioJ lrom 1926 to 1985, lama anJ lronch arguoJ that
moan rovorsion accounts lor alout 35/ ol tho lohavior ol stock pricos.
Though tho tonJoncy is strongost among tho stocks ol smallor lirms, it
holJs lor largo stocks, across 1 inJustry groups, anJ among ovon tho
rolativo hanJlul ol inJiviJual stocks that survivoJ tho ontiro 1926-85 po-
rioJ. lama anJ lronch ouito roasonally olloroJ no practical aJvico to
spoculators on vhat this all moans: Joscriling a tonJoncy that oporatos
lroaJly ovor tho courso ol yoars isn`t much holp to traJors vhoso iJoa ol
tho long torm is tho Jay altor tomorrov.
lt is, hovovor, ol consiJorallo oconomic intorost. Tho tvo Chicagoans
arguo that this lohavior is not nocossarily tostimony in support ol tho irra-
tionality ol linancial markots. Extornal shocks` can oncourago Joparturos
lrom rational ovaluations ol luturo roturns. This is a lavorito ploy ol lroo-
markot thooroticians: instalility must lo soon as oxtornal to tho markot
MARKET MODELS
179
systom, not inhoront in it. But it Joos violonco to languago to call such
rogular, proJictallo loaturos ol tho markot systom oxtornal shocks.`
Shillor, Summors, anJ tho rost aro onto somothing ol moro than statisti-
cal intorost. But thoy Jon`t Jrav somo ol tho moro intorosting conclusions
thoir vork suggosts. Shillor, vho has prolally Jono moro than any singlo
oconomist to Jamago EV thoory, JovotoJ a vholo look (Shillor 1993) to
playing vith tho iJoa ol ostallishing luturos markots so that lusinossos
anJ pooplo coulJ hoJgo thomsolvos against macro` risks liko lig movos
in GDP or houso pricos. No ono, not ovon tho liggost lirm, is oxposoJ to
Jiroct risk lrom GDP grovth, anJ tho practical prolloms in traJing luturos
on a numlor that is rovisoJ lroouontly - tvico in tho months altor its
initial roloaso, again in annual rovisions, anJ yot again in porioJic lonch-
mark rovisions - Jon`t ontor Shillor`s minJ.
32
Why might an oconomist so prominontly associatoJ vith tho notion ol
oxcoss volatility promoto tho Jovolopmont ol nov luturos markots? Oh,
convontion has tho porloct ansvor lor this - a variation on Bill Clinton`s
lavorito maxim, that vhat`s vrong vith Amorica can lo curoJ ly vhat`s
right vith Amorica. That is, markots aro volatilo locauso markots aro in-
comploto` - il thoro voro markots in alsolutoly ovorything, il ovory risk
ol lilo coulJ lo hoJgoJ vith a luturos contract, lrom tho possilility ol
snov tomorrov to that ol loukomia at ago 60, thon oxcoss volatility voulJ
Jisappoar, anJ rationality anJ placiJity voulJ roign.
Summors` acaJomic vork soomoJ to havo no inlluonco in his porlor-
manco as tho chiol oconomist at tho WorlJ Bank anJ lator as tho Clinton
Troasury Dopartmont`s top intornational ollicial.
33
Ho vas at tho Bank vhon
stock markots voro hoavily promotoJ as instrumonts ol ThirJ WorlJ Jo-
volopmont. Nor has ho haJ any apparont inlluonco on Clinton`s linancial
policios: prolally no Domocratic prosiJont has loon so in thrall to Wall
Stroot. AnJ Josoph Stiglitz, as a momlor ol tho ProsiJont`s Council ol Eco-
nomic AJvisors anJ chiol oconomist ol tho WorlJ Bank, has haJ littlo to
say alout vhat his rosoarch moans lor tho roal vorlJ.
34
the marketeers defend themselves
Vany ol tho architocts ol linancial thoory continuoJ to JolonJ thoir
progony`s roal vorlJ ollocts in tho 1980s. ln a spooch roprintoJ in tho WuII
I:~~I {u:uuI, Harry Varkovitz (1991), ono ol tho croators ol moJorn
portlolio thoory anJ CAPV, proJictally summonoJ AJam Smith to Jo-
lonJ program traJing, Salomon Brothors` mortgago-lackoJ lonJ Jopart-
WALL STREET
180
mont, anJ junk lonJ linanco: Vy ovn viov is that tho invisillo hanJ
coulJ vork its magic through moro humans is an ossontial part ol AJam
Smith`s insight. Not many thousanJs ol yoars ago, mon liko this voulJ
havo clulloJ oach othor ovor hunting rights. A lov hunJroJs ol yoars ago
thoy voulJ havo hackoJ oach othor vith axos anJ svorJs. Nov thoy yolloJ
at trainoos vhilo thoy lrought togothor tho supply anJ JomanJ ol |sicl
homo mortgagos on a vorlJ-viJo scalo.`
Through moro humans? Smith, a man ol his timo, sav tho invisillo hanJ
as attachoJ to GoJ`s invisillo arm: aro vo to loliovo that Vilkon 8 Co.
voro Jivino agonts? Has moJorn linanco roally maJo var olsoloto?
AnJ vhat alout this sullimo matchmaking that Salomon Brothors vas
allogoJly porlorming in tho mortgago markots? Varkovitz vas roacting in
part to tho look 1:u:: P~:, Vichaol Iovis` story ol his short, intonso,
anJ comical lilo as an invostmont lankor at Salomon Brothors in tho lato
1980s, an onvironmont rich in gluttony anJ cruJonoss. Varkovitz appar-
ontly ovorlookoJ Iovis` Joscriptions ol hov Salomon`s traJors lought
mortgagos lrom lailing savings anJ loans, ropackagoJ thom into lonJs,
anJ solJ thom lack to tho thrilts at onormous prolit to thomsolvos anJ
hugo lossos to tho S8Is - anJ ovontually, U.S. taxpayors.
35
DorogulatoJ
anJ JoomoJ, thoy voro oagor to play gamos on Wall Stroot.
Horo is Iovis` (1989a, p. 105) Joscription ol tho miraculous Smithian
pricing mochanism at vork:
TraJor Tom DiNapoli lonJly romomlors a call lrom ono thrilt prosiJont.
Ho vantoJ to soll a hunJroJ million Jollars` vorth ol his thirty-yoar loans
.anJ luy a hunJroJ million Jollars ol somo othor loans vith tho cash
lrom tho salo. l tolJ him l`J liJ |luyl his loans at sovonty-livo |conts on tho
Jollarl anJ ollor him tho othors at oighty-livo.` Tho thrilt prosiJont scratchoJ
his hoaJ at tho numlors. Ho vas solling loans noarly iJontical to thoso ho
vas luying, lut tho Jilloronco in yiolJ voulJ loavo him out ol pockot an
unhoarJ-ol ton million Jollars. Or, to put it anothor vay, tho thrilt vas lo-
ing askoJ to pay a transaction loo ol ton million Jollars to Salomon Broth-
ors. That Joosn`t sounJ liko a vory gooJ traJo to mo,` ho saiJ. DiNapoli
vas roaJy lor that ono. lt isn`t, lrom an oconomic point ol viov,` ho saiJ,
lut look at it this vay, il you uuI Jo it, you`ro out ol a jol.` A lollov
traJor talking to anothor thrilt prosiJont on anothor lino ovorhoarJ DiNapoli
anJ crackoJ up. lt vas tho lunniost thing ho haJ hoarJ all Jay. Ho coulJ
picturo tho man on tho othor onJ ol tho phono, just oozing Josporation.
Elsovhoro, Iovis rocalloJ somo ol tho languago his colloaguos haJ usoJ
MARKET MODELS
181
to hooJvink thrilt oxocutivos, phrasos liko risk-controlloJ arlitrago` anJ
CVO oouity.` Tho lirst, Iovis saiJ, vas a lashionallo miJ-1980s
ouphomism.lor lig-timo gamlling in tho mortgago lonJ markot,` anJ
tho soconJ, a 198 invontion, vas a particularly slippory mortgago in-
vostmont. Tho CVO stanJs lor collatoralizoJ mortgago olligation, lut lonJ
salosmon call it toxic vasto.``
36
Tho languago ol portlolio thoorists haJ
locomo an ologant Jisguiso lor huckstors.
Varkovitz arguoJ accuratoly that tho Jays ol DiNapoli`s 10-point, $10
million liJ-ask sproaJs coulJ not last: imitators ouickly poachoJ on
Salomon`s turl, onJing tho Jays ol thoir monopoly prolits. But hov voll
JiJ this mortgago markot vork ovon altor compotition haJ shavoJ Jovn
tho point sproaJs to moro roasonallo lovols? Tho 1980s voro tho lirst Jo-
caJo sinco tho Doprossion Juring vhich homoovnorship ratos loll - partly
a lunction ol Joclining roal vagos, lor suro, lut also a rosult ol continuoJ
inllation in tho cost ol housing. lt vas also a timo vhon mass homolossnoss
locamo a pormanont loaturo ol tho national lanJscapo. AnJ it vas also a
timo vhon tho ratio ol homo mortgagos to tho valuo ol thoir unJorlying
ovnor-occupioJ proportios vont lrom 28/ in 1980 to 43/ in 1990.
3
Tho iJoologists ol tho WuII I:~~I {u:uuIs oJitorial pago coulJ not
rosist apponJing thoir ovn commontary to Varkovitz` locturo, or moro
accuratoly, to lilt somo roasoning lrom anothor Nololist`s prizo locturo,
that ol Vorton Villor (1991). Villor logan his aJJross ly Jonying that ho,
along vith VoJigliani, vas tho co-invontor ol tho lovoragoJ luyout -
tho transaction that porhaps moro than any othor has como to symlolizo
tho linancial oxcossos ol tho 1980s.` Villor arguoJ, accuratoly, that IBOs
- spocilically thoso in vhich youngor, activo managors ol a lirm lor-
rovoJ tho lunJs to luy tho controlling sharos lrom a lirm`s rotiroJ lounJor
(or lrom his ostato)` - voro arounJ long loloro tho lirst VV papor. Tho
IBO`s ol tho 1980s JilloroJ only in scalo, in that thoy involvoJ pullicly-
holJ rathor than privatoly-holJ corporations anJ in that tho takoovors voro
olton hostilo.` Ho might havo aJJoJ that intorost ratos voro a lot lovor in
1958 than thoy voro in 1985. Villor concoJoJ thoso points only to Jismiss
thom, sinco thoy aro onormously Jilloront lrom tho olton sonsillo transac-
tions consummatoJ loloro, say, 1984.
Villor also arguoJ, again accuratoly, that it is ironic that ho anJ VoJigliani
aro croJitoJ as tho thoorists ol IBOs, sinco tho contral mossago ol our
V8V Propositions vas that tho valuo ol tho lirm vas inJoponJont ol its
capital structuro` (asiJo lrom tho tax corroction ol 1963). Villor insistoJ
again that tho VV propositions aro tho linanco oouivalonts ol consorva-
WALL STREET
182
tion lavs` sinco a lirm`s risk JoponJs on tho prolits lrom its roal assots, not
its linancial structuro: lovoraging or Jolovoraging.sorvos moroly to par-
tition that risk among tho lirm`s socurity holJors.` ln lact, vroto Villor, tho
roal gains in valuo achiovoJ in tho IBO`s ol tho 1980s lios, in lact, not in
our novly-rocognizoJ liolJ ol linanco at all,` lut in tho tromonJous olli-
cioncy gains onginooroJ ly IBO ontropronours,` a titlo ovon moro in-
llatoJ than Alan Groonspan`s unalliliatoJ corporato rostructurors.`
38
Thoso
gains, as vo`ll soo in a momont, aro ligmonts ol Villor`s lusy imagination.
Villor has latoly loon ronting himsol out as an oxport vitnoss at tho
unJoultoJly high loos a Nolol lauroato can commanJ. His paiJ tostimony,
hovovor, is harJly ol prizovinning ouality. Tho NasJao hiroJ Villor anJ
sovoral Chicago comraJos, vho colloctivoly traJo unJor tho namo Ioxocon
lnc., to shov that its strango pricing practicos (JiscussoJ in Chaptor 1)
voro not oviJonco ol markot-makor collusion, lut a simplo manilostation
ol tho tonJoncy ol pricos to clustor arounJ magic numlors liko ouartors
anJ halvos rathor than oighths (Ioxocon lnc. 1995). Why tho N\SE Joos
not oxhilit this strango clustoring vas not voll-oxplainoJ: Villor 8 Co.
simply lounJ othor markots that oxhilitoJ similar clustoring.
39
Ol courso,
Ioxocon coulJ not havo anticipatoJ that NasJao clustoring voulJ Joclino
onco tho phonomonon vas pullicizoJ, anJ logal action loomoJ. Nor coulJ
it havo imaginoJ convorsations liko tho ono ouotoJ in Chaptor 1 ol this
look, climaxing in tho lovoly lino, l`m goosing it, cuz.`
A yoar lator, Vorrill Iynch hiroJ Villor anJ Ioxocon in an attompt to
JolonJ itsoll against a lavsuit ly Orango County, Calilornia, in vhich tho
county accusoJ tho lrokor ol solling it somo laJ Jorivativos that Jrovo it
into lankruptcy. ln thoir roport, tho hiroJ guns (Ioxocon lnc. 1996) ar-
guoJ that haJ tho county not liouiJatoJ its portlolio, anJ toughoJ it out
instoaJ, it voulJ havo omorgoJ vholo. Ioxocon JiJn`t montion tho lact
that long-torm intorost ratos loll noarly tvo points ovor tho torm ol tho
stuJy: haJ thoy rison, tho county voulJ havo loon ovon Joopor unJor
vator. ln a lottor to tho WuII I:~~I {u:uuI, a lavyor lor Orango County
(Bonnott 1996) pointoJ out that tho lirm JiJn`t lothor to sulmit Villor`s
papor as oviJonco, locauso tho lirm vas rightly concornoJ that its hiroJ
prolossor coulJ not vithstanJ cross-oxamination il ho voro to appoar in
court.`
40
Vorrill`s claims voro JismissoJ ly tho lankruptcy court.
Back to tho Nololist, anJ his caso lor lovorago. Whon Villor spoko ol
gains in valuo, ho moant tho hugo intorost llovs anJ stock markot gains ol
tho porioJ. lrom 1982, tho loginning ol tho groat lull markot, until 1989,
tho onJ ol tho IBO ora, tho markot valuo ol nonlinancial corporations`
MARKET MODELS
183
stock roso $1.83 trillion (lrom $1.38 trillion to $3.21 trillion), anJ tho valuo
ol corporato lonJs oustanJing roso $519.1 lillion (lrom $40.0 lillion to
$926.1 lillion). But vhilo stocks roso 133/, anJ lonJs, 128/ (anJ, ol
courso, most ol tho gain in lonJs vas tho rosult ol nov issuos, not capital
gains on olJ onos), lusinoss soctor proJuctivity roso 12.6/, anJ tho lroaJ-
ost proJuctivity moasuro ol all, roal GDP por hour vorkoJ throughout tho
ontiro oconomy (incluJing tho govornmont anJ nonprolit soctors), roso
6.3/ - ouito voak ly historical stanJarJs.
That groat IBO loom suggosts moro intorosting analytical torritory, avay
lrom llovs anJ valuations anJ tovarJs vhat might lo calloJ tho politics
ol monoy - tho ovnorship anJ control ol corporations anJ tho oxorciso
ol povor ovor govornmonts.
notes
1. A ouick vay ol Jraving tho Jistinction is that linanco rolors to claims oxorcisoJ ovor
timo, liko Jolts, anJ that monoy is tho instrumont in vhich such claims aro sottloJ. This
Jistinction gots vollly as soon as you push on it: a Troasury lill is a Jolt, lut most
croJitors voulJ lo happy to rocoivo ono to sottlo a claim. T-lills, thon, aro a lorm ol
noar-monoy. Voro on this lator.
2. AnJ traJors traJo on thoso moJols. Thoro`s oviJonco that nov markots gravitato tovarJ
pricos JictatoJ ly moJols that aro lator JiscovoroJ to lo inappropriato to thoir markots
(Chorian anJ Jarrov 1993: Thomas 1995). ln tho caso ol tho Valuo Iino stock inJox
luturos contract, traJors systomatically mispricoJ tho inJox lor its lirst lour yoars ol
traJing, 1982 to 1986: thoy JiJn`t unJorstanJ that stanJarJ pricing lormulas JiJn`t ap-
ply to an inJox JotorminoJ ly goomotric rathor than arithmotic avoragos. Pricing may
havo loon olliciont,` lut it vas vrong - vrong, that is, accorJing to tho right` moJol.
3. Ovor tho last JocaJo or tvo, raJical oconomists - vho nov olton call thomsolvos
hotoroJox, a lar loss conlrontational torm - havo gono lrom criticizing this hypor-
mathomatical turn in tho Jisciplino to trying to outJo thoir mainstroam colloaguos at
tho gamo. Thoy soom to think that luilJing a lottor moJol vill porsuaJo tho main-
stroamors ol tho orrors ol thoir vays.
4. Ol courso thoy voro asking thoso ouostions on lohall ol monoy managors, vho nooJ
aJvico on hov to hanJlo tho trillions ol Jollars thoy run.`
5. BosiJos comlortallo soll-sullicioncy, ono shoulJn`t Jiscount tho macho lool ol having
JominatoJ chaos vith a complox moJol.
6. ln a prisonors` Jilomma, tvo oxporimontal suljocts, motaphorically partnors in crimo,
aro givon tho choico ol lotraying oach othor or hanging tough lor monotary rovarJ. ll
ono Jolocts anJ tho othor Joosn`t, tho skunk gots 3 units. ll loth Joloct, oach gots 1. ll
loth cooporato, oach gots 2.
. Ono Joosn`t vant to got too carrioJ avay naturalizing tomporamont anJ valuos, lut tho
moJol sooms particularly to Jrivo avay vomon anJ nonvhitos, at loast in Amorica,
locauso ol its chilly irroality. lt may just lo that sox anJ raco aro simply convoniont
markors lor hiorarchy -that oconomics is an iJoology ol privilogo, anJ tho alroaJy
privilogoJ, or thoso vho vish to locomo apologists lor tho privilogoJ, aro Jravn to its
stuJy.
WALL STREET
184
8. Corrolation coollicionts lor tho various vorsions ol a suggostoJ in tho toxt aro all voll
ovor .92. Tho corrolation lor tho simplo oouity a (markot valuo ol stock JiviJoJ ly
tangillo assots, as shovn in tho charts anJ usoJ in tho toxt) anJ tho valuos lor 1960-4
roportoJ in Tolin anJ BrainarJ (19) is .9.
9. lt`s intorosting that invostmont roso Juring vhat aro usually consiJoroJ tho laJ yoars ol
tho 190s. lt may lo that tho riso in oil pricos JovaluoJ olJ, onorgy-inolliciont oouip-
mont, lorcing lirms to invost moro than thoy voulJ havo othorviso. Vost analysts, lolt
anJ right, rogarJ high invostmont as a gooJ thing, lut not so ovnors anJ thoir thoo-
rists. Tho oxcossivo` invostmont ol tho 190s vas takon caro ol ly tho sharoholJor
rovolutions ol tho 1980s anJ 1990s, vhich in part vas JosignoJ to shilt corporato prol-
its out ol roal invostmont anJ into Wall Stroot hanJs, mainly through intorost anJ capi-
tal gains on takoovors.
10. Spocilically, thoy rogrossoJ changos in invostmont on changos in cash llov, salos, anJ
stock valuations, alloving tho lunJamontals to ontor tho rogrossions lirst, anJ thon
aJJing in tho stock moasuros. At tho lirm lovol, lunJamontals oxplainoJ 21/ ol tho
variation in invostmont (i.o., tho r2 vas .208): aJJing in stock valuos improvoJ tho
oxplanatory povor to 25/ (r2 - .246), moaning that tho stock markot aJJoJ loss than 4
porcontago points to thoir oouations` povor - in othor vorJs, vory littlo. Tho incro-
montal r2,` in tho jargon, vas ovon lovor lor small lirms anJ lovor still lor tho markot
anJ oconomy as a vholo.
11. Cost ol capital is tho phraso VV uso: it oouals prolits JiviJoJ ly tho markot valuo ol all
outstanJing socuritios, Jolt anJ oouity. This is tho cost ol capital lrom tho issuing lirm`s
point ol viov: outsiJo invostors might think ol it as tho roturn on thoir invostoJ capital.
12. lazzari ot al. point out that invostmont tax croJits, ly roJucing tho cost ol nov invost-
mont, aro not ol much holp to constrainoJ lirms: thoy voulJ lo lottor oll vith lovor
u:~:u~ tax ratos, vhich voulJ incroaso thoir cash llov, most ol vhich voulJ likoly lo
invostoJ.
13. All liguros in tho provious tvo paragraphs aro lrom Bornanko (1983), oxcopt total lank
lailuros, vhich is lrom U.S. Buroau ol tho Consus 195, p. 1038, anJ aggrogato corpo-
rato prolits, lrom tho national incomo accounts.
14. lishor is porhaps most lamous lor his ill-timoJ olsorvation, maJo only Jays loloro tho
1929 crash, that Stock pricos havo roachoJ vhat looks liko a pormanontly high pla-
toau` (ouotoJ in Gallraith 1988, p. 0). Porhaps, thon, his viov ol tho collapso having
no onJ shoulJ lo rogarJoJ skoptically. But his analysis ol tho Jolt Jollation procoss
sooms ontiroly sounJ.
15. Evon though tho U.S. oconomy ontoroJ its lilth yoar ol oxpansion in tho spring ol 1996,
tho GDP grovth rato vas tho slovost ol any lusinoss cyclo upsving sinco tho onJ ol
WorlJ War ll.
16. lntorost horo is moasuroJ against EBlT - or oarnings (prolits) loloro intorost anJ taxos:
a lirm vith $100 in protax prolits, anJ $50 in intorost paymonts, has an intorost lurJon
ol 33/ ol EBlT |(50(100+50)-33/l.
1. All liguros aro lrom tho llov ol lunJs accounts.
18. Horoaltor, EV rolors to olliciont markots, anJ tho EVH to tho olliciont markots hypoth-
osis.
19. Though Chicago is tho Vatican ol lroo-markot thoory, lama himsoll is an aJmirally lair-
minJoJ scholar, not shy alout pullicly changing his minJ. But tho kinJ ol company ho
kopt is tolling. Among thoso lama acknovloJgos at tho outsot ol this papor aro Arthur
Iallor, vho locamo lamous lor tho propostorous curvo ho allogoJly Jrov on a cocktail
napkin that provoJ` that a govornmont coulJ incroaso its rovonuo ly cutting tax ratos,
anJ Vichaol Jonson, vho vas ono ol tho intolloctual goJlathors ol tho 1980s, JiscussoJ
lolov.
MARKET MODELS
185
20. Though most EV thoory is lasoJ on tho stock markot, it can lo applioJ to tho analysis
ol othor linancial assot pricos as voll. Stock,` in a sontonco liko this, is a stanJ-in lor
tho vholo array ol instrumonts.
21. Tho Jolato ovor CAPV sooms to lo not vithout political aspocts. lor oxamplo, tho
Jolonso ly Kothari ot al. (1995) vas lunJoJ ly tho Olin lounJation anJ circulatoJ ly
tho BraJloy Policy Posoarch Contor ol tho William E. Simon School ol Businoss at tho
Univorsity ol Pochostor: BraJloy anJ Olin aro right-ving lounJations, anJ Simon, lo-
siJos loing a linancior, is a right-ving political liguro vho is lamous lor promoting
right-ving philanthropy. AskoJ ly omail to commont, S.P. Kothari lounJ tho iJoa ol
political inlluonco amusing` anJ Jay Shankon saiJ his lirst roaction |vasl to laugh.`
Shankon aJJoJ: il l voro tho typo vho is politically inlluoncoJ, l voulJ prolally lio
in rosponso to your ouostion,` raising spoctors ol tho all Crotans aro liars` lraintvistor.
22. Not improvoJ proJucts,` noto: tho languago ol tho linancial markots sooms to havo
capturoJ ovon this critic ol its inlluonco.
23. TroulloJ lirms, lor oxamplo, coulJ ollor contingont oouity-liko vago ollors` - i.o.,
u~II ju) )u :J u~ uuI I~II) uj J:::I - to unomployoJ vorkors: lut sinco tho
lirms most likoly to ollor thoso contracts (o.g., Eastorn Airlinos) aro just tho lirms lrom
vhom vorkors Jo not vant to accopt thom, such arrangomonts aro Jillicult to mako`
(GroonvalJ anJ Stiglitz 198). Noat iJoa: too laJ it`s impossillo.
24. Ioavo it to tho anciont to lo concornoJ moro alout tho social gooJ than tho moJorn,
vho vorrios mainly alout tho mathomatics ol markot cloaranco anJ tho risk to croJi-
tors.
25. Somo ovon cololrato this lorgotlulnoss. Tochno-VarxoiJ John Poomor, author ol a pro-
postorous schomo lor stock markot socialism (Poomor 1994), says lroouontly in con-
vorsation that to progross, a Jisciplino must lorgot its lounJors.
26. Chong also lounJ that tho stocks ol lonJ issuors Jo not unJorporlorm tho markot,
suggosting among othor things that turning outsiJo lor linanco isn`t tho crucial issuo,
lut that tho lorm it takos - Jolt or oouity - Joos mattor.
2. Tho linJings alout stock ollorings smack ol plannoJ Jocoption on tho part ol sollor
anJ lrokor, anJ ovon soll-Jocoption on tho part ol tho luyor: puro inlo asymmotry
thoorists Jon`t roally havo room lor onthusiasts or liars in thoir moJols.
28. To lo prociso, Shillor JotronJoJ` stock pricos anJ prolits, that is, ho lookoJ only at
thoir Joparturo lrom thoir long-torm grovth tronJ lino. Economotric tochniouos olton
roouiro JotronJoJ Jata, anJ it makos intuitivo sonso to scrutinizo tho stock markot`s
skill at soparating tho orJinary lrom tho oxtraorJinary - tho short- to moJium-torm
oscillations arounJ a long-torm tronJ.
29. Shillor JolivoroJ his 1988 papor at a conloronco JominatoJ ly momorios ol tho Octo-
lor 198 stock markot crash, an ovont that shoulJ havo JoomoJ all notions ol markot
ollicioncy lor gooJ. What rational ovont coulJ havo justilioJ tho ovornight markJovn
ol vorlJ oouity valuos ly $1 trillion? Shillor vas luoyoJ ly his ovn survoy ol monoy
managors shoving that no novs ovont promptoJ tho Jolaclo: 90/ claimoJ to havo
thought tho markot ovorvaluoJ prior to tho crash, lut it took tho sight ol tho Dov
lalling sovoral hunJroJ points to got thom to soll.
30. This conlirms tho oarlior olsorvation that tho psychologically Jillicult stratogy ol valuo`
invosting makos gooJ oconomic sonso.
31. ln survoys ol portlolio managors anJ housoluyors, Shillor (1990) JiscovoroJ that loth
groups, tho lormor supposoJly sophisticatoJ anJ tho lattor not, sulscrilo to oxtromoly
simplo thoorios ol markot Jynamics. Tho linJings loil Jovn to this: pooplo, sophisti-
catoJ or not, tonJ to lollov tho crovJ. A survoy ol IonJon lunJ managors (Taylor
1988) shovoJ that thoso prosumoJ rational traJors ol EV thoory JiJ a protty moJiocro
jol ol lorocasting critical oconomic variallos - not complotoly avlul, lut not conso-
WALL STREET
186
nant vith rational oxpoctations thoory.
32. Shillor is a partnor in a lirm, Caso Shillor Woiss, that computos anJ Jistrilutos rogional
houso pricos lor a loo.
33. Whon ho vas still an acaJomic, Summors JiJ not liko it that his papor tontativoly pro-
moting a transactions tax on socuritios to Jiscourago pointloss traJing vas going to lo
ouotoJ in an oJitorial in TI~ NuI:u. tho oJitorial usoJ his numlors, lut vas strippoJ
ol his timorous onJorsomont (Nation 1989).
34. Though l vas Jying to ask him vhat tho policy implications ol his vork voro, Stiglitz`s
ollico lailoJ to rosponJ to sovoral roouosts lor an intorviov.
35. Hijinks liko thoso aro vhy Jonathan Gray, a socuritios analyst vith SanlorJ C. Bornstoin,
ostimatos that as much as a thirJ ol Wall Stroot`s rovonuos lotvoon 1983 anJ 198 -
tho hoart ol tho Poaring Eightios - camo lrom tho thrilts. AsiJo lrom tho mortgago
chicanory, Wall Stroot lirms also JopositoJ thoir clionts` lunJs vith hotshot thrilts, vho
voulJ thon turn arounJ anJ luy tho (olton Julious) socuritios tho lirms voro poJJling
(Vayor 1990, pp. 296-29). Ol courso, tho U.S. Troasury ultimatoly pickoJ up tho tal
lor this oxorciso in markot ollicioncy.
36. Iovis 1989l, p. 31.
3. liguros lrom loJoral Posorvo`s llov ol lunJs statistics.
38. Groonspan oxplainoJ that thoso lroolancors pouncoJ vhon thoy porcoivoJ sulopti-
mal assot allocations` (Groonspan 1989, p. 268: Jaroslovsky 1989).
39. Ioxocon`s argumont is also JamagoJ ly Vichaol Barclay`s (1996) linJings that NasJao
stocks vith viJo liJ-ask sproaJs that sulsoouontly shiltoJ to tho N\SE shovoJ sig-
nilicant Joclinos in tho sproaJ on oxchango listing.
40. Sovoral calls to Bonnott asking lor an intorviov vont unroturnoJ.
187
5 Renegades
ln a lottor vorlJ, talk ol noiso, laJs, imporloct knovloJgo, anJ omotional
ovorroaction voulJ havo travoloJ loyonJ tho arona ol linancial oconom-
ics to tho roalm vhoro political juJgmonts aro maJo. But such a passago
might lo inconvoniont to tho curront mooJ ol capitalist triumphalism.
So it`s unsurprising that mainstroam oconomists havo loon roluctant to
Jrav too many thoorotical conclusions lrom thoso ompirical Jiscovorios.
HaJ thoy Jono so, it might givo a lilt to tho roputation ol an oconomist
nov rogarJoJ as unlashionallo, John VaynarJ Koynos. Tho moro intor-
osting, anJ raJical, aspocts ol Koynos`s vriting voro lorgotton in tho yoars
just altor WorlJ War ll, vhon his analysis ol capitalism`s tonJoncios to-
varJs polarization anJ volatility vas JomosticatoJ into a lanal stratogy ol
lusinoss cyclo managomont. Tho lov moJorn oconomists vho havo Jo-
volopoJ thoso strains ol Koynosian thought aro marginalizoJ ly tho Jisci-
plino - ospocially thoso vho mix Koynos vith Varx.
lor Koynos, tho linancial markots aron`t noutral anJ olliciont allocators
ol capital or tho lrionJs ol social Jovolopmont, lut rathor irrational, Josta-
lilizing, anJ paraJoxically consorvativo institutions that Jo moro to ox-
panJ rontior voalth than thoy Jo to nourish a lroaJ anJ socuro prospority.
Sinco, in his viov, invostmont in roal assots is tho Jriving lorco ol capitalist
oconomios, anJ sinco tho lovol anJ allocation ol roal invostmont JoponJs
hoavily on tho stato ol tho linancial markots, matorial progross is hostago
to tho vhimsical lorcos ol linanco.
facts on the ground
Porhaps tho lost placo to start this oll-roaJ tour is ly oxploring a lunJa-
montal social lact that olliciont markot thoorists anJ VoJigliani-Villor
partisans havo trioJ to linosso: linancial invostmont anJ roal invostmont
WALL STREET
188
aro Jistinct activitios unJortakon ly Jilloront sots ol pooplo inlluoncoJ
ly Jilloront sots ol motivos, oach not paying vory much attontion to tho
othor` (Koynos, W V, p. 250).
1
Capitalism vas not alvays such. During tho oarly Jays ol tho inJustrial
rovolution, lirms voro run ly inJiviJuals, lamilios, or a small circlo ol
partnors vho roinvostoJ thoir prolits in tho lusinoss. But vith porsistont
grovth anJ incroasing tochnological comploxity, this simplo structuro
locamo untonallo. lor oxamplo, Nov EnglanJ mill ovnors ol tho oarly
19th contury lounJ that thoir prolits, as lat as thoy voro, voron`t sulliciont
to covor tho linancing nooJs ol a rapiJly groving anJ changing inJustry.
Eouipmont haJ to lo lought anJ maintainoJ, anJ vorkors, proviously
paiJ irrogularly in gooJs, haJ to lo paiJ rogularly in monoy, or thoy voulJ
starvo. (Sulsistonco agriculturo vas no longor an option lor urlan vork-
ors.) So mill ovnors incorporatoJ thoir ontorprisos - solling ovnorship
sharos to outsiJors - in orJor to tap tho surplus voalth ol rich Boston
morchants. \ot ovon thon, tho ovnorship circlo vas rathor small: control-
ling sharos in a typical Vassachusotts mill voro typically holJ ly throo or
lour closo associatos anJ thoir lamilios (ChanJlor 19, pp. 58-60).
Such linancing anJ ovnorship structuros voro too intimato to copo
vith tho railroaJ. Early linos lirst turnoJ to larmors, morchants, anJ manu-
lacturors living along tho proposoJ routo anJ to Europoan monoy mar-
kots. But ly tho lato 1840s, railroaJ luilJors logan turning to Wall Stroot:
just a JocaJo lator, all tho instrumonts ol moJorn linanco - lonJs, stocks,
anJ ovon options - voro voll-ostallishoJ in tho U.S., thanks to tho rail-
roaJs` hungor lor capital (ChanJlor 19, pp. 91-92).
Tho lounJs ol spaco anJ porsonal acouaintanco haJ loon lrokon. With
thoso innovations camo a vholo sot ol institutions: tho largo national cor-
poration, vago lalor, prolossional managomont anJ sophisticatoJ linan-
cial markots, institutions that ovolvoJ togothor as tho 19th contury
progrossoJ. ln lact, thoso aro all siJos ol tho samo coin - an appropriato
motaphor, sinco tho link among thom all is monoy.
With tho soparation ol savings anJ invostmont - anJ vith it tho sopa-
ration ol ovnorship anJ control - camo tho possilility ol imlalancos
lotvoon tho tvo. Koynos maJo much ol this potontial lor Jissonanco in
his T:~uI::~ u Mu~), a spravling, tvo-volumo vork that procoJoJ his
~u~:uI TI~:) ly six yoars. Though tho lator volumo ronJoroJ a gooJ lit
ol tho T:~uI::~s thoorizing olsoloto, anJ though tho oarlior volumo is
largoly lorgotton oxcopt ly Koynos cultists, it Joos incluJo lots ol usolul
schomas lor thinking alout an oconomy.
RENEGADES
189
Talk ol savings loing unooual to invostmont sounJs horotical anJ li-
zarro to moJorn oars. As JolinoJ ly national incomo accountants, tho tvo
must alvays lo in lalanco. ln ovory issuo ol tho U.S. Dopartmont ol
Commorco`s llagship statistical pullication, tho u::~) J u::~uI 1u::u~::,
thoro appoars NlPA tallo 5.1, Gross Saving anJ lnvostmont.` Tho liguros
lor 1995 aro roproJucoJ, vith a lit ol oJiting, in tho noarly tallo.
ln English, this moans that gross savings - JolinoJ as tho sum ol por-
sonal savings, corporato prolits not JistrilutoJ to sharoholJors in tho lorm
ol JiviJonJs, Joprociation allovancos, anJ tho govornmont Jolicit - must
ooual gross invostmont, vhich comprisos lusinoss invostmont in luilJ-
ings, machinory, anJ invontorios: porsonal invostmont in housing: anJ
acouisitions ol loroign assots ly U.S. rosiJonts loss acouisitions ol U.S.
assots ly loroignors. ln ovon simplor English, incomo that isn`t spont on
consumption must lo invostoJ (loaving asiJo, ol courso, that vhich is
stulloJ into mattrossos or lost Jovn manholos). ll savings aro JolinoJ sim-
ply as incomo that isn`t spont on consumption, anJ total proJuction con-
sists only ol consumption anJ invostmont gooJs (a simplilication, lut not
a violont ono), thon savings uu:I ooual invostmont, sinco consumption
oxponJituros must ooual tho total salos ol consumption gooJs. Voila, sav-
ings - invostmont: othorviso, vhoro voulJ tho monoy go? Or as Koynos
gross saving and investment, 1995
|billions ol dollars|
gross saving $1,141.6
gross privale saving !,062.5
personal saving 240.3
undislribuled corporale prolils !42.5
consunplion ol lixed capilal
corporale 454.0
noncorporale 225.2
governnenl saving (surplus/delicil 79.!
lederal 33.7
slale and local !67.9
capilal granls received bv lhe U.S. 0.0
gross investment 1,146.1
gross privale doneslic inveslnenl !,065.3
gross governnenl inveslnenl 22!.9
nel loreign inveslnenl !4!.!
slalislical discrepancv 4.5
Survev ol Currenl Business,
WALL STREET
190
saiJ, Savings anJ invostmont aro moroly altornativo namos lor tho Jillor-
onco lotvoon incomo anJ consumption` (W Xlll, p. 552).
ln practical torms, savings anJ invostmont aro lalancoJ through changos
in invontorios, $3 lillion ol vhich aro incluJoJ in tho invostmont liguros
in tho tallo. ln gooJ timos, or in anticipation ol gooJ timos, lirms incroaso
proJuction loyonJ JomanJ to luilJ invontorios: in laJ timos, salos lall
moro ouickly than proJuction (sinco lirms aro proJucing accorJing to
rocont JomanJ), loaJing to a luilJup in invontory. Tho lirst is plannoJ,
tho soconJ, unplannoJ. ln 194, lor oxamplo, tho lolly ol tho 193-5
rocossion, invontory luilJup vas 9/ ol gross nonrosiJontial invostmont.
lnvontorios voro roJucoJ in 195, a lorm ol Jisinvostmont, as managors
throttloJ lack proJuction anJ invostmont plans in tho vako ol 194`s Jis-
appointmonts. lixoJ invostmont vas also cut lack. But tho rocovory that
took holJ in tho lattor part ol 195 Jrovo salos alovo oxpoctations, rosult-
ing in a voluntary accumulation ol invontorios in tho lolloving yoar - up
ly an amount ooual to 9/ gross nonrosiJontial invostmont, anJ 3/ ol
not, in 196. lixoJ invostmont porkoJ up as voll.
Iilo is novor as noat as all that. Tho national incomo anJ proJuct ac-
counts, as thoir namo implios, consist ol tvo halvos, mirror imagos ol oach
othor.
2
ln lusinoss accounting, tho halvos aro olton rolorroJ to as sourcos
anJ usos ol lunJs: moro colloouially, vo coulJ call thom incomo anJ outgo.
Govornmont accountants ostimato tho tvo siJos ol tho loJgor, totaling in-
como (vagos, prolits, otc.) anJ oxponJituros (consumption, physical in-
vostmonts, otc.) soparatoly. ln thoory, tho tvo counts shoulJ match -
vhilo not ovory proJuct that is maJo can lo solJ, ovory salo must havo a
corrosponJing purchaso. But in practico, thoy Jon`t ouito ovon up: in a
$+ trillion oconomy, it`s not surprising that tho sums Jon`t vork out to
tho ponny. That mismatch is shovn as tho statistical Jiscropancy, vhich
vas nogligillo in 1995, lut can run into olovon liguros. AnJ sinco por-
sonal saving cannot lo moasuroJ Jiroctly, lut only ostimatoJ as tho Jillor-
onco lotvoon total incomo anJ sponJing, all thoso numlors shoulJ lo
consiJoroJ as no moro than a voll-oJucatoJ guoss.
But lot`s givo tho national incomo accountants tho lonolit ol tho Joult
anJ assumo thoso ostimatos to lo roughly corroct, anJ that savings must
ooual invostmont ly thoir Jolinition. Put this vay, hovovor, tho oouiva-
lonco ol savings anJ invostmont is on a par vith saying 2+2-4 - accurato,
usolul, lut not vory intorosting. Koynos`s analysis in tho T:~uI::~, vhoro
ho makos tho inoouality ol savings anJ invostmont an important motor ol
oconomic chango, is ol lar groator intorost.
RENEGADES
191
ln tho T:~uI::~, Koynos lattloJ ono orthoJoxy, tho ouantity thoory ol
monoy, vith anothor orthoJoxy, tho rolation lotvoon natural` anJ mar-
kot ratos ol intorost. Tho ouantity thoory ol monoy, tho root ol moJorn
monotarism, starts vith an oconomic truism anJ onJs in a roligion. Though
thoro aro sovoral variants, tho most lamous vorsion ol tho truism is:
VV-PT.
That is, in ono porioJ, typically a yoar, tho amount ol monoy in circula-
tion (V) timos its volocity ol turnovor (V, or tho numlor ol timos thoso
units ol monoy aro spont) oouals tho sum ol tho pricos (P) timos tho num-
lor ol transactions (T). ln practico, somo Jolinition ol tho monoy supply is
sulstitutoJ lor V, GDP sulstitutoJ lor PT, anJ sinco volocity can`t lo soon,
it`s assumoJ to lo vhatovor numlor makos tho oouation lalanco.
Ol courso, tho oouation is alvays truo altor tho lact. But it lails to ox-
plain vhy tho variallos tako on tho valuos thoy Jo. Thoy usually lol alout
vilJly, olton vith littlo rolation to tho othors. ln tho U.S., thoro aro lour
ollicial Jolinitions ol monoy, ranging lrom a narrov ono calloJ V1, lasi-
cally curroncy plus chocking accounts, to a vory lroaJ ono, calloJ V4 or I
(lor liouiJity) vhich incluJos Troasury lills anJ othor short-torm socuri-
tios. Each marchos to its ovn Jrumloat. Volocity is a slippory concopt:
monotarists assumo it to lo constant, lut it isn`t - in lact, it`s all ovor tho
placo. SpooJ ol turnovor is ono ol tho lunJamontal variallos ol capitalist
oconomios, lut ouantity thoory has littlo to say alout it. ln tho monotar-
ists` viov, changos in V causo changos in pricos anJ volumo ol proJuc-
tion: causo runs only lrom lolt to right in tho lasic ouantity oouation anJ
sinco V is assumoJ to lo a constant, it`s ignoroJ. Though moJorn mon-
otarists, lrom Vilton lrioJman to Alan Groonspan`s loJ stall, havo trioJ to
givo thoir Joctrino a Jynamic spin, it`s a llat, static, anJ trivializing viov ol
a multiJimonsional, Jynamic, anJ complox systom.
Keynes's
ln a consiJorallo aJvanco on static monotarism, Koynos logan his moJol-
luilJing ly soparating a community`s incomo into tvo parts, that oarnoJ
in tho proJuction ol consumor gooJs, anJ that in tho proJuction ol in-
vostmont gooJs, anJ soparating its oxponJituros also into tvo parts, that
spont on consumption gooJs anJ that on savings. This loth rojocts tho
homogonoity ol tho monotarists` T, anJ movos avay lrom static iJontitios
tovarJs a Jynamic systom.
WALL STREET
192
Consumption gooJs pricos, Koynos positoJ, voro JotorminoJ jointly
ly vhat aro nov calloJ unit lalor costs - vagos por unit ol output, or
monoy vagos aJjustoJ lor proJuctivity - anJ tho Jilloronco lotvoon
savings anJ invostmont. Or, moro procisoly, cIuu~: in pricos aro causoJ
ly cIuu~: in tho othor tvo torms. Tho othor motor ol tho moJol is tho
rolation lotvoon savings anJ invostmont: changos in tho rolations lotvoon
thoso tvo also motivato changos in tho lroaJ oconomy.
Changos in unit lalor costs aro important to prico Jotormination, anJ
this rolation is at tho hoart ol Koynosian anJ post-Koynosian thoorios ol
inllation.
3
Empirically, tho corrolation lotvoon consumor prico inllation
anJ unit lalor costs in tho U.S. is vory tight. ll vago grovth oxcooJs pro-
Juctivity grovth, proJucors` costs vill riso, anJ thoy vill raiso pricos in
componsation il thoy can got avay vith it. ll thoso proJucors can`t pass
along prico incroasos, thoy olviously vill lo lorcoJ to tako othor actions,
ranging lrom mochanization to union-lusting anJ movos ovorsoas, to pro-
sorvo prolit margins.
Voro rolovant to our torrain is tho soconJ rolation, tho (im)lalanco lo-
tvoon savings anJ invostmont, vhich can gonorato Joliciont or oxcossivo
JomanJ lor consumption gooJs. ll invostmont oxcooJs savings, lrosh Jo-
manJ lor invostmont gooJs vill raiso vagos among vorkors in tho capital
gooJs inJustrios vithout thoro loing any ollsotting Jocroaso in consump-
tion JomanJ olsovhoro (sinco a Joclino in consumption voulJ lo tho
olvorso ol an incroaso in savings). Tho pricos ol consumption gooJs vill
riso, anJ tho valuo ol monoy vill Joclino. Convorsoly, shoulJ savings in-
croaso lastor than invostmont, tho Joclino in consumption JomanJ voulJ
not lo ollsot ly any incroaso in capital gooJs JomanJ (vhich voulJ, in
turn, raiso consumption JomanJ): thoroloro, tho prico ol consumption
gooJs voulJ Joclino, anJ thoir proJucors voulJ sullor lossos.
Pricos aro upsot ly tho lact that tho Jivision ol tho output lotvoon
invostmont anJ gooJs lor consumption is not nocossarily tho samo as tho
Jivision ol tho incomo lotvoon savings anJ oxponJituro on consump-
tion.` AnJ ontropronours aro JociJing inJoponJontly vhat ouantitios ol
consumption anJ invostmont gooJs to proJuco (W V, p. 121-123).
linancial markots aro JominatoJ ly tvo lorcos - savors` villingnoss
to part vith cash to luy socuritios` (or tho choico lotvoon hoarJing`
anJ invosting`) anJ tho gonorosity ol tho lanking systom. ll tho pullic`
- a City anJ Wall Stroot ouphomism lor rich pooplo anJ invostmont man-
agors - is loarish, anxious alout tho luturo, it vill holJ cash rathor than
making long-torm invostmonts. Unloss tho lanking systom oasos croJit to
RENEGADES
193
ollsot that loarishnoss, nov invostmont vill lo chokoJ. Prico lovols ovor-
all JoponJ, thon, on tho savings rato, tho cost ol nov invostmont, tho loar-
ishnoss ol tho pullic, anJ tho volumo ol savings Joposits - a lormula that
loils Jovn to tho oxcoss ol saving ovor tho cost ol invostmont, anJ tho
Jisparity lotvoon tho loarishnoss ol tho pullic anJ tho ollsotting looso-
noss ol tho lanking systom (or lullishnoss anJ tightnoss).
lnvostmont anJ savings, thon, olton conllatoJ in mainstroam thoory,
aro ouito Jilloront things that nonotholoss aro oxpoctoJ to lalanco. lnvost-
mont, in Koynos`s vorJs, is tho positivo act ol starting or maintaining
somo procoss ol proJuction or ol vithholJing liouiJ gooJs. lt is moa-
suroJ ly tho not aJJition to voalth vhothor in tho lorm ol lixoJ capital,
vorking capital or liouiJ capital.`
4
lt is tho act ol tho ontropronour.` Sav-
ing, hovovor, is tho act ol tho inJiviJual consumor anJ consists in tho
nogativo act ol rolraining lrom sponJing tho vholo ol his curront incomo
on consumption` (W V, p. 155). Tho tvo actors, savors anJ invostors, aro
lrought togothor ly tho lanking systom anJ linancial markots, unJor tho
loaJorship ol tho contral lank.
Tho lalanco or imlalanco lotvoon savings anJ invostmont, in tho
T:~uI::~ moJol, is JotorminoJ ly tho intorost rato (sotting asiJo, lor con-
vonionco, tho lact that in tho roal vorlJ thoro aro many intorost ratos) or,
moro procisoly, tho oscillation ol tho markot rato ol intorost arounJ a natu-
ral` rato. Tho natural rato is JolinoJ, somovhat circularly, as tho rato that
voulJ ooualizo savings anJ invostmont, thoroly kooping tho prico ol in-
vostmont gooJs stoaJy (W V, p. 139). ll tho markot rato risos rolativo to
tho natural rato, savings vill lo oncouragoJ anJ invostmont JoprossoJ: il
it lalls, invostmont vill riso rolativo to savings. Booms anJ slumps.aro
simply.an oscillation ol tho torms ol croJit alout thoir oouililrium posi-
tion` (W V, p. 165).
5
This assumos, ol courso, that savings aro stimulatoJ
anJ invostmont is JoprossoJ ly highor intorost ratos: although thoro`s somo
truth to thoso axioms, anJ ovon moro intuitivo appoal, actual roality Jom-
onstratos much loosonoss in tho rolations. But lot`s not ouilllo lor nov.
ll croJit markots voro porloct, changos in intorost ratos coulJ lalanco
savings anJ invostmont porloctly, just as prico is supposoJ to oouililrato
supply anJ JomanJ in all compotitivo markots. Varkots aro imporloct (or
Jon`t cloar) il not ovory luyor or sollor can lo satislioJ at tho propor`
prico. CroJit markots aro lar lrom porloct, Koynos arguoJ: thoro alvays
oxists an unsatislioJ lringo` ol lorrovors vho can`t linJ croJit locauso
lanks turn thom Jovn (W V, p. 190). Or, tho lanks might say, thoy can`t
linJ onough oualilioJ lorrovors to soak up all thoir lonJing potontial (harJ
WALL STREET
194
to imagino loloro 1990). ln tho 1930s anJ tho oarly 1990s, lov intorost
ratos JiJ not oncourago croJit oxpansion locauso lonJors, anJ possilly
lorrovors, haJ loon scaroJ ly tho rocont croJit implosion. This impor-
tant notion ol croJit rationing voulJ lo largoly lorgotton as lantasios ol
porloct markots inloctoJ tho oconomics prolossion Juring tho 1960s anJ
190s, lut it voulJ lator roappoar in tho politically cautious inlormation
assymotry` litoraturo. lt shovs that not only tho prico ol croJit - tho intor-
ost rato - is oconomically important, lut also tho oaso ol its availalility -
its ouantity - as voll. ln high markot thoory, lloxillo pricos assuro a lal-
anco lotvoon supply anJ JomanJ: lut in roal lilo, thoro may lo unslakoJ
urgos to lonJ or lorrov rogarJloss ol prico.
Though tho mooJ ol tho pullic` counts lor somothing - loarishnoss
vill Jrivo up long-torm ratos - changos in intorost ratos aro normally`
loJ ly a nation`s contral lank, vhon it JociJos to chango tho lovol ol
monoy incomos` (W V, p. 142). CroJit availalility, anJ vith it tho sizo ol
tho unsatislioJ lringo,` vill prolally movo in tanJom vith contral lank
policy. SustainoJ porioJs Juring vhich tho markot rato is holJ lolov tho
natural rato vill rosult in oxplosivo croJit JomanJ, runavay invostmont,
anJ a rising prico lovol, that vill continuo as long as tho contral lank por-
mits (W V, pp. 16-1). Convorsoly, porioJs Juring vhich tho markot
rato is holJ alovo tho natural rato vill lo onos ol lov invostmont anJ
lalling pricos. Pullic sontimont can also movo markot ratos: a loarish mooJ
vill push up long-torm intorost ratos.
Tho natural rato itsoll is not a constant thing: a chango in markot ratos
olton sots oll a chango in tho natural rato in tho opposito Jiroction. lor
oxamplo, il markot ratos lall, tho natural rato vill riso, as ontropronours
como to oxpoct rising pricos in tho luturo. Highor luturo pricos holJ tho
promiso ol highor luturo prolits, vhich makos nov invostmonts moro at-
tractivo. Whilo this may provoko a roaction` somotimo in tho luturo -
highor invostmont JomanJ vill Jrivo up tho prico ol invostmont gooJs,
thoroly ollsotting tho possilility ol highor prolits - tho short-torm olloct
is unJonially stimulativo (W V, p. 189-190).
Changos in tho natural rato may also como lrom tho roal` siJo ol an
oconomy. Koynos lollovoJ Josoph Schumpotor in arguing that tochnical
anJ organizational innovations aJoptoJ ly a hanJlul ol ospocially spir-
itoJ ontropronours, vhich compotition lorcos tho loss pionooring to aJopt,
aro at tho hoart ol capitalist progross. But thoso innovators voulJ lo noth-
ing moro than lrustratoJ Jroamors il tho lanking systom - or, moro
lroaJly, linanciors - JiJn`t accommoJato thom ly alloving thom to ront
RENEGADES
195
othor pooplo`s monoy (W Vl, pp. 85-86). A vavo ol innovation vill raiso
avorago prolit ratos (at loast in tho short run, loloro imitators crash tho
innovators` party), raising tho natural rato ol intorost. ll markot ratos lag, as
thoy usually Jo, changos in tho natural rato, invostmont vill lo stimulatoJ
in tho vako ol tho pionoors.
Writing in 1930, Koynos vas most intorostoJ in tho procoss ol Jollation
anJ in countoring tho Jangorous aJvico ol convontional linanco. Ortho-
Joxy put tho pounJ lack on golJ at a punishingly high rato in 1925, tor-
turing British inJustry anJ pushing up unomploymont in tho namo ol sounJ
monoy. Contral lanks, Koynos loaroJ, voro loing too timiJ alout lring-
ing Jovn intorost ratos. Against orthoJoxy`s austority nostrums, Koynos
cololratoJ looms in a mannor that voulJ Jo a Toxas populist prouJ.
Shakospoaro, saiJ Koynos, JioJ rich, anJ his Jays voro tho palmy Jays ol
prolit - ono ol tho groatost lull` movomonts ovor knovn until moJorn
Jays in tho UnitoJ Statos.. |Bly lar tho groator proportion ol tho vorlJ`s
groatost vritors anJ artists havo llourishoJ in tho atmosphoro ol luoy-
ancy, oxhilaration anJ tho lrooJom lrom oconomic caros lolt ly tho gov-
orning class, vhich is ongonJoroJ ly prolit inllations` (W Vl, p. 13).
Tho Shakospoaros ol tho ora ol junk linanco havo yot to lo JiscovoroJ,
unloss Brot Easton Ellis oualilios.
Koynos`s ropoatoJ violations ol tho canons ol orthoJox linanco aro ro-
lroshing in thoso noo-Calvinist Jays ol plant closuros, mass layolls, liscal
austority, anJ mightily tightlistoJ contral lanks. Wo nooJ not vorry, ar-
guoJ Koynos, il ontropronours llov thoir monoy on riotous living: tho
monoy vill roturn to thoir class in tho lorm ol oxcoss prolits in consump-
tion inJustrios. lnvostmont, in so luoyant a climo, voulJ tako caro ol it-
soll. This charming passago, vhich is lounJ to mako a saJomonotarist
scroam, is vorth ouoting at longth:
|Tlho opinion, vhich l havo somotimos hoarJ oxprossoJ, that tho roal voalth
ol tho community incroasos lastor, in spito ol appoarancos to tho contrary,
Juring a Joprossion than Juring a loom, must lo orronoous. lor it is a high
rato ol invostmont vhich must nocossarily ly Jolinition lo associatoJ vith
a high rato ol incromont ol accumulatoJ voalth. Thus l am moro JisposoJ
to sympathiso vith Vr D.H. Polortson, vho thinks that much ol tho mato-
rial progross ol tho ninotoonth contury might havo loon impossillo vithout
tho artilicial stimulus to capital accumulation allorJoJ ly tho succossivo
WALL STREET
196
porioJs ol loom, than vith tho puritans ol linanco - somotimos oxtromo
inJiviJualists, vho aro allo, porhaps, to placato in this vay thoir supprossoJ
roactions against tho Jistastolulnoss ol capitalism - vho Jrav a gloomy
satislaction lrom tho spoculativo anJ lusinoss lossos, tho lov pricos, anJ
tho high roal vagos, accompanioJ, hovovor, ly unomploymont, vhich
charactoriso tho typical Joprossion. Nor is it a sulliciont justilication ol tho
lattor stato ol allairs, that, nocossity loing tho mothor ol invontion, thoro aro
cortain oconomios anJ tochnical improvomonts vhich tho lusinoss vorlJ
vill only mako unJor tho stimulus ol Jistross: lor thoro aro othor improvo-
monts vhich vill only maturo in an atmosphoro ol optimism anJ alun-
Janco (W V, p. 246).
Booms aro not automatic, anJ thrilt campaigns aro Jangorous. lt`s not
guarantooJ that tho savings oncouragoJ ly a thrilt campaign - assuming
thoy matorializo at all, sinco tho rocorJ ol various tax lroaks oxtonJoJ in
tho U.S., liko lPAs, to oncourago savings is Jismal - vill onJ up linancing
proJuctivo invostmonts: thoy may onJ up causing an incroaso in unvantoJ
invontorios instoaJ, or an inllation ol stock pricos as monoy pours into tho
markot rathor than tho roal vorlJ. ll thoro`s no incroaso in roal invostmont,
tho oxcossivo savings` aro moroly ollsot ly lossos among consumor gooJs
proJucors. Thoro is no incroaso ol voalth in any shapo or lorm corro-
sponJing to tho incroaso ol saving - tho saving has rosultoJ in nothing
vhatovor oxcopt a chango anJ chango-alout lotvoon thoso vho con-
sumo anJ lotvoon thoso vho ovn titlos to voalth.` Ioss-making ontro-
pronours voulJ havo to mako up thoir shortlalls through lorroving: instoaJ
ol linancing nov invostmont, tho nov savings in this unlortunato caso
moroly linanco lossos. (W V, pp. 121, 154-15: Vl, pp. 185-186). Tho
analysis is rolovant in thoso Jays vhon incroasing savings is toutoJ as a
social goal vithout any rogarJ lor hov tho savings vill linJ thoir vay into
invostmont, or tho risks ol vhat coulJ happon shoulJ thoy not.
ln tho T:~uI::~, Koynos rolukoJ tho vorlJ`s contral lanks lor loing too
slov to lovor intorost ratos in tho 1920s anJ into tho 1930s. Vassivo sav-
ings in tho yoars altor WorlJ War l voro simply spilloJ,` linancing ontro-
pronours` lossos in tho Jollation that accompanioJ tho ollort to rovivo tho
pro-var golJ stanJarJ (W Vl, p. 185). Koynos also rolukoJ tho U.S. loJ-
oral Posorvo lor shutting Jovn tho 1920s lull markot vith high intorost
ratos. Writing in 1930, loloro it locamo cloar that capitalism vas in tho
oarly Jays ol its vorst crisis ovor, ho arguoJ that tho slump vas causoJ
mainly ly tho porioJ ol tight monoy Juring tho lato 1920s, anJ only soc-
RENEGADES
197
onJarily` ly tho stock markot crash itsoll. High ratos simultanoously Jis-
couragoJ invostmont anJ oncouragoJ savings - a Joullo vhammy -
anJ tho crash only maJo mattors vorso on loth counts. Anticipating tho
rolo psychology voulJ play in tho ~u~:uI TI~:), ho arguoJ that a lull
markot makos pooplo lool richor, moro likoly to sponJ anJ loss likoly to
savo, anJ a loar run has just tho opposito olloct. Contral lankors shoulJn`t
vorry alout tho prico ol ~.::I:u socuritios (vhich is vhat a stock markot
ovorvholmingly is): instoaJ, thoy shoulJ concorn thomsolvos vith koop-
ing u~u savings anJ invostmont in lalanco (W V, 230: Vl, 16). Hov this
lalancing act can lo managoJ vas novor rovoaloJ: prosumally tho con-
tral lank vill lo allo to zoro in on tho natural rato, vhich is somothing
that can novor lo soon. AnJ Koynos ossontially ignoroJ tho Jangors ol a
linancial mania - vasto anJ lrauJ on a tromonJous scalo. Whilo his col-
olration ol oxcoss may soom rolroshing in a porioJ ol austority, it sooms
loss oxcusallo in ono ol a markot loom accompanioJ ly viJosproaJ pov-
orty, not to montion looming ocological crisis.
lnstalility, or at loast tho possilility ol it, is luilt into Koynos`s lunJamon-
tal oouations. Unliko tho simplo iJontity ol VV-PT, his systom is rich vith
potontial imlalancos - lotvoon consumption anJ savings, lotvoon sav-
ings anJ invostmont, lotvoon tho pullic mooJ anJ tho intontions ol tho
contral lank. Thoso imlalancos aro a lit rominiscont ol Varxian moJols ol
ovorproJuction, Jisproportionalitios lotvoon capital anJ consumor gooJs
inJustrios, anJ Jollationary soizuro. Koynos, hovovor, JisplayoJ conli-
Jonco in tho alility ol contral lankors to guiJo tho systom saloly arounJ
thoso rocks in its path.
Dospito tho omphasis on Jisoouililrium, at a Joopor lovol tho thoory is
still comlortingly classical` (IoijonhulvuJ 1992). ConsiJorallo povors ol
soll-aJjustmont still inhoro in tho T:~uI::~s systom. At somo point, lor ox-
amplo, loarish spoculators aro likoly to tiro ol solling lonJs anJ linJ that
intorost ratos haJ rison onough to mako thom a tompting purchaso onco
again. ln anothor classical touch, pricos Jo tho aJjusting, not output, vhich
makos no allovanco lor tho oxtonJoJ unomploymont ol capital anJ lalor.
Tho natural rato ol intorost is also an orthoJox iJoa, though Koynos
allovoJ lor tho markot rato to Joviato consiJorally lrom it. lt is a notion
associatoJ most closoly vith Knut Wicksoll, vho vas hot in pursuit ol a
noutral` monotary systom - ono that lohavoJ tho samo vay a hypo-
thotical vorlJ vithout papor monoy voulJ lohavo. To Wicksoll, tho Jan-
WALL STREET
198
gor vas that tho croJit systom voulJ koop markot intorost ratos lolov
thoir natural lovol, luolling loan JomanJ, incroasing tho monoy supply,
anJ lostoring inllation. Tho importanco ol tho natural rato lios in its rola-
tion to tho provailing rato ol prolit: il monoy can lo lorrovoJ at 5/, anJ
invostoJ in roal assots (or lonJs roprosonting roal assots) at /, thon pro-
spoctivo lorrovors vill mol thoir lanks, laying lor croJit. Koynos, on tho
othor hanJ, vas vorrioJ alout Jollation.
This connoction lotvoon tho natural intorost rato anJ tho rato ol prolit
takos us lack to an ovon moro classical vorlJ than Wicksoll`s, vhoro prol-
its ultimatoly Jotormino tho intorost rato, rathor than lalancing savings
anJ invostmont. PicarJo ouotoJ this olsorvation ly AJam Smith approv-
ingly: |Tlho markot rato ol intorost vill loaJ us to lorm somo notion ol tho
rato ol prolits, anJ tho history ol tho progross ol intorost allorJ us that ol
tho progross ol prolits.` Unlortunatoly, PicarJo commontoJ, statos havo,
lrom mistakon notions ol policy,` olton kopt intorost ratos lrom rising to
appropriato lovols, compromising thoir uso as a proxy lor prolit ratos.
PicarJo JiJ concoJo that tho intorost rato, though ultimatoly anJ por-
manontly govornoJ ly tho rato ol prolit, is, hovovor, suljoct to tomporary
variations lrom othor causos.` Arguing liko tho laithlul ouantity thoorist ho
vas, PicarJo arguoJ that changos in tho stock ol monoy vill alloct tho
prico lovol, anJ vith it intorost ratos, as vill tomporary lluctuations in traJo.
ll, lor oxamplo, pricos lall locauso ol an alunJanco ol supply, a Jimin-
ishoJ JomanJ, or a lall in tho ouantity ol monoy, manulacturors vill accu-
mulato unsolJ invontorios. To moot nocossary paymonts, inJustrialists vill
havo to lorrov to covor tho lossos, pushing up markot intorost ratos. But
thoso strossos alvays contain tho sooJs ol thoir ovn rosolution: oithor pricos
rolounJ, anJ manulacturors aro rostoroJ to solvoncy, or thoy Jon`t anJ
thoy go lust anJ Jisappoar. |Vlonoy anJ intorost rogain thoir roal valuo.`
Iiko PicarJo, tho Koynos ol tho T:~uI::~ thought that prico changos voro
tho vay to rostoro oouililrium, though Koynos imaginoJ a largo rolo lor
tho contral lank in assuring tho aJjustmonts voro maJo.
ln tho yoars altor tho T:~uI::~ vas pullishoJ, Koynos rothought thoso
classical notions. lt locamo cloar that changos in output haJ to play a
much largor rolo. ln a 1931 locturo, Koynos olloroJ tho olsorvation that an
oconomy may como to rost at a spurious oouililrium,` vith a lov lovol ol
proJuction anJ omploymont (WXlll, p. 356). This vas a rojoction ol ono
ol tho contral loaturos ol classical oconomics: supply can novor oxcooJ
JomanJ, anJ consoouontly tho long-torm unomploymont ol pooplo anJ
machinos can`t happon. Olviously it Joos, though many mainstroam
RENEGADES
199
oconomists still insist that human iJlonoss can only lo voluntary in such a
miraculous soll-oouililrating systom as capitalism.
monetarism: money all, money nothing
ln 1932 anJ 1933, Koynos logan Jovoloping vhat ho calloJ a monotary
thoory ol proJuction, a phraso ho usoJ as tho titlo ol a short 1933 ossay.
Tho classical oconomists ol tho 18th anJ 19th conturios vroto as il monoy
JiJn`t oxist, or, moro procisoly, oxistoJ only as a noutral link lotvoon
transactions in roal things anJ roal assots anJ Joos not allov it to ontor
into motivos or Jocisions.` ln such a vorlJ, tho lovol ol pricos has no
olloct on proJuction, consumption, or tho villingnoss to lonJ or lorrov.
But, as Koynos pointoJ out, vagos aro sticky,` moaning thoy Jon`t chango
as rapiJly as commoJity pricos, anJ Jolt contracts aro JonominatoJ in
monoy torms, moaning that il pricos lall, ontropronours vill havo troullo
mooting thoir vago lills anJ sorvicing thoir Jolts. ln classical Joctrino, a
lall in pricos voulJ lo oithor noutral, sinco monoy pricos Jon`t mattor lor
roal oxchango, or possilly stimulativo, sinco tho lall in pricos might in-
croaso JomanJ. Convoniontly, Koynos notoJ, in a vorlJ ol noutral monoy,
crisos u uI ccu: (omphasis in original). lor somoono vriting in 1933,
at tho trough ol Joprossion, this assumoJ avay tho vory mattor unJor
invostigation` (W Xlll, pp. 408-411).
Pight-ving icon lrioJrich Hayok introJucoJ tho torm noutrality ol
monoy` into English, attriluting it vrongly to Wicksoll: it vas actually a
proJuct ol Dutch anJ Gorman vritors ol tho 1920s (Hayok 1932, pp. 2-
28: Patinkin 1992). Tho Joctrino, though not tho torm, goos lack to tho
miJ-18th contury anJ DaviJ Humo (it is ol no mannor ol consoouonco .
vhothor monoy lo in groator or loss ouantity`): tvo lamous statomonts ol
tho thoory, incorporatoJ into tho crooJs ol many oconomists, lolong to
John Stuart Vill (thoro cannot, in short, lo intrinsically a moro insignili-
cant thing, in tho oconomy ol socioty, than monoy`) anJ lrving lishor
(monoy is a voil`).
Ouoting loth Vill anJ lishor approvingly, Vilton lrioJman anJ Anna
Jacolson Schvartz (1963, p. 696) nonotholoss spioJ a holo in tho voil, ono
torn ly govornmonts, typically ly thoir contral lanks, vhich mako torrillo
orrors vhon thoy try to rovorso tho lunJamontally unappoalallo juJgmonts
ol Tho Varkot. Vost ol thoso orrors aro misguiJoJ attompts to stimulato
tho oconomy, as lor oxamplo tho inllation ol tho 1960s anJ 190s, vhich
lrioJman anJ his spavn arguo vas causoJ ly oxcossivo gonorosity ly tho
WALL STREET
200
vorlJ`s contral lanks. Thoy Jo havo a point: tho oxcossivo oxtonsion ol
croJit loyonJ an oconomy`s capacity to satisly tho rosultant JomanJ vill
givo riso to inllation. But this argumont ignoros tho roason govornmonts
usoJ to try to stimulato oconomios - chronically high lovols ol unom-
ploymont. (lt also ignoros tho onJogonoity ol monoy, ol vhich moro lator.)
lrioJman anJ Schvartz also llamoJ capitalism`s most Jiro crisis, tho Groat
Doprossion, on tho allogoJly tightlistoJ policios ol tho loJoral Posorvo, an
argumont that has tho ploasant iJoological olloct ol acouitting tho innor
vorkings ol tho markot systom - such as tho ovorproJuction ol com-
moJitios comlinoJ vith tho polarization ol incomos that charactorizoJ
tho 1920s - ol any involvomont. Crisos may occur, inllationary or Jolla-
tionary, lut thoy`ro tho stato`s lault.
lrioJman (1962) usoJ to urgo that contral lanks lo roouiroJ ly lav or
monotary constitution` to incroaso tho ouantity ol monoy at a constant
rato ol 3-5/ a yoar. Thirty yoars lator, lrioJman`s laith soomoJ a lit shakon:
lt is tompting to concluJo lrom tho closo avorago rolation lotvoon changos
in tho ouantity ol monoy anJ changos in monoy incomo that control ovor
tho ouantity ol monoy can lo usoJ as a procision instrumont lor ollsotting
tho lorcos making lor instalility in monoy incomo. Unlortunatoly, tho looso
rolation lotvoon monoy anJ incomo ovor short porioJs, tho long anJ vari-
allo lag lotvoon changos in tho ouantity ol monoy anJ othor variallos,
anJ tho olton conllicting oljoctivos ol policy-makors procluJo prociso oll-
sotting control` (lrioJman 1992). Nov ho tolls us.
Ouantity thoorists havo almost unanimously maJo oxcoptions lor
monoy`s non-noutrality in tho short torm: a jolt ol lrosh monoy coulJ, ly
goosing up pricos, loost conliJonco, prolits, anJ proJuction lor a littlo
vhilo. But, it vas lurthor arguoJ, tho stimulus voulJ only lo transitory, as
a nov oouililrium vas roachoJ. Put anothor vay, as lrioJman (1968l)
JiJ in his classic scrooJ Tho Polo ol Vonotary Policy,` contral lanks can
only pog nominal ouantitios, not roal onos: tho roal rato ol intorost, tho
rato ol unomploymont, tho lovol ol roal national incomo, tho roal ouantitity
ol monoy` aro all loyonJ its povors. Tho prico lovol is thon a joint out-
como ol tho monotary lorcos Jotormining nominal incomo anJ tho roal
lorcos Jotormining roal incomo` (lrioJman 190). ln othor vorJs, pricos
anJ output, tho monotary anJ tho roal, aro soparatoly, not mutually, Jotor-
minoJ. So vhilo monoy might lo inlluontial in tho short viov, it vas nou-
tral in tho long. Why tho long torm shoulJ lo lunJamontally Jilloront lrom
tho sum ol many short torms is a lit mystorious. AnJ vhy too tho ouantity
thoorists, passionato loliovors in monotary noutrality, alvays caro vith
RENEGADES
201
ooual passion alout inllation is ooually mystorious. ll monoy pricos Jon`t
mattor, thon vhy Joos inllation? But il inllation - alvays anJ ovory-
vhoro a monotary phonomonon,` in tho lrioJmanito mantra - u~: mat-
tor, thon monoy can`t roally lo noutral, can it?
Vonotarism ollicially provailoJ in tho U.S. lrom 199, on Paul Volckor`s
asconsion to tho chair ol tho loJoral Posorvo, to 1982, vhon it vas alan-
JonoJ lor ostonsilly tochnical roasons, lut actually locauso tho U.S.
oconomy vas lalling apart, tho linancial systom vas making horrillo
sounJs, anJ Voxico vas on tho vorgo ol Jolault (GroiJor 198). ln truth,
Volckor`s aJoption ol monotarism vas a ruso lor Jriving up intorost ratos
to unprocoJontoJly high lovols to croato a Joop rocossion, to lroak inlla-
tion, anJ vith it, to crush tho last tracos ol lalor militancy.
Tho Thatchor govornmont inllictoJ an ovon moro savago monotarism
on Britain ovor tho samo porioJ. AccorJing to lrioJman`s aJvico to tho
lron IaJy, tho lato-190s inllation coulJ oasily havo loon JoloatoJ vith
only a moJost roJuction in output
anJ omploymont` (ouotoJ in Gilmour
1992, p. 50). Tho thoorotical roason
lor this conliJonco vas, ol courso,
tho allogoJ noutrality ol monoy:
tightnoss ly tho contral lank shoulJ
havo no olloct on roal output, only
on pricos. ln lact, Britain, liko tho
U.S., vont into a Joop anJ long ro-
cossion, anJ ono that inllictoJ lar
moro sorious long-torm Jamago on
Britai n` s lunJamontal ly voakor
oconomy. UK inJustrial proJuction
JiJn`t roturn to 199 lovols until
1985. Tho U.S. JiJ much lottor, no
Joult thanks to tho massivo liscal
stimulus proviJoJ ly tho Poagan
Jolicit: loth omploymont anJ proJuction rocoupoJ thoir rocossion lossos
ly 1983. HaJ lrioJman`s granJ claims loon truo, tho U.S. anJ UK rocos-
sions shoulJ novor havo happonoJ.
Vaylo thoso voro tho short-torm Jislocations that lrioJman thought
accoptallo. Thoro can lo no Joult, hovovor, that monotarism in loth
countrios, anJ throughout tho vorlJ lrom tho Chiloan coup onvarJ, has
loon an important part ol a conscious policy to crush lalor anJ roJistril-
money growth and inflation
UK U.S.
money
!975-79 !4.9' 6.3'
!930-34 !!.3 7.6
infIation
!975-79 !5.7 3.0
!930-34 9.6 7.5
onev is whal lhe F calls nonev
plus quasinonev, which consisls prin
cipallv ol currencv, checking deposils,
and line and savings deposils. l corre
sponds lo 2 in lhe U.S. delinilion. n
llalion relers lo consuner price inllalion.
Figures shown are arilhnelic averages
ol vearlv rales ol change as reporled in
!992 edilion.
WALL STREET
202
uto incomo anJ povor tovarJ capital - vhich cortainly can`t lo consiJ-
oroJ noutral in tho long torm.
lronically, ovon tho porioJs ol rocossion anJ rocovory Jisprovo mon-
otarist Jogma, as tho noarly tallo shovs. Britain shovoJ a sharpor Jo-
clino in inllation than tho Joclino in monoy grovth voulJ arguo lor, anJ
tho U.S. sav a Joclino in inllation Jospito a incroaso in tho paco ol monoy
grovth.
6
Wo`ll roturn to this lator, vhon looking at thoorios ol vhoro monoy
comos lrom - lrom on high, or lrom lolov.
money changes everything
Having provon monoy to lo non-noutral, anJ monotarism to lo silly, it`s
timo to movo lack to Koynos. ln tho yoars lotvoon tho T:~uI::~ anJ tho
~u~:uI TI~:), Koynos camo to soo that monoy invaliJatoJ Say`s lav, tho
classical Joctrino that assumoJ that supply croatos its ovn JomanJ. Horo`s
hov PicarJo (1911198, pp. 192-193) put it in a lamous passago:
No man proJucos lut vith a viov to consumo or soll, anJ ho novor solls lut
vith an intontion to purchaso somo othor commoJity, vhich may lo immo-
Jiatoly usolul to him, or vhich ho may contriluto to luturo proJuction. By
proJucing, thon, ho nocossarily locomos oithor tho consumor ol his ovn
gooJs, or tho purchasor anJ consumor ol tho gooJs ol somo othor porson.
But in tho roal vorlJ, a man` solls only to accumulato monoy, anJ ho
may lo slov in oxchanging that monoy lor oithor consumor (immoJi-
atoly usolul`) or capital gooJs (contrilut|ionsl to luturo proJuction`). ln
tho classical vorlJ, vhoro monoy has no autonomous inlluonco, gooJs`
anJ socuritios` pricos movo so that intorost ratos lall into lino vith tho ro-
turns on othor assots. Koynos, hovovor, vas proparing to arguo that tho
rato ol intorost is JotorminoJ ly lorcos partly appropriato to itsoll, anJ
that pricos movo until tho marginal ollicioncy ol othor assots lalls into lino
vith tho rato ol intorost` (W XlV, p. 103).
ln classical thoory, Koynos also arguoJ, tho lactors ol proJuction voro
assumoJ as givon: at issuo only vas thoir uso anJ rolativo rovarJs. Knovl-
oJgo vas assumoJ to lo sounJ, anJ
lacts anJ oxpoctations voro assumoJ to lo givon in a Jolinito anJ calcu-
lallo lorm: anJ risks, ol vhich, though aJmittoJ, not much notico vas takon,
voro supposoJ to lo capallo ol an oxact actuarial computation. Tho calcu-
lus ol prolalility, though montion ol it vas kopt in tho lackgrounJ, vas
RENEGADES
203
supposoJ to lo capallo ol roJucing uncortainty to tho samo calculallo sta-
tus as that ol cortainty itsoll: just as in tho Bonthamito calculus ol pains anJ
ploasuros or ol aJvantago anJ JisaJvantago, ly vhich tho Bonthamito phi-
losophy assumoJ mon to lo inlluoncoJ in thoir gonoral othical lohavior
(W XlV, p. 112).
ln tho roal vorlJ, hovovor, uncortainty coulJ not lo statistically Jomosti-
catoJ. Whon tho luturo looks ospocially uncortain, invostors vill lo shy ol
commitmonts, holJing a largo chunk ol thoir voalth in cash. Uncortainty
in a vorlJ ol non-noutral monoy can causo all kinJs ol troullo.
Koynos JopartoJ lrom his proJocossors in placing oxpoctations at tho
contor ol oconomic Jocision-making. Tako, lor oxamplo, his iJoa ol ol-
loctivo JomanJ.` ln Koynos`s Jolinition, olloctivo JomanJ is simply tho
aggrogato incomo (or procooJs) vhich tho ontropronours oxpoct to ro-
coivo, inclusivo ol tho incomo vhich thoy vill hanJ on to tho othor lactors
ol proJuction, lrom tho amount ol curront omploymont vhich thoy Jo-
ciJo to givo` (W Vll, p. 55). As Victoria Chick has vritton, tho torm is
somovhat unlortunato. lt is somotimos misconstruoJ to rolor to tho Jo-
manJ ono can lack up ly purchasing povor,` in contrast to notional Jo-
manJ, vhich is vhat ono voulJ JomanJ coulJ ono soll all ono`s lalor
povor lor vagos. (Givon tho povor ol imagination, notional JomanJ coulJ
lo consiJoroJ noarly inlinito.) Elloctivo JomanJ is tho aggrogato ol ontro-
pronours` oxpoctations ol thoir salos on vhich thoy laso thoir proJuction
Jocisions - lut thoir proJuction Jocisions (hov many vorkors to hiro,
hov long to vork thom, hov many units to proJuco, otc.) in turn in largo
part Jotormino JomanJ, sinco incomos lrom proJuction aro vhat proviJo
tho juico lor JomanJ (Chick 1983, pp. 64-65).
Similarly, ontropronours` invostmont Jocisions anJ rontiors` Jocisions
alout tho allocation ol thoir savings lotvoon cash anJ long-livoJ assots
aro also lasoJ largoly on oxpoctations. Normally, oconomic actors Jorivo
thoir oxpoctations lor tho luturo lrom convontion anJ lrom rocont history,
assuming that tho prosont is a much moro sorvicoallo guiJo to tho luturo
than a canJiJ oxamination ol past oxporionco voulJ shov it to havo loon
hithorto` (W XlV, p. 114). This soll-Jocoption is a stalilizing lorco, sinco
oconomic lilo, anarchists` appoaling Jroams asiJo, voulJ lo unimagin-
allo in a vorlJ that vas constantly turning itsoll upsiJo Jovn. ln turlu-
lont timos, hovovor, savors anJ invostors, proJucors anJ consumors, all
vill como to oxpoct tho vorst, assuming that prosont turlulonco vill con-
tinuo inJolinitoly. Whon pooplo loar lor tho luturo, thoy pull in thoir horns
WALL STREET
204
anJ koop vhatovor assots thoy havo in somothing socuro: usually that
moans cash, or somothing liko it, rathor than stocks, lonJs, or lactorios.
ln ClassicalvorlJ, oxpoctations aro alvays rational, rosourcos omployoJ
to thoir lullost, anJ :uucI::~ IuIuuc~: u:~ z~:` (W XXlX, pp. 215, 256-
25: Vll, p. 26: italics in original). ln KoynosvorlJ, oxpoctations aro not
nocossarily rational, rosourcos can romain unomployoJ lor a long timo,
anJ inactivo lalancos (hoarJs, in plain English) can lo much groator than
zoro. Or, as Goorgo Shacklo put it in his ologant summary ol Koynos`s
~u~:uI TI~:). To luy tho moans.ol proJucing gooJs is to gamllo on
tho ovontual salo ol thoso gooJs. lrom timo to timo lusinossmon loso
thoir norvo anJ roluso this gamllo, prolorring to koop thoir voalth in monoy
rathor than omlark it in tho proJucts ol omploymont` (ouotoJ in Vooro
1988l, p. 249). Tho classicals voro vrong: an oconomy vill not nocossar-
ily como to rost vith tho lull omploymont ol capital anJ lalor.
To Koynos, tho most crucial prollom ol a moJorn capitalist oconomy
vas ovoking a sulliciontly high lovol ol invostmont to assuro lull omploy-
mont, anJ it`s horo that uncortainty anJ tho comlorts ol monoy vork thoir
Jovilmont. Entropronours vill only invost il thoy oxpoct tho nov invost-
mont to yiolJ a groator incomo ovor its lilo than it vill cost thom to linanco
tho assot: in Koynos`s jargon, tho marginal ollicioncy ol capital (VEC) must
lo groator than tho intorost rato thoy pay thoir lankors.
Whilo this may not soom liko an oxtraorJinarily original iJoa at lirst,
thoro aro at loast tvo points ol intorost in tho lormulation. lirst is tho no-
tion that monoy is contral to invostmont Jocisions: Koynos haJ no truck
vith mainstroam piotios alout proJuction sorving consumor nooJs. Tho
lirm.has no oljoct in tho vorlJ oxcopt to onJ up vith moro monoy than
it startoJ vith` (W XXlX, p. 89). SoconJ is tho notion that ~.j~cIuI:u:
aro contral to invostmont Jocisions: tho oxpoctations may lo vrong or
right, rational or irrational, lut vhatovor tho caso, thoy mattor onormously.
lt`s not only tho oxpoctations ol inJustrial managors that mattor to in-
vostmont: tho VEC must lo moasuroJ against tho intorost rato, anJ tho
rato ol intorost is a highly psychological phonomonon` (W Vll, p. 202).
TI~ ~u~:uI TI~:) lanishoJ all notions ol tho intorost rato lalancing
savings anJ invostmont (or, put anothor vay, lalancing tho supply ol anJ
JomanJ lor savings), cut it lroo ol any intimato rolation vith prolit ratos,
anJ JiscarJoJ tho concopt ol a natural rato ol intorost. ll tho natural rato is
JolinoJ as tho ono that maintains tho status ouo, thoro can lo many natu-
ral ratos ol intorost, oach associatoJ vith a Jilloront lovol ol omploymont
- anJ, in gonoral, vo havo no proJominant intorost in tho :IuIu: au`
8
RENEGADES
205
ll thoro is any rato ol intorost that Josorvos spocial status, Koynos arguoJ,
it`s tho ono associatoJ vith lull omploymont (W Vll, p. 243). Ono ol tho
goals ol oconomic analysis anJ policy shoulJ lo to Jiscovor anJ attain
that optimum rato.
lntorost ratos aro a lunction ol tho gonorosity or tightnoss ol tho contral
lank anJ tho JomanJ lor monoy, vhich Koynos calloJ tho stato ol liouiJ-
ity proloronco. IiouiJity proloronco JoponJoJ on throo things in TI~
~u~:uI TI~:) (W Vll, pp. 168-14) - tho transactions motivo, tho
nooJ lor cash to covor porsonal anJ lusinoss oxponsos: tho procautionary
motivo, tho Josiro lor a cash cushion in tho laco ol luturo uncortainty: anJ
tho spoculativo motivo, cash kopt liko Jry povJor, lor taking ouick aJ-
vantago ol markot mis-valuations (liko luying a stock that has loon ham-
moroJ Jovn). To thoso throo, Koynos lator aJJoJ a lourth, a linanco motivo,
ontropronours` short-torm JomanJ lor cash in tho oarly stagos ol an in-
vostmont projoct, tho croJit roouiroJ in tho intorval lotvoon planning
anJ oxocution` (W XlV, pp. 216, 218). ln laJ timos, liko tho 1930s, loar
incroasoJ tho Jogroo ol liouiJity proloronco to crippling lovols: ovoryono
vantoJ tho saloty ol cash, anJ no ono JaroJ go out on a liml.
ln tho oxposition ol liouiJity proloronco in ~u~:uI TI~:), Koynos om-
phasizoJ tho psychological stato ol linancial actors - rontiors anJ City
prolossionals. Whon oxpoctations aro loarish, it takos a vory high intorost
rato to luro rontiors lrom tho socurity ol cash: vhon thoy`ro lullish, it Joosn`t
tako much.
9
Pathor than loing tho rovarJ lor not-sponJing, tho classic
Protostant-moralizing thoory ol intorost, intorost roprosonts tho rovarJ lor
not-hoarJing` - lor taking a risk, lor locoming loss liouiJ. But thoro`s
moro to tho JomanJ lor monoy than tho Josiralility ol hoarJing, as Koynos
omphasizoJ in a lottor to D.H. Polortson. IiouiJity proloronco is also Jo-
torminoJ ly tho scalo ol planning anJ activity anJ tho lovol ol costs` (W
XlV, p. 224). Tho JomanJ lor monoy can incroaso oithor out ol onthusi-
asm or anxioty, in a loom or a panic, vhich vill push up intorost ratos,
othor lactors (liko contral lank policy) romaining unchangoJ.
Sontimont is at tho contor ol Koynos`s thoory ol invostmont, anJ his
most justilially lamous oxploration ol tho linancial passions is Chaptor 12
ol TI~ ~u~:uI TI~:), Tho Stato ol Iong-Torm Expoctations,` ono ol tho
most splonJiJ analysos ol spoculativo markots ovor vritton. Koynos ar-
guoJ that assot pricos aro povoroJ ly vilJ svings ol tomporamont, tho
volatilo juJgmonts ol an ignorant horJ, anJ thoso noisy signals guiJo roal
WALL STREET
206
invostmont, to tho Jotrimont ol prospority. Varkots aro populatoJ ly Jis-
porsoJ invostors vith littlo knovloJgo ol tho roal lusinossos thoy ovn or
lonJ monoy to. Day-to-Jay lluctuations` in tho lortunos ol ontorprisos ol
an ophomoral anJ non-signilicant charactor, tonJ to havo an altogothor
oxcossivo, anJ ovon an alsurJ, inlluonco on tho markot. Amorican com-
panios vhich manulacturo ico tonJ to soll at a highor prico in summor
vhon thoir prolits aro soasonally high than in vintor vhon no ono vants
ico` (W Vll, pp. 153-154). lco sounJs ouaint, lut tho principlo still holJs
truo: tho stock pricos ol rotailors rosponJ to aJvanco inJoxos ol vookly
salos that havo littlo rolation to linal, Jolinitivo salos liguros. |Tlho onor-
gios anJ skill ol tho prolossional invostor anJ spoculator` aro concornoJ
not vith sorious long-torm lorocasts, lut vith lorosooing changos in tho
convontional lasis ol valuation a short timo ahoaJ ol tho gonoral pullic.`
Thus tho prolossional invostor is lorcoJ to concorn himsoll vith tho antici-
pation ol imponJing changos, in tho novs or in tho atmosphoro, ol tho kinJ
ly vhich oxporionco shovs that tho mass psychology ol tho markot is most
inlluoncoJ. This is tho inovitallo rosult ol invostmont markots organizoJ
vith a viov to so-calloJ liouiJity.` Ol tho maxims ol orthoJox linanco
nono, suroly, is moro anti-social than tho lotish ol liouiJity.. lt lorgots that
thoro is no such thing as liouiJity ol invostmont lor tho community as a
vholo. Tho social oljoct ol skilloJ invostmont shoulJ lo to Joloat tho Jark
lorcos ol timo anJ ignoranco vhich onvolop our luturo. Tho actual, privato
oljoct ol tho most skilloJ invostmont to-Jay is to loat tho gun,` as tho
Amoricans so voll oxpross it, to outvit tho crovJ, anJ to pass tho laJ, or
Joprociating, hall-crovn to tho othor lollov (W Vll, p. 155).
This gamo - vhich Koynos likonoJ to Snap, or OlJ VaiJ, or Vusical
Chairs - is ono ol tho thirJ Jogroo vhoro vo Jovoto our intolligoncos to
anticipating vhat avorago opinion oxpocts tho avorago opinion to lo. AnJ
thoro aro somo, l loliovo, vho practico tho lourth, lilth anJ highor Jo-
groos.` Or, as ho put it in TI~ T:~uI::~, tho point is to apo unroason
proloptically` (W Vl, p. 323). Nothing coulJ lo truor. Somo oviJonco
that ho vas right is that unliko many oconomists, Koynos vas a lrilliant
spoculator vho maJo himsoll anJ his CamlriJgo collogo a lortuno.
10
Thoso gyrations might soom silly, JocaJont, or vastolul, lut thoir Jan-
gor lios in thoir inlluonco on roal invostmont. Spoculators may Jo no harm
as lulllos on a stoaJy stroam ol ontorpriso. But tho position is sorious
vhon ontorpriso locomos tho lulllo on a vhirlpool ol spoculation. Whon
tho capital Jovolopmont ol a country locomos tho ly-proJuct ol tho ac-
RENEGADES
207
tivitios ol a casino, tho jol is likoly to lo ill-Jono` (W Vll, p. 159). Koynos
haJ tho Amorica ol tho 1920s in minJ vhon ho vroto this, lut ho coulJ
havo loon vriting alout this country, anJ incroasingly many othors, ovor
tho last 15-20 yoars.
ln a narrov sonso ho vas vrong. Changos in stock pricos roally Jon`t
havo that much inlluonco on roal invostmont: insolar as thoy havo an oco-
nomic logic at all, thoy moroly rolloct (anJ usually amplily) changos in
intorost ratos anJ tho availalility ol croJit, vhich in turn inlluonco roal
JomanJ, anJ ovontually roal invostmont. Wo sav this in Chaptor 4, vith
tho Jissoction ol a thoory anJ tho roviov ol tho vork ol Vorck, Shloilor,
anJ Vishny (1990) shoving that invostmont rosponJs to lunJamontal vari-
allos liko salos anJ cash llov, loth at tho lirm anJ aggrogato lovols, vith
stock roturns aJJing littlo or no oxplanatory povor to thoir moJols. lur-
thor, Vorck anJ comraJos concluJo that Tho notion that tho stock mar-
kot ovaluatos tho Iu-I~:u prospocts ol tho oconomy, anJ so guiJos
long-torm invostmont, is not supportoJ ly tho Jata.`
Thank GoJ lor that. Koynos`s instinctivo Joscription ol tho lorcos lo-
hinJ stock markots aro accurato, lut thoir inlluonco on invostmont is noth-
ing liko vhat ho maJo it soom. But thoro`s intonso intorost among Wall
Strootors anJ thoir pot acaJomics lor lorcing managors to lo moro ol-
sossoJ vith pushing up thoir stock pricos than thoy alroaJy aro. As a long-
torm stratogy, this sooms lrightlully vrong.
But just looking at tho rolationship lotvoon stock pricos anJ invost-
mont is to spocily tho mattor too narrovly. Tho stock markot isn`t just
alout pricos, it`s alout tho control ol vholo corporations, vhich aro lought
anJ solJ, comlinoJ anJ liouiJatoJ, olton on puroly linancial consiJor-
ations through tho mochanisms ol tho stock oxchango. So tho juJgmonts
ol an ignorant, grooJy, anJ oxcitallo mol Jo havo consiJorallo roal vorlJ
ollocts. Evon loss moasurallo is tho olloct ol tho nov sharoholJor
assortivonoss. Tho olloct ol loth activo V8A anJ rontior assortivonoss is to
alloct corporato policios in oualitiativo vays that moro invostmont liguros
can`t moasuro. Wo`ll roturn to thoso topics in tho Chaptor 6.
Keynes: a heretic of sorts
IiouiJity proloronco Jravs attontion avay lrom tho lovol ol savings anJ
tovarJs tho ouostion ol hov thoy`ro allocatoJ. OrthoJoxy arguoJ in
Koynos`s Jay, anJ continuos to arguo in ours, that highor savings ratos aro
to lo oncouragoJ, so that nov invostmont coulJ lo moro choaply linancoJ.
WALL STREET
208
Tho implication is that invostmont capital is short. Koynos arguoJ instoaJ
that vhilo invostmont can lo congostoJ` through a shortago ol cash -
Jilliculty in amassing lorrovoJ monoy unJor tho linanco motivo - it
novor can lo congostoJ ly a shortago ol savings. Ho calloJ this tho most
lunJamontal ol my conclusions vithin this liolJ.` lor tho socioty as a vholo,
long-torm invostmont can lunJ itsoll. lncroasoJ invostmont vill alvays
lo accompanioJ ly incroasoJ saving,` vroto tho optimistic Koynos, lut
it can novor lo procoJoJ ly it. DishoarJing anJ croJit oxpansion pro-
viJos not an uII~:uuI::~ to incroasoJ saving, lut a nocossary proparation
lor it. lt is tho paront, not tho tvin, ol incroasoJ saving.` Attompts to ro-
Juco prossuro on cash ly cutting lack consumption - tho proscription ol
orthoJox thrilt-promotors ol tho 1920s anJ tho 1990s - vill Jo so, lut
only ly Joprossing incomo anJ ultimatoly invostmont. Voroovor, :j~uu-
:u roloasos lunJs just as much as saving Joos, anJ . thoso lunJs vhon
roloasoJ can thon lo usoJ inJillorontly lor tho proJuction oithor ol capital
gooJs or ol consumption gooJs` (W XlV, pp. 216, 219, 222, 229, 232,
281, 282). Vonoy must circulato, not congoal into a hoarJ.
Iiko tho T:~uI::~, tho ~u~:uI TI~:)s mossago is rosolutoly oxpan-
sivo: sponJing, not sparing, gonoratos voalth. Voralists, vhothor Calvin-
ist, nooclassical, or ovon Varxist, linJ this aspoct ol Koynos scanJalous, a
roaction ho soomingly vont out ol his vay to provoko. Vuch ol Chaptor
23 is JovotoJ to a rohalilitation ol historical kinJroJ spirits, ol vhom olli-
cial opinion Jisapprovos: morcantilists, immoralists, unJorconsumptionists,
promotors ol usury lavs - ovon that olJ monotary crank Silvio Gosoll.
Among tho immoralists is a look that a ViJJlosox granJ jury ol 123
convictoJ ol loing a nuisanco, BornarJ VanJovillo`s 1uII~ J II~ 1~~:
Tho poom anJ commontarios sot lorth tho appalling plight ol a prospor-
ous community in vhich all tho citizons suJJonly tako it into thoir hoaJs
to alanJon luxurious living, anJ tho Stato to cut Jovn on armamonts, in
tho intorosts ol Saving` (W Vll, pp. 359-362). Tho community sinks into
Jollation anJ Jospair. VanJovillo`s talo is not vithout a thoorotical la-
sis,` as Koynos points out. ln tho commontary, VanJovillo arguoJ that
vhilo an inJiviJual lamily can savo itsoll rich, a nation cannot - an ol-
sorvation that AJam Smith prolally haJ in minJ vhon ho vroto, contrary
to tho lalulist, What is pruJonco in tho conJuct ol ovory privato lamily
can scarco lo lolly in that ol a groat KingJom.` VanJovillo`s aJvico to tho
stato vas to practico tho oconomics ol joy, oncouraging manulacturos,
arts, anJ agriculturo to proJuco to thoir lullost, anJ to cultivato tho lruits
ol tho Earth anJ tho Ialour ol tho Pooplo, loth ol vhich joinoJ togothor
RENEGADES
209
aro a moro cortain, a moro inoxhaustillo anJ moro roal Troasuro than tho
GolJ ol Brazil or tho Silvor ol Potosi.`
To this Koynos aJJoJ his ovn lillip:
No vonJor that such vickoJ sontimonts calloJ Jovn tho opprolrium ol
tvo conturios ol moralists anJ oconomists vho lolt much moro virtuous in
possossion ol thoir austoro Joctrino that no sounJ romoJy vas Jiscovor-
allo oxcopt in tho utmost ol thrilt anJ oconomy loth ly tho inJiviJual anJ
ly tho stato. Potty`s ontortainmonts, magnilicont shovs, triumphal archos,
otc.` givo placo to tho ponny-visJom ol GlaJstonian linanco anJ to a stato
systom vhich coulJ not allorJ` hospitals, opon spacos, nollo luilJings,
ovon tho prosorvation ol its anciont monumonts, lar loss tho splonJours ol
music anJ tho Jrama, all ol vhich voro consignoJ to tho privato charity or
magnanimity ol improviJont inJiviJuals.
By Koynos`s tolling, VanJovilloan oxuloranco JisappoaroJ lrom rospoct-
allo circlos until Valthus vho, liko Koynos, opposoJ Smith`s Joctrino that
capital is incroasoJ ly parsimony. Valthus loaroJ that mass povorty voulJ
causo a chronic insullicioncy ol JomanJ, loaving capital anJ lalor to lan-
guish unomployoJ. Against this tonJoncy tovarJs anomia, Valthus col-
olratoJ tho oconomically stimulativo olloct ol unproJuctivo consumption
on tho part ol tho lanJlorJs anJ capitalists` (W Vll, p. 363).
Horo Koynos sooms vory much liko a rolol vithin his ovn class. As
Varx (1963, pp. 10-12) arguoJ, VanJovillo anJ Valthus voro part ol an
ollonsivo to countor AJam Smith`s Jistinction lotvoon proJuctivo anJ
unproJuctivo lalor. Capitalism, Varx arguoJ, roproJucoJ ovorything
against vhich it haJ lought in louJal or alsolutist lorm` - a parasitical
olito. Smith, spoaking lor tho oarly capitalists, lounJ this stratum an ol-
staclo: thoy contrilutoJ nothing usolul, consuming social voalth lut pro-
Jucing nothing in roturn. This vas not voll-rocoivoJ among tho lottor
orJors. ln Varx`s vorJs, tho highor graJo` vorkors - such as stato olli-
cials, military pooplo, artists, Joctors, priosts, juJgos, lavyors, otc. - somo
ol vhom aro not only not proJuctivo lut in ossonco Jostructivo.lounJ it
not at all ploasant to lo rologatoJ ~cuu:cuII) to tho samo class as clovns
anJ monial sorvants anJ to appoar moroly as.parasitos on tho actual pro-
Jucors.` This compromiso` lotvoon tho capitalists anJ tho lurJonsomo
olito lounJ tho u-uII:u: anJ thoir ju:u::I~:.a placo in this lost pos-
sillo orJor ol things.` Valthus anJ VanJovillo, Varx concoJoJ, voro to
lo prolorroJ to lator apologists, locauso thoy rocognizoJ tho parasitism ol
tho unproJuctivo ovon as thoy lounJ thoir ovorconsumption holplul.
WALL STREET
210
VanJovillo ovon holJ that Evil` is vhat makos us social croaturos, anJ is
tho soliJ Basis, tho 1:J~ uuu ujj:I J uII T:uu~: uuu EujI)u~uI: vith-
out oxcoption` (Varx 1963, pp. 35-36).
Though Koynos JoclaroJ himsoll an otornal immoralist (W X, p. 44),
thoro`s no cololration ol ovil in his vork, anJ ho vas too humano to col-
olrato tho stimulativo povors ol parasitos. But ho olton llinchoJ vhon
conlronting tho issuo ol vhat monoy shoulJ lo invostoJ in. Though ho
acknovloJgoJ that it voulJ lo lottor to luilJ housos anJ tho liko,` it
voulJ lo lottor than nothing to havo tho Troasury lill olJ lottlos vith
lanknotos,` lury thom, anJ tonJor lor contracts lor pooplo to Jig thom up
again (W Vll, p. 129). Ol courso ho vas loing ironic, lut irony is a vay
ol Jisguising an omlarrassing truth. Iator in tho ~u~:uI TI~:), Koynos
saiJ that in an oconomy vith an unomploymont rato ol 10/, thoro`s no
roason to supposo that tho omployoJ 90/ aro soriously misomployoJ: tho
tragoJy has nothing to Jo vith vhat`s proJucoJ, anJ only to Jo vith tho
insullicioncy ol proJuction. Dospito his unmasking ol markots as not soll-
aJjusting, Koynos statoJ his aim to lo inJicating tho naturo ol tho onvi-
ronmont vhich tho lroo play ol oconomic lorcos roouiros` il tho Vanchostor
Systom` is to roalizo its lull potontial. Onco tho planning luroaucrats got
ovorything right, tho classical thoory comos into its ovn again` (W Vll,
pp. 38-39). Post-Koynosians rightly vail alout tho lanalizing aluso
Koynos sulloroJ at tho hanJs ol tho lastarJ Koynosians, lut tho Vastor
himsoll haJ alroaJy Jono a gooJ jol shoving thom vhoro to start. AnJ
romomlor ho cololratoJ Gosoll as tho avatar ol an anti-Varxian socialism
vho promisoJ tho llourishing ol compotition rathor than its alolition.
\ot this apologia comos just pagos altor passagos proclaiming tho nooJ
lor tho somovhat comprohonsivo socialisation ol invostmont,` arguing
that oxtromo inoouality ol voalth anJ incomo hurt oconomic porlormanco
rathor than holping it, anJ proposing tho outhanasia ol tho rontior, ol tho
lunctionloss invostor` (W Vll, pp. 35-38). What tho socialization ol
invostmont moant vas lolt rathor vaguo in tho ~u~:uI TI~:) lt JiJ not
moan stato socialism,` Koynos assuroJ: most likoly, it moant tho stato voulJ
moroly Jotormino invostmont lovols anJ thoir rovarJs. Koynos olloroJ somo
moro Jotail in a lottor to Havtroy. Whilo it vas thoorotically concoivallo
that communal saving might havo to lo loanoJ to privato ontorpriso,` tho
BoarJ ol National lnvostmont voulJ in ono vay or anothor control ly lar
tho groator part ol invostmont. Privato ontorpriso (moaning inJustry) ro-
ouiros such a tiny lragmont ol total savings that it coulJ prolally look
altor itsoll. BuilJing, transport anJ pullic utilitios aro almost tho only out-
RENEGADES
211
lots lor nov capital on a largo scalo.` Pullic soctor invostmont voulJ mako
capital so plontilul that it voulJ loso its scarcity valuo, intorost ratos voulJ
Jrop to zoro, anJ tho lunctionloss invostor voulJ Jisappoar. lt all coulJ
lo Jono graJually, vith no rovolution, vithout a lroak in tho gonoral
traJitions ol socioty` (W XlV, p. 49).
\ot ovon this program, lor all its ovasions anJ contraJictions, is rovolu-
tionary in tho oyos ol capital. Privato invostmont is largoly soll-linancing,
as Koynos arguoJ, lut to ignoro it is to ignoro vhat shapos tho ovolution
ol much ol our physical anJ social onvironmont. Capital coulJ lo maJo
plontilul in tho physical sonso, lut a systom ol proJuction organizoJ lor
monoy prolits - vhich Koynos acknovloJgoJ capitalism to lo - vill
havo nono ol it. Pontiors, vhilo thoy may lo socially lunctionloss, aro nono-
tholoss tho ovnors ol tho proJuctivo capital stock, anJ tho croJitors ol its
hiroJ managors. Thoy voulJ novor concoJo to thoir outhanasia,` sinco
thoy havo novor thought thoir conJition torminal, at loast sinco tho miJ-
1930s. Nor voulJ omployors ovor consont to a rogimo ol lull omploy-
mont: it voulJ lo tho Joath ol vork Jisciplino.
Ono gots tho sonso, roaJing Koynos, that tho Jriving lorco lohinJ capi-
talism is sontimont, tho lullish or loarish stato ol oxpoctations, anJ that
social roality is important only insolar as it changos oxpoctations through
surpriso, ploasant or unploasant. This is consonant vith Koynos`s highly
aosthoticizoJ viov ol tho vorlJ, his rolollion against vhat ho calloJ
tho oxtraorJinary contraption ol tho Bonthamito School, ly vhich all pos-
sillo consoouoncos ol altornativo coursos ol action voro supposoJ to havo
attachoJ to thom, lirst a numlor oxprossing thoir comparativo aJvantago,
anJ soconJly anothor numlor oxprossing tho prolalility ol thoir lolloving
lrom tho courso ol action in ouostion: so that multiplying togothor tho num-
lors attachoJ to all tho possillo consoouoncos ol a givon action anJ aJJing
tho rosults, vo coulJ Jiscovor vhat to Jo. ln this vay a mythical systom ol
prolallo knovloJgo vas omployoJ to roJuco tho luturo to tho samo calcu-
lallo status as tho prosont (W XlV, p. 124).
Koynos has a point: this is vhat mythmakors ol tho olliciont markot school
Jo, translorm raJical uncortainty into statistical risk. ln this roaction, hov-
ovor, Koynos roturns to tho spirit ol his unJorgraJuato circlo at CamlriJgo,
vhoro nothing mattoroJ oxcopt statos ol minJ, our ovn anJ othor pooplo`s
ol courso, lut chiolly our ovn` (W X, p. 436).
This roaction against Bontham vas so oxtromo that Koynos coulJ at-
triluto tho tochniouos ol rational calculation imposoJ ly compotitivo capi-
WALL STREET
212
talism to a philosophor, rathor than to tho unsontimontal, imporsonal
mochanisms ol tho markot, anJ at tho samo timo Joscrilo Varxism, tho
harshost systomatic critiouo that tho capitalist markot has ovor inspiroJ, as
tho linal :~uucI: uu uI:u:uuu ol Bonthamism` (W X, p. 446).
11
lronically, Koynos`s intorost in a monotary thoory ol proJuction` camo in
part lrom his roaJing ol an account ol Varx`s classic lormula ol capitalist
proJuction, V-C-V` (W XXlX, pp. 81-83). By this, Varx moant that tho
capitalist throvs V|onoyl into proJuction - ongaging loth lalor anJ capi-
tal - to croato a C|ommoJityl lor salo, vhich roturns, il all goos voll, a
sum ol V`|onoyl largor than that laiJ out at lirst. Koynos vas struck ly tho
contrast lotvoon this anJ tho orthoJox iJoa that ontropronours proJuco
proJucts in oxchango lor proJucts (or tho moro moJorn, apologotic iJoa
that thoy proJuco to satisly consumors). UnJor capitalism, tho satislaction
ol nooJs is a positivo oxtornality ol tho pursuit ol prolit, to uso tho moJorn
languago - anJ tho plannoJ croation ol nooJs a loss positivo oxtornality.
Koynos loarnoJ this lrom a soconJ-hanJ sourco locauso ho lounJ tho
original as unroaJallo as tho Koran: Jroary, out-ol-Jato, acaJomic
controvorsializing` (W XXVlll, p. 38) - though Poll Bohrons (1985) ar-
guoJ that Koynos roaJ moro Varx than ho aJmittoJ or his colloaguos knov.
As an oconomist, Koynos rankoJ Varx lolov tho monotary cranks - somo-
thing that causoJ Schumpotor (1936) to oxclaim: l am no Varxian. \ot l
sulliciontly rocognizo tho groatnoss ol Varx to lo ollonJoJ at sooing him
classoJ vith Silvio Gosoll anJ Vajor Douglas.`
12
Varxism as a political philosophy vas a Jolusion` (W XVll, p. 268),
an olsoloto` anJ orronoous.crooJ vhich, prolorring tho muJ to tho
lish, oxalts tho loorish prolotariat alovo tho lourgoois anJ tho intolligon-
tsia vho, vith vhatovor laults, aro tho ouality in lilo anJ suroly carry tho
sooJs ol all human aJvancomont.` Tho hatoJ Joctrino coulJ Jo nothing
to altor.human naturo,` to mako Jovs loss avaricious or Pussians loss
oxtravagant than thoy voro loloro` (W lX, pp. 258-259). Workors ho
lounJ loorish,` though ho gonorously concoJoJ that thoy voro not as
ugly as thoy might lo` (ouotoJ in Porolman 1989, p.). Civilization is not
tho proJuct ol humans vorking togothor, lut a thin anJ procarious crust
oroctoJ ly tho porsonality anJ tho vill ol a vory lov, anJ only maintainoJ
ly rulos anJ convontions skillully put across anJ guilolully prosorvoJ`
(W X, p. 44). Tho cIu:: var,` ho concluJoJ charmingly, vill linJ mo
on tho siJo ol tho oJucatoJ lourgooisio` (W lX, p. 29).
RENEGADES
213
Tho uso ol oJucatoJ` is an intorosting oualilication: it rooks ol tho En-
glish aristocrat`s contompt lor thoso orJinary souls ongagoJ in traJo: Jo-
spito tho anti-linanco lias ol much ol his oconomic vriting, in his hoart ho
soomoJ closor to tho City-gontry noxus than his sulsoouont roputation
might suggost. His arroganco, anothor markor ol his class, coulJ lo lroath-
taking at timos. Unliko Varx, vho vantoJ to organizo tho myriaJ
Iilliputians anJ arm thom vith poisonoJ arrovs,` Koynos thought that
lolks liko him coulJ manago ovorything through thoir JisintorostoJ so-
phistication. Varxism, ho claimoJ, onormously ovorostimatos tho signili-
canco ol tho oconomic prollom. ll you loavo that to mo, l vill look altor it`
(W XXVlll, p. 34).
ln lact, ho thought tho ~u~:uI TI~:) haJ solvoJ tho` oconomic prol-
lom, in loth thoory anJ practico. With that singlo shot, ho claimoJ, ho`J
killoJ loth PicarJo uuu Varx. To Koynos, loth lolongoJ to tho soll-aJ-
justing school` ol classical oconomics` (ouotoJ in Bohrons 1985), lailing
as thoy JiJ to grasp tho Joctrino ol liouiJity proloronco anJ tho Jrag on
invostmont oxortoJ ly high intorost ratos. Horo Varx anJ PicarJo aro joinoJ
in thoir sunninoss. But olsovhoro ho joinoJ thom in gloom: Varxism is a
highly plausillo inlluonco lrom tho PicarJian oconomics, that capitalistic
inJiviJualism cannot possilly vork in practico.` ln loth casos, tho oouiva-
lonco is as strango as loucault`s (193, p. 262) Joclaration that tho strugglo
lotvoon Varxians anJ PicarJians vas no moro than storms in a chilJron`s
paJJling pool,` sinco thoy loth sharoJ a common Jroam ol an onJ to
History. But loucault haJ tho oxcuso ol Jooming oconomics a 19th con-
tury concorn, an oxcuso unavailallo to an oconomist liko Koynos.
13
Koynos coulJ not havo roaJ Varx`s (193, p. 410) succinct criticism ol
PicarJo anJ his colloaguos lor having concoivoJ proJuction as Jiroctly
iJontical vith tho soll-roalization ol capital - anJ honco voro hooJloss ol
tho larriors to consumption or ol tho oxisting larriors ol circulation itsoll,`
locauso tho :uuu::::~ vasn`t pullishoJ until throo yoars altor tho ~u~:uI
TI~:) But it voulJ striko somoono vho`J lothoroJ to roaJ uj:IuI as
protty lamiliar stull: altor all, PicarJo isn`t oxactly knovn as an impas-
sionoJ prophot ol capitalism`s Jomiso in ouito tho samo vay Varx is.
But Koynos coulJ havo roaJ (in Gorman, accorJing to Bohrons, vhich
ho roaJ voll) this lrom tho thirJ volumo ol uj:IuI. Thoso oconomists
liko PicarJo, vho tako tho capitalist moJo ol proJuction as an alsoluto,
lool horo that this moJo ol proJuction croatos a larrior lor itsoll anJ sook
tho sourco ol this larrior not in proJuction lut rathor in naturo (in tho
thoory ol ront)` (Varx 1981, p. 350). Woro tho parasitical lanJlorJs smashoJ,
WALL STREET
214
accumulation coulJ continuo apaco. Koynos, you coulJ say, sought tho
larrior not in naturo, lut in tho minJ ol tho capitalist anJ in tho oxcos-
sivoly austoro policy proloroncos ol a saJomonotarist contral lank.
14
Woro
tho rontiors smashoJ, thon accumulation coulJ continuo apaco. ln that
sonso, Koynos haJ moro in common vith PicarJo than ho voulJ havo
likoJ to aJmit.
livo pagos ol tho ~u~:uI TI~:) (W Vll, pp. 353-358) aro JovotoJ to
tho rohalilitation ol Gosoll, a vritor almost univorsally rogarJoJ as a mon-
otary crank Koynos soos him as a kinJroJ ronogaJo, vililioJ ly tho ortho-
Jox lut roally onto somothing (though ol courso not onto ovorything,
having missoJ tho contrality ol liouiJity proloronco). Koynos cololratoJ
Gosoll as tho invontor ol an anti-Varxian socialism, a roaction against
Iu:::~z-Ju::~ luilt on thoorotical lounJations totally unliko thoso ol Varx
in loing lasoJ on a ropuJiation instoaJ ol on an accoptanco ol tho classi-
cal hypothosos, anJ on an unlottoring ol compotition instoaJ ol its aloli-
tion.` To Gosoll, tho paymont ol intorost holJs lack tho accumulation ol
capital. ll intorost coulJ lo lorcoJ to zoro, thon accumulation voulJ ac-
colorato anJ univorsal prospority voulJ lo our rovarJ.
But ol courso intorost ratos can`t lo lorcoJ to zoro, nor can tho rontior
lo outhanizoJ, nor can linancial innovation lo snulloJ, vithout trans-
lorming capitalism in vays lar moro raJical than Koynos onvisionoJ. Po-
call Schumpotor`s (1939, vol. 2, p. 613) olsorvation that linancial innovation
is ono ol tho most charactoristic loaturos ol tho linancial siJo ol capitalist
ovolution.. This is not moro tochniouo. This is part ol tho coro ol tho
capitalist procoss.` An attack on liouiJity anJ innovation is an attack on
tho coro ol tho capitalist procoss, vhich is vhy Koynos`s suggostions havo
loon so thoroughly roprossoJ ly mainstroam oconomics- raroly ovon
arguoJ vith, lut simply ignoroJ. Vany Koynosians soom mystilioJ ly this
apparont ovorsight, apparontly lolioving that iJoas locomo Jominant sim-
ply on thoir morits.
ln timos ol roaction, vhon Varxism is rogarJoJ as loyonJ tho palo ly
many ovon on tho lolt, Koynos has locomo a moro accoptallo moJol,
ospocially in thoso Jays ol linancial asconJancy. lov oconomists ol any
timo havo haJ as much to say alout tho linancial markots thomsolvos, or
thoir rolation to tho roal vorlJ. As AJorno saiJ ol lrouJ, liko all groat
lourgoois thinkors, ho lolt stanJing unJissolvoJ such contraJictions |thoso
ol lourgoois sociotyl anJ JisJainoJ tho assortion ol protonJoJ harmony
RENEGADES
215
vhoro tho thing itsoll vas contraJictory. Ho rovoaloJ tho antagonistic char-
actor ol tho social roality` (ouotoJ in Zizok 1994, p. 14).
15
Tho moro lor-
vont lits - liko tho call lor tho somovhat comprohonsivo socialization ol
invostmont` - ollor tho appoal ol raJicalism, lut in a calm, ologant lorm,
anJ in ono that may unsottlo, lut not shock, tho ruling orJor. Koynos vas
a vory soJuctivo vritor. But as Vichaol Porolman (1989, p. 1) put it in his
vory usolul look on Koynos, ho olton sounJoJ moro raJical than ho vas.`
Tako, lor oxamplo, tho concopt ol uncortainty,` vhich ho maJo a lot
ol, anJ his moro loyal moJorn lollovors troat as rovoaloJ truth. lt is an
accurato Joscription ol tho conJitions unJor vhich roal human loings,
not Grook lottors in a noat acaJomic moJol, mako roal Jocisions alout
invostmont anJ many othor aspocts ol lilo as voll. lt is a povorlul antiJoto
to tho cortaintios ol Chicago School oconomists. But it can only oxplain so
much. Post-Koynosians holJ that it is tho main oxplanation lor tho oxist-
onco ol monoy: il thoro voro no uncortainty, pooplo voulJ lo happy to
sottlo transactions in lOUs (lackoJ ly promisos), lut in an untrustvorthy
vorlJ, monoy (lackoJ ly tho stato) is ossontial to tho sottlomont ol Jolts.
16
Whilo this is not vithout truth, this lanalizos monoy, rolling it ol its lorco
as tho lunJamontal principlo ol social organization unJor capitalism.
But tho roal prolloms vith Koynos lio ultimatoly in tho navoto anJ
consorvatism lurking lohinJ his sophisticatoJ anJ iconoclastic stylo. Hav-
ing (ro)JiscovoroJ that ontropronours` (a vorJ ho anJ post-Koynosians
liko DaviJson prolor to tho moro loaJoJ capitalists`) aro in lusinoss to
mako monoy, anJ nothing olso, ho somohov concluJoJ that rontiors vill
consont to thoir outhanasia. Comparo this vain vish to a 150-yoar-olJ ol-
sorvation: ln EnglanJ thoro takos placo a stoaJy accumulation ol aJJi-
tional voalth, vhich has a tonJoncy ultimatoly to assumo tho lorm ol
monoy` (ouotoJ in Varx 1981, p. 543). A tonJoncy inJooJ: monoy, vhat-
ovor its oconomic rolo, is most Jolinitoly not noutral in its social rolo: tho
accumulation ol monoy is tho lonJost Josiro ol ovory gooJ capitalist citi-
zon. Koynos roalizoJ this vith ono hall ol his minJ, anJ thon vith tho
othor hall thought you coulJ tvoak this lunJamontal tonJoncy out ol ox-
istonco almost unnoticoJ. Having laiJ laro somo roal contraJictions, ho
spuriously proposoJ to rosolvo thom.
AnJ lurthor, having JiscovoroJ in tvo vays, thoso ol tho T:~uI::~ anJ
tho ~u~:uI TI~:), that capitalism Joos not tonJ ol its ovn accorJ to lull
omploymont anJ stalility, Koynos (1936, p. 39) thon JoclaroJ at tho onJ
ol tho ~u~:uI TI~:) that his goal vas not to ovorturn tho Vanchostor
systom,` lut moroly to lilorato its lull potontial.
WALL STREET
216
Tho complaint against tho prosont systom is not that thoso 9,000,000 mon
ought to lo omployoJ on Jilloront tasks, lut that tasks shoulJ lo availallo
lor tho romaining 1,000,000 mon. lt is in Jotormining tho volumo, not tho
Jiroction, ol actual invostmont that tho oxisting systom has lrokon Jovn.
Thus l agroo vith Gosoll that tho rosult ol lilling tho gaps in tho classical
thoory is not to Jisposo ol tho Vanchostor Systom,` lut to inJicato tho na-
turo ol tho onvironmont vhich tho lroo play ol oconomic lorcos roouiros il
it is to roalizo tho lull potontialitios ol proJuction.
Tho prollom ol capitalism lios not in tho oxploitation ol lalor, tho cro-
ation ol povorty amiJst plonty, tho aluso ol naturo, tho atomization ol
socioty, nor tho trivialization ol culturo, lut simply in its incomplotonoss
- that ono in ton aro JonioJ its lull Jolights. But givon lull liconso, Koynos
anJ his opigonos coulJ solvo that prollom. Too laJ tho capitalists havon`t
lot thom Jo it yot.
But thoy JiJ, in a sonso - not tho sonso in vhich Koynos moant it, anJ
post-Koynosians still moan it, lut in a sonso illuminatoJ ly Antonio Nogri
(1988). Horo`s hov Koynos (W XlV, pp. 112-122) JolinoJ uncortainty in
a 193 ossay that vas a rosponso to critics ol tho ~u~:uI TI~:).
By uncortain` knovloJgo, lot mo oxplain, l Jo not moan moroly to Jistin-
guish vhat is knovn lor cortain lrom vhat is only prolallo. Tho gamo ol
roulotto is not suljoct, in this sonso, to uncortainty: nor is tho prospoct ol a
victory lonJ loing Jravn.. Evon tho voathor is only moJoratoly uncor-
tain. Tho sonso in vhich l am using tho torm is that in vhich tho prospoct ol
a Europoan var is uncortain, or tho prico ol coppor anJ tho rato ol intorost
tvonty yoars honco, or tho olsolosconco ol a nov invontion, or tho posi-
tion ol privato voalth-ovnors in tho social systom in 190. Alout thoso
mattors thoro is no sciontilic lasis on vhich o lorm any calculallo prolalil-
ity vhatovor. Wo simply Jo not knov.
Tho oxamplos givon, notally tho last - tho position ol privato voalth-
ovnors in tho social systom in 190` - aro ol a voighty sort, tho kinJs ol
Joults that nag invostors in tho miJst ol crisos liko thoso ol tho 1930s. ln
tho lirst WorlJ, vo havon`t soon its liko in 60 yoars. Horo`s hov Nogri roaJ
Koynosian uncortainty anJ tho rolo ol tho stato:
lnvostmont risks must lo oliminatoJ, or roJucoJ to tho convontion, anJ tho
stato must tako on tho lunction ol guarantooing tho lasic convontion ol
oconomics. Tho stato has to JolonJ tho prosont lrom tho luturo. AnJ il tho
only vay to Jo this is to projoct tho luturo lrom vithin tho prosont, to plan
RENEGADES
217
tho luturo accorJing to prosont oxpoctations, thon tho stato must oxtonJ its
intorvontion to tako up tho rolo ol plannor, anJ tho oconomic thus locomos
incorporatoJ in tho juriJical.... |Tho statol vill not guarantoo tho cortainty ol
luturo ovonts, lut it vill guarantoo tho cortainty ol tho convontion.... ln
olloct, tho lilo ol tho systom no longor JoponJs on tho spirit ol
ontropronourialism, lut on liloration lrom tho loar ol tho luturo.
Tho rolo ol tho stato, thon, is to stalilizo oxpoctations - to guarantoo thoro
von`t lo Joprossions, anJ to guarantoo (insolar as anything can lo guar-
antooJ) tho position ol privato voalth-ovnors in tho systom. ln thoso sonsos,
lastarJ Koynosianism JiJ tho trick - ol, to paraphraso Claus Ollo, rogu-
lating tho systom politically vithout matorially politicizing it. Tho ostal-
lishmont took vhat it nooJoJ lrom Koynos anJ lolt tho rost.
posties
Though l`vo montionoJ post-Koynosian oconomics sovoral timos in this
chaptor, l`vo laroly lloshoJ out tho montions. But tvo mattors Josorvo
closor attontion - thoorios ol monotary onJogonoity, anJ tho vork ol
Hyman Vinsky. Both aro laroly acknovloJgoJ, much loss knovn, in tho
mainstroam.
ln convontional oconomics, ol loth tho monotarist anJ tho ocloctically
mainstroam variotios, tho monoy supply (not alvays procisoly JolinoJ) is
JotorminoJ lrom outsiJo` tho systom ol privato oxchango ly tho contral
lank: thoso aro oxogonous thoorios ol monoy. Tho loJ or any ol its sil-
lings arounJ tho vorlJ injocts monoy into tho systom, anJ lanks, houso-
holJs, anJ lirms Jo thoir lusinoss accorJingly. AJhoronts to onJogonous
thoorios ol monoy arguo instoaJ that tho monoy supply is a lunction ol tho
JomanJ lor croJit, vhich is itsoll a lunction ol tho lovol ol oconomic activ-
ity. Tho lanking systom, along vith tho contral lank, croatos as much
monoy as pooplo nooJ, though thoro aro Jisagroomonts on just hov olas-
tic this procoss is.
1
Polort Pollin (1991: 1993) usolully JiviJoJ tho tvo major schools ol
post-Koynosian onJogonists into tho accommoJativo anJ tho structural.
AccommoJativo onJogonoity holJs that tho contral lank has no choico
lut to valiJato privato croJit JomanJ ly proviJing vhatovor rosorvos tho
lanking systom nooJs to accommoJato tho loans that it has alroaJy maJo:
WALL STREET
218
that moans thoro is no olloctivo constraint on croJit. IoaJing propononts
ol this school incluJo Nicholas KalJor anJ Basil Vooro. Structural
onJogonoity - tho lranch that appoals to loth Pollin anJ mo - holJs
that contral lank attompts to constrain tho grovth ol croJit aro lroouontly
ovaJoJ through croativo linanco.
Vooro (1988a, p. 139), tho loaJing living accommoJationist, takos a
gooJ iJoa vay too lar, as ho JiJ in this surroal passago:
Tho procoss ol monotary accommoJation, tho valiJation ol monoy vago
incroasos vhich tho Jata rovoal, is mistakonly viovoJ, ly loth monotarists
anJ post-Koynosians aliko, as tho rosult ol a procoss ol ucI::~ policy intor-
vontion ly tho contral lank. Tho notion appoars to lo that tho monotary
authoritios koop thoir oyos locusoJ on tho stato ol tho oconomy in gonoral,
anJ on tho lovol ol unomploymont in particular.
lnstoaJ, Vooro arguos, tho contral lank passivoly valiJatos Jocisions maJo
ly privato croJitors.
ln lact, tho loJ scrutinizos tho roal oconomy closoly. Tako, lor oxamplo,
tho minutos ol tho Docomlor 22, 1992 mooting ol tho loJoral Opon Var-
kot Committoo (loJoral Opon Varkot Committoo 1993, p. 323)
Tho inlormation roviovoJ at this mooting suggostoJ that oconomic activity
vas rising approcially in tho lourth ouartor. Consumor sponJing, in asso-
ciation vith an apparont upturn in vago incomo anJ a surgo in conliJonco,
haJ improvoJ consiJorally: sizallo gains voro loing rogistoroJ in tho salos
anJ starts ol singlo-lamily homos: anJ lusinoss sponJing lor capital oouip-
mont romainoJ strong. Thoro also haJ loon soliJ aJvancos in inJustrial
output, anJ privato payroll omploymont haJ turnoJ up. Data on vagos anJ
pricos haJ loon slightly loss lavorallo rocontly |that is, vagos havo loon
rising, alvays a Jangor - D.H.l, anJ on lalanco thoy raisoJ tho possilility
that tho tronJ tovarJ lovor inllation might lo sloving a littlo.
Tho minutos vont on to roport JotailoJ olsorvations rogarJing omploy-
mont, tho avorago vorkvook, inJustrial proJuction, rotail salos, lusinoss
invosmont, construction, anJ tho traJo picturo. (To givo a moasuro ol hov
JotailoJ: salos ol hoavy trucks roso sharply, anJ lusinoss purchasos likoly
accountoJ lor somo ol tho rocont sizallo incroaso in salos ol light trucks:
on tho othor hanJ, shipmonts ol comploto aircralt voro voak.`) All this
Jiscussion ol tho roal oconomy procoJoJ Jiscussion ol linancial anJ mon-
otary allairs, anJ lar oxcooJoJ it in volumo as voll. Tho contral lank runs
a hugo oconomic Jata gonoration anJ analysis apparatus, vhich conli-
RENEGADES
219
Jontly soconJ-guossos ollicial statistics, anJ, a loJ oconomist onco tolJ
mo, lroouontly prompts corroctions that aro lurioJ in routino monthly ro-
visions in Commorco anJ Ialor Dopartmont Jata. Evory tvitch in tho sta-
tistics is notoJ anJ musoJ ovor to Joath.
AnJ thoso conclusions aro lasoJ on pullic roloasos ol tho loJ`s min-
utos. AccorJing to Drov Univorsity oconomist EJvin Dickons (porsonal
communication), vho`s roaJ tho lull transcripts - vhich aro roloasoJ only
20 yoars altor tho lact, anJ roaJ ly almost no ono - policymakors aro
oxcooJingly olsossoJ vith vago incroasos anJ tho stato ol lalor militancy.
Thoy`ro not only concornoJ vith tho stato ol tho macrooconomy, convon-
tionally JolinoJ, thoy`ro also concornoJ vith tho stato ol tho class strugglo,
to uso tho olJ-lashionoJ languago.
Whon things look too lullly lor tho loJ`s satislaction, it tightons policy,
ly lovoring its targots lor monoy supply grovth anJ raising its targot lor
tho loJ lunJs rato. ln Joing so, it hopos to slov Jovn tho oconomy, lut
thoro`s olton many a slip lotvoon tightoning anJ slovJovn. Tho roason
lor this gap vas oxploroJ noarly 40 yoars ago ly Hyman Vinsky (195) in
a classic papor moJostly titloJ Contral Bank anJ Vonoy Varkot Changos.`
Vinsky pointoJ to tvo innovations ol that rolativoly sloopy timo, tho loJ-
oral lunJs markot, vhich allovs aggrossivo lanks to transconJ tho limits
ol thoir ovn rosorvos ly lorroving lrom surplus lanks, anJ tho groving
prosonco ol nonlinancial corporations, oagor to mako monoy on sparo
cash, as proviJors as voll as usors ol croJit. Both voro rosponsos to rising
short-torm intorost ratos, vhich, as Vinsky vroto, pushoJ actors to linJ
nov vays to linanco oporations anJ nov sulstitutos lor cash assots.` Var-
kot innovations, Vinsky strossoJ, voulJ complicato tho vork ol contral
lankors, sinco tight policy coulJ lo partly ollsot vith nov instrumonts.
lnnovations, as Vinsky (195, p. 6) lator pointoJ out, allov capital assot
pricos to continuo rising (anJ oconomios to continuo oxpanJing) against
tho Jamponing inlluonco ol rising intorost ratos.
Ovor timo, vith tho proliloration ol linancial innovations, tho com-
pounJoJ changos vill rosult in an inhorontly unstallo monoy markot so
that a slight rovorsal ol prospority can triggor a linancial crisis,` vroto Vinsky
40 yoars ago. This voulJ roouiro an oxtonsion ol tho contral lank saloty
not to tho ontiro linancial matrix, not moroly tho commorcial lanks that
voro its logal chargos. lighting inllation might ontail a torrillo linancial
cost, anJ so tho loJ voulJ lo lorcoJ to orr on tho siJo ol inJulgonco
vhonovor tho croJit systom lookoJ rocky.
Porhaps Vinsky vas a littlo oarly - tho lirst linancial crisis ol tho post-
WALL STREET
220
1945 porioJ vas tho croJit crunch ol 1966 - lut ho JoscriloJ tho mocha-
nism porloctly: lirst tho rising inllation ol tho 1960s anJ 190s, lollovoJ
ly tho Volckor clampJovn, vhich vas liltoJ vhon it lookoJ liko Voxico`s
Jolault voulJ lring tho vorlJ lanking systom Jovn. But tho Volckor
clampJovn roouiroJ Jriving intorost ratos lar highor, anJ lor a longor po-
rioJ ol timo, than anyono voulJ havo oxpoctoJ, to shut tho oconomy
Jovn, so croativo aro tho innovators at ovaJing contral lank rostraints. ln
tho 1980s anJ 1990s, innovations proliloratoJ, as intorost ratos romainoJ
high ly historical stanJarJs (Jospito thoir Joclining tronJ). Capital vas
molilizoJ as it haJn`t loon in 60 yoars, as it locamo cloar that vhilo tho
poor coulJ oxpoct no inJulgonco lrom tho nov oconomic orJor, tho rontior
class, somo notorious laJ applos asiJo, coulJ count on a llank chock.
Ol courso, Vinskian innovations can`t ovaJo tho tightoning hanJ ol tho
contral lank lorovor. Porhaps tho most sonsillo viov ol tho vholo mattor
vas that oxprossoJ ly a contral lankor, Alan Holmos (1969, p. 3), thon a
sonior vico prosiJont at tho Nov \ork loJ, spoaking at a timo vhon tho
monotarist challongo vas marginal lut on tho riso: ln tho roal vorlJ, lanks
oxtonJ croJit, croating Joposits in tho procoss, anJ look lor tho rosorvos
lator. Tho ouostion thon locomos ono ol vhothor anJ hov tho loJoral
Posorvo vill accommoJato tho JomanJ lor rosorvos. ln tho vory short run,
tho loJoral Posorvo has littlo or no choico alout accommoJating that Jo-
manJ: ovor timo, its inlluonco can olviously lo lolt.` This is a rolroshing
antiJoto loth to tho mochanistic nostrums ol tho monotarists anJ to tho
vision ol limitloss olasticity ol tho oxtromo onJogonoists liko Vooro. Tho
loJ, liko all contral lanks, is mighty, lut it is not almighty.
Why Joos this mattor loyonJ tho vorlJ ol scholarship? ll tho onJog-
onous monoy thoorists aro right - anJ thoy aro - thon monoy anJ com-
morco aro insoparallo: noutrality is a lantasy. That has sovoral implications.
lt locatos tonJoncios tovarJs linancial instalility anJ crisis at tho hoart ol
tho systom, rathor than outsiJo it, as lrioJman anJ othor stato-llamors
voulJ havo it. lt makos convontional monotary policy moro Jillicult to
manago, sinco monoy` locomos a vory slippory thing. AnJ it makos raJi-
cal rolorms moro Jillicult than many populists voulJ liko, sinco policios
aimoJ at linanco aim at a moving targot, anJ ono not oasily soparallo lrom
proJuction, or lrom ovnorship.
Varx (193, p. 126: 1981, p. 64: soo also Jo Brunholl 196, pp. 80, 98)
anticipatoJ moJorn Koynosian onJogonists, arguing (against PicarJo anJ
tho classical ouantity thoorists) that tho ouantity ol monoy in circulation is
JotorminoJ ly oconomic activity, anJ not tho othor vay arounJ. Not tho
RENEGADES
221
loast ol tho roasons lor this inlluonco is that tho oxtonsion ol croJit is such
a short stop lrom simplo oxchango lor monoy: an lOU can lo oxchangoJ
lotvoon any agrooallo partnors, anJ it`s only a small mattor to lring in a
lank to lormalizo tho transaction. This vas truo ovon unJor a golJ stan-
JarJ: thoso spontanoous contracts mako tho lino lotvoon monoy anJ croJit
a porous ono, anJ that oxplains vhy tho moJorn monoy supply is so llox-
illo. Ol courso, in Varx`s viov, thoso oxtonsions ol croJit locomo vorth-
loss in a crisis, as ovoryono scramllos lor golJ: this kinJ ol crisis hasn`t
loon soon in this contury, as contral lanks havo loarnoJ hov to contain
crisis anJ mako short-torm govornmont papor soom as gooJ as golJ.
Ol all tho moJorn thoorists in tho Koynosian traJition, ono ol tho most
intorosting is Hyman Vinsky, vho JovotoJ his caroor to oxploring tho
rolations lotvoon linanco anJ tho roal vorlJ.
18
Wo`vo alroaJy lookoJ at
his contrilution to thoorios ol monotary onJogonoity: tho rost ol his vork
Josorvos a lov moro pagos.
lolloving tho loaJ ol Koynos`s T:~uI::~, vith its soparato inJustrial anJ
linancial sphoros, Vinsky JovolopoJ a tvo-sphoro thoory ol a moJorn
capitalist oconomy, ono ol curront output anJ ono lor capital assots, vhich
jointly Jotormino tho lovol ol oconomic activity. Expoctations alout tho
short torm Jotormino hov much ol oxisting capacity vill lo usoJ: oxpoc-
tations alout tho long torm Jotormino Jocisions alout vhothor to oxpanJ
capacity. Docisions ol tho lattor sort havo consoouoncos ovor timo: man-
agors vho mako laJ invostmonts, anJ ospocially thoso vho lorrov monoy
to mako thom, vill sullor lossos. ll such lossos aro sustainoJ anJ viJo-
sproaJ, tho systom lacos tho risk ol Jollationary collapso. This analysis is
lamiliar to a roaJor ol Koynos`s ~u~:uI TI~:), lut it got lost vhon Koynos
vas JomosticatoJ lor toxtlooks anJ politicians.
A sorious prollom vith Vinsky`s analysis, at loast vhon applioJ to tho
moJorn U.S. oconomy, is that rathor littlo roal invostmont is linancoJ ly
lorrovoJ monoy. So vhilo lorroving anJ invostmont Jocisions havo long-
torm consoouoncos, thoy`ro not simply tvo siJos ol tho samo coin. ln tho
U.S. anJ most othor lirst WorlJ oconomios, invostmonts aro ovorvholm-
ingly linancoJ intornally, through prolits. Corporato managors havo shovn
groat roluctanco in rocont yoars to commit thomsolvos to long-torm invost-
mont, lor loar ol loing stuck vith usoloss capacity in a rocossion: invost-
mont has incroasingly loon skovoJ to short-livoJ, ouick-payoll oouipmont.
But Juring tho 1980s, managors voro not shy alout lorroving: horo an-
WALL STREET
222
othor portion ol Vinsky`s analysis is illuminating. ln a taxonomy that can lo
applioJ to inJiviJual units, liko lirms or housoholJs, or vholo oconomios,
Vinsky (198: 1986, pp. 20-209) JiviJoJ linancial structuros into throo
typos, hoJgoJ, spoculativo, anJ Ponzi. A unit vith a hoJgoJ` structuro is
ono that can comlortally sorvico all its Jolts, intorost anJ principal, out ol
curront incomo: a spoculativo` unit can moot its intorost paymonts, lut
must raiso nov lunJs, oithor through tho salo ol assots or tho oxtonsion ol
nov loans, to pay oll principal: anJ a Ponzi` unit can`t mako its intorost
paymonts, much loss pay oll principal, vithout linJing lrosh cash.
19
Economios travorso tho hoJgo-spoculativo-Ponzi soouonco, until a laJ
linancial acciJont scaros playors into pruJonco, anJ tho cyclo starts ovor
again. ln rocont Amorican oxporionco, tho lato 1920s voro a timo vhon
tho lorJor vas crossoJ lrom spoculativo to Ponzi, until tho groat crash
anJ sulsoouont Doprossion lrought tho schomo to a Jisastrous onJ. That
lout maJo noarly ovoryono vory Jolt shy, anJ tho largoly oxcollont por-
lormanco ol tho U.S. oconomy in tho 30 yoars altor WorlJ War ll moant
that lirms anJ housoholJs haJ littlo nooJ lor outsiJo linanco. But, Vinsky
arguoJ, that kinJ ol GolJon Ago makos pooplo moro complacont, roJuc-
ing thoir loar ol inJoltoJnoss: stalility is Jostalilizing,` a lormulation
somotimos calloJ tho Vinsky paraJox. lor a vhilo, this nov impruJonco
luols a loom, lut vith lov signs ol gonoral linancial strain: inJiviJual
units, anJ tho vholo oconomy, cross lrom hoJgoJ to spoculativo linancial
structuros, as Jolts aro rolloJ ovor. Tho margin ol orror narrovs. Whilo
hoJgoJ linancial structuros aro vulnorallo to roal-vorlJ shocks - lirms
might laco nov compotition, or housoholJs laco a porioJ ol unomploy-
mont - thoy`ro largoly immuno to linancial Jisturlancos. But spoculativo
units aro not only moro vulnorallo to roal-vorlJ shocks, thoy`ro vulnor-
allo to linancial markot troullos as voll, sinco thoy nooJ nov croJits to
pay oll olJ principal. ll intorost ratos spiko upvarJs, or croJit gots harJ to
como ly, a spoculativo unit is in troullo.
Whilo it voulJ lo harJ to Jrav a lino historical lino, it sooms that tho
U.S. oconomy ontoroJ tho spoculativo roalm somotimo in tho 190s, as
linancial crisos locamo moro prominont loaturos ol tho lusinoss cyclo
(Wojnilovor 1980: Wollson 1986). But in ovory caso, tho loJoral Posorvo
stoppoJ in to provont tho linancial crisis lrom locoming gonoralizoJ: inJi-
viJual institutions might lo allovoJ to go unJor, lut tho authoritios voulJ
novor allov this localizoJ crisis to sproaJ into a lroaJ Jollationary col-
lapso. lurthor, Big Govornmont anJ its Jolicit sponJing put a lloor unJor
tho oconomy, provonting a truo cascaJo ol lailuro lrom Jovoloping. But
RENEGADES
223
valiJating throatonoJ linancial usagos,` in Vinsky`s (1986, p. 251) phraso,
only omlolJons playors lor lurthor aJvonturos in lovorago on tho noxt up
cyclo. AnJ so tho inJulgonco ol tho 190s laiJ tho grounJvork lor tho
ovon moro oxulorant 1980s, vhon tho U.S. oconomy unouostionally on-
toroJ a Ponzi phaso. Corporato takoovors voro lroouontly Jono vith tho
opon aJmission that tho Jolt coulJ novor lo comlortally sorvicoJ, anJ
that only vith assot salos or Jivino intorvontion coulJ lankruptcy lo
avoiJoJ. HousoholJs, too, ongagoJ in similar practicos, as lalloon mort-
gagos voro arrangoJ - that linal lalloon paymont coulJ only lo maJo ly
taking out anothor mortgago as tho lirst ono maturoJ.
What Joos Vinsky`s moJol say alout rocont history? Whilo tho slump
ol tho oarly 1990s vas cloarly tho rosult ol a Ponzi structuro going sour,
tho authoritios movoJ to contain tho crisis. Botvoon 1989 anJ oarly 1994,
tho loJ Jrovo Jovn intorost ratos harJ anJ kopt thom thoro. At tho samo
timo, tho U.S. govornmont lailoJ out tho savings anJ loan inJustry through
tho Posolution Trust Corp., sponJing $200 lillion in pullic lunJs. Thoso
movos kopt tho linancial systom lrom uttor collapso, lut unliko tho 1930s,
Jolts voro not vritton oll. Thanks to lovor intorost ratos, Jolts voro oasior
to sorvico, lut tho stock ol Jolt - principal - tolls a Jilloront story. Tho
lost vay to moasuro this is ly comparing tho lovol ol Jolts outstanJing
vith tho incomos that support thom. lor nonlinancial corporations, total
inJoltoJnoss in 1995 vas noarly 11 timos altor-tax prolits - an improvo-
mont lrom tho ovor 22 timos lovol ol 1986, lut still tvico tho lovols ol tho
1950s anJ 1960s. lor housoholJs, tho liguros shov no such improvomont:
in 1995, consumor Jolts voro ooual to 91/ ol altor-tax incomo, tho high-
ost lovol sinco tho loJ startoJ collocting such Jata in 1945, anJ voll alovo
1980s lovols, vhich voro thomsolvos voll alovo 190s lovols.
To uso Vinsky`s languago, tho lusinoss soctor sooms to havo sottloJ
lack lrom Ponzi to spoculativo, lut housoholJs continuo to oxploro lrosh
Ponzi torritory, vith no signs ol tomporanco. Ono mossago ol thoso num-
lors is that tho U.S. oconomy romains vory vulnorallo to highor intorost
ratos. At high onough short torm intorost ratos spoculativo units locomo
Ponzi units` (Vinsky 198), anJ Ponzi units oxploJo.
Vinsky omphasizoJ linancial lactors in causing instalility, vith tho roal
montionoJ almost as an altorthought. A moro lalancoJ intorprotation voulJ
say that linancial structuros aro contral to tho propagation ol a gonoral
oconomic crisis. Any shock to a highly lovoragoJ structuro - a lusinoss,
housoholJ, or national oconomy - makos it impossillo to sorvico Jolts
that soomoJ tolorallo vhon thoy voro contractoJ. lor a systom-viJo cri-
WALL STREET
224
sis, tho shocks aro gonorally ol a lroaJ sort - a normal lusinoss cyclo
rocossion, capital llight, or a political crisis. lor lorvarJ-thinking connois-
sours ol crisis, ono coulJ imagino somo ocological crisis causing crop lail-
uros or Jisastrous climato changos, vhich causo a spiko in pricos anJor a
collapso in output. PogarJloss ol tho causo, a hoJgoJ linancial structuro
might lo allo to copo vith such throats, lut a Ponzi coulJn`t.
money, mind, and matter: a psychocultural digression
Mu~) :: u :uu J j~I:)
- Wallaco Stovons
WI u::u: u c:~u:I ~I: Iu:c~ u: u:uu
- Turkish provorl
Ono virtuo ol Koynos`s attontion to psychology anJ sontimont is that it
urgos us to think alout oconomics in a vay that most oconomists linJ
souishy anJ unsciontilic. This narrovnoss ol vision has harmoJ tho Jis-
mal scionco immoasurally.
CroJit is monoy ol tho minJ, as Jamos Grant (1992) put it in a look titlo,
though ol courso ovory nov anJ thon montal monoy lacos an unploasant
coming to torms vith mattor. Still, in thoso Jays ol multilillion-Jollar lail-
outs, it sooms that minJ can sustain lantastic valuations lor lar longor than
ovor soomoJ imaginallo in tho past.
Wo coulJ Jato tho moJorn croJit culturo`s loginning to tho sovoranco
ol papor curroncios lrom golJ in tho oarly 190s. lt vaxoJ Juring tho 1983-
89 lingo, vanoJ Juring tho 1989-92 slump, anJ vaxoJ again starting in
1993. At its root, it`s lasoJ on tho assumption that a munilicont rivor ol
liouiJity vill llov lor all timo. Somoono vill alvays lo villing to tako an
ovorvaluoJ assot oll your hanJs tomorrov at a prico comlortally highor
than toJay`s. Tvo lamous axioms lrom apostlos ol croJit illustrato this
laith. ln tho lato 190s, Citilank chair Waltor Wriston, a promotor ol ThirJ
WorlJ lonJing, roluttoJ skoptics vith tho argumont that Countrios Jon`t
go lankrupt` (ouotoJ in Kuczynski 1988, p. 5). Tho 1980s` chiol
Joltmongor, tho junk lonJ supromo Vichaol Vilkon, usoJ to arguo in tho
Jays loloro his incarcoration that capital isn`t a scarco rosourco, capital is
alunJant - it`s vision that`s scarco (ouotoJ in Bruck 1988, p. 22).
This croJit culturo is a long vay lrom that JoscriloJ ly a 19th contury
Scottish lankor, G.V. Boll (ouotoJ in Varx 1981, p. 69), vho thought his
colloaguos to lo linor moralists than clorics:
RENEGADES
225
Banking ostallishmonts aro moral anJ roligious institutions. Hov olton has
tho loar ol loing soon ly tho vatchlul anJ roproving oyo ol his lankor
JotorroJ tho young traJosman lrom joining tho company ol riotous anJ
oxtravagant lrionJs.? Has ho not tromlloJ to lo supposoJ guilty ol Jocoit
or tho slightost misstatomont, lost it shoulJ givo riso to suspicion, anJ his
accommoJation lo in consoouonco rostrictoJ or JiscontinuoJ |ly his
lankorl?... AnJ has not that lrionJly aJvico loon ol moro valuo to him than
that ol priost?
Tho cult ol monoy,` vroto Varx (193, p. 232), has its ascoticism, its soll-
Jonial, its soll-sacrilico - oconomy anJ lrugality, contompt lor tho mun-
Jano, tomporal, anJ llooting ploasuros.. Honco tho connoction lotvoon
English Puritanism or also Dutch Protostantism, anJ monoy-making.` ln a
phraso Koynos also usoJ, it is uu:: :uc:u Juu~: - tho sacroJ hungor lor golJ.
This austority strikos moJorns, saturatoJ vith commoJitios, as ouaint
- though thoro`s nothing passo alout saJomonotarist aJjustmont pro-
grams. But thoro`s anothor sonso in vhich monoy anJ roligion travol to-
gothor - ospocially vhon monoy takos tho lorm ol a promiso rathor than
a harJ lorm ol sottlomont, that is, vhon monoy locomos croJit (lrom Iatin,
l loliovo`). A croJit agroomont is a prolossion ol laith ly loth partios:
short ol a svinJlo, loth partios loliovo tho Joltor vill lo allo to ropay tho
loan vith intorost. lt is a lot on tho luturo. This thoological sultloty is lost
on tho inlormation asymmotry thoorists, vho, ovon as thoy concoJo tho
possilility ol Jocoption, Jon`t allov Joparturos lrom rational soll-intorost.
lor most ol history, croJit`s Jroamior oxcossos voro limitoJ ly golJ, a
motal at onco soon as loth natural monoy` anJ puro onough to touch tho
loJy ol Christ. Varx (193, p. 2):
Tho monotary systom |i.o., golJ-lasoJl is ossontially Catholic, tho croJit sys-
tom ossontially Protostant.... |Tlho monotary oxistonco ol commoJitios has
a puroly social oxistonco. lt is Ju:II that lrings salvation. laith in monoy
valuo as tho immanont spirit ol commoJitios, laith in tho moJo ol proJuc-
tion anJ its proJostinoJ Jisposition, laith in tho inJiviJual agonts ol pro-
Juction as moro porsonilications ol soll-valorizing capital. But tho croJit
systom is no moro omancipatoJ lrom tho monotary systom as its lasis than
Protostantism is lrom tho lounJations ol Catholicism.
Vonoy conllatos tho sacroJ anJ prolano: it`s no acciJont that U.S. cur-
roncy conlossos that ln GoJ Wo Trust.`
This conllation ol high anJ lov, ol mattor anJ spirit, is onough to sonJ
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a stuJont ol monoy to lrouJ. By classical psychoanalysis, monoy is golJ,
anJ golJ is translormoJ shit, anJ oxchango rolations, sullimatoJ rituals ol
tho anus. Though this is ly nov a commonplaco, roaJors lounJ this a
rathor shocking thosis almost 90 yoars ago. lrouJ`s (1908) ossay on tho
anal charactor logan ly noting tho cooxistonco ol a trio ol loaturos in such
casos: orJorlinoss, olstinacy, anJ thrilt. lrouJ spoculatoJ that this unholy
trinity - hallmarks ol tho Victorian lourgoois - springs lrom an inlantilo
intorost in tho anus anJ its proJucts. OrJorlinoss, saiJ lrouJ, givos tho
improssion ol a roaction-lormation against an intorost in vhat is uncloan
anJ Jisturling anJ shoulJ not lo part ol tho loJy.` Olstinacy roprosonts
tho laly`s lingoring roluctanco to part vith stool on commanJ.
AnJ tho inlantilo roots ol thrilt aro porhaps tho most intorosting ol all.
lrouJ notoJ tho rich associations lotvoon monoy anJ Jirt lounJ in lolk-
loro anJ ovoryJay languago. ln English, thoro aro oxprossions liko stink-
ing rich` anJ lilthy lucro.` ln logonJs, tho golJ vhich tho Jovil givos his
paramours turns into oxcromont altor his Joparturo.. Wo also knov alout
tho suporstition vhich connocts tho linJing ol troasuro vith Jolaocation,
anJ ovoryono is lamiliar vith tho liguro ol tho shittor ol Jucats` |a Gorman
iJiom lor a voalthy sponJthrilt: vo havo our gooso vith its golJon oggs,
moro lortilo than local, lut omorging lrom a noighloring loJily rogionl.
lnJooJ, ovon accorJing to anciont Balylonian Joctrino golJ is tho laocos
ol holl.`` linally, lrouJ suggostoJ that it is possillo that tho contrast lo-
tvoon tho most procious sulstanco knovn to mon anJ tho most
vorthloss.has loJ to th|ol spocilic iJontilication ol golJ vith laocos.`
lrouJ`s oarly lollovors - notally Alraham, loronczi, anJ Jonos -
troJ tho anal path llazoJ ly tho mastor. Tho accumulation ol monoy is a
sullimatoJ urgo to rotain locos lor tho vory ploasuro ol it, anJ tho proJuc-
tion ol commoJitios is tho psychic Jorivativo ol tho oxpulsion ol locos.
Vonoy, in loronczi`s (196) marvolous phraso, is nothing othor than
oJourloss, JohyJratoJ lilth that has loon maJo to shino.`
20
Tho psychological oouivalonco ol Jirt anJ monoy is suggostoJ ly tho
lov social status ol lankors in promoJorn timos. Using nonlocal roason-
ing, philosophor ol monoy Goorg Simmol (198, p. 221) spoculatoJ that
tho importanco ol monoy as a moans, inJoponJont ol all spocilic onJs,
rosults in tho lact that monoy locomos tho contor ol intorost anJ tho propor
Jomain ol inJiviJuals anJ classos vho, locauso ol thoir social position,
aro oxcluJoJ lrom many kinJs ol porsonal anJ spocilic goals.` Among
Simmol`s oxamplos aro tho omancipatoJ Poman anJ Athonian slavos vho
locamo lankors, as JiJ Armonians in Turkoy: Voors in Spain: anJ Hu-
RENEGADES
227
guonots, Ouakors, anJ Jovs across Europo. PoaJing Simmol 80 yoars lator,
ono thinks hov tho social prostigo ol lanking incroasoJ along vith tho
Jovolopmont ol croJit, that is, vith its ovolving liloration lrom golJ.
Norman O. Brovn, not tho most lashionallo ol vritors, lounJ lrouJian
orthoJoxy vanting. Ho roturnoJ tho sacroJ to tho analysis ol monoy anJ
JomoanoJ loth ooually. lor Brovn (1985, p. 29), monoy anJ tho sacroJ
voro loth sullimatoJ proJucts ol a rovulsion lrom tho loJy. Such sulli-
mation, vhothor aimoJ at goJ or mammon, is tho Jonial ol lilo anJ tho
loJy.. Tho moro tho lilo ol tho loJy passos into things, tho loss lilo thoro
is in tho loJy, anJ at tho samo timo tho incroasing accumulation ol things
roprosonts an ovor lullor articulation ol tho lost lilo ol tho loJy.`
To Brovn, tho oxchango rolation is imluoJ vith guilt, anJ tho Joltor-
croJitor rolation vith saJomasochism. ln this, Brovn lollovoJ Niotzscho,
lor vhom all roligions aro systoms ol cruoltios` anJ lor vhom croJitors
onjoy a varrant lor anJ a titlo to cruolty` (Niotzscho 196, SoconJ Essay).
(VoJorn usago conlirms tho link ol Jolt vith loth saJomasochism anJ
tho sacroJ: lonJs` imposo conJitions knovn as covonants` on Jolt-
ors.) CroJitors in tho anciont vorlJ coulJ inllict ovory kinJ ol inJignity
anJ torturo upon tho loJy ol tho Joltor: lor oxamplo, cut lrom it as much
as soomoJ commonsurato vith tho sizo ol tho Jolt.` CroJitors can tako
ploasuro in loing allovoJ to vont |thoirl povor on ono vho is povorloss,
tho voluptuous ploasuro u~ Ju::~ I~ uuI ju: I~ jIu:::: u~ Iu Ju::~, tho
onjoymont ol violation.` Niotzscho might havo onjoyoJ thoso ploasuros.
lor Brovn, Jolt is a sickly triluto paiJ ly tho prosont to tho past. (Ol
courso, vo postmoJorns olton soo - consciously or not - croJit as a
vay to stoal lrom tho luturo.) But lor a partisan ol tho loJy, Brovn vas
nonotholoss guilty ol tho anciont psychoanalytic halit ol Jomatorializing
its nooJs. As tho oarly analyst Paul SchilJor (196) - vho rightly lamontoJ
tho alsonco ol a psychoanalysis ol vork - notoJ, Whon ono looks ovor
largo parts ol tho psychoanalytic litoraturo ono voulJ not concoivo tho
iJoa that ono oats locauso ono is hungry anJ vants looJ lor sustaining
ono`s lilo lut ono voulJ rathor supposo that oating is a sly vay ol satisly-
ing oral liliJo.. Silloror onco saiJ.|thatl accorJing to psychoanalytic
concoptions.tho Danulo.is moroly a projoction ol urino anJ lirthvator.`
Similarly, Brovn`s golJ is moro a lotishizoJ projoction ol intrapsychic
Jrama than an alionatoJ omloJimont ol social povor. His monoyoJ sul-
jocts lack class, raco, nationality, anJ sox. lor Varx, golJ vas valuallo lo-
causo it omloJioJ human lalor anJ sorvoJ as tho univorsal oxchango
oouivalont lor all othor commoJitios, vhoso valuo arisos lrom tho lalor that
WALL STREET
228
maJo thom. But tho naturo ol markot rolations - anonymous, mathomati-
cal - hiJos tho social naturo ol proJuction anJ oxchango lohinJ a voil ol
monoy. As psychoanalysis lacks a thoory ol vork, so Joos orthoJox Varx-
ism lack an unJorstanJing ol tho passions that sustain tho Jisguiso. With
croJit comos a sot ol passions ontiroly Jilloront lrom thoso ol golJ.
Vonoy, Brovn saiJ, is lut part ol tho commitmont to mathomatizo tho
vorlJ, intrinsic to moJorn scionco.` But moJorn scionco has mathomatizoJ
monoy. AsiJo lrom Joomsayors, survivalists, anJ othor golJlugs, tho
monotary lunctions ol JohyJratoJ lilth aro all lut lorgotton. Evon papor
monoy is gotting scarco - only alout 10/ ol tho lroaJly JolinoJ monoy
supply (V2). Vost monoy nov livos a ghostly oloctronic lilo.
With this Jomatorialization ol monoy has como at loast a partial lanish-
mont ol tho guilty saJomasochism ol tho anus. That lanishmont vas soon
at its lullost in tho 1980s, vhon lantasy ruloJ tho linancial scono: in tho
oarly 1990s, tho roprossoJ maJo a partial roturn, lut tho miJ-1990s sav a
rolapso ol oxuloranco. But tho psychological Jothronomont, hovovor com-
ploto or incomploto, ol anality anJ guilt has an intorosting analoguo in tho
cultural anJ social translormations that so troullo Amorican roactionarios.
Capitalism, having unJorminoJ tho authoritarian-patriarchal lamily, nov
proJucos lovor guilt-riJJon olsossivos anJ moro hungry narcissists than
it JiJ in tho Jays vhon golJ anJ JaJJy roignoJ as tho harsh taskmastors
lrom vhom thoro vas no appoal. Iiko tho narcissist, toJay`s consumor
sooms loss intorostoJ in tho accumulation ol possossions than in tho (nov-
olty-rich, croJit-linancoJ) act ol purchaso itsoll.
21
Pathor than tho guilty
olstinacy ol tho anus - or tho Puritan charactor iJontilioJ ly Vax Wolor
as tho spirit ol capitalism - ono Jotocts a moro primitivo, licklo, anJ otor-
nally JissatislioJ orality. ln contrast vith tho Jry, tight, lixoJ, masculino`
aura ol golJ, moJorn croJit monoy sooms protoan, liouiJ, anJ lominino.`
22
Unliko tho classic nourotic, vhoso conllicts contoroJ arounJ anxioty
anJ guilt ovor vhat voro soon as Jangorous or lorliJJon Josiros, tho
moJorn narcissist complains most alout a sonso ol omptinoss, ol Jiscon-
noctoJnoss, ol a lroo-lloating rago anJ anxioty attachoJ to nothing in par-
ticular. UnJor a suporlicially voll-lunctioning vonoor, tho upscalo narcissist,
in Jool Kovol`s (1980) vorJs, is unallo to allirm a unity ol projoct or
purposo, a common goal, vith othor pooplo in a vay that goos loyonJ
immoJiacy or instrumontality.`
AccorJing to Kovol, tho translormations ol Jomostic lilo that havo oc-
curroJ sinco tho capitalist inJustrial rovolution lirst gavo us tho authoritar-
ian-patriarchal-olsossivo porsonality typo, only to lo succooJoJ ly tho
RENEGADES
229
moJorn, or postmoJorn, narcissistic typo. Tho lroakup ol traJitional so-
cial arrangomonts that camo vith tho Jovolopmont ol tho capitalist lalor
markot moant that tho scalo ol social lilo oxpanJoJ - transportation anJ
communication making pooplo lar moro molilo anJ inlormoJ alout lilo
loyonJ thoir locality - anJ shrank, as tho nucloar lamily locamo tho
contral locus ol all non-vork lilo. ChilJhooJ` in tho sonso ol a protoctoJ,
privilogoJ phaso ol lilo vas invontoJ somotimo in tho 19th contury.
This chilJ-contoroJ, lathor-JominatoJ lilo locamo incroasingly pon-
otratoJ, Kovol arguoJ, ly tho stato, tho moJia, anJ tho incroasing povor
ol tho commoJity lorm. Tho lamily, in Kovol`s coinago, locamo Jo-sociatoJ.
Pooplo`s livos locamo incroasingly JotorminoJ ly institutions lar loyonJ
thoir immoJiato sphoro ol oxporionco. Docisions alout livos in Nov Jor-
soy aro olton maJo ly oxocutivos in Tokyo: alout livos in Brazil maJo in
Grosso Pointo anJ Vilan. Tho lamily has olloctivoly coasoJ to lo a larrior
against outsiJo ovonts, a havon in a hoartloss vorlJ.
A right-ving vorsion ol this analysis calls lor a roturn to tho patriarchal
lamily, vhich is impossillo anJ unJosirallo. But loaving asiJo tho issuos
ol tho politics ol tho housoholJ, vo havo to vonJor hov capitalism can
survivo this nov porsonality typo. On ono hanJ, tho systom, ospocially its
Amorican variant, JoponJs on croJit-linancoJ consumption to koop tho
vhools spinning, lut on tho othor, tho linancial systom can`t livo inJoli-
nitoly vith its consoouoncos. Policymakors can imposo saJomonotarism,
lut it`s not cloar that tho systom can loar it oithor oconomically or psycho-
politically ovor tho long torm. Tho attompt to ovaJo tho saJomonotarist
logic proJucos only a I:zzu:::u ol hollov prospority, spoculativo lulllos,
anJ an atmosphoro ol gonoralizoJ irrosponsilility. Tho attompt to con-
lorm to it provokos oconomic stagnation anJ corrosivo popular rosont-
mont. This is anothor vay ol looking at tho Vinsky paraJox.
Mar
As Jamos Crotty has saiJ, Koynosians havo historically omphasizoJ linanco
at tho oxponso ol proJuction, anJ Varxists proJuction at tho oxponso ol
linanco: many Varxists havo troatoJ proJuction as lunJamontal, anJ li-
nanco as opiphonomonal, a curious roplication ol orthoJoxy.
23
Whilo this
is a lasically accurato charactorization ol much ol tho Varxian traJition,
it`s not roally truo ol Varx himsoll. Though Varx`s vritings on linanco aro
mostly lragmontary anJ unJovolopoJ, thoy aro richly suggostivo, anJ it`s
cloar ho consiJoroJ it contral to his analysis.
24
WALL STREET
230
Ono ol tho roasons lor tho sorry stato ol Varxian thoorios ol linanco -
vith tho honorallo, though rocont oxcoption ol vritors liko Crotty, GoralJ
Epstoin, Polort litch, Duncan loloy, DaviJ Harvoy, Polort Pollin, anJ tho
oJitors ol MuIII) R~::~u - is tho shaJov cast ly PuJoll HillorJing anJ
his 1:uuuc~ uj:IuI Tho look contains somothing olsoloto, misloaJing,
or vrong on almost ovory pago, lrom minor ollonsos to major.
Sovoral oxamplos: HillorJing`s (1981, p. 13) claim that changos in in-
torost ratos can lo proJictoJ vith a high Jogroo ol prolalility` voulJ lo
volcomo novs to lonJ traJors, voro it truo.
25
Whilo tho rolation lotvoon
tho stock markot anJ roal activity is lar lrom simplo, it is propostorous to
arguo, as HillorJing JiJ, that proJuction is unalloctoJ ly changos in ovn-
orship (pp. 135, 141): tho V8A loom ol tho 1980s anJ 1990s has raJically
alloctoJ tho roal vorlJ. Ho mockoJ tho notion that intorost paymonts can
Jampon prolits, anJ thoroly invostmont, or that changos in intorost ratos
havo any signilicant olloct on tho lusinoss cyclo (pp. 286-28) - tvo
notions ontiroly rolutoJ ly moJorn oxporionco. Prolally his groatost mis-
tako, hovovor, vas his assortion that inJustry anJ linanco voro locoming
ono, tho proJuct ol this union loing tho linanco capital ol tho titlo, anJ
vith it cartols voulJ roplaco compotition anJ high tarills voulJ supor-
coJo lroo traJo. Tho English systom` - nov knovn as tho Anglo-Amori-
can systom ol stock-markot contoroJ capitalism - vas outmoJoJ` anJ
ovoryvhoro on tho Joclino` (p. 293): honcolorth, lanks voulJ control
tho commanJing hoights. Spoculation anJ linancial crisos voro rologatoJ
to tho past, part ol tho youthlul inJiscrotions ol a nov-maturo capitalism
(pp. 292, 294).
26
Ol courso it voulJ lo vrong to viov rocont history, vhich has soon tho
sproaJ ol tho Anglo-Amorican systom to tho ThirJ WorlJ, anJ tho unJoing
ol tho lank-contoroJ systoms ol Gormany anJ Japan, anJ say that tho
luturo lolongs to stock markots. Social analysts havo an unlortunato halit
ol projocting thoir ovn local anJ rocont oxporionco into tho univorsal lu-
turo. But history has not turnoJ out HillorJing`s vay, anJ thoro is no ovi-
Jonco right nov that timo is on his siJo. Tho rolations lotvoon linancial
capital anJ roal, lotvoon sharoholJors anJ managor, though groving ovor
closor, aro nonotholoss oxtromoly complicatoJ: it`s harJ to say anything
alout thom vithout vanting to say lut.` immoJiatoly altorvarJs.
HillorJing`s orrors voro moro than intolloctual - ho JiJ roal political
Jamago sorving as linanco ministor ol tho Social Domocratic govornmont
RENEGADES
231
in Gormany in 1923 anJ in 1928-29. lacoJ vith inllation in his lirst torm,
ho aJvocatoJ a roturn to golJ - orthoJox, lut porhaps unJorstanJallo, il
unimaginativo, in tho contoxt ol tho porioJ`s hyporinllation. His soconJ
torm coinciJoJ vith tho groat collapso, vhich Jrovo unomploymont lrom
/ to 30/ in a mattor ol throo yoars. As tho collapso unlolJoJ, HillorJing
again aJvocatoJ austority - luJgot cuts anJ tax incroasos, vhilo rosisting
all inllationary` schomos (Darity anJ Horn 1985). Whilo HillorJing olvi-
ously can`t lo llamoJ lor tho collapso, his loyalty to capitalist linancial
orthoJoxy - vhat Koynos JoriJoJ in Britain as tho Troasury viov` - is
inoxcusallo in a socialist, anJ lurthor prool that in practical mattors,
Varxians can lo as llinkoroJ as tho most austoro Chicagoan.
Sovoral aspocts ol Varx`s thoorizing on monoy anJ croJit aro vorth savor-
ing: tho insoparalility ol monoy anJ commorco, tho political naturo ol
monoy (anJ tho insoparalility ol markot anJ stato), anJ tho rolo ol croJit
in lroaking capital`s ovn larriors to accumulation.
Unliko mainstroam oconomics, vhich has a harJ timo joining thoorios
ol monoy to thoorios ol proJuction, tho tvo aro insoparallo in Varx. Pro-
Juction is alvays lor prolit, anJ oxchango is alvays lor monoy, anJ tho
oxistonco ol monoy prosupposos anJ omloJios tho vholo sot ol capitalist
social rolations. This is important not only in tho strictly oconomic` sonso
lut as is alvays tho caso in Varx, also tho lroaJly political sonso as voll.
Tho inJiviJual carrios his social povor, as voll as his lonJ vith socioty,
in his pockot` (Varx 193, p. 15). WorJs liko povor` anJ lonJ` aro not
soon in mainstroam oconomics toxts.
BohinJ tho illusions ol tho markot as a vory EJon ol tho innato rights
ol man.tho oxclusivo roalm ol lrooJom, Eouality, Proporty, anJ Bontham`
(Varx 19, p. 280) lio harshor roalitios. Vonoy, lar lrom loing tho noutral
lulricant ol classical thoory, or tho politically noutralizallo ono ol Koynosian
thoory, is lunJamontally alout compulsion anJ commanJ: capitalists vho
can`t turn thoir proJucts into cash go unJor (or in thoso moro inJulgont
Jays, lilo lor roorganization), anJ vorkors vho can`t turn thoir lalor into
cash vill starvo. As Nogri (1991, p. 23) saiJ in ono ol his loss opaouo
momonts, |Vlonoy has only ono laco, that ol tho loss.` Or as Vartin
Scorsoso put it, talking alout his movio u::u, Tho moro golJ, tho moro
llooJ. Tho moro you shov tho monoy, you havo to shov tho llooJ`
(Woinraul 1995).
2
What is truo lor Scorsoso anJ Nogri is raroly truo lor
orthoJox oconomics: it invonts moJols that hiJo tho llooJ anJ tho loss.
WALL STREET
232
ln this Jooply political rolo, as ono ol tho lunJamontal mochanisms ol
social organization unJor capitalism, monoy anJ croJit not only Jrivo com-
potition lotvoon capitals anJ lorco vorkors to vork or Jio, thoy also rogu-
lato tho allairs ol vholo govornmonts anJ countrios. Varx omphasizoJ
that Jospito tho lantasios ol lilortarians, vho Jroam ol statoloss monios
liko golJ, monoy has to lo guarantooJ ly a stato, anJ croJit suporvisoJ ly
ono. Vonoy is puroly convontional: thoro`s nothing intrinsically magic alout
golJ or loJoral Posorvo notos. Tho various lorms ol monoy aro valuallo
locauso pooplo agroo thoy aro, anJ somo lorcolul monopolist - a contral
lank anJ a national Troasury - has to lo tho ultimato guarantor ol agroo-
mont, or convontion voulJ Jissolvo.
28
CroJit, too, is an important lorm ol social coorcion: mortgagoJ vorkors
aro moro pliallo - loss likoly to striko or mako political troullo. AnJ thoy
nooJ monoy to livo: noarly ovoryono lolov tho uppor miJJlo class is just
a lov paychocks lrom insolvoncy. Any stato-sponsoroJ action that lossons
tho sting ol starvation`s Jisciplino - unomploymont insuranco, minimum
vagos, omploymont guarantoos - is possillo only vhon tho vorking class
is strong, anJ in turn strongthons tho class politically: capital passionatoly
vants to maximizo tho nakoJ rulo ol monoy. Evon a tight lalor markot is a
throat to Jisciplino, vhich is vhy inJustrialists as voll as lankors vorry
vhon tho unomploymont rato gots too lov. Somo loyal Koynosians, ovon
altor having livoJ through tho last 20 yoars, in vhich tho rulo ol monoy
has loon sharponoJ, still roluso to concoJo thoso points.
Just locauso proJuction anJ monoy can`t oasily lo soparatoJ Joosn`t moan
thoy`ro iJontical. ln lact, Varx anticipatoJ Koynos in sooing tho soparation
ol proJuction anJ salo as tho root ol possillo crisis - anJ in troating this
as an oxplicit rojoction ol Say`s lav. Vonoy lrings in timo anJ tho possilil-
ity ol hoarJing: timo, locauso a gooJ is usually solJ somo timo altor it is
maJo, running tho risk that its salo prico coulJ lall lolov tho cost ol its
proJuction, viping out tho capitalist`s oxpoctoJ prolit, anJ hoarJing lo-
causo incomo nooJ not lo spont lut may moroly lo kopt iJlo, sinco monoy
is a uniouoly imporishallo commoJity` (Varx 193, pp. 149, 198-200).
Puro papor anJ lank monoy JiJ porish in 19th contury crisos, so lor
Varx tho most imporishallo lorm ol monoy vas golJ. ln a normal, moJ-
orn crisis, tho llight to monoy is usually to Troasury lills: lut ovon in moJ-
orn crisos, golJ, riJiculoJ ly Koynos as a larlarous rolic,` usually rogains
its charms. ln tho ThirJ WorlJ, a panic can tako tho lorm ol a llight lrom
RENEGADES
233
tho Jomostic curroncy, not into golJ, lut into U.S. Jollars. Economios vith
curroncios in collapso olton havo a vholo soconJ sot ol Jollar pricos, though
it`s usually tho allluont vho havo accoss to groonlacks.
Tho prociso moaning ol a cash hoarJ is not as cloar as it might soom.
lor Koynos, capital kopt as monoy rathor than loing put into long-torm
instrumonts liko stocks anJ lonJs vas hoarJoJ. But most moJorns hoarJ
ly parking thoir monoy in somo short-torm instrumont liko a monoy mar-
kot lunJ or Troasury lills. Thoroloro, vhat tho hoarJor moans not to sponJ
still linJs its vay into tho linancial circulation, vhich may onJ up lunJing
GV`s vorking capital or tho Pontagon`s purchaso ol inlraroJ linoculars.
Convorsoly, monoy spont luying stocks or lonJs almost oxclusivoly goos
to tho provious holJors rathor than thoir issuing lirms. Cloarly, though, tho
moro monoy that ontors tho linancial circulation, tho loss is spont on ac-
tual gooJs, thoroly incroasing tho risk ol commoJitios going unsolJ.
Thoso complications asiJo, a roluctanco on tho part ol luyors to part
vith thoir lunJs can lring alout a contraction in an oconomy, anJ it`s tho
oxistonco ol monoy (anJ JovolopoJ linancial markots) that makos it pos-
sillo lor playors to rotiro oasily anJ saloly lrom gooJs markots.
Just as monoy can`t lo soparatoJ lrom proJuction or oxchango, noithor
can croJit lo lully sovoroJ lrom tho roal` oconomy, appoarancos ol thoir
inJoponJonco to tho contrary. A rociprocal olloct takos placo horo. Tho
Jovolopmont ol tho proJuction procoss oxpanJs croJit, vhilo croJit in
turn loaJs to an oxpansion ol inJustrial anJ commorcial oporations` (Varx
1981, p. 612). This is truo in sovoral sonsos: lusinossos lorrov to linanco
capital oxponJituros or luy othor companios: lusinossos lorrov to luy
rav matorials anJ parts: lusinossos oxtonJ croJit to thoir customors (traJo
croJit): anJ inJiviJuals lorrov to luy consumption gooJs. All thoso lorms
ol croJit strotch tho limits ol loth proJuction anJ consumption loyonJ
vhat curront incomos alono coulJ havo managoJ.
BosiJos thoso nooJs lrom tho lorroving siJo, thoro is also tho nooJ ol
capitalists anJ rontiors to Joploy thoir monoy prolitally: thoso surplusos, vhich
omorgo lrom proJuction, Jrivo tho supply ol croJit. Tho croJit systom makos
all lorms ol capital lungillo: it lulricatos tho transition ol ovory lorm ol voalth
into its most vonJorlully liouiJ lorm, monoy - tho matorial roprosontativo
ol gonoral voalth` (Varx 193, p. 233) - anJ makos it possillo lor monoy,
storilo in itsoll, to lo translormoJ into prolit-sooking capital. lrom this point
ol viov, loth siJos ol tho argumont lotvoon nooclassicals anJ Koynosians
alout vhothor savings procoJos invostmont or vico vorsa soom rociprocally
incomploto: tho tvo activitios JoponJ on oach othor.
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234
Varxists anJ othor thoorists ol unJorconsumption havo long pointoJ
to tho limitoJ luying povor ol tho massos as a porpotual llav ol capital-
ism. Tho ultimato roason lor all roal crisos alvays romains tho povorty
anJ rostrictoJ consumption ol tho massos, in tho laco ol tho Jrivo ol capi-
talist proJuction to Jovolop tho proJuctivo lorcos as il only tho alsoluto
consumption capacity ol socioty sot a limit to thom` (Varx 193, p. 615).
Though it`s not olton thoorizoJ as such, consumor croJit can lo thought
ol as a moJorn instanco ol croJit`s assistanco to capital in lroaking tho
larriors to its oxpansion. Whoro Varx (193, p. 613) saiJ that croJit to
proJucors strotchos thoir capacity irrospoctivo ol tho limits ol consump-
tion,` consumor croJit strotchos tho limits ol consumption - anJ pro-
viJos lonJors vith yot anothor chanco to oarn intorost on cash that might
othorviso havo gono iJlo.
CroJit Joos this mighty vork ol limit-strotching ly pushing lirms anJ
housoholJs into lunJamontally unsustainallo positions - translorming
thom into Ponzi units, in Vinsky`s taxonomy. At somo point, a shock to
tho systom makos Jolts unsorvicoallo, anJ thon, as thoy say on Wall Stroot,
it`s rovoaloJ that lovorago is as povorlul on tho JovnsiJo as it is on tho
upsiJo. Whilo it`s improciso to say that croJit causos` such a crisis - tho
shock` is usually somo intorruption ol incomos lor tho inJoltoJ units -
tho croJit systom is at tho contor ol any crisis` onsot anJ propagation. ln
tho 19th contury anJ into tho oarly 20th, crisos voro typically markoJ ly
panics` - linancial crashos that motastasizoJ throughout tho oconomy,
loaJing to oxtonJoJ Joprossions. Tho most rocont, anJ ouito possilly li-
nal, oxamplo ol this vas tho 1929 stock markot crash, vhich markoJ tho
oponing ol capitalism`s groatost crisis, tho Groat Doprossion. Popular ox-
planations somotimos namo tho crash as tho causo` ol tho Doprossion,
vhilo allogoJly moro sophisticatoJ oxplanations Jony tho rolation. But
tho crash is lost soon as tho oponing movomont ol tho lroaJor crisis -
tho unravoling ol a monstrously lovoragoJ linancial structuro. CroJit haJ
sorvoJ to push stocks to unsustainally high lovols: it haJ also allovoJ
proJuction to oxpanJ capacity loyonJ tho limits ol consumption. Tho
crash oxposoJ thoso limits, announcoJ tho unsustainalility ol promisos to
pay, anJ ronJoroJ invostmonts unprolitallo anJ Jolts unsorvicoallo. A
lishor Jollation vas unJorvay.
Ol courso, vo Jon`t havo lishor Jollations toJay: vo havo oxponsivo
lailouts, anJ not just in tho U.S. Actually, tho rocont U.S. lank anJ S8I
lailouts voro rathor moJost in comparison to Jisastors olsovhoro. Esti-
matos aro that tho comlinoJ lossos anJ roscuo costs in tho U.S. Jisastor
RENEGADES
235
voro alout 3/ ol a yoar`s GDP - comparoJ vith 4/ lor Norvay`s lank
crisis, 6/ lor SvoJon`s, 8/ lor linlanJ`s (all lrom tho lato 1980s anJ oarly
1990s), anJ, tho vorlJ champion, 1/ lor Spain`s (vhich ran lrom 19 to
1985). Altogothor, alout tvo-thirJs ol lVl momlor countrios oxporioncoJ
somo sort ol croJit Jisastor lotvoon 1980 anJ 1996. Such Jisastors may
havo loon succosslully containoJ, lut that Joosn`t moan thoy`ro insignili-
cant or raro. ln lact, somo analysts arguo that tho lanking Jisastors ol tho
last ouartor-contury aro historically unprocoJontoJ in loth lroouoncy anJ
sizo (GolJstoin anJ Turnor 1996).
Thoro is an important oxcoption to tho rulo that gonoralizoJ collapsos
no longor happon. As Ponny Ciancanolli (1992) nicoly put it, Juring tho
Jolt crisis ol tho 1980s tho lirst WorlJ lanks got a Vinsky lailout vhilo
tho ThirJ WorlJ sulloroJ a lishor Jollation. Domostic lanking crisos in
ThirJ WorlJ countrios ovor tho last JocaJo or tvo havo loon lar moro
intonso than in tho lirst, vith lossos ranging lrom 10/ to 25/ ol GDP.
Thoso countrios, hovovor, voro unallo to mount tho kinJs ol roscuo op-
orations soon in tho North, anJ thoir oconomios havo, in many casos, sul-
loroJ Joprossions, sparkoJ anJ propagatoJ in tho classic lishor mannor.
But tho oxporionco ol succosslul lirst WorlJ lailouts shovs that Varx
(1981, p. 621) laJly unJorostimatoJ tho povor ol tho stato vhon ho saiJ
that crisos coulJ not lo avoiJoJ ly alloving ono lank, o.g. tho Bank ol
EnglanJ, to givo all tho svinJlors tho capital thoy lack in papor monoy
anJ to luy all tho JoprociatoJ commoJitios at thoir olJ nominal valuos.`
Contral lanks anJ govornmonts nooJ not go that lar: pruJontial suporvi-
sion (lorgotton in tho 1980s, lut moro or loss romomloroJ in tho 1990s,
vith tho occasional oxcoption) anJ multilillion Jollar roscuo packagos
havo Jono thoir vork.
Still, croJit has maJo it possillo lor oxpansions to oxcooJ vhat voulJ
othorviso havo loon thoir natural limits, anJ tho throat ol crisis aroso vhon
thoso limits locamo cloar. Tho S8I Jisastor riponoJ (loaving asiJo tho puro
svinJling, tho yacht partios vith thoir cocaino anJ call girls, tho thrilt prosi-
Jonts stoaling monoy to oxpanJ thoir porsonal art colloctions, otc.) vhon
it locamo cloar that tho shopping contors anJ conJos that voro luilt on its
linos ol croJit provoJ oconomically pointloss: tho junk lonJ crisis rip-
onoJ vhon tho corporato luyouts anJ rostructuring that junk originally
linancoJ voro rovoaloJ as tho Ponzi units thoy voro. Vonoy ol tho minJ
haJ an uncomlortallo collision vith mattor. But thanks to tho Posolution
Trust Corp. anJ Alan Groonspan, thoso crisos novor locamo gonoralizoJ,
unliko thoir ancostors 60 yoars oarlior. No ono can proclaim that it vill
WALL STREET
236
vork this vay lorovor, lut so lar, this has to lo countoJ a major innova-
tion in tho stato managomont ol capitalism. lt may lo that tho slov rot that
has charactorizoJ tho U.S. oconomy ovor tho last 25 yoars - lov lovols ol
invostmont anJ proJuctivity grovth anJ tho Joclino in roal vagos - is
tho systom`s sultlo rovongo on its political saviors. But it voulJ lo vrong,
at loast ly Varx`s lights, to call that rot a crisis, sinco pormanont crisos Jo
not oxist` (Varx 1968, p. 49).
What aro vo to mako socially anJ politically ol tho lacts that tho linancial
markots havo so marginal a rolo in guiJing proJuction in aJvancoJ ocono-
mios, anJ that tho stock markot`s inlluonco on roal invostmont is thank-
lully minimal? lt`s that rontiors sorvo littlo social rolo loyonJ thoir ovn
onrichmont. As Varx (1963, p. 212) saiJ, rontiors, liko paupors, livo only
on tho rovonuo ol tho country: lrom an oconomic point ol viov thoy aro
ooually unproJuctivo: rontiors aro simply rospoctallo paupors.`
29
Varx (1981, pp. 483-484) also ouotoJ Pamsay approvingly as saying
that as a country gots richor it proJucos rontiors, anJ in olJ anJ rich coun-
trios, tho amount ol national capital lolonging to thoso vho aro unvilling
to tako tho troullo ol omploying it thomsolvos, loars a largor proportion
to tho vholo proJuctivo stock ol socioty, than in novly sottloJ anJ pooror
Jistricts.` Varx thought this groving accrotion ol rontior voalth voulJ
Jopross intorost ratos ovor tho long torm, lut this sooms not to lo tho caso.
But it has como to Jominato tho capitalist vorlJ-picturo. Vonoy, tho
goJ among commoJitios,` locomos II~ principal oljoct ol grooJ - grooJ
in its most gonoral lorm, lor voalth itsoll, rathor than moro spocilic olsos-
sions, lor clothos, voapons, jovols, vomon, vino, otc.`
30
Cortainly 19th
contury magnatos lovoJ thoir monoy, lut thoy also took priJo in tho physi-
cal capital thoy ovnoJ - stool mills anJ transcontinontal railroaJs. Such
olsossions nov soom ouaint: moJorn tycoons lovo thoir portlolios most
ol all. lntorost-loaring capital, Varx (191, pp. 454-539) vroto, is tho most
lotishistic lorm ol all, capital ju: ~.c~II~uc~, vith prolit (intorost) appoar-
ing vith no moro than tho moro passago ol timo, vith no apparont on-
gagomont vith proJuction: monoy-loaring locomos charactoristic ol
capital just as grovth is charactoristic ol troos.`
Whilo this progrossion lrom inJustrial to rontior Jominanco sooms to
provail on tho glolal lovol, it`s ospocially visillo vhon ono looks at tho
history ol inJiviJual countrios anJ tho movomont ol capitalism`s contor ol
gravity: lrom tho NothorlanJs to Britain to tho U.S. anJ tovarJs Asia. Tho
RENEGADES
237
spooJ ol this ovolution sooms to havo accoloratoJ, vith Japan ovolving
lrom mastor inJustrialist to rontior nation in littlo moro than a gonoration.
ln highor rontior consciousnoss, proJuction Jisappoars lrom viov. This
is apparont not only in ruling-class thinking, lut ovon among its supposoJ
critics. Vany postmoJorn cultural thoorists, lor vhom class is an olsoloto
concopt lolt ovor lrom vhon proJuction mattoroJ most, soo tho vorlJ as
ono ol iJontitios anJ Josiros lormoJ anJ oxprossoJ in tho sphoro ol con-
sumption. Capital,` complainoJ AnJrov Poss (1988, ouotoJ in Havkos,
1996, p. 8), or rathor our imaginary ol Capital, still lolongs lor tho most
part to a Jomonology ol tho Othor. This is a Jomonology that inhilits
unJorstanJing anJ action as much as it artilicially koops alivo olJor lorms
ol :~::~uI:u~uI that havo littlo or no purchaso on postmoJorn consumor
socioty.`
31
Capital locomos lictivo, a proJuct ol imagination rathor than a
roal social rolation: all antagonism Jisappoars, anJ monoy locomos not a
lorm ol coorcion, lut a roalm ol Josiro, ovon ol lrooJom. This is
unsurprising coming lrom capital`s houso intolloctuals, lut it sooms to in-
loct ovon its oppononts. lorms moant to Jissominato thoso mystilying tomp-
tations - tho moJia, aJvortising, PP - locomo tho principal oljocts ol
stuJy in thomsolvos, ovorshaJoving rolations ol proporty anJ povor.
lmmatoriality simplilios tho vork ol apologists, as it complicatos that ol
critics. lntorost-loaring capital is a goJsonJ` to lourgoois oconomists,
vho yoarn to roprosont capital as an inJoponJont sourco ol valuo in pro-
Juction - vhich thoroloro ~u:u: its prolit just as vorkors oarn thoir vagos.
lntorost, ospocially in its compounJoJ lorm, appoars as a Voloch Jo-
manJing tho vholo vorlJ as a sacrilico lolonging to it ol right, vhoso
logitimato JomanJs, arising lrom its vory naturo, aro hovovor novor mot
anJ aro alvays lrustratoJ ly a mystorious lato` (Varx 191, p. 456). But
rolormors vho aim to translorm or alolish croJit vithout touching upon
roal capitalist proJuction |arol moroly attacking ono ol its consoouoncos.`
lntorost-loaring capital is a Jistillation ol capital as a social lorm, not somo
phonomonon alovo or apart lrom it. Thoroloro, alolishing intorost anJ
intorost-loaring capital, Varx (191, p. 42) arguoJ, moans tho alolition
ol capital anJ ol capitalist proJuction itsoll.`
Capitalism vithout intorost may lo impossillo, lut croJit anJ intorost
proJatoJ capitalism: usury, anJ prohilitions against it, aro anciont. Usury
camo to Jominato tho louJal orJor, llooJing it ol voalth anJ hastoning its
Jomiso, lut unJor capitalism, Varx (191, p. 531) arguoJ, croJit is sulor-
JinatoJ to proJuction. That looks loss truo nov: tho nooJs ol monoy soom
incroasingly to tako procoJonco ovor thoso ol proJuction. This is soon
WALL STREET
238
most visilly in tho shilt ol policy-making in tho rich countrios lrom tho
stimulation ol grovth to its supprossion in tho namo ol holJing Jovn
inllation. lnstoaJ ol acting as a stimulus to proJuction, tho croJit systom
- tho prosorvation ol papor valuos - looks incroasingly liko a larrior.
lt voulJ lo vrong, though, to attriluto this just to a mooJ sving among
tho policy-making class. As oconomios maturo, rontior voalth accumu-
latos: lamily ontorprisos locomo pullic companios, anJ lortunos locomo
sovoroJ lrom thoir roots. On tho capital markots:
All particular lorms ol capital, arising lrom its invostmont in particular sphoros
ol proJuction or circulation, aro ollitoratoJ.. lt oxists in tho unJilloronti-
atoJ, soll-iJontical lorm ol inJoponJont valuo, ol monoy.. Horo capital
roally Joos omorgo, in tho prossuro ol its JomanJ anJ supply, as II~ cu-
uu cuj:IuI J II~ cIu::. |lt appoarsl as a concontratoJ anJ organizoJ
mass, placoJ unJor tho control ol tho lankors as roprosontativos ol tho
social capital in a ouito Jilloront mannor to roal proJuction (Varx 1981, pp.
490-491: omphasis in original).
Tho moJorn ovning class is lormoJ in largo part through tho croation anJ
traJing ol stanJarJizoJ claims on tho voalth anJ lalor ol othors.
What Jo such ovnors contriluto? ln vhat Varx knov as a joint-stock
company, anJ vo knov as tho moJorn largo corporation, not much. Un-
liko classical capitalists, vho ran tho oporation anJ thus oarnoJ somo-
thing liko a vago ol suporintonJonco along vith a sharo ol tho prolits,
toJay`s managors aro paiJ a (high) vago ol suporintonJonco, vhilo tho
prolits go mainly to outsiJors. Ol courso that high managorial vago, ovon
il it takos tho lorm ol a paychock, still has to lo consiJoroJ mainly a sharo
ol prolits. But tho lion`s sharo goos to outsiJo stockholJors anJ croJitors.
lt`s tompting to lomoan this rolation as parasitical, vhich it is, lut that`s
not all. Tho social lorm ol capital Jovolvos on intorost, lut oxprossoJ in a
noutral or inJilloront lorm: tho oconomic lunction ol capital Jovolvos on
prolit ol ontorpriso, lut vith tho spocilically capitalist charactor ol this
lunction romovoJ` (Varx 1981, pp. 506-50). That is, rontiors rocoivo thoir
sharo ol prolits in vhat lools liko intorost, ovon il thoir litoral lorm is Jivi-
JonJs vith littlo traco ol its origins (sinco JiviJonJs appoar as tho roturn
that capital oarns simply vith tho passago ol timo), anJ tho managors run
lirms as prolossional suporvisors - as vorkors (ovon il moro royally paiJ
than in Varx`s Jay) rathor than ovnors.
32
Tho classic 19th contury apology
lor capital, vhich holJ prolit to lo tho vagos ol suporintonJonco, has
long loon unJorminoJ. ln tho lato 20th contury, tho social rolo ol lunc-
tionloss ovnors is raroly invostigatoJ, lut thoir caso is harJly compolling.
RENEGADES
239
VoJorn lossos u:~ paiJ monstrous salarios: ono stuJy, ly Poarl Voyor
8 Partnors lnc., lounJ that CEOs ol lig lirms oarnoJ 212 timos vhat tho
avorago U.S. vorkor JiJ in 1995, comparoJ vith a moro 44 timos in 1965
(Dull 1996). But thoir rolo as managors Joosn`t roouiro thoso vast sums:
thoy`ro paiJ that voll just locauso thoy can got avay vith it. AnJ vith tho
grovth ol prolossional managors vorking lor Jistant sharoholJors, tho
capitalist vanishos lrom tho proJuction procoss as somoono suporlluous.`
Cooporativos shov, Varx saiJ, that vorkors coulJ hiro managors as oasily
as Jo tho ovnors ol capital (Varx 1981, pp. 511-512).
Tho grovth ol croJit allovoJ ontropronours vith no capital, vhothor
skilloJ, unskilloJ, or lolonious, to uso tho capital ol othors. Provisioning
DonalJ Trump, vhoso not vorth vas holJ togothor in tho 1980s in part ly
slick, pullicist-gonoratoJ magazino articlos alout hov rich anJ succosslul
ho vas, Varx vroto: Tho actual capital that somoono possossos, or is
takon to possoss ly pullic opinion, nov locomos simply tho lasis lor a
suporstructuro ol croJit.` Provisioning moJorn ponsion lunJ managors,
vho appropriato vorkors` savings anJ run thom largoly in thoir ovn intor-
ost, paying thomsolvos granJly in tho procoss, ho vroto: What tho spocu-
lating traJor risks is social proporty, not his ovn. Eoually alsurJ nov is
tho saying that tho origin ol capital is saving, sinco vhat this spoculator
JomanJs is procisoly that II~:: shoulJ savo lor him` (Varx 1981, p. 50).
Tho chain ol JisplacoJ rosponsililitios that charactorizo moJorn cor-
porato capitalism, Varx arguoJ, vas ossontial loth to its Jovolopmont anJ
tho Jovolopmont ol lottor possililitios.
But vithin tho capitalist systom itsoll, this oxpropriation takos tho antithoti-
cal lorm ol tho appropriation ol social proporty ly a lov: anJ croJit givos
thoso lov ovor moro tho charactor ol simplo aJvonturors. Sinco ovnorship
nov oxists in tho lorm ol sharos, its movomont anJ translor locomo simply
tho rosult ol stock-oxchango Joalings, vhoro littlo lishos aro gollloJ up ly
tho sharks, anJ shoop ly tho stock-oxchango volvos. ln tho joint-stock sys-
tom, thoro is alroaJy a conllict vith tho olJ lorm, in vhich tho moans ol
social proJuction appoar as inJiviJual proporty. But tho translormation into
tho lorm ol sharos still romains trappoJ vithin tho capitalist larriors: in-
stoaJ ol ovorcoming tho opposition lotvoon tho charactor ol voalth as
somothing social, anJ privato voalth, this translormation only Jovolops this
opposition in a nov lorm.. Without tho lactory systom that arisos lrom tho
capitalist moJo ol proJuction, cooporativo lactorios coulJ not Jovolop. Nor
coulJ thoy Jo so vithout tho croJit systom that Jovolops lrom tho samo
WALL STREET
240
moJo ol proJuction. This croJit systom, sinco it lorms tho principal lasis
lor tho graJual translormation ol capitalist privato ontorprisos into capitalist
joint-stock companios, prosonts in tho samo vay tho moans lor tho graJual
oxtonsion ol cooporativo ontorprisos on a moro or loss national scalo. Capi-
talist joint-stock companios as much as cooporativo lactorios shoulJ lo
viovoJ as transition lorms lrom tho capitalist moJo ol proJuction to tho
associatoJ ono, simply that in tho ono caso tho opposition is alolishoJ in a
nogativo vay, anJ in tho othor in a positivo vay (Varx 1981, pp. 51-52)
At tho loginning ol this oxcorpt, Varx soomoJ to lo vriting alout tho
lormation ol moJorn corporations in tho miJ-19th contury, a timo ol Pol-
lor Barons, scam artists, anJ linancial panics - a procoss loing ropoatoJ
toJay in tho so-calloJ omorging markots ol tho ThirJ WorlJ. ln tho lirst
WorlJ, things aro a lit moro rogularizoJ nov. But Varx`s ossontial point is
that corporations roprosont prool that tho mochanisms ol social proJuc-
tion aro soparallo lrom tho structuro ol ovnorship. ln othor vorJs, tho
moJorn corporation shovs that proJuction can lo organizoJ on a largo
scalo ovor timo anJ spaco, lringing togothor thousanJs ol vorkors in pho-
nomonally proJuctivo cooporation. But thoso institutions aro nonotholoss
run ly anJ lor a small group ol ovnors anJ managors vhoso social rolo is
poriphoral or ovon harmlul to tho institution`s propor running. This con-
traJiction, in Varx`s vorJs, constitutos tho latont alolition ol capital ovn-
orship containoJ vithin it` (Varx 1981, p. 52).
Capitalist ovnorship haJ thus locomo socially usoloss at tho samo timo
corporato capitalism haJ croatoJ a povorlul organizational lorm. lnJooJ,
this vory soparation ol ovnorship anJ managomont, maJo possillo ly tho
joint-stock company anJ stimulatoJ ly tho Jovolopmont ol moJorn croJit
markots, haJ locomo a povorlul motor ol grovth:
| CroJi t i sl tho pri ncipal lovor ol ovorproJuct ion anJ oxcossivo
spoculation.locauso tho roproJuction procoss, vhich is olastic ly naturo,
is nov lorcoJ to its most oxtromo limit: anJ this is locauso a groat part ol
tho social capital is applioJ ly thoso vho aro not its ovnors, anJ vho thoro-
loro procooJ ouito unliko ovnors vho, vhon thoy lunction thomsolvos,
anxiously voigh tho limits ol thoir privato capital. This only goos to shov
hov tho valorization ol capital lounJoJ on tho antithotical charactor ol capi-
talist proJuction pormits actual lroo Jovolopmont only up to a cortain point,
vhich is constantly lrokon through ly tho croJit systom. Tho croJit systom
honco accoloratos tho matorial Jovolopmont ol tho proJuctivo lorcos anJ
tho croation ol tho vorlJ markot, vhich it is tho historical task ol tho capi-
RENEGADES
241
talist moJo ol proJuction to lring to a cortain lovol ol Jovolopmont, as
matorial lounJations lor nov lorms ol proJuction. At tho samo timo, croJit
accoloratos tho violont outlroaks ol this contraJiction, crisos, anJ vith thoso
tho olomonts ol Jissolution ol tho olJ moJo ol proJuction.. Tho croJit
systom has a Jual charactor immanont in it: on tho ono hanJ it Jovolops tho
motivo ol capitalist proJuction, onrichmont ly tho oxploitation ol othors`
lalour, into tho purost anJ most colossal systom ol gamlling anJ svin-
Jling, anJ rostricts ovor moro tho alroaJy small numlor ol tho oxploitors ol
social voalth: on tho othor hanJ hovovor it constitutos tho lorm ol transi-
tion tovarJs a nov moJo ol proJuction. lt is this Jual charactor that givos
tho principal spokosmon lor croJit, lrom Iav through to lsaac Poroiro, thoir
nicoly mixoJ charactor ol svinJlor anJ prophot (iliJ., pp. 52-53).
VoJorn anticorporato antiglolalizors - liko pooplo in anJ arounJ tho
San lrancisco-lasoJ lntornational lorum on Glolalization (HonvooJ
1996a: 1996l) - soom not to approciato any ol thoso virtuos ol capitalist
socialization, anJ havo no sonso ol hov to organizo social proJuction on
any roasonallo scalo.
33
Big multinationals may lo too largo on social anJ
political grounJs, il not oconomic onos, lut thoro`s no vay to sustain an
inJustrial socioty vithout somothing liko tho corporato lorm.
Varx`s viov that corporato capitalism has maJo possillo its ovn tran-
sconJonco, ly organizing proJuction on a largo anJ sustainoJ scalo anJ
simultanoously ronJoring its ovnors socially vostigial, has gono somovhat
out ol lashion, to put it milJly, lut is soroly vorth rocovoring. ln tho light
ol his intorprotation ol tho corporation as containing tho sooJs ol a
postcapitalist luturo, an analysis ol that institutional lorm is in orJor - in
tho intorosts not only ol unJorstanJing lut also ol translormation.
notes
1. Poloroncos to Koynos, unloss othorviso notoJ, aro to tho II~cI~u W::, allroviatoJ
as W, lollovoJ ly tho volumo numlor anJ pago. TI~ ~u~:uI TI~:) is volumo Vll,
anJ its pagination matchos that ol tho popular Harcourt Braco paporlack oJition.
2. ProJuction is moasuroJ ly oxponJituros on proJuction Juring tho porioJ covoroJ:
incomos aro thoso JorivoJ lrom proJuction. Whilo capital gains on tho salo ol assots
may soom liko incomo to an inJiviJual, to tho NlPAs thoy Jon`t oxist, sinco thoro is no
corrosponJing proJuction to chargo tho incomo against. lor moro on national incomo
accounting convontions, soo \oung anJ Tico (1985) anJ U.S. Dopartmont ol Commorco,
Buroau ol Economic Analysis (1992).
3. Post-Koynosianism is a lalol applioJ to a varioJ sot ol oconomic thoorios that aro at
oJJs vith loth contrist Koynosian anJ right-ving monotarist thoorios. Post-Koynosians
WALL STREET
242
typically Jismiss vhat Joan Polinson calloJ lastarJ Koynosianism` - tho rovisions ol
Koynos`s thought that guttoJ its moro raJical contont, roJucing it to a moro tool lor
countoring tho lusinoss cyclo - particularly tho notion ol loosting tho luJgot Jolicit
through tax cuts anJor sponJing incroasos to light a rocossion. Post-Koynosians placo
groat omphasis on linancial instalility anJ tho importanco ol uncortainty in kooping
invostmont lolov tho lovol that voulJ guarantoo lull omploymont. Post-Koynosians
Jon`t loliovo that capitalist oconomios tonJ automatically tovarJ optimal outcomos:
instoaJ, markots olton lail, pricos Jon`t nocossarily givo tho right signals to participants,
anJ tho lost plans aro olton lrustratoJ ly surprisos that como vith tho passago ol timo.
By contrast, mainstroam nooclassical oconomists loliovo that markots alvays cloar (that
is, supply anJ JomanJ alvays lalanco, loaving noithor luyors nor sollors unsatislioJ),
pricos givo accurato signals, anJ timo is ol littlo thoorotical intorost oxcopt maylo in tho
short torm. Though gonorally lolt-ol-contor, post-Koynosians rango lrom thoso liko Paul
DaviJson, vho aro strongly pro-capitalist, through social Jomocrats anJ, at tho ox-
tromo, to oconomists vho comlino Koynosian thoorios ol linanco vith a Varxian analysis
ol proJuction anJ a hostility to capitalism as a systom. Tho lattor traco thoir poJigroo to
Vichal Kalocki: othor ur-liguros incluJo Nicholas KalJor anJ Joan Polinson. DaviJson
insists on spolling it Post Koynosian.` Ho saiJ (porsonal communication) this vas to
Jistinguish his lranJ ol thought lrom tho lranJ ol nooclassical synthosis Koynosianism`
that Paul Samuolson vas calling post-Koynosian in tho 190s. Tho hyphon`s alsonco,
saiJ DaviJson, is a mattor ol proJuct Jillorontiation.` Evon DaviJson, hovovor, is
rogarJoJ as uI:~ ly tho mainstroam ol tho oconomics prolossion. lor a lriol ovor-
viov, soo Holt (1996).
4. lixoJ capital consists mainly ol machinory anJ luilJings: vorking capital, ol matorials
in tho procoss ol proJuction: anJ liouiJ capital, ol invontorios (Koynos W V, p. 116).
5. Noto that intorost ratos alloct only invostmont gooJs markots. Koynos, accuratoly ro-
llocting tho practico ol his timo, saiJ that lorroving to linanco consumption vas so
uncommon` that it coulJ lo saloly nogloctoJ (W V, p. 238). But nov it roaJs liko a
momoir ol an innocont timo. ln tho lirst ouartor ol 1996, consumor croJit in tho U.S.,
oxcluJing mortgagos, totaloJ $1.1 trillion, anJ homo mortgago Jolt, $3.4 trillion -
amounts that coulJ novor lo ignoroJ, thoorotically or practically.
6. Whon l prosontoJ a vorsion ol this argumont at a :uuI: 1uI~:~:I RuI~ I:~::~: conlor-
onco in 1994, Sir Alan Waltors, a Thatchor intimato vho vas in tho auJionco, oljoctoJ
stronuously to my choico ol monotary aggrogato - vhat corrosponJs to tho U.S. V2.
No no no!,` ho oxclaimoJ: you shoulJ havo usoJ Storling V0!` A moJioval thoologian
coulJ havo Jono no lottor. A roviov ol somo major ompirical stuJios ol tho rolation
lotvoon monoy grovth anJ inllation ly tho Bank lor lntornational Sottlomonts (Gorlach
1995) shovoJ that most ol tho talos ol monoy causing inllation aro tho rosult ol incluJ-
ing countrios vith vory high ratos ol inllation: vhon thoso aro oliminatoJ, tho rolation
all lut Jisappoars. ln most casos, oxtromo inllation is associatoJ vith gigantic luJgot
Jolicits linancoJ ly tho contral lank`s printing monoy, typically in rosponso to somo
oxtromo conJition liko var or social collapso - in othor vorJs, casos ol littlo rolovanco
to normal situations in tho rich inJustrial countrios.
. Ol courso thoro aro many ratos ol intorost in tho roal vorlJ, JoponJont on tho maturity
ol a loan anJ tho porcoivoJ riskinoss ol a lorrovor. Spoaking ol tho` rato ol intorost is
moroly shorthanJ lor tho constollation ol ratos in olloct at a givon momont. Koynos`s
uso ol VEC is rhotorically intorosting: ono vonJors il ho prolorroJ tho tochnocratic
torm locauso it avoiJs tho unploasant class associations ol prolits.`
8. lt is almost a lav ol tho social scioncos that tho virtuo ol anything calloJ natural` is that
it prosorvos tho status ouo. Pilling on Wicksoll`s concopt ol tho natural intorost rato,
Vilton lrioJman introJucoJ tho iJoa ol naturo to unomploymont. ln his 196 prosiJon-
RENEGADES
243
tial aJJross to tho Amorican Economic Association - his prosiJoncy vas an oarly sign
ol t ho prolossion` s right varJ movo out ol BastarJ Koynosianism t ovarJs
saJomonotarism - ho arguoJ that il tho authoritios pushoJ unomploymont lolov its
natural rato, inllation voulJ lo inovitallo (lrioJman 1968l: Posaran 1992).
9. Or as thoy say on Wall Stroot, Juring a lull markot, cash is trash.
10. Tho Joscription applios to many markots, not just stocks. What roasonallo talos havo
tho gyrations in oil pricos ovor tho last 25 yoars tolJ? Woro tho long-torm prospocts ol
oil any Jilloront at $30 a larrol lrom $3? Do any ol thoso pricos toll us that oil is a linito
rosourco that vill asphyxiato us il vo lurn all tho cruJo that lios unJorgrounJ?
11. AnJ ol courso it voulJ lo tho vorst sort ol vulgar Varxism to attriluto Bontham`s
omorgonco anJ inlluonco to tho nooJs ol tho ovolving compotitivo markot systom.
12. By monotary crank l moan somoono vho loliovos that tho major prolloms ol capital-
ism aro tho rosult ol Jolt anJ intorost, ignoring tho ovorriJing importanco ol prolit, anJ
instoaJ holJing that il you lix linanco ovorything olso vill lall into placo.
13. Tho iJoa must ol loon all ovor Paris in tho oarly 190s. ln TI~ M:::: J P:uucI:u,
BauJrillarJ (195) maJo a vory similar argumont.
14. Ono ol tho loaJing post-Koynosians, Paul DaviJson (porsonal communication) ro-
sponJoJ to my assortion that tho Joclino in roal lusinoss invostmont vas causoJ ly tho
Joclino in corporato prolitalility ly saying that tho Joclino in prolitalility vas tho ro-
sult ol laJ monotary policy.
15. Both lrouJ`s anJ Koynos`s thoorizing vas translormoJ ly lourgoois socioty into toch-
niouos ol aJjustmont: psychoanalysis locamo a lranch ol montal hygiono, anJ
Koynosianism part ol a toollox lor lusinoss cyclo managomont.
16. Thoro vas a livoly oxchango on this topic on tho Post Koynosian Thought (PKT) com-
putor notvork involving Paul DaviJson, PanJall Wray, anJ many othors incluJing mo
in tho spring ol 1995. lt`s on tho PKT archivo, <http:csl.coloraJo.oJumailpkt
inJox.html>. Iook lor tho April-Juno 1995 lilos.
1. This paragraph oliJos tho Jistinction lotvoon monoy anJ croJit, as l`vo Jono sovoral
timos throughout this look. ln tho narrovost sonso, monoy is tho instrumont usoJ lor
tho linal sottlomont ol Jolts. ln a vorlJ vhoro golJ is consiJoroJ tho only roal monoy
anJ ovorything olso - lrom papor monoy to tho most oxotic linancial instrumont - is
croJit, tho Jistinction is protty lirm. But in a vorlJ vhoro golJ is a rolic anJ papor anJ
oloctronic transactions provail, thon tho Jistinction is vory harJ to prosorvo. Wo think ol
Jollar lills as monoy, lut thoy aro an olligation ol tho loJoral Posorvo, lackoJ, il you
can call it that, ly tho loJ`s assots, vhich aro mainly U.S. Troasury lonJs. Curroncy
accounts lor only alout a thirJ ol V1, tho narrovost Jolinition ol tho monoy supply in
U.S. practico: chocking accounts aro rosponsillo lor most ol tho lalanco, lut chocks
aro lunJamontally a croJit instrumont, sinco tho rocipiont has to assumo thoy`ro not
maJo ol rullor. Classically, most lorms ol monoy in JovolopoJ capitalist oconomios
roprosont lialilitios ol tho lanking systom - somo lorm ol Joposit or othor - or in-
strumonts, liko monoy markot lunJs, that aro analogous to lank Joposits. To harJ-
monoy nuts, this is surroal, lut thoir viov ol golJ as tho ossonco ol monoy still JoponJs
on a social convontion, an act ol laith not unliko croJit. At a slightly highor lovol ol
sophistication, golJlugs lovo tho motal locauso it`s tho only lorm ol monoy that Joosn`t
JoponJ on tho croation ol Jolt, lut il it voron`t lor Jolt, capitalist oconomios voulJ
novor havo grovn as Jramatically as thoy havo. Dolt is moro lunJamontal to capitalism
than golJ.
18. As l vas making linal corroctions on this look, Vinsky JioJ. This vas a groat loss. lt`s
harJ to think ol anothor oconomist vho contrilutoJ as much in tho JocaJos altor WorlJ
War ll, anJ vith as littlo rocognition.
19. Tho namo Ponzi` comos lrom tho lamous linancial con gamo run ly Charlos Ponzi,
WALL STREET
244
vhich promisoJ hugo roturns to invostors - lut coulJ pay oll tho lirst rounJ ol plung-
ors only vith monoy takon in lrom a soconJ rounJ, tho soconJ lrom tho thirJ, anJ so
on. Soonor or lator you run out ol nov suckors, anJ tho vholo thing crashos Jovn.
Vainstroam oconomists somotimos oljoct to Vinsky`s uso ol tho torm as inappropriato
to somothing as sorious as corporato linanco, lut it sooms oxactly right to mo.
20. Anyono vho has olsorvoJ moJorn golJlugs knovs that lohinJ thoir laith olton lios a
Joop snollory, a contompt lor common,` JolasoJ lorms ol monoy liko papor, vhich
lack tho aristocratic status ol tho sacroJ motal. Economically, thoy lovo tho austoro,
punishing rogimo ol a golJ stanJarJ, vhich makos mass prospority Jillicult, anJ hato
looso monoy, vhich throatons to mako prospority moro viJosproaJ than it shoulJ lo.
Though thoro is an oconomic point to this, tho psychosocial truth is anothor mattor
ontiroly: vhilo golJ is cortainly raror than locos, loth aro unJillorontiatoJ sulstancos:
an ingot is as charactorloss as a turJ. But, as lonichol (1945, p. 281) vroto, tho anal
charactors vho lovo monoy lovo tho kinJ that ujj~u:: to lo uI JoinJiviJualizoJ:
thoy lovo golJ anJ shining coins.`
21. Or as tho Slits put it in thoir 199 song SponJ, SponJ, SponJ`: l nooJ somothing nov
Somothing trivial vill Jol nooJ to satisly this ompty looling.`
22. NooJloss to say, tho gonJor contrast alluJos to convontion, not to timoloss ossoncos.
23. Evon a Varxist as aJmirallo as Anvar Shaikh (1995) takos a vory lunJamontalist viov
ol linanco. To Shaikh, tho volatility ol stock roturns is not a lunction ol Shillor-liko
ovorroaction, lut is an accurato rolloction ol roal-soctor Jovolopmonts - spocilically,
tho marginal prolitalility ol nov corporato invostmonts. Whon ouostionoJ, Shaikh says
that tho Jiroction ol inlluonco is only ono vay, lrom tho roal to tho linancial, vith tho
linancial siJo having no signilicant olloct on tho roal at all. Shaikh is unallo to proviJo
a mochanism that oxplains this Jotormination othor than a notion ol turlulont arli-
trago`: ho can ostimato marginal prolitalility, lut no roal invostors computo it tho vay
ho Joos. lt`s likoly that his moJol is simply capturing tho samo lusinoss cyclo anJ
intorost rato ollocts that link stock markots anJ tho roal vorlJ: in lact, his moasuro is not
unliko Wall Stroot ostimatos ol tho noxt ouartor`s prolits - though ol courso tho ana-
lysts Jo thoirs ahoaJ ol tho lact, anJ oconomists altor it. lurthor, his Jiscovory` harJly
unJorminos tho notion that stock markots ovorroact to short-torm Jata - ouito tho
contrary, it conlirms it in a rounJalout vay.
24. Ono oxamplo ol this contrality: l oxcluJo SismonJi lrom my historical survoy horo
locauso a critiouo ol his viovs lolongs to a part ol my vork Joaling vith tho roal
movomont ol capital (compotition anJ croJit) vhich l can only tacklo altor l havo lin-
ishoJ this look` (Varx 191, p. 53).
25. Not only is this ompirical nonsonso, it`s un-Varxian. Unliko commoJity oxchango, ar-
guoJ Varx, vhich is ultimatoly rogulatoJ ly tho lav ol valuo - tho rolativo lalor timo
omloJioJ in commoJitios - tho rato ol intorost is rogulatoJ only ly markot compoti-
tion (though lroaJly concoivoJ, alloving lor tho inlluonco ol traJition, culturo, anJ
contral lank policy). AnJ, vhon it is compotition as such that JociJos, tho Jotormina-
tion is inhorontly acciJontal, puroly ompirical, anJ only poJantry or lantasy can sook to
prosont this acciJont as somothing nocossary` (Varx 1981, p. 485).
26. No list ol his most omlarrassing momonts can omit his proJiction, uttoroJ Jays loloro
Hitlor`s appointmont to tho Chancollorship, that tho Nazis voulJ novor tako povor
(Darity anJ Horn 1985).
2. This sonso ol monoy is snulloJ ly romarks liko thoso ol Duncan loloy, in his introJuc-
tion to Jo Brunholl`s (196, p. viii) Mu:. u Mu~): Varx`s vritings on monoy romain
in a pro-moJol` stago, anJ it vill lo nocossary lor us to lring this thoorotical position to
tho point ol oxact oxprossion in a sorios ol moJols.` Why ovor must vo Jo this? Hov
voulJ it ollor any moro illumination than tho :uuu::::~s proso? WoulJ it mako it a
RENEGADES
245
Varxian` moJol il ono incluJoJ a Jummy variallo lor tho loss`s laco, anJ anothor lor
tho spillago ol llooJ?
28. Pocall that ovon Juring tho Jays ol tho high golJ stanJarJ in tho 19th contury, tho
ultimato rogulator ol tho systom vas tho Bank ol EnglanJ, vith tho British Navy alvays
lurking in tho lackgrounJ.
29. Varx opposoJ rovonuo to capital: capital is a kinJ ol cash llov that roturns a prolit, lut
rovonuo Joosn`t. lrom tho omployors` point ol viov, a vago paiJ to a proJuctivo vorkor
is a lorm ol capital, sinco tho vorkor croatos moro in valuo lor tho capitalist than ho or
sho pays out in tho vago: lrom tho loss`s point ol viov, a vorkor is a prolitallo invost-
mont. (ll this sounJs harsh, llamo capitalism, not Varx.) But paupors anJ rontiors pro-
Juco nothing in roturn lor thoir incomo: thoy simply consumo, vithout contriluting a
prolit or a proJuct in roturn.
30. Vany postmoJornists aro skoptical alout spoaking ol capitalism as a systom. But in its
rolo as tho gonoral lorm ol voalth, anJ in its political` rolo as omphasizoJ ly Nogri,
monoy is tho institution that ronJors - in its violont, roJuctivo, yot soJuctivo vay - all
tho lragmonts into oxchangoallo parts ol a singlo systom, lo tho lragmonts commoJi-
tios, sorvicos, lits ol naturo, ovon livos thomsolvos.
31. Poss sooms to havo ovolvoJ avay lrom this position, vith his moro rocont intorost in
tho svoatshop roality lohinJ tho glitz ol tho lashion inJustry.
32. Actually, Varx also anticipatoJ tho Vichaol Jonson critiouo ol lloatoJ managomonts
svinJling sharoholJors out ol thoir rightlul looty: ovor anJ alovo tho actual manag-
ing Jiroctor, a numlor ol govorning anJ suporvisory loarJs ariso, lor vhich manago-
mont anJ suporvision aro in lact a moro protoxt lor tho rollory ol sharoholJors.`
(Varx 1981, p. 514).
33. Tho llG is lunJoJ ly lounJations sponsoroJ ly Doug Tompkins, tho co-lounJor ol
Esprit Clothing. Tompkins maJo his lortuno in procisoly tho sorts ol ThirJ WorlJ anJ
Jomostic svoatshops his lorum nov Jonouncos. Tompkins` lounJation lor Doop Ecol-
ogy - vhich ironically ovns stock in Tololonos Jo Voxico, Allstato, Citicorp, anJ Wal-
Vart - has tho most Valthusian roputation in tho groon lunJing vorlJ, not a placo
knovn lor hostility to tho Parson.
246
6 Governance
ll monoy is an instrumont ol control, thon linancial markots aro a lot moro
than tho institutional matchmakors lor saving anJ invostmont. \ou can
soo that cloarly ly looking at hov an ovning class`s povor is assortoJ
ovor corporations anJ govornmonts through linancial mochanisms.
governing corporations
/T]I~ uu~:u c:j:uI:u uu) I~ :~u:u~u uI ::ujI) u: u~
J:u J :c:uI :uu:zuI:u IuI jI~uI:uII) (:J uI )~I ucIuuII) u:
II~ uu:uuuI :u:I:IuI:u J II~ uu~:u u:Iu. WI~:~ :I: uu
:uI~:~:I: u:~ cuc~:u~u, :I ~:~u uII~ujI: I uu:uuI~ II~ :IuI~
- AJolph A. Borlo anJ GarJinor C. Voans, TI~ Mu~:u
:j:uI:u uuu P:::uI~ P:j~:I)
Varx vas right: tho soparation ol tho unitary capitalist into tho rontior anJ
managor vas an important innovation in tho history ol capitalism. Surpris-
ingly lov oconomists sinco havo givon tho mattor much thought.
Givon tho vast povors ol lig lusinoss, hov lirms aro run is ol groat
intorost to almost ovoryono. But in Amorican pullic spooch, consiJoration
ol tho lirm anJ hov it`s run is conlinoJ to a lairly narrov circlo ol spocial-
ists in tho prolossional anJ lusinossos pross.
1
So rostrictoJ, tho Jolato
takos on tho ouality ol a lamily light vithin capital. lor oxamplo, vriting
in tho Hu::u:u 1u::u~:: R~::~u, a placo vhoro acaJomic thoory moots
roal lusinoss practico, ono ol tho gurus in tho liolJ, John PounJ (1995),
iJontilioJ tho throo critical constituoncios` ol a lirm: managors, sharo-
holJors, anJ tho loarJ ol Jiroctors. OrJinary vorkors, customors, suppli-
ors, anJ communitios aron`t incluJoJ.
GOVERNANCE
247
Ono roason tho govornanco issuo is intorosting is that it`s an implicit
aJmission that markots Jo not rogulato thomsolvos as porloctly as vo`ro
tolJ. ll tho compotitivo markot systom vorkoJ as voll as its aJhoronts say,
thon thoro voulJ lo littlo nooJ lor sharoholJors to vorry alout hov thoir`
corporations aro run: rovarJ anJ punishmont voulJ lo aJministoroJ ly
tho markot,` vith minimal conscious intorvontion. Tho samo coulJ lo
saiJ alout tho stock markot: il it roally JiJ Jisciplino inolloctivo managors
anJ rovarJ gooJ onos, thon tho govornanco Jolato voulJ lo protty small
loor. But olviously noithor tho proJuct nor stock markots vork as aJvor-
tisoJ. That moans that capital is aJmitting that corporations must lo sul-
joct to somo kinJ ol outsiJo ovorsight. ll that`s tho caso, thon tho ouostion
locomos ovorsight ly vhom, in vhat lorm, anJ in vhoso intorost.
lov oconomists pay much attontion to corporations, or hov thoy`ro
ovnoJ anJ run. As Eugono lama (1991) notoJ, many ol tho corporato-
control stuJios appoar in linanco journals, lut tho vork goos to tho hoart
ol issuos in inJustrial organization, lav anJ oconomics, anJ lalor oco-
nomics.` Ho might havo aJJoJ politics anJ culturo, sinco thoso too shapo
anJ aro shapoJ ly lig lusinoss. Corporato govornanco is too important a
mattor to lo lolt to linanco thoorists.
Economists olton analyzo linancial structuros, il thoy look at thom at
all, in a lairly mochanistic lashion. Changos in corporato invostmont aro
troatoJ as almost hyJraulically inlluoncoJ ly changos in intorost ratos or
stock pricos.
2
Thoy pay much loss attontion to linancial structuros as insti-
tutions ol logal anJ social control.
Tako, lor oxamplo, tho Jilloronco lotvoon Jolt anJ oouity. VoJigliani
anJ Villor lamously saiJ thoro vas nono ol any signilicanco. But as Olivor
E. Williamson (1988: 1993) notoJ, thoro aro groat oualitativo Jilloroncos
lotvoon thom. AccorJing to Williamson, tho appropriato lorm ol linanco
varios vith tho naturo ol tho unJorlying corporato assots. Dolt is appro-
priato il tho procooJs aro usoJ to lunJ highly roJoployallo` assots: il tho
lorrovor gots in troullo, tho Jolt-linancoJ assots coulJ lo solJ, anJ tho
Jolts ropaiJ. To linanco moro spocializoJ invostmonts, vhich JoponJ on
a spocilic lirm or a narrov markot lor thoir valuo, oouity is moro appropri-
ato, sinco oouity givos tho suppliors ol lunJs tho right to suporviso manag-
ors - anJ roplaco thom, shoulJ things go vrong. ln practico, hovovor,
sharoholJor suporvision isn`t as oasy as that sounJs, as vo`ll soo in a lit.
Tho rolations lotvoon linancial anJ govornanco structuros havo lo-
como cloaror in rocont yoars, as incroasing attontion has loon paiJ to in-
tornational Jilloroncos in corporato ovnorship anJ control anJ thoir
WALL STREET
248
possillo inlluonco on oconomic porlormanco. BroaJly spoaking, tho U.S.
anJ Britain sharo a structuro charactorizoJ ly viJoly JisporsoJ ovnor-
ship anJ looso oxtornal controls, vhilo Japan anJ Gormany oxhilit much
moro concontratoJ ovnorship anJ tightor oxtornal control. Ol courso, such
an oxtromo charactorization Joos violonco to tho particulars, anJ ospo-
cially so sinco tho systoms in all lour countrios havo loon changing in
rocont yoars, lut it`s still a usolul placo to start.
Tho lunJamontal issuos aro thoso: stockholJors vant high stock pricos,
lonJholJors anJ othor croJitors vant thoir intorost paiJ rogularly anJ
thoir principal ovontually roturnoJ, anJ managors vant a poacolul lilo vith
high salarios anJ minimal oxtornal intrusion. (ln most mainstroam thoo-
rios, vhat vorkors vant is ol no mattor: tho only thoorotical prollom is
hov to got tho most ollort out ol thom lor tho loast pay anJ vith tho loast
suporvisory oxortion.) Olton thoso goals colliJo. High-risk stratogios that
might pay oll in a lig gain in a lirm`s stock prico may striko croJitors as
putting tho socurity ol thoir paymont stroam at risk. StockholJors may ro-
sont tho consorvativo inlluonco ol croJitors on corporato stratogios. Both
sots ol outsiJo intorosts may rosont managorial porks anJ complaconcy,
vhilo managors might try to misloaJ outsiJors into thinking tho corpora-
tion is Joing lottor than it roally is. Whon a lirm gots into troullo, stock-
holJors aro likoly to lavor inJulgonco (that is, somo Jogroo ol Jolt
lorgivonoss), vhilo croJitors aro olton happy to soo stockholJors vipoJ
out anJ tho lirm vholly or partly liouiJatoJ to satisly thoir claims. lurthor,
Jilloront classos ol croJitors - thoro`s usually a hiorarchy, vith somo moro
sonior than othors - may havo Jilloront intorosts in a lankruptcy. Vanag-
ors, hovovor, aro olton tioJ to a lirm, oithor through halit, or convonionco,
or vhat oconomists call lirm-spocilic human capital (vhich moans that
skills honoJ ovor tho yoars in a particular corporato onvironmont may lo
noar-vorthloss in anothor), anJ roluctant to soo it liouiJatoJ.
ln much rocoivoJ oconomic thoory, tho lirm is a simplo llack lox, vith no
conllicts among managors, vorkors, croJitors, anJ ovnors (stockholJors).
3
Tho lirm simply applios rav matorials to its stock ol machinos anJ lalor,
croatos a proJuct that it costlossly anJ unprollomatically solls, anJ oarns
prolits lor its sharoholJors. Iator, VoJigliani anJ Villor voulJ shov that it
JiJn`t mattor vhoro tho capital camo lrom, so oxtornal linanco too lo-
camo just anothor input, liko lalor anJ rav matorials, ol no groat thooroti-
cal or practical intorost.
GOVERNANCE
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ln a lamous papor that vas largoly rosponsillo lor his vinning ol tho
1991 Nolol Prizo in Economics, PonalJ H. Coaso (193) challongoJ this
orthoJoxy. Coaso posoJ tho ouostion, largoly unaskoJ in classical oco-
nomics, ol vhy lirms oxist. Coaso ouotoJ this aphorism lrom Sir Arthur
Saltor as omloJying tho classic (anJ classical) moJo ol thought - a viov
that vas to locomo tho routino punJitry ol tho 1990s: Tho normal oco-
nomic systom vorks itsoll.` That is, supply anJ JomanJ, proJuction anJ
consumption, aro oouililratoJ ly tho soll-rogulating mochanism ol tho
prico systom. Ol courso, inJiviJuals plan lor thomsolvos vithin this soll-
rogulating miraclo, lut no coorJinating institution loyonJ that is roouiroJ.
But, Coaso countoroJ, Saltor`s viov Joos not oltain vithin tho lirm at
all. ll a vorkman movos lrom Jopartmont \ to Jopartmont X, ho Joos not
go locauso ol a chango in rolativo pricos, lut locauso ho is orJoroJ to Jo
so.` lirms, in a lormulation ol D.H. Polortson that Coaso ouotoJ approv-
ingly, aro islanJs ol conscious povor in this ocoan ol unconscious co-
oporation liko lumps ol luttor coagulating in a pail ol luttormilk` (as il tho
luttorlumps thought thomsolvos into oxistonco). Not ovory aspoct ol oco-
nomic activity can lo oncompassoJ ly tho prico systom. Tho costs ol no-
gotiating contracts lor ovorything voulJ lo prohilitivo: voro a loss to
tako liJs anJ vrito a contract lor ovory lottor sho nooJs typoJ, nothing
voulJ ovor got Jono. ln Coasian languago, tho transaction`s costs voulJ
oxcooJ its roturn. lurthor, contracts cannot lo vritton to covor ovory ovon-
tuality: ovory spill can`t lo anticipatoJ, so it pays to havo a janitor on hanJ
to Joploy vhonovor an unoxpoctoJ Jisastor prosonts itsoll. ln such casos,
tho prico systom harJly ontors tho picturo. Or, in Coaso`s conciso Jolini-
tion, tho Jistinguishing mark ol tho lirm is tho suporsossion ol tho prico
mochanism.`
But unJor capitalism, tho scopo ol conscious planning raroly oxtonJs
loyonJ a lirm`s lounJarios: tho prico systom is tho normal govornor ol
rolations among lirms anJ lotvoon lirms anJ linal consumors. Convon-
tional oconomics still troats tho markot as ossontially soll-rogulating: tho
systom, outsiJo tho lirm, still vorks itsoll. But in roality thoro aro sulstan-
tial costs ol timo anJ monoy JovotoJ to making tho systom vork. Sollors
must sook luyors, anJ luyors must voigh tho compotonco anJ honosty ol
sollors. Transactions costs aro lar lrom trivial - as much as hall U.S. GDP,
accorJing to ono ostimato citoJ ly Coaso (ouotoJ in Williamson anJ Win-
tor 1993, p. 63).
Though Coaso JiJn`t mako tho point, tho transaction cost argumont lor
tho oxistonco ol tho lirm can lo applioJ to tho provision ol capital. Con-
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250
vontional thoory assumos that ontropronours can raiso capital lor thoir
projocts ollortlossly anJ costlossly, vhon in lact thoy cannot: ovon tho
most soasonoJ corporation has to pay commissions to tho lankors unJor-
vriting its papor, anJ lor loss ostallishoJ anJ virginal vonturos, capital
can lo oxponsivo to raiso, il it`s availallo at all. EstallishoJ lirms ocono-
mizo on such costs ly tapping thoir ovn in-houso sourcos ol capital -
prolits. As tho liguros citoJ in Chaptor 2 on tho cost ol linanco shov, thoso
transaction costs aro ouito still, making intornal linanco ouito attractivo.
By introJucing tho lirm as an institution anJ tho transaction as a unit ol
analysis, Coaso JiJ holp lring oconomics into closor ongagomont vith tho
roal vorlJ - though as ho notoJ in 190, tho papor vas much citoJ anJ
littlo usoJ` (ouotoJ in Williamson anJ Wintor 1993, p. 61). Vainstroam
oconomics romainoJ largoly inJilloront to tho costs ol tho prico systom, at
loast until tho 190s - ironically, as tho supposoJly costloss magic ol tho
markotplaco` vas alout to scoro groat political triumphs.
But in somo vays, Coaso simply oxchangoJ ono llack lox lor anothor.
Whilo his lirm vas oxposoJ to tho compotitivo prico systom on tho out-
siJo, tho lirm itsoll vas a conllictloss hiorarchy that vorkoJ itsoll.` Tho
vorkman tolJ to movo lrom \ to X JiJ as ho vas tolJ, anJ thoro vas no
conllict lotvoon managors anJ ovnors, or croJitors anJ stockholJors.
AnJ asiJo lrom tho rigors ol compotition, his moJol ol transactions vas
also rathor pacilic. Thoro vas no stark conllict lotvoon proJucor anJ con-
sumor, vorkor anJ loss. Whilo his intolloctual hoirs havo introJucoJ somo
aspocts ol thoso conllicts into thoir analysis, thoy tonJ to uso tho iJoologi-
cally noutoroJ languago ol transactions, contracts, anJ inlormation, rathor
than tho moro llooJoJ languago ol conllict anJ strugglo.
4
Tho roJiscovory ol Coaso in tho 190s loJ to a school ol transactions
costs oconomics, Olivor Williamson prominont among its practitionors,
vho uso tho thoory to oxplain much ol social lilo. Any organization can lo
soon as oxisting to oconomizo on costs. Whilo it`s rolroshing to soo main-
stroam oconomists tako somo notico ol institutions, thoir assumptions aro
still Jooply inJiviJualistic. Thoir lasic unit ol analysis is tho transaction:
all tho social mochanisms that procoJo anJ surrounJ tho transaction aro
oliJoJ. Tho lirm - or nonprolit organization, govornmont, or ovon lamily
- is soon as a vol ol inJiviJual contracts, not a social organism vith a
lilo ol its ovn. Politics anJ povor largoly Jisappoar in vhat`s calloJ tho
nov institutional oconomics.
PaJical institutionalists look to Vollon lor a sharpor viov (KnooJlor
1995). Vollon notoJ that many transactions aro unJortakon not lor olli-
GOVERNANCE
251
cioncy, lut lor roasons ol povor - to unJormino compotitors or socuro
monopoly position. Ho omphasizoJ that lusinossos vantoJ to mako
monoy, not run tho lost inJustrial systom imaginallo. Tho Jilloronco in
omphasis is important, locauso tho Coasian viov soos tho corporation`s
rolo as maximizing ollicioncy, not prolit, vhich is anothor mattor ontiroly.
AJvortising, plannoJ olsolosconco, proJatory pricing, anJ spurious inno-
vation aro partly or vholly socially usoloss, ovon malignant, activitios, lut
thoy aro prolit-maximizing. Vollon also arguoJ that an inJustrial systom
run lor social ollicioncy rathor than maximum prolit might soo moro intor-
nalizoJ anJ lovor markot transactions. Somotimos prolit-maximizing vill
loaJ to socially lonolicial comlination anJ coorJination, lut somotimos
it von`t. Janot KnooJlor (1995) arguoJ, lor oxamplo, that GV`s intogration
vith its suppliors (liko lishor auto loJy) haJ loss to Jo vith oconomizing
on costs than vith simplilying tho annual stylo chango, a markoting rathor
than an inJustrial consiJoration. But that is gotting political, vhich is somo-
thing most oconomists novor Jo.
\ou havo to loavo tho liolJ ol oconomics to linJ much intorosting thinking
alout corporations. Thoro`s no lottor starting point than tho taxonomy
proposoJ ly tho Cosar Ayala (1989) in his oxcollont survoy ol tho liolJ.
Ayala, a sociologist, JiviJoJ tho litoraturo on tho control ol lig lusinoss
into throo schools ol thought - Pollor Baron, Vanagorial, anJ Bank-
Sphoros. As ho put it, Tho Pollor Baron school is committoJ to tho iJoa
that Big Businoss roprosonts a historical rogrossion vhich rointroJucoJ
louJal` olomonts into tho oconomy: tho Vanagorial school is committoJ
to tho iJoa that managors rulo` tho oconomy: anJ tho Bank-Sphoros school
is committoJ to tho iJoa that lanks rulo` tho oconomy.` All throo viovs
havo a long poJigroo, anJ romain popular toJay, omloJJoJ in populist
thought ol loth lolt anJ right.
Tho Pollor Baron school holJs that tho groat ompiro luilJors ol tho
lato 19th anJ oarly 20th contury - liko GoulJ, Pockolollor, anJ Vorgan -
appropriatoJ through violonco anJ conspiracy tho voalth ol tho nation
that vas onco JisporsoJ in tho hanJs ol small proJucors. Pathor than viov-
ing concontration as procooJing lrom tho innor ossonco ol capitalism, as
loth Varxists anJ most lusinoss historians voulJ, tho Pollor Baron school
soos it as a porvorsion ol a natural` stato ol compotition. This naturaliza-
tion ol potty capitalism is a Joarly holJ Amorican myth: it lorgots tho vio-
lonco that markoJ tho appropriation ol tho continont in tho lirst placo, anJ
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it also lorgots tho oarlior violonco that markoJ tho ostallishmont ol capi-
talism in Europo - tho tholt ol common lanJ, tho criminalization ol va-
grancy, ol ovon povorty itsoll, that Varx calloJ primitivo accumulation.
Whilo tho Pollor Barons unJoultoJly committoJ many crimos, logal anJ
moral, Juring tho courso ol thoir ompiro luilJing, anJ lusinossos toJay
commit crimos, litorally anJ ligurativoly, ovory Jay ol thoir oxistonco, thoro
is littlo Joult that largo lirms aro lar moro olliciont anJ lormiJallo com-
potitors than tho tiny proJucors thoy roplacoJ. lt vas not crimo that maJo
lig lusinoss vhat it is toJay, nor is it crimo that koops it thoro.
ln this rogarJ, an intorosting contrast can lo maJo vith British capital-
ism, vhich vas vory lato in aJopting tho moJorn largo corporato lorm.
Early joint-stock companios voro JissolvoJ altor thoy`J Jono thoir vork
ol oponing up loroign traJo, anJ tho mainstroam ol lusinoss vas Jomi-
natoJ ly small anJ miJ-sizoJ lirms ol a sort moro congonial to tho Pollor
Baron school. Tho smallor lirms voro ovnoJ ly a lamily or a small group
ol partnors, anJ run in a highly porsonal` stylo, rathor than loing prolos-
sionally managoJ ly a voll-structuroJ hiorarchy. This organizational lack-
varJnoss gavo U.S. anJ Gorman lirms a critical oJgo as Britain lost grounJ
to its rivals in tho lato 19th anJ oarly 20th conturios (Arrighi 1994, p. 282:
ChanJlor 1990, chaptors -9).
5
Thoso British lirms also lailoJ to invost at a sulliciontly high lovol. As
ChanJlor (1990, p. 285) notoJ, thoso lailuros happonoJ Jospito tho lact
that IonJon vas tho largost anJ most sophisticatoJ capital markot in tho
vorlJ,` a markot, ironically, that Gorman anJ U.S. lirms tappoJ lor li-
nanco. British monoy capital prolorroJ to vanJor ovorsoas in soarch ol
highor roturns than voro availallo at homo. Doop capital markots aro no
sulstituto lor gooJ managomont, anJ tho prosonco ol tho lirst is no guar-
antoo ol tho Jovolopmont ol tho soconJ.
Typically, tho concorn vith tho govornanco ol tho moJorn largo corpora-
tion, vhich hingos in tho classic lormulation on tho soparation ol ovnor-
ship anJ control, is tracoJ to AJolph Borlo anJ GarJinor Voans`s TI~
Mu~:u :j:uI:u uuu P:::uI~ P:j~:I) (1932196). To Borlo anJ
Voans, moJorn capitalism is charactorizoJ ly tho simultanoous concon-
tration ol proJuction in tho largo corporation anJ tho Jisporsion ol ovn-
orship among horJos ol sharoholJors. That Jual movomont markoJ a
prolounJ translormation in tho naturo ol proporty. Tho lunction ol tho
19th contury ovnor-ontropronour haJ loon JiviJoJ in tvo. lormal ovn-
GOVERNANCE
253
orship vas JolivoroJ into tho hanJs ol thousanJs, ovon millions, ol Jis-
porsoJ stockholJors, raroly capallo ol organizing thomsolvos to alloct tho
oporations ol tho lirms vhoso titlos thoy holJ. Actual control, hovovor,
loll to managors, vho though lormally rosponsillo to tho stockholJors,
voro in lact largoly inJoponJont, soll-sustaining, anJ ansvorallo to no
ono in particular as long as things JiJn`t go laJly vrong. ln tho oyos ol
jurispruJonco, a lirm anJ its ovnors voro ontiroly Jistinct, vith tho corpo-
ration itsoll acouiring tho rathor mystical status ol a porson unJor lav.
This arrangomont is a surprisingly rocont innovation in oconomic anJ
logal lilo. ln tho oightoonth contury, tho corporato chartor vas ossontially
a gilt ol tho stato, typically lor a vory spocilic purposo, liko tho right to
traJo in tho HuJson Bay aroa, or to run a lorry sorvico.
6
This traJition
oxtonJoJ into tho 19th contury, as tho oarly railroaJs voro laiJ Jovn.
lroouontly it vas a grant ol monopoly privilogos. Chartors typically voro
spocilic: tho ontorpriso`s mission vas tightly JolinoJ, anJ its capital struc-
turo anJ linancial practicos voro closoly suporvisoJ.
With tho grovth in tho scalo ol proJuction, thoso stricturos voro loos-
onoJ. ln 183, Connocticut passoJ tho lirst moJorn lav ol incorporation,
pormitting associations lor any lavlul lusinoss.` Ovor tho noxt 60 yoars,
most othor statos loll into lino. Stop ly stop vith tho Jovolopmont ol tho
moJorn corporation - or maylo just a stop or tvo lohinJ - camo tho
grovth ol managorial autonomy. lor oxamplo, in tho oarly 19th contury,
sharoholJors voron`t allovoJ to Jologato thoir voto ly proxy to manago-
mont: lut ly tho timo ol Borlo anJ Voans, tho proxy haJ locomo ono ol
tho principal instrumonts not ly vhich a stockholJor oxorcisos povor ovor
tho managomont ol tho ontorpriso lut ly vhich his povor is soparatoJ
lrom him` (p. 129). SharoholJors typically havo haJ noithor tho timo nor
tho machinory nocossary lor scrutinizing managomont anJ attonJing an-
nual mootings, so in normal timos thoy Jologato tho rosponsilility ol vot-
ing thoir sharos to tho managors vho aro lormally thoir hiroJ agonts.
ln his prolaco to tho 196 rovisoJ oJition, Borlo JoscriloJ tho nov sys-
tom as ono ol colloctivo capitalism,` an allair that yokos togothor thou-
sanJs ol corporations, anJ millions ol omployoos, ovnors, anJ customors
- too many pooplo to lo consiJoroJ privato ontorpriso in tho classic sonso:
anJ sinco tho stato vas nov so Jooply involvoJ in oconomic allairs, no
roJolinition ol privato` coulJ ovor lo lroaJ onough to apply. Posoarch
vas no longor carrioJ out ly lono invontors, lut in toams, anJ no longor
vithin a singlo ontorpriso, lut in cooporation vith univorsity anJ govorn-
mont rosoarchors - olton vith sulsiJios lrom pullic anJ nonprolit sourcos.
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(Dospito tho inJiviJualist iJoology ol tho high-toch vorlJ, lasic rosoarch
as voll as proJuct Jovolopmont still is highly social.) To tho 196 Borlo,
thoso changos haJ movoJ us tovarJ a nov phaso lunJamontally moro
alion to tho traJition ol prolit ovon than that lorocast` in tho lirst oJition ol
thoir look, pullishoJ 35 yoars oarlior.
PoaJing tho upJatoJ Borlo 2 yoars lator, ovon moro than tho 1932 origi-
nal, it`s harJ to imagino that anyono coulJ havo thought that moJorn cor-
porato socioty movos ly anything signilicantly Jilloront lrom tho
maximization ol prolit. But tho loliol that tho aJvont ol tho largo corpora-
tion haJ changoJ capitalism into a moro humano, progrossivo lorco vas a
coro loliol ol Amorican liloralism lrom tho Nov Doal through tho onJ ol
tho 1960s. Prolit maximization, tho motor ol 19th contury ontropronourial
capitalism, haJ loon roplacoJ ly grovth, anJ compotition ly long-torm
corporato planning anJ aJministoroJ pricos. ln ono moving c:: u~ :~uI:~:
(pp. 115-116), Borlo anJ Voans JonouncoJ tho potontial lor managorial
aluso ol tho poor ovnor: out ol prolossional priJo,` managors may main-
tain lalor stanJarJs alovo thoso roouiroJ ly compotitivo conJitions,` or
improvo ouality alovo tho point` that is likoly to lo maximally prolitallo
to sharoholJors! This holJs tho potontial lor a nov lorm ol alsolutism,
rologating ovnors` to tho position ol thoso vho supply tho moans vhoroly
tho nov princos may oxorciso thoir povor.` Povorsing tho usual populist
casting, it`s not tho ovnor ol capital vho is tho parasito in this moJol, lut
tho managors vho run proJuction.
As Borlo anJ Voans put it, historically spoaking, sharoholJors havo sur-
ronJoroJ a sot ol Jolinito rights lor a sot ol inJolinito oxpoctations` (p.
244). lor oxamplo, sharoholJors havo no right to soll corporato proporty
on thoir ovn: thoy Jologato such povors to thoir agonts, managors. That
alono makos sharoholJing a Jilloront kinJ ol ovnorship lrom vhat tho
common sonso ol tho vorJ Joscrilos. But sharoholJors havo an out: thoy
can soll thoir sharos. As Borlo anJ Voans saiJ, stock markots aro a moans
lor translorming thoso oxpoctations into cash, vhich is vhy tho markot is
a local point in tho corporato systom ol toJay` (p. 248). ll thoro voro no
markot to lot thom out ol a position ouickly anJ choaply, alsontoo ovnors
voulJ think tvico alout assuming thoir strango rolo.
Borlo anJ Voans spoko ol invostors as supplying capital to corpora-
tions, anJ arguoJ that tho markots` provision ol liouiJity allovs thom to
got this monoy lack on a momont`s notico at no oxponso to tho corpora-
tion. But stock invostors raroly supply lunJs to tho corporations thoy ovn:
vith raro oxcoptions, thoy`ro simply luying sharos issuoJ long ago lrom
GOVERNANCE
255
othors vho lought thom in tho samo mannor. So tho social Jivision ol
lalor that Borlo anJ Voans Joscrilo - lotvoon tho proviJors ol capital
vho aro tho roal risktakors anJ tho managors vho aro largoly insulatoJ
lrom risk - is too llattoring to tho rontior.
Thoir charactorization ol stockholJors as ontiroly passivo is ouaint. Whilo
Borlo anJ Voans JiJ acknovloJgo a Jisciplinary rolo lor stock pricos in
gonoral - lirms that vant to raiso oouity capital havo to cultivato tho mar-
kots` lavor - thoy allovoJ lor no Jiroct assortion ol sharoholJor inllu-
onco on managomont. Ouito tho contrary: thoy JoscriloJ tho rolation
lotvoon stockholJors anJ tho moJorn lirm as lunJamontally casual.
lor proporty to lo oasily passoJ lrom hanJ to hanJ, tho inJiviJual rolation
ol tho ovnor to it must nocossarily play littlo part. lt cannot lo JoponJont
lor its continuoJ valuo upon his activity. Consoouontly, to translato prop-
orty into liouiJ lorm tho lirst roouisito is that it JomanJ as littlo as possillo
ol its ovnor.... |lll proporty is to locomo a liouiJ |sicl it must not only lo
soparatoJ lrom rosponsilility lut it must locomo imporsonal - liko lago`s
purso: `tvas mino, tis his, anJ hath loon slavo to thousanJs` (p. 250).
lmporsonal, alionatoJ proporty, oasily parcoloJ out anJ passoJ arounJ:
vhat an alluring moJol ol socioty.
TI~ Mu~:u :j:uI:u uuu P:::uI~ P:j~:I) olloroJ a rothink ol tho
notion ol prolit (p. 300). By ollicial Jolinitions, prolit is tho rovarJ lor
risk-taking anJ a spur to ollicioncy. What thon vill motivato moJorn man-
agors? Although thoy control tho paco ol innovations in proJuction, any
vinJlall prolits thoy might gonorato vill mostly lo passoJ on to stock-
holJors. ll managors Jo innovato, thoy aron`t proporly rovarJoJ: anJ il
thoy knov thoy von`t lo proporly rovarJoJ, thoy may shirk at innova-
tion. Buroaucracy, JisporsoJ ovnorship, anJ complox anJ contraJictory
sots ol incontivos haJ roplacoJ tho clarity ol tho ovnor-managor ol yoro.
Borlo anJ Voans (p. 245) rathor oxcossivoly calloJ this an approach to-
varJ communist moJalitios.`
lronically, this lino ol thinking has gono out ol lashion vith tho capital-
ist triumphalism ol rocont yoars, vhoso prolorroJ moJo has loon tho col-
olration ol tho ontropronour. Ol courso, right-ving iJoologuos anJ
pullicists havo cololratoJ smallor lirms anJ JomoanoJ Jinosaurs liko lBV,
lut tho grip ol giant lirms on tho U.S. oconomy - anJ incroasingly on tho
glolal oconomy - has harJly loon loosonoJ.
Thoso iJoas JiJn`t originato vith Borlo anJ Voans. A contury anJ a hall
oarlior, AJam Smith (196, Book 2, pp. 264-265) haJ this to say alout tho
WALL STREET
256
joint-stock company (a ouoto that`s a staplo ol tho corporato govornanco
litoraturo, anJ this chaptor vill lo no oxcoption):
Tho Jiroctors ol such companios, loing tho managors rathor ol othor pooplo`s
monoy than ol thoir ovn, it cannot lo voll oxpoctoJ that thoy shoulJ vatch
ovor it vith tho samo anxious vigilanco vith vhich tho partnors in a privato
copartnory lroouontly vatch ovor thoir ovn. Iiko tho stovarJs ol a rich
man, thoy aro apt to consiJor attontion to small mattors as not lor thoir
mastor`s honor, anJ vory oasily givo thomsolvos a Jisponsation lor having
it. Nogligonco anJ prolusion, thoroloro, must alvays provail, moro or loss,
in tho managomont ol tho allairs ol such a company.
Smith maJo this sounJ liko tho Joom ol capitalism, somothing tho corpo-
rato lorm has olviously not lrought alout.
Borlo anJ Voans thomsolvos citoJ Walthor Pathonau`s olsorvations,
Jravn lrom Gorman oxporionco, that ovnorship haJ loon Joporsonal-
izoJ,` anJ tho ontorpriso itsoll haJ loon oljoctilioJ` into an inJopon-
Jont lilo, as il it lolongoJ to no ono.. |Thisl loaJs to a point vhoro tho
ontorpriso locomos translormoJ into an institution vhich rosomllos tho
stato in charactor` (p. 309). This proliguroJ Borlo anJ Voans: Smith`s ol-
sorvation roaJs moro liko an oarly vorsion ol moJorn rontior thought.
Writing in 1896, Horlort Sponcor (192) notoJ that tho Jovolopmont ol
tho croJit systom haJ allovoJ proJuction to lroak loyonJ tho limits ol
inJiviJual ovnors or small partnorships, a Jovolopmont that also maJo
availallo lor inJustrial purposos, numlorloss savings vhich othorviso
voulJ havo loon iJlo.. |Sltagnant capital has almost JisappoaroJ.` Stag-
nant capital is no capital at all: Sponcor moant that monoy hoarJs that
might havo lostoroJ in isolation can, ly virtuo ol tho moJorn systom, lo
translormoJ into capital. But, as ho`J vritton 30 yoars oarlior in Pailvay
Vorals anJ Pailvay Policy,` tho joint-stock structuro is rich vith opportu-
nitios lor mischiol. Tho systom roproJucos all tho laults ol political Jo-
mocracy, Sponcor arguoJ: just as thoro aro tromonJous gaps lotvoon votors
anJ thoir roprosontativos, sharoholJors havo littlo olloctivo control ovor a
lirm`s Jiroctors anJ managors, anJ Jiroctors anJ managors rosont any ox-
prossion ol suporvisory intorost. Iiko thoir prototypo, joint-stock compa-
nios havo thoir oxponsivo oloction contosts, managoJ ly oloction
committoos, omploying oloction agonts: thoy havo thoir canvassing vith
its sunJry illogitimato accompanimonts: thoy havo thoir occasional manu-
lacturo ol lrauJulont votos.` Whilo moJorn lav has maJo outright lrauJ
oxtromoly raro, in loth tho political anJ corporato aronas, Sponcor`s Jo-
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257
scription romains an accurato charactorization ol tho corporato proxy con-
tost. Tho Jilliculty ol running an oloctoral challongo to corporato manago-
mont givos tho small organizoJ party` a groat aJvantago ovor tho largo
unorganizoJ ono.` SharoholJors aro JillusoJ throughout tho vholo king-
Jom, in tovns anJ country housos: knoving nothing ol oach othor, anJ
too romoto to cooporato voro thoy acouaintoJ.` Thoy knov nothing alout
lusinoss, anJ aro, in most casos, incompotont to juJgo ol tho ouostions
that como loloro thom.` Sponcor paintoJ this unllattoring picturo ol tho
typical railvay`s ultimato ovnors:
|Elxocutors vho Jo not liko to tako stops involving much rosponsilility:
trustoos loarlul ol intorloring vith tho proporty unJor thoir caro, lost pos-
sillo loss shoulJ ontail a lavsuit: viJovs vho havo novor in thoir livos
actoJ lor thomsolvos in any allair ol momont: maiJon laJios, aliko norvous
anJ innocont ol all lusinoss knovloJgo: clorgymon vhoso Jaily Jisciplino
has loon littlo calculatoJ to mako thom acuto mon ol tho vorlJ: rotiroJ
traJosmon vhoso rotail transactions havo givon thom small alility lor grasp-
ing largo consiJorations: sorvants possossoJ ol accumulatoJ savings anJ
crampoJ notions: vith sunJry othors ol liko holploss charactor - all ol thom
ronJoroJ moro or loss consorvativo ly ignoranco or timiJity, anJ propor-
tionatoly inclinoJ to support thoso in authority. To thoso shoulJ lo aJJoJ
tho class ol tomporary sharoholJors, vho, having lought stock on spocula-
tion, anJ knoving that a rovolution in tho Company is likoly to Jopross
pricos lor a timo, havo an intorost in supporting tho loarJ irrospoctivo ol
tho gooJnoss ol its policy.
Don`t managors anJ sharoholJors sharo an intorost in maximizing prolits?
No, Sponcor saiJ: managors may havo no long-torm intorost in tho lirm,
lut may lonJ its allairs to maximizo thoir porsonal prolits rathor than tho
lirm`s. Sponcor joins Smith as a procursor ol moJorn rontior thought.
Borlo anJ Voans maJo tho samo point alout managorial opportunism
in thoir conclusion: tho mon in control ol a corporation can oporato it in
thoir ovn intorosts, anJ can Jivort a portion ol tho assot lunJ or incomo
stroam to thoir ovn usos,` anJ tho sharoholJors aro sociologically anJ
logally povorloss to stop this. HaJ thoy stoppoJ horo, Borlo anJ Voans
voulJ havo lit nicoly into tho proto-rontior crovJ. But, accorJing to thom,
instoaJ ol trying to strongthon tho rights ol passivo sharoholJors,` tho
community` coulJ chooso to rolax classic notions ol proporty rights. Out-
right plunJor shoulJ lo provontoJ, lut tho community must also assort its
rights, anJ tho corporation must lo govornoJ in tho largor intorosts ol
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258
socioty. ShoulJ tho corporato loaJors, lor oxamplo, sot lorth a program
comprising lair vagos, socurity to omployoos, roasonallo sorvico to thoir
pullic, anJ stalilization ol lusinoss,` tho sharoholJors shoulJ accopt tho
hit to prolits guarantooJ ly this high-minJoJ program. Corporato control,
thoy concluJoJ, shoulJ Jovolop into a puroly noutral tochnocracy, lal-
ancing a varioty ol claims ly various groups in tho community anJ assign-
ing to oach a portion ol tho incomo stroam on tho lasis ol pullic policy
rathor than privato cupiJity` (pp. 312-313). Economic govornmont voulJ
como to rosomllo classic Amorican intorost-group politics.
Vainstroam oconomics acknovloJgoJ tho translormations outlinoJ ly

Borlo anJ Voans, lut claimoJ that thoy JiJn`t mattor much. Compotitivo
proJuct markots anJ tho throat ol takoovor assuroJ tho lasic classical no-
tions ol tho lirm (insolar as tho lirm vas thoorizoJ at all) still applioJ to
largo, managor-JominatoJ lirms as voll as small ontropronourial units. Tho
lirm as llack lox ossontially survivoJ loth Coaso anJ Borlo anJ Voans.
OutsiJo mainstroam oconomics, hovovor, managorialism holJ groat
svay, ovon on much ol tho lolt. As Baran anJ Svoozy (1966, pp. 15-16)
saiJ in MujI) uj:IuI, in tho moJorn giant corporation, control rosts
i n t ho hanJs ol managomont. .. a sol l-porpotuati ng group` vi th
|rlosponsilility to tho loJy ol stockholJors...a JoaJ lottor.` Thoy JismissoJ
lashionallo propaganJa ol tho 1950s anJ 1960s - liko Borlo`s, among
othors - alout hov tho soullul corporation` haJ como to lalanco social
rosponsilility vith prolit making, arguing to tho contrary that moJorn lirms
aro il anything lottor positionoJ to maximizo prolits than tho smallor onos
ol yoro, locauso ol longor planning horizons. ln thoir moJol, invostmont
lunJs aro almost ontiroly intornally gonoratoJ (vhich thoy still aro), anJ
thoroloro lirms aro largoly inJoponJont ol tho linancial soctor (vhich thoy
still aron`t). Whilo Baran anJ Svoozy rightly notoJ tho incroJillo oxponso
ol intormoJiation - tho army ol high-paiJ lrokors, agonts, anJ lankors
- its rolo vas largoly unoxaminoJ: instoaJ, linanco vas roJucoJ to an
alsorlor ol surplus,` anJ JismissoJ in loss than throo pagos (Baran anJ
Svoozy 1966, pp. 139-141).
lor lilorals ol tho 1960s, tho scripturo vas Gallraith`s (196198) N~u
1uuu:I::uI IuI~ To Gallraith, tho stockholJors voro vostigial, a puroly
pocuniary association` JivorcoJ lrom managomont, too numorous anJ
JisporsoJ to havo any inlluonco (Gallraith 196198, pp. 1-9, 138).
Whon JisploasoJ vith thoir` corporation, thoy voulJ soll tho stock rathor
than pick a light vith managomont. StockholJor rolollion among largo
corporations vas so raro that it can lo ignoroJ,` locauso troullo-lroo
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259
prolitalility vas tho norm. Ol courso, managomont tolJ Congrossional
committoos that tho loarJ anJ tho stockholJors voro in control, anJ con-
JuctoJ yoarly mootings to llattor tho nominal ovnors, lut Gallraith`s cor-
poration vas run ly tho tochnostructuro.
Unliko Baran anJ Svoozy, Gallraith JismissoJ prolit maximization as
tho goal ol tho giant lirm in lavor ol tho grovth in salos anJ prostigo. To
thrivo, it nooJoJ not maximum prolits, lut a socuro minimum ol oarn-
ings` that voulJ koop it lrom having to tap troullosomo capital markots
or copo vith JomanJing outsiJo stockholJors (pp. 151-152). Socuro mo-
Jiocrity vas tho iJoal. Tho tochnostructuro haJ littlo to gain lrom high
prolits, vhich voulJ only lo passoJ along to sharoholJors, anJ might
ovon ontail highor risk - risk that coulJ Jisturl managorial autonomy.
His tochnocrats voro moJostly paiJ, anJ managorial componsation vas
JivorcoJ lrom tho stock prico. |Tlho caso lor maximization ol porsonal
roturn ly top managomont is not strong` (p. 108). Grovth in rovonuo,
hovovor, vas a suro routo to groving povor, prostigo, anJ omploymont:
Expansion ol output moans oxpansion ol tho tochnostructuro itsoll` (p.
15). Tho totom ol salos grovth vas magnilioJ on tho national lovol in tho
sanctilication ol rapiJ GDP grovth as tho onJ ol all oconomic activity.
But, varnoJ Gallraith, any lapso in grovth coulJ lo catastrophic. His
roasoning is illuminating in light ol rocont miJJlo-managomont layolls.
Costs can no longor lo roJucoJ simply ly laying oll lluo-collar vork-
ors.` Tho tochnostructuro haJ locomo a major cost-contor, in moJorn jar-
gon, anJ coulJ not lo roJucoJ piocomoal, lut voulJ havo to lo loppoJ
oll in vast svathos. Worso, tho tochnostructuro voulJ havo to mako tho
Jocision to attack itsoll - to liro ono`s lollov clul momlors. Such actions
voulJ not havo tho agrooallo imporsonality vhich is associatoJ vith lir-
ing somoono at a groator Jistanco or ol a Jilloront social class` (p. 158).
Iiko Borlo, lut unliko Baran anJ Svoozy, Gallraith arguoJ that tho largo
corporation haJ locomo sulsorviont to socioty anJ tho stato. Govornmont
stalilizoJ tho oconomy, proviJoJ a skilloJ vorklorco, anJ sot tho strato-
gic tono lor tho national oconomy. Planning anJ aJministration, a joint
vonturo ly largo lirms anJ tho stato, haJ roplacoJ markot rolations. Stock-
holJors haJ locomo passivo anJ lunctionloss, romarkallo only in his
capacity to sharo, vithout ollort or ovon vithout approciallo risk, tho gains
lrom tho grovth ly vhich tho tochnostructuro moasuros its succoss` (p.
356). Tho (Koynos-ochoing) outhanasia ol stockholJor povor,` along vith
tho suporsossion ol tho markot mochanism ly tho stato anJ tho tochno-
structuro, haJ locomo accoptoJ lacts ol lilo` (p. 35). Gallraith loJgoJ
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260
aosthotic oljoctions to this nov rogimo - it maJo ugly citios anJ vulgar
aJs - lut its political anJ oconomic triumph soomoJ socuro.
EJvarJ Horman`s 1981 stuJy, linancoJ ly tho Tvontioth Contury lunJ,
vas a svan song ol managorialism. BasoJ on 190s Jata, Horman lounJ
U.S. lirms to lo ovorvholmingly unJor managorial control, vith a stoaJy
Joclino in control ly lamilios, linancial intorosts, anJ outsiJo corporations
sinco tho 1920s. Citing vork ly PicharJ Pumolt, Horman nonotholoss ro-
joctoJ Gallraith`s claims alout tho JiminishoJ rolo ol prolit maximiza-
tion, arguing that tho moJorn corporation`s JocontralizoJ prolit contors,`
inJiviJual units rosponsillo lor prolit anJ loss to top managomont, voro a
lorm ol Jiroct scrutiny that coulJ lo ovon moro intonso than tho loss im-
moJiato prossuros ol proJuct markots. Sonior managors ol U.S. corpora-
tions olton run thom as a sort ol hothouso capital markot, vith Jivisions
compoting aggrossivoly lor tho allocation ol capital lrom hoaJouartors.
Vanagorialism, liloral anJ Varxist, sharoJ a loliol that compotition vas
a thing ol tho past. Stallo oligopolios anJ managorial rationality haJ ro-
placoJ tho anarchy ol 19th contury Iu:::~z-Ju::~ ln somo sonso, this vas
an accurato Joscription ol tho vorlJ, particularly tho UnitoJ Statos, in tho
1950s anJ 1960s. lt coasoJ to lo truo ly tho 190s. Tho conglomoratization
movomont ol tho lato 1960s thrust Wall Stroot into tho romaking ol corpo-
rato Amorica: noithor vostigial nor passivo, linancial oporators playoJ loarJ
gamos vith vholo companios. Tho rocossion ol 193-5, thon tho vorst
sinco tho 1930s, shattoroJ conliJonco anJ vas tho lirst viov ol a nov
nastinoss in tho oconomic tono that voulJ charactorizo tho noxt 20 yoars.
U.S. lirms voulJ sullor tho lito ol compotition lrom Japan anJ Europo,
smashing tho Gallraithian iJyll. Tho Joop loar markot ol 193-4, tho
lirst act ol sovoral yoars ol sluggish-to-avlul stock markots, loJ to massivo
sharoholJor Jisappointmont anJ a lrosh vavo ol takoovor activity, tho
lirst sinco tho 1960s. Vanagorialism vas unJor siogo.
Aux arnes, renliers!
Early U.S. manilostations ol lank or linancial control thoorios voro tho
hoartlanJ populism ol tho miJJlo anJ lato 19th contury, vhich vas Ji-
roctoJ against tho railroaJs anJ tho linanciors lohinJ thom. This populist
traJition vas pickoJ up ly tho muckrakors ol tho turn ol tho contury, vho
llastoJ StanJarJ Oil, Vorgan, anJ tho othor sphoros ol inlluonco` (Ayala`s
Bank-Sphoros school). ln 1913, tho lamoJ Pujo Committoo ol tho U.S.
Houso ol Poprosontativos uncovoroJ a systom ol intorlocking Jiroctoratos
anJ othor lorms ol inlluonco contoroJ arounJ six major lanks: J.P. Vor-
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261
gan 8 Co.: lirst National Bank ol Nov \ork: tho National City Bank ol
Nov \ork: Ioo, Higginson 8 Co.: KiJJor PoaloJy: anJ Kuhn, Iool. Tho
lankors` control ovor croJit to tho giant ontorprisos in thoir orlit gavo
thom control ovor tho commanJing hoights ol tho U.S. oconomy, croating
signilicant larriors to ontry lor thoso outsiJo tho circlo. This is tho purost
lorm ol lankor control thoory. Iator analysts, incluJing Paul Svoozy in
tho 1930s, maJo similar inlluonco maps, though not alvays vith tho samo
namos anJ positions. Svoozy`s moJol vas not lank-contoroJ, lut ho JiJ
incluJo a lank in oach ono ol his oight major groups. Only a lov yoars
lator, hovovor, Svoozy JociJoJ that linancial povor haJ JoclinoJ Juring
tho Doprossion (Ayala 1989), anJ ly tho 1960s, linanco largoly JisappoaroJ
lrom MujI) uj:IuI lt roappoaroJ, though, in tho pagos ol Svoozy`s
MuIII) R~::~u starting in tho 190s. This oscillating thoorotical rolo lor
linanco is a rolloction ol historical tronJs, rathor than conlusion or incon-
sistoncy: it`s rolroshing to vatch a thoorist chango vith tho timos rathor
than catochistically stick to a singlo moJol anJ lonJ tho lacts to lit.
lntorost in linancial control, or at loast inlluonco, logan to grov across
tho iJoological spoctrum. ln tho mainstroam, Baum anJ Stilos (1965), spioJ
a groving potontial lor linancial povor that vas as yot unoxorcisoJ. Altor
tho 1968 pullication ol a roport ly tho Houso Banking Committoo, Jotail-
ing tho ovnorship ol largo llocks ol stock ly tho trust Jopartmonts ol tho
major Nov \ork City lanks, thoorios ol linancial control onjoyoJ a ronais-
sanco on tho lolt, notally tho long, look-longth sorios in c:uI::I R~:Iu-
I:u ly Polort litch anJ Vary Opponhoimor (190) anJ tho lator look ly
DaviJ Kotz (198) - a look that ovos a groat Joal to litch anJ
Opponhoimor. Vost Varxists rojoctoJ tho litchOpponhoimor thosis -
that tho Nov \ork lanks voro oxorting incroasing control ovor inJustrial
Amorica, anJ that managorialism vas JoaJ - vith groat vohomonco.
ln a rosponso to litch anJ Opponhoimor, Paul Svoozy (192) ansvoroJ
tho ouostion ol thoir titlo, vho rulos tho corporations?` vith a simplo
Joclaration: monopoly capital rulos tho corporations, incluJing not only
inJustrials anJ utilitios lut also lanks anJ othor prolit making institutions.`
lolloving Varx`s lormula that tho capitalist is tho porsonilication ol capi-
tal, Svoozy arguoJ that monopoly capital vas porsonilioJ ly monopoly
capitalists, that is, tho inhalitants ol tho oxocutivo suitos anJ loarJrooms
ol Amorica`s giant corporations.` AccorJing to Svoozy, thoro vas no con-
llict lotvoon linancial anJ inJustrial intorosts: laithlul to Ionin anJ
HillorJing, ho arguoJ instoaJ that monopoly capital vas tho union ol li-
nanco anJ inJustry into a singlo ontity. Tho giant corporation, vith its
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262
Jozons ol sulsiJiarios anJ Jivisions, vas moro a linancial loing, not un-
liko a stock portlolio, than tho simplo proJuctivo unit run Jiroctly ly an
olJ-stylo inJustrialist. ll linanco voro soparato lrom anJ Jominant ovor
inJustry, Svoozy askoJ, vhy JiJ tho lorJly linanciors allov Gonoral Vo-
tors to sot up a sulsiJiary to linanco vohiclo purchasos (tho Gonoral Vo-
tors Accoptanco Corp., or GVAC)?
Thoro`s no ouostion that tho largo lortuno 500-class inJustrial corpora-
tion is run on linancial principlos, that its lusinoss units aro olton Jooply
involvoJ in linanco - Gonoral Eloctric has a vory activo linancial arm, GE
Capital: tho othor lig auto companios havo largo units liko GVAC: anJ all
tho lamiliar rost. But thoro`s also no ouostion that in rocont yoars puroly
linancial intorosts havo incroasingly assortoJ thoir inlluonco ovor thoso
hylriJizoJ giant corporations.
Kotz outlinoJ sovoral stagos in tho ovolution ol linanco`s rolationship
vith nonlinancial corporations. Tho lirst, lotvoon tho Civil War anJ WorlJ
War l vas charactorizoJ ly lirst tho promotion ol railroaJs anJ thon thoir
sulsoouont roorganization, vith tho holp ol Europoan capital, anJ thon
tho promotion ol tho lig inJustrial trusts - all unJor tho guiJing hanJ ol
lankors. Tho noxt porioJ, vhich ran through tho 1929 crash, vas markoJ
ly a tronJ tovarJs institutionalization anJ avay lrom strong inJiviJual
lankors, anJ tho intornational translormation ol tho U.S. lrom lorrovor
to lonJor. During tho Nov Doal, tho lankors voro on tho run, llamoJ lor
tho slump anJ linJing thomsolvos unJor closor scrutiny anJ tightor rogu-
lation. No ono nooJoJ tho invostmont lankors oithor: largo corporations
linancoJ thomsolvos, oithor through prolits or Jiroct Joals vith institu-
tions, anJ tho loJoral Poconstruction linanco Corp. usurpoJ a groat part
ol tho lunctions ol vhat in an oconomic sonso is invostmont lanking,` in
tho vorJs ol a Wall Stroot partnor (ouotoJ in Carosso 190, p. 395). Altor
WorlJ War ll, hovovor, Kotz arguoJ, thoro vas a rosurgonco ol lankor
povor, loJ ly insuranco companios, mutual lunJs, anJ, most important,
tho trust Jopartmonts ol commorcial lanks.
Unlortunatoly, Kotz turnoJ to tho olJ moJol ol groups, though ho
coulJn`t JociJo vhothor tho groups voro JominatoJ ly thoir lanks, vith
tho inJustrial momlors sulorJinato, or il thoy roprosontoJ a lusion ol com-
mon intorosts. Kotz`s classilication schomo vas this: a Chaso group, con-
sisting ol tvo commorcial lanks, Chaso Vanhattan anJ Chomical, anJ
tvo insuranco companios, Votropolitan Iilo anJ tho Eouitallo: a Vorgan
group, consisting ol tvo commorcial lanks, Vorgan Guaranty anJ Bank-
ors Trust, tho PruJontial insuranco company, anJ tvo invostmont lanks,
GOVERNANCE
263
Vorgan, Stanloy anJ Smith, Barnoy: a Vollon group, consisting ol
Pittslurgh`s Vollon Bank anJ tho invostmont lank lirst Boston: anJ a
Iohman-GolJman, Sachs Group, consisting ol thoso tvo olJ-lino (pro-
Jominantly Jovish, in contrast to tho WASPy poJigroo ol tho othor groups)
invostmont lanks (Kotz 198, p. 85). Whilo tho caso lor such alliancos has
loon Jillicult to mako sinco tho Nov Doal rolorms ol tho 1930s, tho con-
copt looks hopolossly out ol Jato in tho 1990s. Iong-torm rolationship
lanking lroko apart loginning in tho lato 190s: customors anJ lankors
nov shop arounJ lor tho lost Joal rathor than rospocting long-torm lusi-
noss tios: portlolio managomont loutiouos havo oclipsoJ lank trust Jo-
partmonts in monoy managomont: anJ ovnorship changos havo
translormoJ tho supposoJ intorost-group lanJscapo. PruJontial lought
Bacho in tho oarly 1980s to havo its ovn in-houso invostmont lank anJ
Jistrilution notvork lor ollloaJing somo ol its ovn linancial holJings:
Smith Barnoy is nov a sulsiJiary ol tho Travolors insuranco company:
lirst Boston is ovnoJ ly a Sviss lank: anJ Iohman has loon lought anJ
solJ sovoral timos.
Kotz vas also unallo to arguo porsuasivoly that linancial control maJo
much Jilloronco. Ho claimoJ that corporations unJor linancial control voro
likoly to maximizo prolits, vith porhaps a lit moro caution than thoy might
othorviso - moro liko olJ-lino capitalist lirms than tho soullul` man-
agor-run corporations ol high liloral thoory (Kotz 198, pp. 143-144). Ho
lurthor arguoJ that linancial control moant a groator concontration ol oco-
nomic anJ political povor than toxtlook myths alout compotitivo mar-
kots anJ JisporsoJ povor. Whilo this is unJonially truo, largo managor-run
corporations also givo tho lio to toxtlook myths - it`s harJ to roconcilo
tho roal GV vith tho toxtlook imago ol tho passivo, prico-taking corpora-
tion aJapting to markot conJitions - anJ Kotz`s claims alout tho oxor-
ciso ol monopoly povor ly lanks voro largoly spoculativo anJ unprovoJ.
Kotz anJ litch anJ Opponhoimor voro virtually alono in tho 190s in
arguing lor a major linancial rolo in tho govornanco ol lig lusinoss.
Vanagorialism haJ largoly von tho thoorotical argumont anJ it soomoJ
ompirically voll-grounJoJ, too.
Things in tho miJ-1990s, hovovor, aro anothor story ontiroly. ToJay`s cor-
porato vorlJ loars littlo rosomllanco to that JoscriloJ ly Gallraith, Baran
anJ Svoozy, anJ Horman: sharoholJors aro lar loss passivo, loarJs loss
rullor-stampish, anJ managomonts loss autonomous than at any timo sinco
WALL STREET
264
Borlo anJ Voans. Sinco tho oarly 1980s, inlluonco lrom tho linancial sphoro
has loon groator than at any timo sinco tho 1920s.
lt`s not so much that tho managorialists voro vrong. Thoir Joscriptions
anJ analysis voro right lor thoir timo, lut tho corporato vorlJ has changoJ
onormously ovor tho past 20 yoars. Thoro vas littlo conllict lotvoon man-
agors anJ stockholJors Juring tho GolJon Ago, anJ it ovon soomoJ pos-
sillo that vagos coulJ incroaso stoaJily vithout oating into prolits. Iargo
lirms coulJ lohavo as ouasi-monopolios, raising pricos vhon costs roso,
controlling tho paco ol tochnical chango, anJ llocking ontry ol compoti-
tors. Nov that GolJon Ago is gono. Grovth is supprossoJ through tight
monotary anJ liscal policy, tochnical chango is rapiJ, companios as granJ
as lBV anJ GV can stumllo, vagos havo loon lorcoJ Jovn to oxpanJ
prolits, anJ compotition is oncouragoJ vorlJviJo ly Jorogulation anJ
markot-oponing policios. Tho ovnors - stockholJors, Wall Stroot, vhat-
ovor you vant to call thom - havo oncouragoJ thoso changos in tho intor-
osts ol controlling inllation anJ loosting tho pricos ol linancial assots.
Thoir control isn`t proominont: managors havo rosistoJ stockholJor intor-
loronco, though vorkors havo lost noarly ovory lattlo. Vanagorialism anJ
tho vostigial rolo ol tho stockholJor voro historically contingont loaturos
ol tho GolJon Ago, not tho markors ol a nov phaso ol capitalism.
linancial control` is an aJmittoJly improciso torm, oncompassing a
vholo spoctrum ol inlluoncos. lts classic U.S. usago rolors to tho takoovor
ol inJustrial lirms ly lankor-oporators liko J.P. Vorgan, luying up an
important sharo ol its socuritios anJ taking soats on tho loarJ. Whon a
lirm vas VorganizoJ,` thoro vas no ouostion alout vho controlloJ it,
vhatovor tho lormal linancial anJ managorial structuros. Whilo that kinJ
ol Jiroct lankorly control vas lannoJ ly tho linancial rolorms ol tho 1930s,
thoro aro somo inJustrial lirms that voro takon ovor Juring tho 1980s,
lrought unJor tho control, il not ovnorship, ol lovoragoJ luyout lou-
tiouos liko Kohllorg Kravis Polorts anJ lorstman, Iittlo - though lor tho
most part this troatmont vas rosorvoJ lor lirms lolov lortuno 500 sizo. ln
many, porhaps most, casos, thoso voro not intonJoJ as pormanont ar-
rangomonts: tho iJoa vas to tako tho company pullic again at a lator Jato
at a groat prolit to tho luyout artisans - oithor locauso thoy managoJ to
achiovo nov ollicioncios thanks to thoir managorial gonius anJ tho Jisci-
plinary ollocts ol Jolt, or locauso an intorminallo lull markot voulJ sim-
ply accommoJato thom prolitally through tho moro passago ol timo.
lnlluonco nooJ not lo so Jiroct as outright ovnorship. Tho classic toxt-
look oxplanation ol tho povor ol linanco is that invostors anJ lankors
GOVERNANCE
265
scrutinizo lirms vhon thoy sook outsiJo monoy, oithor Jolt or oouity. Cor-
tainly this is tho caso, lut inlluonco nooJ not lo ovon this Jiroct. Vanagors
may simply tako a cuo lrom tho prico ol thoir lirm`s stock, or liston to tho
aJvico ol analysts anJ invostors alout vhat courso thoy coulJ tako to
loost it. Also, most largo corporations havo roprosontativos ol lanks anJ
insuranco companios sitting on thoir loarJs, lut ol courso thoir Jogroo ol
inlluonco is loth Jolatallo anJ variallo.
Such linancial loarJmomlors may only oxort thoir inlluonco at critical
momonts. As Kovin Dolanoy (1992, pp. 69-1) pointoJ out, John SchrooJor,
a rotiroJ vico-chair ol J.P. Vorgan vho sorvoJ on tho Johns-Vanvillo loarJ,
vas instrumontal in pushing tho lirm to lilo lor lankruptcy vhon lacoJ ly
mounting logal claims lor oxposing its vorkors anJ customors to aslos-
tos. (Vorgan haJ sorvoJ as Vanvillo`s loaJ lank lor ovor 50 yoars.) Bank-
ruptcy protoctoJ tho assots ol tho company against claims ol tho litigants,
alloving tho croJitors not only to lo ropaiJ in lull, lut also to lonJ Vanvillo
lrosh monoy at high intorost ratos. StockholJors voro noarly vipoJ out,
anJ tho aslostos victims` avarJs voro strictly cappoJ. Tho moral - tho
corporato govornanco moral, that is, loaving asiJo tho stingy troatmont ol
tho injuroJ - is that tho linancior on tho loarJ may lo ouiot vhon things
aro going voll, lut in a crisis, ho or sho may lo a crucial playor.
Tho Johns-Vanvillo oxamplo may lo a moJol ol tho lroaJor upsurgo
ol linancial inlluonco: linanciors may havo loon satislioJ vith corporato
porlormanco Juring tho GolJon Ago, lut moro rocont JocaJos havo loon
tho oconomy-viJo oouivalont ol an aslostos crisis. This might lo a gooJ
timo to tako a look at rocont thoorios ol corporato govornanco.
Starting in tho miJ-190s, Vichaol Jonson, Chicago-school lollov travollor
nov at HarvarJ, logan Jovoloping a linanco-lasoJ thoory ol corporato
govornanco that voulJ locomo inlluontial in tho 1980s. Though it took
somo timo to ovolvo to lull riponoss, Jonson`s argumont is, in a phraso, that
stockholJors can`t trust tho managors thoy`vo hiroJ to run thoir corpora-
tions, anJ a raJical roalignmont is in orJor.
ln 196, Jonson anJ his collalorator William Vockling trioJ to luilJ a
lormal moJol rolating linancial structuro anJ managorial porlormanco. As
vith most lormal moJols, thoir inJilloronco curvos anJ B(X
'
)`s voro luilt
on a sorios ol simplilying assumptions. Iisting thoso ol Jonson anJ Vockling
shoulJ rominJ lay roaJors just hov strango thoso oxorcisos can got (num-
lors omittoJ):
WALL STREET
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All taxos aro zoro.
No traJo croJit is availallo.
All outsiJo oouity sharos aro non-voting.
No complox linancial claims such as convortillo lonJs or prolorroJ stock
or varrants can lo issuoJ.
No outsiJo ovnor ovor gains utility lrom ovnorship in a lirm in any vay
othor than through its olloct on his voalth or cash llovs.
All Jynamic aspocts ol tho multiporioJ naturo ol tho prollom aro ignoroJ
ly assuming thoro is only ono proJuction-linancing Jocision to lo maJo
ly tho ontropronour.
Tho ontropronour-managor`s monoy vagos aro holJ constant throughout
tho analysis.
Thoro oxists a singlo managor (tho poak coorJinator) vith ovnorship intor-
ost in tho lirm.
Evory ono ol thoso assumptions violatos roality. Among tho moro glaring
violations: taxos oxist prominontly: not traJo croJit to nonlinancial corpo-
rations vas ovor $340 lillion at tho onJ ol 1995: it`s a raro corporation that
issuos nonvoting sharos: timo is continuous anJ onJlossly complicating,
sinco toJay`s laJ Jocision can haunt managors lor yoars: thoro aro many
layors ol managomont lonoath tho poak coorJinator.`
Iot`s sot thoso rosorvations asiJo, hovovor, anJ oxploro Jonson`s vorlJ.
No mattor vhat you think ol his ansvors, Jonson anJ his collalorators -
Vockling, horo - havo askoJ somo important ouostions alout a social
institution that is commonly accoptoJ as part ol tho lanJscapo, tho largo
joint-stock corporation: Hov Joos it happon that millions ol inJiviJuals
aro villing to turn ovor a signilicant lraction ol thoir voalth to organiza-
tions run ly managors vho havo so littlo intorost in thoir vollaro? What is
ovon moro romarkallo, vhy aro thoy villing to mako thoso commitmonts
puroly as rosiJual claimants, i.o., on tho anticipation that managors vill
oporato tho lirm so that thoro vill lo oarnings vhich accruo to tho stock-
holJors?` ln plainor English, vhy, in a vorlJ that runs on soll-intorost, Jo
inJiviJual anJ institutional sharoholJors ontrust tho managomont ol tho
corporations that thoy logally ovn to strangors? AnJ vhy Jo thoy arrango
it so that thoy, as stockholJors, aro tho last in lino to lo paiJ, altor suppli-
ors, croJitors, anJ omployoos?
lt`s a marriago ol convonionco, ol courso, anJ, tho nov critiouo asiJo,
it`s loon a succosslul ono. lor ono, it makos sonso lor inJiviJual ontropro-
nours vho striko it rich to tako thoir companios pullic, accumulato linan-
GOVERNANCE
267
cial capital, anJ put thoir oggs into laskots othor than thoir ovn.
8
AnJ just
locauso invostors havo monoy Joosn`t moan thoy havo tochnical anJ or-
ganizational skills: in an oconomy charactorizoJ ly tho rolontloss sulJivi-
sion ol lalor, it`s no surpriso thoy hiro holp to run tho proportios. But ovor
timo tho rontior lunction has locomo institutionalizoJ anJ tho holp has
ovolvoJ into tho prolossional managors ol tho moJorn transnational cor-
poration. Thoso tvo groups can lo oxpoctoJ to havo aroas ol Jisagroo-
mont. ln tho traJo, this is knovn as principal-agont conllict.
Jonson anJ Vockling spont a lot ol timo laying out tho agoncy costs ol
tho soparation ol ovnorship anJ control lor largo U.S. corporations. Van-
agors vill typically try to pampor thomsolvos loloro passing along Jivi-
JonJs to tho logal ovnors: tho Jonson-Vockling moJol actually lormalizos
this as X - x
1
, x
2
,.,x
n
- a voctor ol ouantitios ol all lactors anJ activitios
vithin tho lirm lrom vhich tho managor Jorivos non-pocuniary lonolits,
such as ollico spaco, air conJitioning, thicknoss ol tho carpots, lrionJli-
noss ol omployoo rolations, otc.` - porks. Calling thom porks voulJ look
unsciontilic: Jisguising thom as a voctor lonJs tho prostigo ol mathomatics
to thoso oasily soJucoJ ly sulscripts. To minimizo pork-gralling, croJi-
tors anJ stockholJors roouiro oxplicit, lroouont linancial roporting anJ
outsiJo auJits, anJ also tinkor onJlossly vith tho vays ol paying sonior
managors so as to proviJo tho right mix ol punishmont anJ rovarJ. On
tho othor hanJ, oxocutivos aro suspicious that outsiJo stockholJors anJ
croJitors aro alvays trying to soconJ-guoss thom, or cramp thoir manago-
rial stylo. Vanagors anJ claimants inovitally koop a vary oyo on oach
othor: tho oxponso ol Joing so is knovn as agoncy costs.
Vanagors, Jonson anJ Vockling arguoJ, voulJ manago in tho intorost
ol tho outsiJo claimants il thoy holJ liggor stakos in tho companios. (lt`s
assumoJ that stockholJors` intorosts aro paramount.) Exocutivos` Jolt anJ
stock holJings shoulJ lo ovonly lalancoJ, to assuro thoy novor try to ro-
varJ or scrov ono class ol holJors at tho oxponso ol tho othor (liko risky
vonturos that might ollor a lig stock payoll, lut coulJ loaJ to Jolault on
tho lonJs, or cautious invostmonts that guarantoo stoaJy intorost paymonts
lut coulJ loro stockholJors). Jonson`s ultimato sympathios aro vith risk:
in vhat voulJ lator locomo an olsossion, ho anJ Vockling arguoJ that
stock options shoulJ lo an important part ol a top managor`s pay, vhich
in olloct givo him |sicl a claim on tho uppor tail ol tho outcomo Jistrilu-
tion` - a lig porsonal payoll il tho stock looms. Unspokon is tho as-
sumption that stock pricos rolially prico managorial Jocisions: Jonsonito
thoorios ol govornanco rost on olliciont markot thoory. ll tho markot sots
WALL STREET
268
pricos inolliciontly, thon companios vill somotimos vrongly got takon ovor
anJ managors vill somotimos lo unlairly ovorpaiJ (as opposoJ, l guoss,
to normal timos vhon thoy`ro lairly ovorpaiJ).
But Jonson haJn`t yot truly varmoJ to his suljoct. Dospito all tho vorJs
anJ lormulas JovotoJ to tho costs ol agoncy, his collaloration vith
Vockling onJoJ vith this Jolonso ol tho status ouo: Tho grovth in tho
uso ol tho corporato lorm as voll as tho grovth in markot valuo ol ostal-
lishoJ corporations suggosts that at loast, up to tho prosont, croJitors anJ
invostors havo ly anJ largo not loon JisappointoJ vith tho rosults, Jo-
spito tho agoncy costs inhoront in tho corporato lorm.`
Earlior in tho papor, tho authors haJ JismissoJ vhat voulJ lator lo
calloJ lovoragoJ luyouts, a transaction vhoso primary acaJomic cololrant
vas tho lator Jonson. lt voulJ lo possillo, Jonson anJ Vockling arguoJ, to
oliminato agoncy costs il sharoholJors solJ lirms to managors, vho linancoJ
thoir purchaso ol 100/ ol tho lirm`s stock vith Jolt anJ porsonal voalth.
Sinco this raroly happons, thoy roasonoJ, thoro must lo somo compolling
roasons vhy. Among thoso roasons, thoy concluJoJ, voro a rational vari-
noss on tho part ol croJitors, vho voulJ vorry that managors voulJ tako
lig gamllos, hoping lor lig payolls that, shoulJ thoy not arrivo, voulJ
groatly incroaso tho risk ol Jolault, ovon lankruptcy. Provonting thoso
risks voulJ groatly incroaso tho croJitors` agoncy costs, sinco thoy`J havo
to koop managors unJor constant scrutiny to mako suro thoy voron`t play-
ing roulotto vith tho croJitors` monoy.
Jonson changoJ his minJ in tho 1980s, locoming tho scourgo ol tho
pullic corporation anJ tho typical CEO. A papor vritton just sovon yoars
lator vith PicharJ Pulack (Jonson anJ Pulack 1983) cololratoJ tho vir-
tuos ol tho markot lor corporato control as a markot in vhich altornativo
managorial toams compoto lor tho rights to manago corporato rosourcos.`
This markoJ a shilt, saiJ Jonson anJ Pulack, lrom tho classic viov in vhich
stockholJors hiroJ anJ liroJ managomont:
|Tlho managorial compotition moJol instoaJ viovs compoting managomont
toams as tho primary activist ontitios, vith stockholJors (incluJing institu-
tions) playing a rolativoly passivo.juJicial rolo.. |SltockholJors in this
systom havo rolativoly littlo uso lor JotailoJ knovloJgo alout tho lirm or
tho plans ol compoting managomont toams loyonJ that normally usoJ lor
tho markot`s prico sotting lunction. StockholJors havo no loyalty to incum-
lont managors: thoy simply chooso tho highost Jollar valuo ollor lrom thoso
prosontoJ to thom in a voll-lunctioning markot lor corporato control.
GOVERNANCE
269
ln this vorlJ, ovorything is constantly up lor auction. lt assumos that
tho markot` - vhich it`s concoJoJ is populatoJ ly playors vith no spo-
cial oxportiso in tho lusinossos thoy havo at thoir morcy - can valuo oach
managomont slato`s cash-gonorating potontial prosciontly, anJ that this
constant turmoil has no harmlul olloct on proJuction. Why ovoryono
shoulJ turn somorsaults to satisly passivo, almost vostigial, stockholJors
is ono ol tho groat unoxploroJ mystorios ol Jonsonism: tho stock markot is
alvays axiomatically tho ultimato arlitor ol social gooJ.
Jonson (1986a) turnoJ up tho hoat just throo yoars lator, arguing thon
that it vasn`t onough to chango managors: managors haJ to lo put unJor
a nov Jisciplinary structuro. Dospito tho prossuros ol compotitivo proJuct
markots, tho lossos ol lig, pullic corporations vasto monoy on unpro-
Juctivo (that is, unprolitallo) oxponJituros liko porks, invostmont, anJ
P8D - monoy that shoulJ instoaJ lo pipoJ to sharoholJors. lroo cash
llov` vas tho prollom, anJ Jonson`s Jolinition is vorth ouoting:
lroo cash llov is cash llov in oxcoss ol that roouiroJ to lunJ all projocts
that havo positivo not prosont valuos vhon JiscountoJ at tho rolovant cost
ol capital. Conllicts ol intorost lotvoon sharoholJors anJ managors ovor
payout policios aro ospocially sovoro vhon tho organization gonoratos sul-
stantial cash llov. Tho prollom is hov to motivato managors to Jisgorgo
tho cash rathor than invosting it at lolov tho cost ol capital or vasting it on
organzation |::cl inollicioncios.
Jonson`s Jolinition sounJs moro prociso than it roally is. Cash llov anJ
cost ol capital aro rolativoly oasy to liguro - though Jilloront analysts vill
como up vith Jilloront moasuros lor oach.
9
JuJging luturo projocts is tho
roally tricky lit: it assumos lirms can knov hov much monoy a projoct
can oarn. Ol courso thoy novor can. ln practico, ono can Jo littlo lut ox-
trapolato lrom tho past, lut that`s not roally tho samo thing.
Still, ouilllos asiJo, Jonson vas roally onto somothing. Vany lig lirms
havo moro monoy than thoy knov vhat to Jo vith - or, moro strictly
spoaking, havo moro monoy than thoy can invost in thoir lasic lusinossos
at a roasonallo prolit - a moro colloouial Jolinition ol lroo cash llov.
10
Vargarot Blair anJ Vartha Schary (1993a anJ 1993l) ostimatoJ lroo cash
llov lor 18 anJ thon 1 inJustrial soctors. Thoy usoJ historical Jata on
prolitalility, vhich isn`t puro Jonson, lut that`s alout all you can Jo, sinco
ono can`t Jivino tho luturo. Thoy lounJ a sharp souoozo on lirms, vith
prolitalility roughly llat lut vith a sharp incroaso in tho cost ol capital
lrom tho 190s into tho 1980s, tho rosult mainly ol sustainoJ high intorost
WALL STREET
270
ratos. As tho cost ol capital roso - tho rato ol roturn roouiroJ ly invostors
unJor orthoJox linanco thoory - lirms coulJ justily only tho highost-
prolit (anJ ono might assumo ouickost paylack, though Blair anJ Schary
Jon`t say this) projocts. As thoy put it, Tho oxpoctoJ prolitalility ol luturo
invostmonts loll just as tho prolitalility roouiroJ ly tho capital markots
climloJ to unprocoJontoJ highs.. |llrom 1982 through 1989 tho U.S.
corporato soctor vas caught up in an opiJomic ol lroo cash llov` (Blair
anJ Schary 1993a, p. 128). ln tho miJ-1990s, it looks liko thoy aro onco
again, lut thoy`ro Joing Jilloront things vith tho monoy nov lrom vhat
thoy JiJ in tho 1980s.
Jonson`s (1986a) ansvor vas to loaJ up thoso lirms vith Jolt - a nico
irony, sinco a lroaJ anJ sustainoJ JomanJ lor lrosh Jolt vill push intor-
ost ratos highor than thoy voulJ othorviso lo, thoroly making ovon moro
cash llov lroo.` Jonson olloroJ a nico rationalo lor Wall Stroot`s liloration
ol ovor moro cash llov. Unliko stock, vhich allovs managors to pay vhat
thoy liko to sharoholJors, high Jolt lills lonJ` managors to pay out a
stoaJy stroam ol cash, rathor than vasting rosourcos on lov-roturn
projocts.` Vanagors shoulJ also rocoivo a largo sharo ol thoir componsa-
tion in tho lorm ol stock, to mako thom think anJ act liko sharoholJors.
As tho JocaJo voro on, Jonson cololratoJ tho aJvont ol a nov lorm -
tho IBO (lovoragoJ luyout) association (Jonson 1989a). Tho largo pullic
company vas OK, Jonson saiJ, in groving soctors liko computors, liotoch,
anJ linanco. But olJor inJustrios -tiros, stool, chomicals, lroving, lroaJ-
casting, tolacco, pulp anJ papor proJucts nov, anJ aorospaco, cars, lank-
ing, oloctric utilitios, machinory in tho luturo - nooJ to lo translormoJ
through lovorago anJ ovnorship. ln an IBO, a group ol invostors, olton
along vith a lirm`s sonior managomont, tako a company privato ly going
Joop into Jolt. Tho stock typically Joosn`t traJo on a pullic oxchango -
though occasionally a small stul` ol sharos is lolt ovor anJ continuos to
traJo oponly - lut is holJ tightly ly tho circlo ol invostors.
11
Tho Jisci-
plino ol Jolt anJ tho potontial vast rovarJs lrom holJing tho stock voulJ
inspiro managors to horoic loats ol accumulation.
This is a markoJ turnalout lrom tho Jonson ol 196, vho haJ saiJ (vith
Vockling) that tho pullic corporation soomoJ to lo horo to stay, arguing
ovon that IBOs voro porvorso anJ risky. AskoJ ly omail to oxplain this
raJical turn in his thinking, Jonson roplioJ: What happonoJ vas that tho
Jata logan to inJicato ouito cloarly that tho systom vas not vorking OK.
That tho inollicioncios voro in lact just as vo haJ soon thom in thoory, lut
tho markots took a vhilo to aJjust. That aJjustmont is still taking placo.`
GOVERNANCE
271
Jonson ospocially cololratoJ IBOs onginooroJ ly loutiouos liko
Kohllorg Kravis Polorts (KKP) anJ Clayton 8 Dulalior: ontropronours`
liko Carl lcahn, PonalJ Porolman, lrvin Jacols, anJ Warron Bullott: mor-
chant lanking arms ol Vorgan Stanloy anJ IazarJ lroros: anJ lamilios
liko tho Pritzkors anJ Bronlmans. Thoso lino pooplo - tho lorgotton stars
ol tho largoly lorgotton 1980s - shoulJ lo trustoJ to run corporato Amorica
liko a stock portlolio, lrom thoir thinly stalloJ (20 to 60 pooplo) homo
ollicos, translorming tho inJustrial citios ol yostoryoar into ghost tovns.
With all its vast incroasos in Jata, talont, anJ tochnology, Wall Stroot can
allocato capital among compoting lusinossos anJ monitor anJ Jisciplino
managomont moro olloctivoly than tho CEO anJ hoaJouartors stall ol tho
typical JivorsilioJ company. KKP`s Nov \ork ollicos anJ lrvin Jacols` Vin-
noapolis laso aro Jiroct sulstitutos lor corporato hoaJouartors in Akron
anJ Pooria.
Tho iJoal arrangomont, tho IBO Association, vas a vonturo among throo
constituoncios`: tho sponsoring loutiouo: sonior managomont vith a largo
oouity stako: anJ tho lig institutional invostors vho lunJ tho Joals. Jonson
also cololratoJ tho groat innovation pionooroJ` ly Droxol Burnham Iam-
lort, tho junk lonJ - lov-ratoJ, high-risk, high-intorost-rato Jolt that
povoroJ tho cololrity Joals ol tho 1980s. Thanks to Droxol`s Jistrilution
notvork, tho coasolossly innovativo Vichaol Vilkon, sitting at his X-shapoJ
Josk in Bovorly Hills, coulJ invont a Joal anJ placo tho lonJs nocossary
to linanco it in tho Wall Stroot oouivalont ol ovornight. His notvork ol
S8Is, insuranco companios, mutual lunJs, anJ rich inJiviJuals, supportoJ
in no small part ly thoir Ponzi-liko proponsity lor luying oach othors`
papor, vas thoro lor his tapping.
KKP vas tho prototypo lor Jonson`s nov corporato lorm. ln tho oarly
yoars altor its lirth on Vay Day 196, KKP JiJ moJost Joals, locusing on
smallish companios (Bartlott 1991).
12
Tho partnors voulJ approach a lirm,
porsuaJo tho managors to lorrov a lunch ol monoy, anJ jointly luy tho
lirm. Thoy maJo suro thoro vas plonty ol Jaylight lotvoon tho cash com-
ing in anJ tho intorost paymonts going out. ll all vont voll, tho nov ovn-
ors, lull ol incontivo anJ onorgy, voulJ rovivo tho company, anJ proparo
it lor salo somo yoars Jovn tho roaJ at vast prolits. Tho schomo vorkoJ
liko magic. As tho yoars progrossoJ, tho partnors lustoJ altor liggor anJ
liggor Joals. To sving thoso, thoy nooJoJ lig outsiJo lacking, anJ thoy
got it, though it took somo timo to convinco tho hyporcautious that lovor-
ago coulJ lo so prolitallo. As oarly as livo yoars altor KKP`s lounJing,
WALL STREET
272
thoir invostors incluJoJ PruJontial, Aotna, GE`s ponsion lunJ, Votropoli-
tan Iilo, J.P. Vorgan, anJ Northvost Vutual. Iator on, thoy`J rocruit tho
Orogon, Washington, anJ Wisconsin stato ponsion lunJs, among othors.
So Jospito its guorrilla-ish imago, KKP vas lackoJ ly tho innormost circlos
ol linanco joinoJ ly tho rotiromont monoy ol pullic soctor vorkors.
KKP`s oarly yoars voro spoctacular. Tho livo major luyout lunJs, orga-
nizoJ ovor 198-86, paiJ annual prolits ol ovor 32/ to thoir invostors
(Bartlott 1991, p. 346). But tho 1989 lunJ, vhich JiJ tho PJP luyout, vas a
turkoy, roturning a moro 4/ (Sloan 1994). Tho nov corporato lorm lailoJ
tho crucial tost: Jolivoring sustainoJ prolits to its invostors. Tho pullica-
tion ol Sarah Bartlott`s (1991) look, vhich portrayoJ KKP as putting its
ovn intorosts lar ahoaJ ol thoso ol its invostors anJ its stallo ol compa-
nios, to put it gontly, JiJ littlo to lurthor tho luyout loutiouo`s roputation.
Back, though, to Jonson anJ his manilosto. lt Jrov a llizzarJ ol ro-
sponsos, mainly lrom anti-Jonsonitos. Ono, lrom Potor Pna (1989), hoaJ
ol tho lBJ SchroJor Bank 8 Trust in Nov \ork, maJo sovoral points vorth
ouoting - anJ Pna`s position as a linancior rathor than an inJustrialist
makos his commonts ospocially intorosting. lirst, Pna arguoJ that Jonson
grossly ovorstatoJ tho sharoholJors` caso. ln roturn lor limits on thoir li-
alility (thoy can soo tho valuo ol thoir stock vipoJ out, lut tho rost ol thoir
assots can`t lo attachoJ), sharoholJors givo up tho right to Jisposo ol cor-
porato proporty on thoir ovn: thoy can soll tho sharos, lut not tho lirm`s
assots. By making tho sharoholJor sacrosanct, Jonson proomptoJ any
thoughtlul analysis ol tho vory ouostion that is at tho hoart ol tho issuo -
vhat :IuIu lo tho rights anJ privilogos ol sharoholJors?` SoconJ, tho
IBO is lasoJ on tho roJistrilution toJay ol cash llovs oxpoctoJ tomor-
rov anJ loyonJ: il thoso ostimatos aro vrong, thon tho pullic sharoholJ-
ors vho aro lought out in an IBO havo tho cash anJ ovoryono olso is lolt
vith a carcass.` But sharoholJors aro in tho gamo only to maximizo valuo:
having consummatoJ this goal, thoy tako protty much tho samo viov ol
tho corporation as tho praying mantis Joos ol hor mato.` linally, Jonson
assumoJ that sharoholJors aro lottor juJgos ol capital projocts than aro
managors anJ corporato loarJs - an iJoologically inspiroJ assortion
that lacks ompirical support.` As Pna says, it`s harJ to imagino hov ono
voulJ go alout tosting this ompirically, lut tho lurJon is on Jonson` to
tako on tho task, sinco ho has alroaJy roportoJ tho rosults.`
Jonson`s (1989l) rosponso to Pna vas ovasivo, olloring littlo to rolut
tho chargos against him. Jonson JiJ, hovovor, holplully list somo lorcos
ho viovoJ as olstaclos to oconomic progross: striking Eastorn Air Iinos
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pilots, Pittston Coal minors, |anJl Nov \ork Tolophono omployoos, vho
soom porloctly contont to Jostroy or Jamago thoir omployor`s organiza-
tion vhilo attompting to sorvo thoir ovn intorosts. Palph NaJor`s consumor
activist organization is anothor oxamplo.` (lt`s a nico irony that pullic
omployoo ponsion lunJs voro usoJ to smash somo ol Jonson`s impoJi-
monts to progross.) Tho only sulclass ol Jonson`s socioty to havo a claim
on corporations, it`s cloar, aro sharoholJors: vorkors (managors among
thom) anJ consumors sorvo only at tho ovnors` ploasuro.
Ono ol tho most intorosting statomonts Jonson maJo on tho appropri-
atonoss ol sharoholJors to this groat social task is actually somothing ho
lorgot to say. DolonJing tho PJP Nalisco Joal - tho lloatoJ climax ol tho
1980s mania, tostimony that his horo Honry Kravis vas as vainglorious as
any cash-lurning CEO - Jonson (1991) pointoJ to tho lirm`s immonso
vasto ol monoy on porks, sports promotions, anJ unproJuctivo capital
oxponJituros anJ organizational inollicioncios.` To that phraso is apponJoJ
lootnoto 4:
As rovoaloJ in tho look |1u:Iu::uu: uI II~ uI~ (Burrough anJ Holyar
1990, pp. 30-31)l, John Grooniaus, hoaJ ol |CEO Possl Johnson`s laking
unit, tolJ KKP that il tho oarnings ol this group go up 15 or 20/.l`J lo in
troullo.` His chartor vas to sponJ tho oxcoss cash in his Nalisco Jivision to
limit oarnings in orJor to proJuco moJorato, lut smoothly rising prolits -
a stratogy that voulJ mask tho potontial prolitalility ol tho lusinoss..
SounJs liko a porloct oxamplo ol managorial vasto - tho kinJ ol plannoJ
moJiocrity ovokoJ in Gallraith`s N~u 1uuu:I::uI IuI~. But curiously, Jonson
lailoJ to roport tho roason lor this prolit-masking, rovoaloJ right altor tho
ollipsis: lt vas all Jono, Grooniaus oxplainoJ, locauso Wall Stroot cravoJ
proJictalility.` Whon unproJictallo things happon, Wall Stroot comos
unhingoJ - olliciont markot thoory, vhich Jonson onco lamously JoscriloJ
as tho lost-ostallishoJ principlo in all tho social scioncos, to tho contrary.
Iu:~IIu~:: voro rosponsillo lor plannoJ moJiocrity at PJP Nalisco,
somothing it voulJ lo vory Jamaging lor Jonson to aJmit.
Throo lootnotos lator, Jonson (1991, p. 15) got vorkoJ up ovor Susan
laluJi`s (1990) Pulitzor-prizo-vinning
13
WuII I:~~I {u:uuI pioco on tho
IBO ol Salovay, tho grocory chain, anothor KKP Joal. Tho Joal, rogarJoJ
as ono ol tho lovorago movomont`s groat succossos, lrought $28 million in
stock prolits anJ $100 million in options to top Salovay oxocs, $65 million
to tho invostmont lankors, anothor $25 million to lavyors, anJ $60 million
in up-lront loos lor KKP - anJ pay cuts anJ unomploymont lor Salovay
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vorkors. laluJi`s talos ol suiciJo, hoart attack, impovorishmont, anJ Jo-
spair among vorkors JisplacoJ altor tho luyout voro nothing comparoJ
to long-run ollicioncy ollocts` (Jonson 1991, p. 15). To JuJo Wanniski
(1990), tho laluJi pioco vas puro anJ simplo propaganJa, tho vork ol
an iJoologuo using tho {u:uuIs lront pago to propagato a spocilic opin-
ion alout hov corporato Amorica shoulJ conJuct its allairs.` Wanniski, ol
courso, is tho supply-siJo iJoologuo vho onco usoJ tho {u:uuI oJitorial
pago to propagato a spocilic opinion on hov Amorica shoulJ conJuct its
liscal allairs, ono that all lut a hanJlul ol unroconstructoJ maniacs nov
rogarJ as a Jisastor.
A moro Jispassionato stuJy ol a Joal Jonson also lovoJ, this ono lrom a
lusinoss school anJ not a lusinoss novspapor, also shovoJ harsh ollocts
on vorkors. Wayno IanJsman anJ Douglas ShackollorJ (1993) roportoJ
that ol tho 2,209 vorkors vho lost thoir jols altor tho PJP luyout, 2/ ro-
ontoroJ tho vorklorco at 4/ ol thoir pro-luyout vagos, that vomon voro
moro laJly hurt than mon, anJ olJor omployoos hurt moro than youngor.
To tho luyout apologist, thoso aro not nocossarily laJ things: thoy voulJ
prolally lo takon as oviJonco that PJP vas ovorstalloJ anJ its vorkors
ovorpaiJ, a vasto ol monoy that rightly lolongs to sharoholJors. An IBO
is a lorm ol class strugglo.
BosiJos lalor, naturo too sulloroJ lrom tho luyout loom. ln ono stuJy
ol 62 hostilo takoovor liJs lotvoon 1984 anJ 1986, lor oxamplo, an im-
portant targot vas lumlor lirms vho voro not cutting onough timlor givon
tho intorost rato, tho grovth rato ol troos, anJ tho prico path lor timlor.`
Tho inlamous Vaxxam takoovor ol Pacilic Iumlor vas inspiroJ ly lallov
olJ roJvooJs that tho lattor voulJn`t cut. Vaxxam, povoroJ ly junk, took
ovor Pacilic Iumlor anJ liouiJatoJ tho troos. Thinking liko oconomists,
Sanjai Bhagat, AnJroi Shloilor, anJ Polort Vishny (1990, p. 54), JoclaroJ
that vo havo a caso in vhich cutting tho troos raisos ollicioncy.` AnJ il
troos aro not sacrilicoJ at tho rato JictatoJ ly intorost ratos, thon Wall Stroot
is loing choatoJ ol lroo cash llov.
Pising to a highor thoorotical pitch in his oarly 1990s vork, Jonson lik-
onoJ tho nov IBO associations` - thoso vith a KKP-liko loutiouo at tho
contor - to Japanoso ~::~I:u, vhich aro groups ol associatoJ lirms vith
a largo lank at thoir contor (Jonson 1991). But thoro aro important Jillor-
oncos lotvoon ~::~I:u anJ tho lalloJ constollation ol IBOs. As Jonson
concoJoJ, Japanoso managors Jon`t ovn stock (anJ aro ouito moJostly
paiJ ly U.S. stanJarJs), lut in his IBO iJoal, stock voulJ lo tho main
lorm ol managomont componsation.
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Actually tho ovnorship structuro ol ~::~I:u is ouito intriguing, anJ somo-
thing markot socialists as voll as social markot typos shoulJ stuJy.
14
Thoro
is a lank at tho contor ol oach group, lut tho lank is not tho controlling
lactor: group momlors aro al so hoavy holJors ol thoi r lol lov
groupmomlors` sharos. Thoro aro also oxtonsivo loarJ intorlocks, vith
tho main lank typically having a loarJ prosonco as voll. Though mom-
lors Jo lusinoss - ovon linancial lusinoss - vith lirms outsiJo tho group,
thoy also Jo major lusinoss vith oach othor. Cloarly thoso aro complox
organizations vith Joop linancial, porsonal, anJ tochnical tios, not tho
narrov ovnor-ovnoJ rolation charactoristic ol Jonson`s IBO associations.
Thoso cross-holJings anJ intorlocks linJ tho lirms togothor, oach koop-
ing an oyo on tho othors: thoy chock lor timolinoss ol Jolivory, proJuct
ouality, lovol ol invostmont` - roal, tolling signs ol corporato hoalth that
voulJ oluJo Jistant sharoholJors (Borglol anJ Porotti 1994) . ln a crisis,
group momlors como to tho aiJ ol a troulloJ lirm, vith tho lank coming
in only in caso ol a moro sorious crisis (typically solvoJ through rostruc-
turing or lorcoJ morgor). Tho Japanoso torm lor rociprocal sharoholJings,
uIu:I:: ucI:u:, has tho moaning ol mutual holp, sharoJ intorJopon-
Jonco, anJ stalility.` ln tho nonoconomic litoraturo, tho sharos aro troatoJ
as oxprossions ol mutual trust - signs ol tho rolationship, not tho rola-
tionship itsoll. Dospito tho alsonco ol tho takoovor throat, managors in
troulloJ lirms aro noatly romovoJ - porhaps moro so than tho U.S. ln tho
Japanoso caso, main lanks also proviJo important linanco - tho oppo-
sito omphasis ol an IBO matrix, vhich oxists to Jolivor a lat stroam ol
intorost paymonts to tho sponsors. Borglol anJ Porotti also thoorizo that
having tho lank as tho rosponsillo party ol last rosort is an oxcollont Jis-
ciplino on tho group, locauso tho lank must vorry alout kooping Jopos-
its. ll tho lirms unJor its oyo Jo laJly, thon Jopositors may shilt thoir
monoy olsovhoro.
15
Thoso tios aro nov loosoning unJor tho prossuro ol
tho long rocossion that hit Japan altor its lulllo lurst in 1989. lt vill lo
intorosting to soo hov an oconomic rocovory comlinoJ vith Japanoso
govornmont commitmonts to lurthor linancial Jorogulation vill translorm
corporato anJ linancial structuros in tho lato 1990s.
ln his moro rocont vork, Jonson (1993) has incroasingly omphasizoJ
lunJamontal tochnological, political, rogulatory, anJ oconomic lorcos`
as tho sourco ol 20 yoars ol intonso lusinoss anJ social uphoaval: Joop
roJuctions in tho costs ol proJuction, Jorogulation, glolalization,` ro-
JucoJ grovth ratos in lalor incomo, oxcoss capacity, anJ - ultimatoly -
Jovnsizing anJ oxit.` Jonson oxplainoJ tho 1895-1904` morgor loom as
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276
a lorm ol such oxit - tho Jostruction ol capital through comlination, as
capacity vas roJucoJ through tho consoliJation anJ closuro ol marginal
lacilitios in morgoJ ontitios.` That`s loon happoning again in tho 1980s
anJ 1990s. This is a gloomior mossago than his talo ol tho 1980s - moro
omphasis is placoJ on shrinkago than rovival - lut it`s prolally a moro
accurato picturo ol vhat V8A is all alout.
His social mossago is ovon harshor. Tho stross ol this Nov lnJustrial
Povolution vill placo strains.on vorlJviJo social anJ political systoms.`
IuJJitos or marching armios ol tho unomployoJ coulJ throaton tho loau-
tilul rovolution anJ might havo to lo mot vith samo militia` that sul-
JuoJ` tho IuJJitos. Tho harsh moJicino must lo takon: Wo nooJ look no
lurthor than contral anJ oastorn Europo or Asia to soo tho ollocts ol poli-
cios that protoct organizations lrom loroign anJ Jomostic compotition`
(Jonson 1993, p. 845). Unions must lo lrokon, omploymont maJo moro
tonuous, plants must lo closoJ - anJ U.S. corporato govornanco struc-
turos aro still not up to tho task. Tho crushing ol Droxol, tho rogulatory
murJor ol tho junk lonJ markot, tho political lacklash against tho lovor-
ago artists lolt a vacuum in tho Jisciplinary structuro.
Dospito his latuous choorloaJing anJ callous sulorJination ol human
livos to ollicioncy, it must lo saiJ again that Jonson roally is onto somo-
thing important in moJorn Amorican capitalism, somothing that is olton
JonioJ ly his liloral anJ populist critics. Thoro is constant prossuro on
olJor lirms - anJ givon tho voakonoJ stato ol largo parts ol tho main-
lramo computor lusinoss, olJor` can lo JolinoJ protty lilorally - com-
ing loth lrom JomanJing rontiors anJ proJuct markot compotition. Givon
tho ovnorship anJ managomont structuro ol U.S. inJustry, thoro`s a con-
llict among stockholJors, managors, anJ vorkors ovor hov to manago
thoso strains. Wall Stroot voulJ liko to vithJrav capital lrom thoso inJus-
trios - slim thom Jovn or oliminato thom ontiroly - anJ pockot tho
monoy. ln high markot thoory, Wall Stroot can lo rolioJ upon to roJoploy
this liloratoJ capital lonolicontly, anJ tho souoozoJ inJustrios vill oithor
Jiscovor a lountain ol youth unJor tho Jisciplino ol Jolt or Jio. Sinco tho
last 200 pagos ol this look havo arguoJ that Wall Stroot isn`t up to that
task, tho vholo linanco anJ govornanco structuro is calloJ into sorious
ouostion.
Tho groat aJvantago ol Jonsonism is that, vhon comlinoJ vith an un-
critical accoptanco ol tho olliciont markot roligion, it amounts to a unilioJ
liolJ thoory ol oconomic rogulation: all-knoving linancial markots vill
guiJo roal invostmont Jocisions tovarJs thoir optimum, anJ vith tho propor
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sot ol incontivos, ovnor-managors vill lollov this guiJanco vithout ros-
orvation. Vany ol Jonson`s critics, vhothor thoy knov or montion him ly
namo or simply rolor to tho 1980s` or Jovnsizing or corporato rostructur-
ing, havo no cohoront rosponso to tho prolloms ol ovorcapacity, olsolos-
conco, or lurious compotition. ln a timo vhon only tho lravo or loolish
Jaro criticizo capitalism itsoll, critiouos only ol a cortain stylo ol capitalism
aro all that can lo uttoroJ. ln tho 1990s, tho rhotoric has changoJ: nov it`s
tochnology` anJ glolalization` that aro JonouncoJ - lut tho analysis is
still narrovly Jravn anJ tho tono ol critiouo ooually timorous.
On a loss granJ noto, anothor virtuo ol Jonson`s vork is that it chal-
longos tho VV thoorom. Whothor you vant to omphasizo tho positivo as-
pocts ol Jolt - its povors to inspiro inJoltoJ managors - or its nogativo
onos - tho povor to lankrupt othorviso hoalthy corporations - linan-
cial structuro cloarly mattors, anJ mattors a lot.
Jonsonism is a spocial caso ol a lroaJor concopt knovn as tho liouiJ mar-
kot lor corporato control. Truo roligionists loliovo that vhilo tho stock
markot imposos a cortain Jisciplino on managomont - il you loliovo in
olliciont markot thoory, thon tho stock prico is a roal-timo roport carJ on
corporato managomont - moro markot pricos aro not onough in oxtromo
casos. ll tho stock prico gots lov onough anJ managomont is unvilling or
unallo to rosponJ, thon tho ultimato sanction lor incompotonco is a tako-
ovor, actual or throatonoJ. An IBO can lo thought ol as ono lorm ol this
Jisciplino, lut it can tako many othor lorms.
A lanJmark in tho ovolution ol this lino ol thinking vas Honry Vanno`s
(1965) papor Vorgors anJ tho Varkot lor Corporato Control.` Tho soconJ
part ol that titlo, olton moJilioJ vith liouiJ,` vas a commonplaco ol tho
1980s popular anJ acaJomic litoraturo, almost all ol it cololratory. Tho
cololration roachoJ an oxtraorJinary pitch as tho lovorago loom poakoJ
in 1989. Ono moasuro ol that mania is a spooch JolivoroJ in January ol
that yoar ly Polorto VonJoza, thon tho VP lor V8A at tho Vorgan Bank.
Tho Vorgan, onco tho opitomo ol vhito-shoo proprioty, turnoJ moro ag-
grossivo as tho 1980s voro on. Altor praising tho liouiJ markot in corpo-
rato control, VonJoza (1989) olloroJ this rolloction:
Wo olton roaJ in tho pross ol roturns on oouity ol 800 to 900 porcont ovor a
tvo- or throo-yoar porioJ. Somohov tho lias has takon holJ that this is an
oxcossivo roturn, or that somoono is loing oxploitoJ. Wo loliovo that linan-
WALL STREET
278
cial luyors aro intolligontly using tho mothoJology that many stratogic cor-
porato luyors Jo not uso, anJ that tho roturns aro not oxcossivo: in lact,
thoy aro vory roasonallo. Tho linancial luyor is using lovorago in a croativo
anJ intolligont mannor.
Whatovor your moral philosophy, roturns ol 800-900/ aro not sustain-
allo. But sinco VonJoza`s argumont can lo tracoJ in part to Vanno`s ar-
ticlo, lot`s tako a look at it.
TracoJ only in part, though: noto VonJoza saiJ that linancial` luyors
rathor than stratogic corporato` luyors - that is, lankors anJ Joalmakors,
rathor than lirms in rolatoJ inJustrios. Vanno`s articlo vas in largo moa-
suro pitchoJ as an attack on thon-provailing antitrust Joctrino, vhich vas
inhiliting morgors among compotitors. But Vanno also haJ a largor point
to mako - that an opon soason on corporato managors vas a vay ol
ovorcoming tho prollom ol tho soparation ol ovnorship anJ control.
Vanno`s argumont vas lasoJ on olliciont markot thoory loloro it roally
haJ that namo, anJ tho conllation ol markot anJ oconomic notions ol
ollicioncy: A lunJamontal promiso unJorlying tho markot lor corporato
control is tho oxistonco ol a high positivo corrolation lotvoon corporato
managorial ollicioncy anJ tho markot prico ol sharos ol that company.`
Poor managomont makos lor a JoprossoJ stock, vhich makos lor riponoss
lor takoovor. Whilo acknovloJging in a lootnoto that markot pricos aro
suljoct to vhat lator voulJ lo calloJ noiso, Vanno concluJoJ, vith tho
usual thoological lorvor, that ovor somo porioJ ol timo it voulJ soom that
tho avorago markot prico ol a company`s sharos must lo tho corroct` ono.`
Thoso vith tho vit anJ capital (or at loast a lino ol croJit) to tako aJvan-
tago ol this opportunity can mako onormous` roturns lrom tho succoss-
lul takoovor anJ rovitalization ol a poorly run company.` Antitrust Joctrino
anJ othor rogulations, Vanno claimoJ, voro impoJing tho molility ol
capital,` anJ thoroly a moro olliciont allocation ol rosourcos.`
Vanno vas a prolossor ol lav, anJ most ol his citations aro ol tho logal
litoraturo, lut his roasoning rolioJ on a thoory as puro as that ol VoJigliani
anJ Villor. Varkots aro olliciont, anJ ly GoJ, anything that gots in thoir
vay is tho onomy ol human progross. But Jo morgors vork tho magic ho
vas convincoJ thoy JiJ?
No, thoy Jon`t soom to. lirst, a lit ol history. Vorgors aro olton groupoJ
into lour major vavos - lrom 1898 to 1904, vhon tho moJorn giant cor-
poration took shapo, olton assomlloJ lrom many smallor lirms in tho samo
inJustry: tho 1920s, a porioJ ol lurthor consoliJation (or monopolization,
GOVERNANCE
279
in somo oyos): tho 1960s, tho porioJ vhon conglomoratos ol unrolatoJ
lusinossos voro lashionallo: anJ tho oarly 1980s to at loast tho momont in
1996 vhon thoso vorJs voro vritton, a porioJ Juring vhich many ol tho
conglomoratos voro lrokon apart, anJ comlinations lotvoon lirms in
tho samo or rolatoJ inJustrios proJominatoJ. Why morgors shoulJ occur
in vavos is listoJ in Broaly anJ Vyors` (1991, p. 923) linanco toxtlook as
ono ol tho 10 groat unsolvoJ mystorios ol tho liolJ. Whatovor tho ansvor
- tho orthoJox Jismiss oxplanations lasoJ on such voolly concopts as
manias` anJ lulllos,` lut that oxplanation sooms just lino to mo -
thoro`s no ouostion that morgors Jo tonJ to clustor.
lor a look at tho historical rocorJ ono coulJ Jo no lottor than a spocial
issuo ol tho 1uI~:uuI:uuI {u:uuI J 1uuu:I::uI :uu:zuI:u pullishoJ
in 1989. BaJ V8A porlormanco goos lack a long long vay. lor oxamplo,
Jospito Vanno`s complaints alout post-1929 rogulations intorloring vith
tho puro markot in corporato control, a stuJy ol 134 comlinations Juring
tho 1920s (Borg, Borg, anJ Ioith 1989) lounJ only moJost succoss,` vith
tho avorago prolitalility - moasuroJ ly stock porlormanco ol tho acouir-
ing lirms - littlo Jilloront lrom morgors Juring tho 1960s anJ 190s, Jo-
spito hugo Jilloroncos in tho oconomic anJ logal onvironmonts, incluJing
tho olloctivo susponsion ol antitrust onlorcomont altor 1920. Tho oarlior
morgors voro harJly a moJol: Borg 8 Co. ouoto a 1921 ovaluation ol tho
turn-ol-tho-contury morgor vavo that shovoJ that in only livo ol 35 casos
JiJ prolits moot or oxcooJ tho promisos ol tho promotors in tho JocaJo
lolloving tho comlination.
StuJios ol actual oporating rosults in a moro contomporary onviron-
mont shov similar Jisappointmonts. An oxamination ol loJoral TraJo
Commission rocorJs ovor tho porioJ lrom 195 to 19, vhich allovs lairly
JotailoJ stuJy ol actual linos ol lusinoss rathor than ontiro lirms, anJ lor
privatoly holJ lirms vith no pullicly traJoJ socuritios - loth oxcoptions
to tho rulo lor most morgor stuJios - shovoJ that prolits ol acouiroJ
lirms tonJoJ to Joclino sharply, a point conlirmoJ ly tho high rato ol
sulsoouont Jivostituros lor tho gollloJ-up units (Pavonscralt anJ Schoror
1989). That stuJy also shovs that prolits ol acouiroJ units voro olton un-
commonly high loloro tho morgor: thus,` tho authors concluJo, thoro is
no lroaJ-gaugoJ support lor tho inolliciont managomont Jisplacomont`
hypothosis that acouiroJ companios voro sulnormal porlormors.`
Pavonscralt anJ Schoror concluJoJ, in typically unJorstatoJ acaJomic stylo,
that tho oviJonco manJatos consiJorallo skopticism tovarJ tho claim
that morgors aro on avorago ollicioncy-onhancing.`
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280
Ono roason morgors turn out laJly is that acouiring lirms pay too much.
An oxamination ol 13 acouisitions Jono lotvoon 196 anJ 1984 shovoJ
that acouiring lirms paiJ vory optimistic pricos lor thoir proy: lair pricos
liguroJ on tho lasis ol provailing ratos ol roturn shovoJ that tho porlor-
manco gains nocossary to justily tho pricos paiJ in takoovors voro impos-
sillo to achiovo in normal inJustrial oxporionco (Allorts anJ Varaiya 1989).
A lroaJor roviov ol tho oviJonco ly PicharJ Cavos (1989) strongthons
skopticism tovarJ tho claim that morgors aro on avorago ollicioncy-on-
hancing.` Whilo thoro`s no Jonying that tho stockholJors ol targot lirms
onjoy lat prolits - thoy gain lrom tho luyors` ovorpaymonts - Cavos
concluJoJ that acouirors roalizoJ littlo prolit, anJ vhat thoy JiJ oltain
camo mainly in a privato lut not a social lorm.` That is, thoro`s no sorious
oviJonco that morgors aro gooJ lor tho alstraction knovn as tho
oconomy,` though partios to tho Joal occasionally mako out liko lanJits.
Cavos also citos British stuJios shoving littlo proJuctivity gain anJ lro-
ouont lossos coming lrom morgors - somothing ho attrilutos to transi-
tion costs,` incluJing managorial timo takon to mako tho marriago vork
anJ tho Jistractions to all omployoos vhilo ovoryono conjocturos on tho
courso ol tho axo`s Joscont.`
Whatovor thoir track rocorJ, morgors anJ takoovors Jo ollor vinJlalls
to stockholJors ol targot companios. Whoro Jo tho gains to stockholJors
in takoovors como lrom? Tho ouostion is not as silly as it may soom at lirst.
ll tho stock markot voro rationally valuing tho targot lirm thon vhy shoulJ
luyors pay signilicantly moro than tho provailing prico? ll acouirors Jo
ovorpay, anJ sharoholJors ol targot lirms roap a vinJlall, vho, il anyono,
losos? Vany stuJios havo como to many conclusions, lut tho stuJy ol hos-
tilo Joals in tho miJ-1980s ly Bhagat, Shloilor, anJ Vishny (1990) olloroJ
a protty convincing array ol possililitios. Thoy attrilutoJ somo rolo to lay-
olls - important lut not.Jominant`: moro important in thoir oyos voro
tax savings (a lyproJuct ol incroasoJ inJoltoJnoss): loss important voro
lossos to sharoholJors ol tho luying lirm (a ponalty ol ovorpaymont) anJ
cuts in invostmont ly tho targot lirm. Tho Jismantling ol conglomoratos
anJ morgors vithin inJustrios, thoy arguoJ, also rosultoJ in improvoJ por-
lormanco that comos vith spocialization, anJ possilly ovon incroasoJ
markot povor` (that is, monopoly pricing povor). lmportantly, though,
tho takoovor ora vas
not typically a rolloction ol a chango in tho intornal organization ol tho lirm.
Vanagomont luyouts anJ acouisitions ly raiJors aro olton a tomporary stop
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in tho roallocation ol assots: thoy aro not a nov pormanont organizational
lorm. Tho ovontual holJors ol assots aro largo pullic corporations, vhich
aro not alout to lo oclipsoJ (Bhagat, Shloilor, anJ Vishny 1990, p. 5).
Tho closing vorJs aro an allusion to Jonson`s (1989a) inlamously vrong
Hu::u:u 1u::u~:: R~::~u articlo Eclipso ol tho Pullic Corporation.`
ll morgors havo such a Jismal rocorJ, vhy Jo thoy happon? Thoro aro
sovoral thoorios, many ol thom prosontoJ vith tho usual comploxitios, lut
thoy all can lo loiloJ Jovn into simplo English. Euj::~-Iu:Iu:u Vanag-
ors lool richor anJ moro povorlul il thoir lirm is groving, anJ il tho lusi-
noss can`t grov ouickly on its ovn, thon thoy can golllo up othors. PolatoJ
to this is tho iJoa that vhilo morgors may not rosult in a highor rato ol
roturn (prolits JiviJoJ ly invostoJ capital), thoy may rosult in a highor
ouantity ol prolits, that is moro zoroos on tho lottom lino. HuI::: Whilo
tho avorago morgor may lo a Jog, ovory nov anJ thon ono can lo ox-
traorJinarily succosslul, anJ porpotrators aro convincoJ thoy can lo tho
lucky onos. P:uI~:: :uI~:~:I: Bankors vho act as matchmakors mako
ooJlos ol monoy, vith loos running arounJ 1/ ol tho valuo ol a largo
morgor (Du Boll anJ Horman 1989: Truoll 1995): lor a routino largo morgor,
this moans loos in tho scoros ol millions, JiviJoJ among a hanJlul ol lank-
ors anJ lavyors lor sovoral vooks` vorth ol aJmittoJly intonso vork.
16
TI~:~I:cuI II:uuu~:: Economists ropoat tho Vanno anJ Jonson mantras
locauso thoy uu:I lo truo, tho markot uu:I lo right, invostors uu:I lo
rational - all music to invostmont lankors` oars, ol courso.
Or, maylo morgors aro vays ol managing Joclino, ol vithJraving capital
anJ playors lrom a saggy soctor. ln this caso it shoulJ lo no surpriso that
morgors Jon`t Jo voll: ovon strong lirms in a Joclining inJustry aro still in
a Joclining inJustry. Tho mystory is that stock invostors still can`t liguro
this out vith a contury`s track rocorJ to stuJy.
lar lrom liguring it out, Anglo-Amorican capital markots soom moro
villing to lunJ grovth ly acouisition than through intornal grovth ly
ostallishoJ lirms, anJ thoy aro olton shy alout linancing startups. This
proloronco, vhich sooms charactoristic ol Anglo-Amorican stylo markots
anJ govornanco structuros, voulJ, it sooms roasonallo to concluJo, Jo-
pross invostmont lovols anJ oconomic grovth ratos. ln a stuJy ol British
lirms, Vanmohan S. Kumar (1984) lounJ that lirms linancoJ thoir intornal
grovth vith intornal rosourcos, turning to oxtornal linanco mainly lor ac-
ouisitions - acouisitions JiJ not in tho majority ol casos havo a lavourallo
impact on prolitalility` (p. 18). ll tho capital markots voro oxorcising
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282
thoir aJvortisoJ Jisciplinary lunction, that linanco shoulJ not havo loon
availallo, lut it vas.
Saying tho capital markots` havon`t liguroJ out tho llimsinoss ol most
morgor rationalos olscuros tho Jivisions lotvoon porpotrators anJ vic-
tims (tho rich victims, not thoso lonoath sorious consiJoration, liko Jis-
placoJ vorkors). Spocilically, invostmont lankors Jo thoir lost to zap tho
momorios ol thoir clionts. Vost V8A vavos aro povoroJ ly somo linan-
cial laJ: nov issuos ol vatoroJ stock at tho turn ol tho contury to linanco
tho trustilication ol vholo inJustrios: unsocuroJ Jolt instrumonts calloJ
Jolonturos (Chinoso papor`) usoJ as tho curroncy ol conglomoratization
in tho 1960s: junk lonJs usoJ to linanco tho lovoragoJ rocapitalizations in
tho 1980s. Tho logic lohinJ this oJJ anJ ovor-changing llooJ ol papor
vas oxplainoJ ly an anonymous invostmont lankor ouotoJ in TI~ 1~uI
1~cuu~ (Blair 1993, p. 298): Vost morgors Jo not mako sonso. Thoroloro
you havo to uso socuritios that tho luyors Jo not unJorstanJ anJ that aro
Jilloront lrom tho last rounJ ol laJ morgor socuritios.`
Somo roaJors may think l`vo contraJictoJ mysoll: having JolonJoJ tho
grovth ol tho giant corporation against tho criminality hypothosis ol tho
Pollor Baron school, l nov marshal oviJonco to shov that morgors Jon`t
vork vory voll. This apparont contraJiction is oasily rosolvoJ. lirst, morgor
isn`t tho only vay to grov: it may lo a soconJ-lost approach lor lirms that
can`t grov on thoir ovn. Tho computor inJustry toJay is populatoJ ly
lirms that JiJn`t oxist 20 yoars ago - Doll anJ Compao, lor oxamplo.
Acouisition haJ nothing to Jo vith thoir ontry into tho lortuno 500: tho
lirms grov liko vilJliro locauso thoy proJucoJ gooJ machinos anJ mar-
kotoJ thom voll. Japan has soon much lovor lovols ol V8A than tho U.S.
or Britain: Japanoso companios havo historically rolioJ hoavily on intornal
grovth, vith concomitant lonolits to tho Japanoso oconomy in tho lorm
ol nov invostmont anJ grovth` (Vuollor 1989). SoconJ, tho ollicioncy ol
tho prolossionally managoJ largo corporation is a soparato issuo lrom
grovth through acouisition: in most casos, small lirms aro no match lor
tho provoss ol largor onos, though ol courso olJor giants liko Gonoral
Votors Jo stumllo laJly nov anJ thon. But most ol GV`s prolloms camo
lrom othor giant lirms, liko Toyota, anJ not lrom plucky startups. AnJ
linally, unJor capitalism, monoy talks. Small lirms Jon`t havo tho accoss to
capital or intornally gonoratoJ prolits that lig onos Jo. Big lirms havo so
much monoy, in lact, that thoy can vasto it on stupiJ acouisitions anJ still
livo to toll tho story. Thoro`s nothing criminal alout that unloss you con-
siJor tho prolit systom itsoll criminal.
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283
IBOs voro a spocial caso ol tho markot lor corporato control, anJ onough
timo has gono ly to pass rigorous juJgmont on hov thoy vorkoJ out.
Thoro sooms littlo Joult that IBO anJ othor rostructuring targots voro in
slov-groving inJustrios, or unJorporlormors vithin thoir inJustrios (Blair
anJ Schary 1993l, p. 201): most voro in lov- or miJ-toch soctors. StuJios
that shov cutlacks in invostmont or P8D ly lovorago targots may lo shov-
ing tho vory intontion ol tho rostructurings - to shilt capital out ol tho
hanJs ol managors ol slov-groving lirms anJ into Wall Stroot`s.
William Iong anJ DaviJ Pavonscralt (1993a) summarizoJ thoir ovn
anJ othors` linJings on IBOs as lollovs.
1
lirst, a lirm vas moro likoly to
lo a targot Juring tho 1980s il its lroo cash llov vas high, or il manago-
mont sharoovnorship vas high: it vas loss likoly to lo targotoJ il its valu-
ation vas high (pricooarnings, Tolin`s a), or il JiJ lots ol P8D. SoconJ, a
gooJ lit ol tho promiums paiJ to sharoholJors in oxcoss ol pro-Joal mar-
kot valuo camo lrom tax savings. AnJ thirJ, IBOs improvoJ oporating
incomo, though this largoly got suckoJ avay ly high intorost paymonts,
anJ roJucoJ capital oxponJituros anJ taxos paiJ. lourth, omploymont at
lovoragoJ lirms grov at a slovor rato than tho avorago ol thoir rolovant
inJustrial soctors. AnJ linally, IBOs oxporioncoJ a groat Joal ol linancial
Jistross,` anJ loll Jooply out ol lashion.
Iong anJ Pavonscralt also shovoJ a Jotorioration as tho JocaJo vont
on. Early-1980s (1981-84) IBOs shovoJ gooJ improvomonts in prolit-
alility): lator Joals shovoJ a Jotorioration in porlormanco, though not at
statistically signilicant lovols. Thoir stuJios at tho plant lovol, hovovor,
shovoJ no groat improvomonts, moaning that ovorhoaJ roJuctions voro
tho sourco ol most ol tho cost savings.
18
Iong anJ Pavonscralt also Jom-
onstratoJ that Joals linancoJ vith lank Jolt groatly outporlormoJ thoso
Jono vith junk - a rathor intorosting linJing, anJ ono conlirmoJ ly Kaplan
anJ Stoin (1993). This is anothor llov to Jonsonmania, anJ a stroko in
lavor ol lank ovor markot linanco. lt`s truo that avorago P8D sponJing ly
IBO targots vas lov, lut that lov avorago hiJos tho lact that almost hall
tho manulacturing IBOs in Iong anJ Pavonscralt`s (1993c) univorso voro
consiJoroJ largo P8D porlormors ly tho National Scionco lounJation. ln
thoir samplo, P8D JoclinoJ ly 40/ altor an IBO, anJ capital oxponJi-
turos ly 9/. Again, such cuts aro porloctly in lino vith tho Jonson stratogy
ol translorring capital lrom corporato managors to portlolio managors:
vhothor socioty is lottor oll is anothor ouostion.
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284
Elsovhoro, Iong anJ Pavonscralt (1993l) roportoJ that vhilo IBOs loJ
to sulstantially` improvoJ oporating porlormanco, tho gains laJoJ altor
throo yoars, anJ that lour to livo yoars altor tho luyout tho lirm vas lack
vhoro it startoJ. But Jospito tho oporating improvomont, tho intorost lur-
Jon took a lig lito, loaving not prolits altor Jolt sorvico lolov pro-IBO
lovols. Again, that`s porloctly consistont vith tho Wall Stroot-lattoning strat-
ogy, lut has littlo to Jo vith lostoring a social ronaissanco.
ln a stuJy ol 124 largo luyouts lotvoon 1980 anJ 1989, Stovon Kaplan
anJ Joromy Stoin (1993) camo to sovoral lunJamontal conclusions: (1)
pricos roso rolativo to unJorlying prolits or cash llov as tho JocaJo pro-
cooJoJ: (2) lank principal ropaymont roouiromonts stillonoJ, loaJing to
loss ol a cash cushion lor intorost paymonts: (3) lank Jolt vas roplacoJ
ly junk lonJs as tho sourco ol outsiJo monoy: (4) managomont toams
anJ Joalmakors took ovor-largor loos up lront: anJ (5) Joals struck lator in
tho JocaJo voro lar moro likoly to oxporionco Jistross` - Jolault or
lankrupcy - than thoso consummatoJ in tho oarly yoars. Only ono ol tho
41 1980-84 luyouts thoy stuJioJ oxporioncoJ Jistross,` lut 30 ol 83 (36/)
ol tho 1985-89 Joals JiJ - many ol thom Jospito cost-cutting anJ im-
provoJ oporating prolitalility. Too much Jolt can ruin ovon tho lost lusi-
noss, lut altor 1985, thoso Joals voro lar lrom gooJ.
This lroaJ picturo ol 1980s V8A, Jravn mainly lrom JotailoJ stuJios
ol inJiviJual Joals, is conlirmoJ ly oconomy-viJo Jata as voll. Going
into tho 1980s, corporato Amorica vas Jooply unJorvaluoJ. Tho stock-
only vorsion ol Tolin`s a ratio (tho valuo ol oouity JiviJoJ ly unJorlying
tangillo assots) avoragoJ 34/ lotvoon 194, tho Jopth ol tho post-OPEC
loar markot, anJ 1982, tho yoar tho groat 1980s lull markot logan, just
ovor hall its historical avorago.
19
As tho JocaJo voro on, hovovor, tho a
roso sharply - to 4/ in 1986, anJ 60/ in 1989, vhon tho lovorago loom
onJoJ (llov ol lunJs Jata). Vorgors havo continuoJ sinco at ovon highor
as, lut vith novhoro noar tho Jogroo ol lovorago: you`J havo to lo in-
sano - or havo a high toloranco ol risk, to put it moro coolly - to lorrov
hoavily to pay pricos liko 1996`s. Cash anJ stock aro tho curroncy ol 1990s
Joals: lirms still havo plonty ol lroo cash llov. Tho morgors may not vork
out in tho long run, lut at loast thoy von`t loavo any Jolt tailings that
coulJ turn toxic ovor timo: only tho stockholJors aro at risk.
Doals locamo moro ovorpricoJ anJ riskior at tho samo timo tho com-
mitmonts ol managors anJ linanciors to tho Joals voro voakoning. High
up-lront loos oncourago irrosponsillo Joal making - look tho Joal nov,
tho holl vith long-torm prospocts. Tightor ropaymont schoJulos moant
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285
that assot salos - solling oll piocos ol a company - rathor than improvo-
monts in prolitalility voro contral to tho linancing stratogy - tho vory
Jolinition ol Vinsky`s Ponzi linancial structuro. Tho inlorior porlormanco
ol tho pullic junk lonJ markot suggosts that lank lonJors aro lottor juJgos
ol croJit than aro mutual lunJ managors anJ othor portlolio jugglors.
Tho vholo picturo ol liggor, Jumlor Joals as tho luyout lingo ma-
turoJ is a sovoro llov to notions ol olliciont markots: tho vholo allair vith
lovorago looks in rotrospoct liko ono ol tho groat linancial lulllos ol all
timo. But it vas a lulllo vith a llossy intolloctual poJigroo, Joop support
lrom tho govornmont (loth tho oloctoJ ono anJ tho loJoral Posorvo) anJ
linancial ostallishmont, anJ vith Jamaging consoouoncos to tho roal U.S.
oconomy. Nono ol tho porpotrators - invostmont lankors, linanco aca-
Jomics, or contral lankors - havo sulloroJ any llov to thoir prostigo.
AnJ nono ol tho govornanco issuos raisoJ ly Jonson anJ his comraJos
havo loon solvoJ: vo knov nov that tho IBO association hasn`t locomo
tho nov moJol ol lusinoss organization, lut sharoholJors aro still conniv-
ing to got a liggor sharo ol corporato cash llov.
l saiJ oarlior that lilorals anJ populists JonouncoJ tho luyout mania as
an outlurst ol grooJ vithout analyzing any ol its unJorlying mochanisms.
Ono ol thoir lavorito voicos ol outrago vas a Wall Strootor, tho soullul
lankor, lolix Pohatyn, vhoso position prosumally gavo him somo au-
thority, an authority that coulJn`t survivo a sorious conlrontation vith his
rosumo. Pohatyn - author ol toJious, moralizing piocos in tho N~u :
R~::~u J 1:, supplior ol sormon-liko ouotos to pross hacks, lailoJ
poronnial Domocratic canJiJato lor Troasury Socrotary, anJ nov somo-
thing ol a has-loon - vas actually tho inspiration lor ono ol tho 1980s`
Jashingost liguros, Joo Porolla. Porolla, partnor vith Bruco BiJ `om Up`
Wassorman in ono ol tho groat luyout machinos ol tho timo, tolJ
1u:I:IuI:uuI 1u:~:I: in 1984: l sav lolix knocking oll thoso morgors at
$1 million a clip, vith no capital. l vas improssoJ not only vith his skill
lut also ly tho shoor potontial ol V8A loos` (ouotoJ in HonvooJ 1990).
lolix, togothor vith his montor AnJro Voyor, put togothor lTT anJ othor
groat 1960s conglomoratos at IazarJ lroros. Pohatyn anJ Voyor holpoJ
turn Stovo Poss lrom a parking-lot oporator into tho cuj ol Warnor Bros.
IazarJ vas tho lirst to lroak tho $1 million lanking loo, lut Voyor
vantoJ nothing to Jo vith tho munJano lusinoss ol unJorvriting socuri-
tios to linanco roal companios: ho likoJ playing vith vholo companios
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286
lottor. ln 1963, Voyor, vith his tasto lor tho suro thing,` lought a lronch
company oporating in Wyoming namoJ, appropriatoly onough, lranco
Wyoming, liouiJatoJ it anJ liroJ all tho omployoos anJ practically ovor-
night maJo a 300/ prolit. A namo-lranJ invostmont lank lought a com-
pany, lustoJ it up, anJ got avay vith a hugo prolit anJ its roputation
intact: this vas a losson not lost on Wall Stroot (Poich 1983, pp. 243-24).
Iator, Pohatyn voulJ Jonounco such practicos anJ urgo tho croation ol
a Poconstruction linanco Corporation to rotool Amorica. A Joalmakor vho
JiJ virtually nothing to lunJ proJuctivo invostmont, Pohatyn lroouontly
urgoJ tho govornmont to tako on tho munJano lusinoss ol inJustrial li-
nanco, cloarly too Jomoaning a task lor tho sophisticatos ol Wall Stroot. As
tho novolist-polomicist Vichaol Thomas put it (porsonal communication),
lolix pounJs tho pulpit vith ono hanJ anJ onJorsos chocks vith tho othor.
As tho 1980s laJoJ, it locamo cloar that tho IBO association vas not alout
to roplaco tho pullic corporation. Dospito a lurst ol V8A activity in tho
miJ-1990s altor a lull oarly in tho JocaJo, tho Jominant transaction vas a
morgor lotvoon largo pullic corporations, or tho alsorption ol ono unit
ol a pullic corporation ly anothor pullic corporation. A nov lorm ol
rontior assortivonoss camo lorvarJ in tho 1990s as tho loutiouos anJ lono
oporators laJoJ - sharoholJor activism.
Jonson anJ his ilk llamo tho collapso ol tho luyout movomont on rogu-
lators anJ tho moJia. By jailing Vilkon, lusting Droxol, anJ roining in tho
S8Is, thoso spoilsports snulloJ tho only hopo lor tho rostructuring ol cor-
porato Amorica. ln lact, tho movomont JiJ itsoll in. A vavo ol Jolaults in
1988 anJ 1989 lollovoJ ly tho noar implosion ol tho U.S. oconomy in tho
oarly 1990s scaroJ all lut tho loopiost avay lrom oxporimonts in lovorago.
ln an intorviov, Jonson oxprossoJ groat rogrot that Droxol vas not
arounJ to linanco Kirk Korkorian`s spring 1995 attompt to tako ovor
Chryslor. Korkorian saiJ tho automakor vas sitting on pilos ol cash, lut
Chryslor JolonJoJ itsoll ly saying it vas huslanJing rosourcos lor tho
noxt rocossion. Jonson saiJ that il Korkorian haJ succooJoJ, Jolt voulJ
havo suckoJ avay this cash, vhich has maJo Chryslor managomont lat,
lloatoJ, Juml, anJ happy.` With loss cash, tho lirm voulJ shut inolli-
ciont plants (vhich it shoulJ Jo rathor than incroaso capacity, Jospito ro-
lust JomanJ), anJ Jrivo a harJor largain vith lalor anJ suppliors. To
Jonson, Chryslor`s groatost momonts voro vhon it vas noar Joath, anJ
vas Jrivon ly loar to invont groat nov ollicioncios.
20
(Ol courso, a loan
GOVERNANCE
287
lrom tho U.S. govornmont JiJn`t hurt oithor.) But, alas, thoro vas no Droxol,
anJ lankors shioJ avay lrom linancing Korkorian`s attack. lt vas a lirm
sign that tho 1980s voro still too lrosh in too many minJs lor a rovival.
Vaylo in livo or liltoon yoars, lut not in 1995.
Tho main roason that tho lovorago stratogy vas so JiscroJitoJ is tho
insolvoncy loom graphoJ noarly, ono ol tho groatost in U.S. history, ri-
valoJ only ly tho Jollations ol tho lato 19th contury anJ oarly 1930s. Jonson
himsoll haJ arguoJ that going lust voulJn`t roally lo much ol a prollom
lor lovoragoJ lirms: tho nov structuro, ho assortoJ, voulJ givo riso to tho
privatization` ol lankruptcy - out-ol-court arrangomonts among tho
hanJlul ol playors in an IBO, a contrast vith tho usual lig, oxponsivo
court light lotvoon lragmontoJ groups ol croJitors anJ sharoholJors.
A stuJy ly tho Nov \ork loJ maJo this olsorvation on tho insolvoncy
loom: EviJonco suggosts that in 1990-92, U.S. corporations lounJ man-
aging thoir Jolt in a porioJ ol voak cash llovs moro Jillicult than antici-
patoJ. Porhaps managors took soriously tho argumont that highly lovoragoJ
lirms vith voak cash llovs coulJ gonorally roorganizo thoir Jolt vithout
rosorting to lankruptcy` (Pomolona ot al. 1992-93, p. 3). Tho last son-
tonco is markoJ ly a lootnoto to congrossional tostimony ly Jonson.
Actually, Jonson sooms to havo haJ hall, or maylo a ouartor, ol a point
on lankruptcy`s privatization. Whilo statistics on tho costs ol lankruptcy
aro surprisingly harJ to como ly, ono stuJy ol corporato insolvoncios lo-
tvoon 1986 anJ 1993 (Botkor 1995) shovoJ that tho cost ol a classic Chaptor
11 corporato lankruptcy avoragoJ 3.93/ ol pro-lankruptcy assots, lut an
IBO or similar lovoragoJ rostructuring ol tho Jonsonito sort gonorally
knockoJ alout 1.3 porcontago points oll tho total. Still, all thoso
rostructurings - vhothor a classic Chaptor 11 or an intimato Jonson-stylo
0.0'
0.5'
!.0'
!.5'
2.0'
2.5'
3.0'
liabilities of bankrupt businesses,
!996. !s! quar!er annua|ized
WALL STREET
288
allair - still lolt lovoragoJ lirms unJor hoavy Jolt. Vany 1980s Joals vont
through tvo lankruptcios. Pajosh Aggharval (1995) arguoJ that that hap-
ponoJ locauso croJitors voro unvilling to lorgivo onough Jolt to mako a
lirm viallo: thoy loaroJ that il thoy lorgavo, somoono olso (liko a nonpar-
ticipating croJitor) voulJ gain vhat thoy lost.
Tho lailuro ol tho IBO movomont to translorm tho lunJamontal naturo ol
tho corporato lorm lolt sharoholJors at a lit ol a loss. Not satislioJ vith
ono ol tho groat long-torm lull markots in U.S. history, thoy continuoJ to
vhino alout unlocking sharoholJor valuo` hiJJon in tho crovicos ol cor-
porato Amorica. Sinco lovorago turnoJ out to lo a vory risky vay ol lilor-
ating thoso hiJJon Jollars, a nov stratogy vas in orJor.
As tho JocaJo turnoJ, that stratogy turnoJ out to lo sharoholJor activ-
ism. lronically, ono ol tho oarly signs ol tho nov activism vas tho anti-
aparthoiJ movomont`s prossuro on univorsitios, churchos, pullic ponsion
lunJs, anJ othor institutional invostors to soll tho sharos ol lirms Joing
lusinoss in South Alrica. This vas a markoJ Joparturo lrom tho classic
passivity ol institutional sharoholJors. But tho ontiroly lauJallo goal ol
using linancial voapons to onJ ollicial racism vas thon ouickly oclipsoJ
ly moro munJano concorns - prossing tiroJ managomonts to livon up
thoir companios anJ thoroly Jrivo tho stock prico northvarJs.
A curious porsonal talo ol tho ovolution ol tho nov linancial assortivonoss
is tho caroor ol T. Boono Pickons, vho vas ono ol tho cuuuuuuuI~: ol
tho lirst vavo ol tho sharoholJor rolollion. His stal at Gull vas ono ol tho
groat oarly momonts ol tho Joal JocaJo. During tho 1980s, Pickons maJo
rolontloss lun ol CEOs liko AnJrov Siglor, tho loss ol Champion lntorna-
tional vho vas managorial Amorica`s mouthpioco vhilo tho likos ol Pickons
voro vilJing thoir vay across tho corporato lanJscapo. Whilo Siglor ar-
guoJ that socioty` ovnoJ lirms, not sharoholJors,` Pickons countoroJ
that sharoholJor valuo vas all. His oil company JiJn`t roally Jrill much -
ho prolorroJ to oxploro lor oil on tho Nov \ork Stock Exchango, ly luy-
ing up othor companios vith lorrovoJ monoy (HonvooJ 198).
Companios that trioJ to llock takoovors vith poison pills anJ othor
schomos voro Pickons` groat onomios.
21
But in 1995, Vosa lounJ itsoll
unJor attack ly hostilo suitors incluJing Pickons` lormor siJokick DaviJ
BatcholJor. Pathor than tako his ovn moJicino, Pickons haJ tho loarJ
aJopt a poison pill. Vosa`s argumonts sounJ liko Siglor`s a JocaJo oarlior
- tho outsiJo group vas in it just lor a ouick luck. Pickons` Jolonso: his
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289
Jays ol trying to tako ovor othor companios voro long gono anJ that ho
hatoJ to lo calloJ a corporato raiJor. Tho last timo l vas involvoJ in a
Joal vas almost 10 yoars ago,` ho saiJ. Thoro`s no vay anyloJy coulJ
charactorizo mo as anything othor than a harJ vorking oilman` (Vyorson
1995l). HarJ vork nooJn`t guarantoo rovarJ: lotvoon 1985 anJ 1995,
Vosa`s stock loll 63/, vhilo tho ovorall markot roso 11/. By Pickons`
ovn stanJarJ, ho vas a Jisgraco. Ho vas linally oustoJ in 1996.
Pickons vas lohinJ an attompt to organizo small sharoholJors into a lor-
mal prossuro group, tho UnitoJ SharoholJors Association, cutoly allroviatoJ
USA. lrom its 1986 lounJing to its 1993 Jissolution, USA trackoJ tho por-
lormanco ol largo pullic corporations anJ compiloJ a Targot 50 list ol
losors. Tho USA voulJ try to nogotiato vith tho unJorporlormors, urging
thom to slim Jovn, unJo anti-takoovor provisions, anJ just Jolivor thoir
sharoholJors moro valuo.` ll satislaction vasn`t lorthcoming, USA voulJ
ask its 65,000 momlors to sponsor sharoholJor rosolutions to chango gov-
ornanco structuros. USA-inspiroJ rosolutions voro olton co-sponsoroJ ly
groups liko tho Calilornia Pullic Employoos Potiromont Systom (Calpors), tho
Collogo Potiromont Eouitios lunJ (CPEl), anJ tho Nov \ork City Employoos
Potiromont Systom (Nycors). ln a moasuro ol tho smallnoss ol oconomists`
minJs, ono stuJy JiscovoroJ that in tho tvo-Jay ovont vinJov |altor its
announcomontl.tho avorago USA-sponsoroJ agroomont rosults in an al-
normal stock prico roaction ol approximatoly 0.9/. This alnormal roturn
roprosonts a gain in sharoholJor voalth ol approximatoly $54 million.`
(StricklanJ, Wilos, anJ Zonnor 1994). ln tiny stops Joos progross como.
USA vas JissolvoJ ly its loarJ locauso as its prosiJont, Palph
Whitvorth, put it, it vas not USA`s goal to stay arounJ inJolinitoly as a
corporato vatchJog activism organization.. Boono Pickons lounJoJ USA
in tho spirit ol chango - an organization that voulJ sot goals, tako action,
anJ got things Jono` (StricklanJ, Wilos, anJ Zonnor 1994). This suggosts
that ovon vith visilility, momlorship, anJ lunJing, it`s noar impossillo to
got small, JisporsoJ sharoholJors to act as a unit. lt may pay a lig-timo
raiJor to play this gamo, lut cortainly not small holJors, anJ apparontly
not ovon small holJors lanJoJ togothor.
ln 1995, Whitvorth joinoJ vith Pickons` lormor associato BatcholJor to
lorm Polational lnvostors, a San Diogo-lasoJ lunJ JosignoJ to invost in
poorly porlorming companios anJ act as a catalyst lor chango.` Thoy
voro lackoJ ly a numlor ol largo institutional invostors, incluJing Calpors,
tho most prominont ol tho sharoholJor activists. Pross roports oxplain that
this movo is part ol a nov phaso in Calpors` corporato govornanco pro-
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290
gram, a vay ol prossing unJorporlormors to chango thoir vays ol Joing
lusinoss. This, it sooms, is tho moJol lor tho miJ-1990s. Tho hoirs ol Pickons
aro nov tho provling agonts ol pullic ponsion lunJs, looking lor valuo,
roaJy to proJ moro than pounco.
22
lt`s surprising hov lov ponsion lunJs havo loJ tho rolollion. Vost promi-
nont is Calpors, vith a hanJlul ol othor pullic ponsion lunJs at thoir siJo.
Usoom (1996, p. 56) notoJ that thoso lunJs - controlloJ ly oloctoJ olli-
cials anJ holJ in tho namo ol pullic soctor vorkors - linJ it oasy to aJopt
an antimanagomont rhotoric, ospocially vhon JiroctoJ against lig lusi-
noss.` Thoir agonJa, though, looks much loss raJical than tho rhotoric.
Tho strictly govornanco aspocts ol this agonJa typically incluJo: lringing
moro outsiJors on to tho loarJ, in tho namo ol inJoponJonco: shrinking
largo loarJs (15 or moro) Jovn to arounJ a Jozon, on tho thoory that
largo loarJs aro moro scattoroJ, anJ thoroloro moro oasily JominatoJ ly
managomont: oncouraging moro scrutinty ol managomont stratogy ly
outsiJo Jiroctors: romoving olstaclos to takoovors in corporato chartors:
anJ tying oxocutivo anJ Jiroctor pay to stock porlormanco, rathor than
paying llat (anJ lat) salarios (Salmon 1993: Usoom 1996, Chaptor ).
Voro lroaJly, thoso movos havo translatoJ into tho lamoJ Jovnsizing
anJ invostmont cutlacks ol tho lirst hall ol tho 1990s: tho point ol tho
govornanco agonJa, altor all, is to incroaso sharoholJor voalth ly incroas-
ing sharoholJor control. Pullic justilications lor thoso Jovnsizings havo
almost alvays pointoJ to tochnological chango anJ glolal compotition,
vhich takos human intorost anJ agoncy out ol tho picturo, lut in lact tho
proximato causo has moro olton loon prossuro lor highor stock pricos
coming lrom Wall Stroot portlolio managors.
lnstitutional invostors havo maJo thoir prosonco lolt most lamously
through annual hit lists, liko Calpors`, anJ anothor Jravn up ly tho Coun-
cil ol lnstitutional lnvostors, a consortium ol 100 major ponsion lunJs vith
somo $800 lillion in assots. Such pullic humiliations, vhich havo loJ to
loarJroom shakoups at housoholJ-namo lirms, havo thoir ollocts not only
on tho namoJ targots, lut also on tho managors ol othor lirms, vho got tho
mossago anJ tako appropriato action to avoiJ loing on noxt yoar`s list. As
Calpors` gonoral counsol, PicharJ Koppos, saiJ, \ou locus on a lov vis-
illo onos anJ mako ovoryono olso norvous` (ouotoJ in Boronloim 1994,
p. 29). But asiJo lrom thoso visillo strugglos, ponsion lunJ managors havo
also vorkoJ lohinJ tho sconos, prossing thoir vish lists on olton rocalci-
trant managomonts, anJ in somo casos, mooting vith lirms` outsiJo Jiroc-
tors, pushing tho caso lor managorial rovolution (Iullin 1995l: Usoom
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291
1996, p. 108). AccorJing to a Conloronco BoarJ survoy, oxocutivos lrom
86/ ol largo U.S. lirms voro contactoJ ly thoir institutional sharoholJors:
almost hall roportoJ an incroaso in tho numlor ol sharoholJor calls, vith
lov roporting a Jocroaso (Boronloim 1994).
Why havo tho pullic ponsion lunJs, anJ only a hanJlul ol thom at that,
loon prominont in tho sharoholJor rolollion, to tho oxclusion ol othor
institutional invostors? Thoro aro sovoral roasons. Privato ponsion lunJs
aro inhilitoJ ly conllicts ol intorost, actual or potontial: GV`s ponsion
lunJ voulJ havo a harJ timo taking a visillo position on a managomont
shakoup at Chryslor. Voro lroaJly, sinco corporato ponsion lunJs aro ul-
timatoly run ly CEOs, tho chioltains aro not oagor to stoko challongos to
thoir authority. Vutual lunJs havo also shioJ avay lrom govornanco is-
suos: liJolity, it`s saiJ ly somoono in tho knov, trioJ it anJ vithJrov
locauso ol laJ pross, lut tho company JiJn`t roturn phono calls asking
lor commont. lirms liko mutual lunJs vith highly visillo pullic imagos
Jon`t vant to got caught up in pullic controvorsios. But it`s highly likoly
that many ol tho nonparticipating institutions aro happy to havo tho activ-
ist lunJs in tho loaJ, Joing thoir vork lor thom: thoy got tho lonolit ol
highor sharo pricos vithout having to tako tho troullo, or risk thoir pullic
imago ly pushing a controvorsial agonJa.
Just locauso Wall Stroot`s short-tormism is a clicho Joosn`t moan it isn`t
truo. ln survoys, CEOs anJ corporato invostor rolations managors ropoat-
oJly complain ol prossuro lrom monoy managors anJ Wall Stroot analysts
to proJuco ouick prolit grovth. This is no spocial ploaJing coming lrom a
lormorly pamporoJ class: monoy managors thomsolvos conlirm to survoy-
takors that thoir colloaguos aro too olsossoJ vith ouartor-to-ouartor novs,
anJ tako too littlo hooJ ol long-torm prospocts. lt can harJly lo othorviso,
sinco most lig invostmont managors aro graJoJ on thoir ouartorly porlor-
manco. (Usoom 1996). Still, stroking thoso portlolio jockoys takos a lot ol
managorial timo. CEOs ol lig U.S. corporations holJ six mootings a month
vith monoy managors anJ stock analysts, anJ chiol linancial ollicors (ClOs)
holJ ovor tvico as many: lrom that, it`s loon ostimatoJ that ClOs sponJ
20/ ol thoir vork timo courting Wall Stroot (Bakor ot al. 1994). Suroly thoy
havo somothing lottor to Jo vith thoir timo than sponJing it vith pooplo
vho oarn lig loos lor unJorporlorming tho avoragos.
That sot holJs CEOs to somo strango stanJarJs inJooJ. Conlirming
Koynos`s thoorizing ol 60 yoars ago, oxpoctations olton mattor moro than
WALL STREET
292
actual rosults. Porvorsoly, ono stuJy citoJ ly Usoom (1996, p. 88) shovs
that company shortlalls in mooting analyst lorocasts aro lottor proJictors
ol |topl oxocutivo Jismissal than aro shortlalls in tho actual oarnings. Put
Jillorontly, you aro moro likoly to loso your jol il you shock invostor son-
sililitios than il you Jock company oarnings.` AnJ thoso aro tho lolks vho
vant an ovon liggor pioco ol tho action.
As Charlos Wohlstottor (1993), lormor chair ol Contol, put it, ln sum,
vo havo a group ol pooplo vith incroasing control ol tho lortuno 500
vho havo no provon skills in managomont, no oxporionco at solocting
Jiroctors, no loliovallo juJgmont in hov much shoulJ lo spont lor ro-
soarch or markoting - in lact, no oxporionco oxcopt that vhich thoy havo
accumulatoJ controlling othor pooplo`s monoy.`
Ponsion lunJs aro tho loast rogulatoJ ol tho major institutional invos-
tors, vhich is ono roason thoy`vo loon activo in tho sharoholJor rolollion,
lut this makos thom accountallo on nono lut puroly linancial moasuros.
So rathor than solving tho agoncy prollom, activist sharoholJing simply
aJJs anothor layor ol potontial irrosponsilility.
AnJ vhat Jo thoy roally havo to contriluto? Tho lost porioJs ol U.S.
oconomic grovth havo occurroJ vhon managors ran corporations anJ
sharoholJors kopt thoir mouths shut. AJmittoJly thoro`s a chickon-ogg
prollom horo: it`s no acciJont that Borlo anJ Voans` look camo out Jur-
ing tho Doprossion, that govornanco issuos rocoJoJ Juring tho GolJon
Ago, anJ that thoy roturnoJ as oconomic porlormanco JotorioratoJ in tho
190s. But tho point is that thoro`s no oviJonco that sharoholJor intorvon-
tion promotos lottor porlormanco ovor tho long torm - lottor porlor-
manco, that is, lor anyono lut sharoholJors.
23
Apologists lovo to linosso this Jistinction, troating highor sharo pricos
as synonymous vith a highor social roturn. But ono coulJ arguo that ly
roJucing tho lunJs availallo lor roal invostmont, incroasing tho roturn to
sharoholJors vill Jopross grovth anJ omploymont ovor tho long torm. lt`s
likoly that invostmont projocts or P8D that sharoholJors might conJomn
as unoconomic` voulJ nonotholoss loavo socioty as a vholo lottor oll.
Whon l askoJ Usoom vhat purposo stockholJors sorvo, ho ansvoroJ,
vrongly, that thoy`ro an important sourco ol capital. l`vo JovotoJ a gooJ
lit ol this look to shoving that tho signals omittoJ ly tho stock markot aro
oithor irrolovant or harmlul to roal oconomic activity, anJ that tho stock
markot itsoll counts lor littlo or nothing as a sourco ol linanco. SharoholJ-
ors :IuIu lo vostigial: thoy havo no usolul rolo. lnstoaJ, thoy havo grovn
incroasingly assortivo ovor tho last 15 or 20 yoars, Jisguising thomsolvos
GOVERNANCE
293
lohinJ a rhotoric ol Jomocracy, inJoponJonco, anJ accountalility.
SharoholJors lovo to prosont thomsolvos as tho ultimato risk-loarors.
But thoir lialilitios aro limitoJ ly Jolinition to vhat thoy paiJ lor tho sharos,
thoy can alvays soll thoir sharos in a troulloJ lirm, anJ il thoy havo Jivor-
silioJ portlolios, thoy can hanJlo an occasional vipoout vith harJly a
stumllo. Employoos, anJ olton customors anJ suppliors, aro raroly so voll-
insulatoJ. AJJ to this Koynos`s argumont that tho notion ol liouiJity can-
not apply to a community as a vholo, anJ you havo a vory Jamaging
critiouo ol sharoholJor-contoroJ govornanco: vhat`s Jivino lor rontiors is
laJ novs lor ovoryono olso.
Apologists lor tho rontior agonJa also arguo that thom aro us`: tho
portlolio managors JomonizoJ as grooJy Wall Strootors aro roally manag-
ing all ol socioty`s savings lor tho long-torm intorost ol all.
24
Tho liguros on
concontration ol stock ovnorship prosontoJ in Chaptor 2 mako that argu-
mont harJ to sustain, lut apologists also point to tho ponsion lonolits that
vo`ll all colloct somoJay il vo`ro lucky onough to mako it to 65 or 6. This
too is Jovious. Ponsion assots, vhilo loss concontratoJ than othor lorms ol
linancial holJings, aro still concontratoJ: unJor 40/ ol tho vorklorco is
covoroJ ly a ponsion plan (U.S. Buroau ol tho Consus 1995, p. 383) anJ
tho richost 10/ control 62/ ol ponsion assots (Wolll 1996). lt sooms oJJ
that vorkors shoulJ lo askoJ to traJo a lov oxtra porcontago points ro-
turn on thoir ponsion lunJ, on vhich thoy may Jrav somo JocaJos in tho
luturo, lor 30 or 40 yoars ol lalling vagos anJ rising omploymont insocu-
rity. Tho point ol sharoholJor activism` is to incroaso tho prolit sharo ol
national incomo, anJ to claim a largor portion ol that prolit sharo lor rontiors.
Any gains to pooplo ol moJost moans aro acciJontal.
Vaylo tho prosont vavo ol sharoholJor assortivonoss vill vano: tho
tomptation to soll a stock rathor than tako tho troullo ol lollying manago-
mont may ovontually triumph ovor tho apparontly moagor gains to activ-
ism. lt may lo that ovon vith tho institutionalization ol ovnorship,
sharoholJing still romains too JisporsoJ to sustain tho kinJ ol rolation-
ship invosting` aJvocatoJ ly Calpors, tho Tvontioth Contury lunJ (1992),
or Polort Vonks (1995). Prolossional rontiors anJ thoir lankors vill no
Joult linJ a nov laJ JosignoJ to unlock sharoholJor valuo, anJ Joviso a
lrosh sot ol argumonts lor vhy thoir onrichmont is synonymous vith tho
common gooJ.
AsiJo lrom Vargarot Blair - though sho is lar moro moasuroJ than l -
no prominont stuJont ol corporato govornanco has Jravn tho olvious
conclusion lrom all this rosoarch: il outsiJo sharoholJors sorvo no usolul
WALL STREET
294
purposo, thon thoro is no lottor argumont lor turning lirms ovor to thoir
vorkors.
25
Ol courso, tho sharoholJors Jon`t soo this solution as olvious,
lut that`s anothor story.
governing governments
This chaptor anJ this look havo mainly loon alout tho privato soctor, lut
it voulJ lo incomploto to linish a chaptor on govornanco` vithout look-
ing at tho rolations lotvoon Wall Stroot anJ govornmont, not only in tho
U.S., lut on a vorlJ scalo.
Ono aJvantago that Wall Stroot has in pullic oconomic Jolato, asiJo
lrom its immonso voalth anJ povor, is that it`s ono ol tho lov institutions
that look at tho oconomy as a vholo. Amorican oconomic policymaking,
liko tho othor kinJs, is largoly tho rosult ol a clash ol intorost groups, vith
ovory traJo association ploaJing its ovn spocial caso. Wall Strootors pro-
sumo to caro alout hov all tho piocos como togothor into a macrooconomy.
Tho lroaJost policy tochniouos - liscal anJ monotary policy - aro con-
tral Wall Stroot concorns. lor somo roason, intolloctuals liko tho oJitors ol
tho N~u : R~::~u J 1: anJ tho .IIuuI:c havo JociJoJ that invost-
mont lankors liko lolix Pohatyn anJ Potor Potorson havo thoughts vorth
roaJing. Not surprisingly, loth uttor a mossago ol austority - tho lirst
vith a liloral, anJ tho soconJ vith a consorvativo, spin - hiJJon lohinJ
a rhotoric ol oconomic nocossity. Thoso lankor-philosophors, croaturos
ol tho most ovorpaiJ lranch ol lusinoss ontorpriso, aro miraculously pro-
sontoJ as JisintorostoJ policy analysts.
Wall Stroot`s povor locomos ospocially visillo Juring liscal crisos, Jo-
mostic anJ intornational. On a vorlJ scalo, tho intornational Jolt crisis ol
tho 1980s soomoJ lor a vhilo liko it might lring Jovn tho glolal linancial
systom, lut as it olton Joos, linanco vas allo to turn a crisis to its ovn
aJvantago.
Whilo oasy accoss to commorcial lank loans in tho 190s anJ oarly
1980s allovoJ countrios somo lrooJom in Josigning thoir oconomic poli-
cios (much ol it misusoJ, somo ol it not), tho outlroak ol tho Jolt crisis in
1982 changoJ ovorything. ln tho vorJs ol Joromo l. Iovinson (1992), a
lormor ollicial ol tho lntor-Amorican Dovolopmont Bank:
|Tol tho U.S. Troasury stall.tho Jolt crisis allorJoJ an unparalloloJ oppor-
tunity to achiovo, in tho Joltor countrios, tho structural rolorms lavoroJ ly
tho Poagan aJministration. Tho coro ol thoso rolorms vas a commitmont
GOVERNANCE
295
on tho part ol tho Joltor countrios to roJuco tho rolo ol tho pullic soctor as
a vohiclo lor oconomic anJ social Jovolopmont anJ roly moro on markot
lorcos anJ privato ontorpriso, Jomostic anJ loroign.
Iovinson`s analysis is soconJoJ ly Sir William Pyrio (1992), oxocutivo vico
prosiJont ol tho lntornational linanco Corporation, tho WorlJ Bank`s pri-
vato soctor arm. Tho Jolt crisis coulJ lo soon as a llossing in Jisguiso,`
ho saiJ, though aJmittoJly tho Jisguiso vas a hoavy ono.` lt lorcoJ tho
onJ to lankrupt` stratogios liko import sulstitution anJ protoctionism,
vhich hopoJ, ly rostricting imports, to nurturo tho Jovolopmont ol Jo-
mostic inJustrios.
26
Vuch ol tho privato capital that is onco again lloving
to Iatin Amorica is capital invostoJ alroaJ Juring tho run-up to tho Jolt
crisis. As much as 40-50 conts ol ovory Jollar lorrovoJ Juring tho 190s
anJ oarly 1980s.may havo loon invostoJ alroaJ. This monoy is nov
coming lack on a signilicant scalo, ospocially in Voxico anJ Argontina.`
ln othor vorJs, much ol tho lorrovoJ monoy vas skimmoJ ly ruling
olitos, parkoJ prolitally in tho Cayman lslanJs anJ Zurich, anJ ThirJ WorlJ
govornmonts voro lolt vith tho lill. Whon tho policy onvironmont changoJ,
somo ol tho monoy camo lack homo - olton to luy novly privatizoJ
stato assots lor a song.
That millions sulloroJ to sorvico thoso Jolts sooms to mattor littlo to
Pyrio. Dosporato Southorn govornmonts haJ littlo choico lut to yiolJ to
Northorn lankors anJ luroaucrats. lmport sulstitution vas JroppoJ, stato
ontorprisos voro privatizoJ, anJ lorJors voro maJo porous to loroign
invostmont. Altor Pyrio`s cololratoJ capital inllov, Voxico sulloroJ an-
othor Jolt crisis in 1994 anJ 1995, vhich vas solvoJ` using U.S. govorn-
mont anJ lVl guarantoos to lail out Wall Stroot lanks anJ thoir clionts,
anJ croating a Joop Joprossion: to mako tho Jolts gooJ, Voxicans voulJ
havo to sullor. Onco again, a Jiro linancialliscal crisis - tho insolvoncy
ol an ovorinJoltoJ Voxican govornmont - vas usoJ to lurthor a capital-
lrionJly oconomic agonJa.
Thoso lortunato usos ol crisis lirst appoaroJ in thoir moJorn lorm Jur-
ing Nov \ork City`s lankruptcy vorkout ol 195. This is no placo to ro-
viov tho vholo crisis: lot it just lo saiJ that suJJonly tho city lounJ its
lankors no longor villing to roll ovor olJ Jolt anJ oxtonJ lrosh croJits.
Tho city, lroko, coulJ not pay. ln tho namo ol liscal roctituJo, pullic sor-
vicos voro cut anJ roal liscal povor vas turnoJ ovor to tvo stato agon-
cios, tho Vunicipal Assistanco Corp. (VAC, chairoJ ly Pohatyn), anJ tho
Emorgoncy linancial Control BoarJ, sinco maJo pormanont vith tho Emor-
WALL STREET
296
goncy JroppoJ lrom its namo. AsiJo lrom tho most routino municipal lunc-
tions, tho city no longor govornoJ itsoll: a committoo ol lankors anJ thoir
Jologatos JiJ, Pohatyn lirst among thom. Pohatyn, vho voulJ lator criti-
cizo Poaganism lor loing too harsh, vas tho Jiroctor ol its Jross rohoarsal
in Nov \ork City. Pullic sorvicos voro cut, vorkors voro laiJ oll, anJ tho
physical anJ social inlrastructuro vas lolt to rot. But tho lonJs, thank
goJ, voro paiJ, though not vithout a littlo moloJrama, gimmickry, anJ
Jolay (Iichton 1986, Chaptor 6).
Tho city vas aJmittoJly lorroving irrosponsilly - though tho lonJ-
ors, it must lo saiJ, voro lonJing irrosponsilly as voll. Whon a lulllo is
luilJing, noithor siJo has an incontivo to stop its inllation. But vhon it
lroko, all tho pain ol aJjustmont loll on tho citizon-Joltors. Tho pattorn
voulJ lo ropoatoJ in tho ThirJ WorlJ Jolt crisis, in many U.S. citios ovor
tho noxt 20 yoars, anJ, most rocontly, vith tho loJoral luJgot.
Olviously tho lankors havo tho aJvantago in a Jolt crisis: thoy holJ
tho koy to tho roloaso ol tho noxt post-crisis rounJ ol linanco. Anyono
vho vants to lorrov again, anJ that incluJos noarly ovoryono, must go
along. But that`s not thoir only aJvantago. Tho sourcos ol thoir povor
voro citoJ ly Jac lrioJgut ol Citilank (iliJ., p. 192):
Wo |tho lanksl haJ tvo aJvantagos |ovor tho unionsl.. Ono is that sinco
vo voro Joaling on our homo turl in torms ol linancos, vo knov lasically
vhat vo voro talking alout, anJ vo knov anJ haJ a lottor iJoa vhat it
takos to roopon tho markot or soll this lonJ or that lonJ.. Tho soconJ
aJvantago is that vo Jo havo a cortain nollosso olligo or tight anJ lirm
Jisciplino. So that vo coulJ marshal our lorcos, anJ vhon vo spoko to tho
city or tho unions vo coulJ spoak as ono voico.. Onco a cortain lasic
procoss has loon ostallishoJ that`s an onvironmont in vhich our intolloc-
tual loaJorship.can lo toloratoJ or rocognizoJ.vo`ro allo to got things
olloctoJ.
lt`s plain lrom lrioJgut`s romarkally canJiJ languago that to countor this,
ono nooJs oxportiso, Jisciplino, anJ tho norvo anJ organization to chal-
longo tho intolloctual loaJorship` ol such supromoly soll-intorostoJ par-
tios. But tho city unions haJ nono ol this. AccorJing to tho union loss
Victor Gotlaum (in an intorviov vith Polort litch, vhich litch rolayoJ to
mo), tho unions` main oxport at tho timo, Jack Bigol, JiJn`t unJorstanJ tho
luJgotary issuos at all, anJ JolorroJ to Pohatyn, vhom ho trustoJ to Jo
tho right thing. lor tho sorvicos ronJoroJ to municipal lalor, tho onco-
Communist Bigol vas paiJ somo $50,000 a yoar, onough to luy himsoll a
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posh lilth Avonuo Juplox (Zvoig 1996). Gotlaum locamo a closo lrionJ
ol lolix Pohatyn. Politically, tho unions voro voak, JiviJoJ, soll-protoc-
tivo, unimaginativo, anJ vith no political tios to orJinary Nov \orkors.
Actually thoy JiJ spoak in ono voico, that ol surronJor. lt`s oasy to soo vhy
tho lankors von.
What vas at stako in Nov \ork vas no moro lonJ markot concorn. ln
a classic 196 N~u : T:u~: op-oJ pioco, I.D. Solomon, thon pullishor
ol N~u : .JJu:::, vroto: Whothor or not tho promisos.ol tho 1960`s
can lo rolloJ lack.vithout violont social uphoaval is loing tostoJ in
Nov \ork City.. ll Nov \ork is allo to ollor roJucoJ social sorvicos vith-
out civil JisorJor, it vill provo that it can lo Jono in tho most Jillicult
onvironmont in tho nation.` Thanklully, Solomon concluJoJ, tho poor
havo a groat capacity lor harJship` (ouotoJ in HonvooJ 1991).
BohinJ a liscal crisis` lurkoJ an ontiro class agonJa, ono that has loon
ouito succosslully prosocutoJ in sulsoouont crisos lor tho noxt tvo Jo-
caJos. But sinco thoso aro lought on tho lankors` torrain, using thoir lan-
guago, thoy instantly vin tho political aJvantago, as nonlankors rotroat in
conlusion, Jospair, or loroJom in tho laco ol all thoso JamnoJ numlors.
At tho national lovol, rampant lorroving ly tho U.S. govornmont
throughout tho 1980s anJ oarly 1990s stimulatoJ a loom lor a vhilo, lut
onJoJ vith tho austority packagos ol tho miJ-1990s. Tripling tho outstanJ-
ing loaJ ol loJoral Jolt not only maJo Wall Stroot a lot ol monoy - un-
Jorvriting, traJing, anJ holJing tho lonJs - it groatly incroasoJ rontior
inlluonco ovor policy. Tho opinion ol tho markots` - ossontially tho richost
1-2/ ol Amoricans anJ tho prolossionals vho manago thoir monoy - is
nov tho linal vorJ on oconomic anJ social policy. Iilorals anJ populists
vho aro sanguino alout Jolicit linancing shoulJ rocall lrioJgut`s vorJs:
croJitors spoak vith ono voico, anJ thoy`ro allo to got things olloctoJ.
Thoso ollocts gonorally involvo onriching tho croJitors at tho oxponso ol
ovoryono olso.
notes
1. An intorosting contrast is Britain, vhoro loth politicians anJ punJits iJontily laJ cor-
porato govornanco as ono ol tho sourcos ol Britain`s limp oconomic porlormanco.
2. HyJraulically` is prolally too 19th contury anJ inJustrial. lt Josorvos translation into
somothing moro virtual.
3. Though thoro is a largo anJ groving litoraturo on thoso topics, tho lasic issuos aro
concisoly summarizoJ ly Stophon Provso (1994), ospocially pp. 10-15. Tollingly, vork-
ors Jo not appoar in Provso`s list ol tho principal actors in tho corporato control Jrama.
4. Pollocting on his articlo lilty yoars lator, Coaso JoclaroJ it unlortunato that ho usoJ tho
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omployor-omployoo oxamplo so prominontly, rathor than, say, tho contracts that on-
allo tho organizors ol tho lirm to Jiroct tho uso ol capital (oouipmont or monoy) ly
acouiring, loasing, or lorroving it` (Williamson anJ Wintor 1993, p. 65). But tho rola-
tion ol managors anJ oxtornal linanciors is a lot moro complox: ono party is raroly allo
to toll tho othor to Jo somothing as oasily as tho loss movos Coaso`s omployoo lrom \
to X. lntorostingly, tho logal toxt that Coaso ouotoJ lrom, Batt`s TI~ 1uu J Mu:I~: uuu
~::uuI, usoJ classical logal languago that makos tho povor rolationship much cloaror
than tho moJorn omployor-omployoo` JyaJ. Writing in tho 1930s, Coaso usoJ loth
pairs ol vorJs: vriting in tho 1980s, ho usoJ only tho ouphomism.
5. lnolliciontly small scalo proJuction may lo a prollom vith a long poJigroo in Britain.
ln a caso stuJy ol a Vanchostor cotton ontorpriso lrom 198 to 182, Harvoy Jamos
(1996) arguoJ that tho lack ol outsiJo capital (anJ tho rolianco ontiroly on intornal
lunJs lor oxpansion) kopt tho scalo ol tho lirm too small lor maximum ollicioncy.
6. This historical skotch lollovs Borlo anJ Voans 1932196, Book ll, Chaptor 1.
. Ol courso, intorost group moJols ovo as much to myth as lact: somo intorosts, liko
lonJholJors anJ Jovolopors, aro moro povolul than othors, liko vollaro moms.
8. Ono critiouo ol omployoo stock ovnorship plans is that thoy lorco vorkors to put a
largo portion ol thoir savings into a singlo assot, anJ ono in vhich thoy voro alroaJy
invostoJ` through thoir jols. ll tho lirm lails, thoy voulJ loso not only thoir jols, lut
all thoir savings as voll.
9. Cost ol capital is usually liguroJ as tho oxpoctoJ roturns on a company`s outstanJing
socuritios - that is, tho avorago ol tho stock roturns roouiroJ ly invostors anJ tho
intorost rato paiJ on tho lirm`s Jolts. Eouity roturn is usually liguroJ using tho CAPV or
similar moJols: actual intorost ratos aro usoJ to liguro tho cost ol Jolt (Broaloy anJ
Vyors 1991, Chaptor 9). Survoys shov that lirms actually havo a hurJlo rato` - a
minimum rato ol roturn nocossary lor an invostmont projoct to lo unJortakon - voll
alovo thoir cost ol capital. lor oxamplo, Potorla anJ Summors (1991) roportoJ that tho
lirms thoy survoyoJ usoJ a hurJlo rato ol 12.2/ uJI~: inllation - lar lar alovo tho long-
torm roal roturn ol / on stocks anJ 2/ on lonJs. Tho authors olsorvoJ that thoso
Jisparitios raiso an important ouostion alout tho link lotvoon tho variallos that linan-
cial oconomists locus on in moasuring tho cost ol capital, anJ tho actual practicos ol
lirms.` A hurJlo rato this high guarantoos an opiJomic ol lroo cash llov, sinco tho
avorago prolitallo corporation vill throv oll much moro monoy than it shoulJ roinvost
accorJing to this stanJarJ.
10. On tho othor hanJ, managors, as Joromy Stoin (1989) arguos, may Joliloratoly
unJorinvost, loaving thomsolvos a Jogroo ol linancial slack, in orJor to insulato thom-
solvos lrom tho scrutiny ol capital markots. But tho ovorall oconomy might lo lottor oll
il tho slack lunJs voro lully invostoJ.
11. Tho typical linancial structuro ol a lirm altor a lovoragoJ luyout is oouity, 5-20/: so-
nior Jolt, 40-0/: junior Jolt, 10-30/ (Borio 1990, p. 36). ln a crisis, lirst tho oouity
holJors voulJ got vipoJ out, thon tho junior JoltholJors: il things vont voll, tho
junior JoltholJors voulJ livo to soo tho high intorost paymonts succosslully maJo, anJ
tho stock voulJ riso sharply in valuo. Ol courso, thoso stock gains voulJ moroly lo on
papor, unloss tho holJings voro privatoly solJ or tho lirm voro to go pullic again.
12. Vax HollanJ`s (1989) stuJy WI~u TI~ MucI:u~ Ijj~u, paints a highly unllattoring
portrait ol an oarly KKP Joal, tho luyout ol tho machino toolmakor HouJaillo lnJus-
trios - a saJ talo ol inJustrial Joclino anJ linancior rapacity. But invostors in tho KKP
lunJ that linancoJ tho HouJaillo luyout JiJ smashingly: too laJ tho Amorican tool
inJustry hasn`t Jono as voll.
13. Tho moJilor Pulitzor-prizo-vinning` is thoro not as tostimony to tho story`s oxcollonco
- laluJi`s story is ouito lino, lut lots ol crap vins Pulitzors anJ othor prizos - lut to
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shov that a lunch ol mainstroam vorthios took it soriously, an inJox ol tho shilt ol
olito opinion against Jonson anJ Kravis as tho JocaJo turnoJ. A similar pioco ly Bill
AJlor (1988) in tho T~.u: I:~::~: garnoroJ no such notico: laluJi says sho JiJn`t
loarn ol AJlor`s pioco until sho vas voll along in hor rosoarch (Pothmyor 1991).
14. OlJor linancial ~::~I:u incluJo Vitsulishi, Vitsui, anJ Sumitomo, vith ancostors in
tho pro-WorlJ War ll zu:IuI:u. tho loosor, novor groups incluJo luyo, Sanva, anJ
DKB. Tho zu:IuI:u thomsolvos havo roots in 19th contury lamily lirms that JivorsilioJ.
lt shoulJ lo omphasizoJ that ~::~I:u aro not cartols: thoy compoto ouito intonsoly in
tho Jomostic Japanoso markot.
15. ln tho miJ-1990s, it locamo vory lashionallo to Jonounco Japanoso practicos anJ col-
olrato Amorican onos, locauso ol Japan`s lingoring rocossion altor its linancial lulllo
lurst in 1989. This convoniontly ovorlooks Japan`s oxtraorJinary grovth in tho livo
JocaJos lolloving WorlJ War ll - lrom an avorago incomo ooual to 11/ ol tho U.S. in
1945 to 86/ ol tho U.S. in 1994 (VaJJison 1995, tallo D-1a).
16. As vas pointoJ out oarlior, loos Juring tho rocont (post-1980) morgor vavo havo prol-
ally totaloJ lotvoon $20 lillion anJ $40 lillion. loos lor inJiviJual Joals can lo truly
lroathtaking: IazarJ lroros lilloJ tho airlino pilots` union $8.25 million lor aJvising
thom on thoir Ju:I~u luyout liJ lor UnitoJ Airlinos - a Joal vhoso collapso lrought
alout a mini-crash in tho stock markot in Octolor 1989. That sum vorks out to $41,045
por lankor por Jay - u u Iu:I~u u~uI (HonvooJ 1990). Evon il thoy vorkoJ arounJ
tho clock, that`s an hourly rato ol $1,10.
1. Iong anJ Pavonscralt`s stuJy covoroJ sovoral hunJroJ IBOs consummatoJ lotvoon
1981 anJ 198: tho oxact numlor varios lrom 192 to 821, JoponJing on tho Jata sorios
in ouostion. lt usos ouito JotailoJ Consus Jata at tho lirm anJ plant lovol. Thoro voro 91
1981-84 IBOs, anJ 10 1985-8 Joals.
18. Vargarot Blair saiJ in an intorviov that most ol tho lirm- anJ oconomy-viJo gains in
proJuctivity claimoJ ly luyout partisans voro tho rosult ol shutting voakor plants,
rathor than ol an improvomont in tho porlormanco ol sitos that romainoJ opon. lm-
proving proJuctivity at ongoing oporations is a vory complicatoJ task.
19. Iov as aro olton associatoJ vith morgors. lor oxamplo, targots ol proJatory` acouisi-
tions Juring tho 1960s voro Jisproportionally lov-a lirms (Barlor, Palmor, anJ Wallaco
1994).
20. ln tho samo intorviov, Jonson claimoJ that GV vas ovorstalloJ ly 25-50/. Ho JiJn`t
Jiscloso hov ho knov this.
21. Poison pills` aro an antitakoovor tactic that kick in vhon a lirm is unJor attack ly a
hostilo suitor. Spocilically, thoy aro varrants to luy tho lirm`s stock at a largain rato
that aro issuoJ to oxisting sharoholJors onco a hostilo suitor has accumulatoJ a spoci-
lioJ amount ol stock. Tho intont is to mako a hostilo takoovor prohilitivoly oxponsivo.
22. A logal roason lor tho nov institutional assortivonoss vas a sot ol important changos in
socuritios rogulation in 1992 that maJo it much oasior lor sharoholJors to unito anJ
sulmit proxy rosolutions that lorco othor sharoholJors to voto on corporato policy or
loarJ makoup, anJ also maJo it logal lor a group ol sharoholJors to lolly thoir col-
loaguos anJ prosont a caso to managomont. Postrictions on communications among
sharoholJors voro lirst imposoJ to provont lig guys lrom putting small holJors at a
JisaJvantago, lut small lry havo not yot oljoctoJ to tho nov rogimo, no Joult locauso
tho lollying ollorts soom to havo loJ to highor sharo pricos (Blair 1995, pp. 0-3).
23. An announcomont that a lirm is tho targot ol a govornanco campaign ly institutional
sharoholJors loosts its sharo prico in tho short torm, lut proviJos littlo long-torm gain
in oithor sharo prico or prolitalility (Gillian anJ Starks 1995: Wahal 1995). But ol courso,
sharoholJor assortivonoss takos many moro lorms than such pullic lingor-pointing.
24. Polort Vonks (1995), a lormor Poaganito vho is an oagor polomicist on lohall ol sharo-
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300
holJor rights, is imaginativo onough to arguo that sinco ponsion lunJs roprosont tho
massos` capital, thoy aro tho institutions to vhich corporations shoulJ lo accountallo.
(By ponsion lunJs ho moans thoir managors, ol courso.) This accountalility roprosonts
a chock on vhat Vonks aJmits to lo tho rathor anomalous position ol corporations in
a prolossoJly Jomocratic socioty.
25. Tho Tvontioth Contury lunJ`s (1992) most rocont tako on govornanco, WI: M:uu:u
II~ I:~., is luilt arounJ an ossay ly Polort Shillor on oxcoss volatility. \ot tho policy
conclusions tho lunJ Jravs lrom Shillor`s vork aro tho voakost toa imaginallo: on-
couraging pationt capital through moral suasion, vhilo taking no tax or rogulatory stops
tovarJs that goal.
26. ln somo casos, liko Japan anJ South Koroa, tho protoctionist stratogios succooJoJ: in
Iatin Amorica, hovovor, thoy olton protoctoJ corrupt anJ incompotont lrionJs ol tho
govornmont. Thoro`s no guarantoo that protoctionism can vork as aJvortisoJ, lut it`s
harJ to linJ an oxamplo ol a country that inJustrializoJ succosslully - incluJing tho
U.S. in tho lato 19th contury - vithout rostricting imports.
301
7 What is (not) to be done7
Altor a long critiouo liko this, tho author must alvays lo roaJy lor tho
ouostion, OK, so vhat voulJ )u Jo?` Tho tomptation is to Jismiss it
high-minJoJly, saying thoro`s a virtuo to critiouo alono, lut that voulJ
look too covarJly.
Boloro approximating an ansvor, though, l havo to say that rolorms ol
tho linancial sphoro aro novhoro noar as oasy as is somotimos arguoJ. ll
you loliovo that monoy anJ linanco aro somohov opiphonomonal - ol
soconJary importanco to tho roal action ol proJuction, or lizarro malig-
nancios that havo somohov arison on tho oconomic loJy ovor tho yoars
- thon tho path ol action is a lot cloaror. But l`vo spont a lot ol timo argu-
ing that this isn`t tho caso. Whilo linanco is oxponsivo anJ vastolul, prolit
alvays takos tho lorm ol monoy, capital yoarns to lo liouiJ anJ oasily
molilizoJ, anJ linancial instrumonts aro tho moans ly vhich ovnorship
anJ control aro organizoJ. ll Nogri is right, anJ ho is, that monoy has tho
laco ol tho loss, thon taking on monoy moans taking on tho loss.
lt voulJ lo much oasior il tho populists anJ ProuJhonists voro right in
arguing that monoy anJ croJit aro kopt artilicially scarco, anJ tho gonor-
ous provision ol loth voulJ mako lilo prolounJly oasior lor most ol us.
But Varx`s critiouo ol ProuJhon, liko that in tho :uuu::::~, shoulJ chas-
ton ovory linancial rolormor. Varx arguoJ that changos in tho instrumont
ol circulation alono Jo not aJJross tho rolations ol proJuction anJ Jistri-
lution, locauso thoso rolations aro omloJJoJ in tho vory notion ol monoy.
Tho nooJ lor monoy makos vorkors vork anJ capitalists compoto: it`s not
somo ouantity that comos lrom outsiJo tho oconomic systom, lut lrom
Joop vithin it. To lo moaninglul, any attack on tho monoy systom is an
attack on tho prorogativos ol ovnorship anJ class povor.
lnstoaJ ol socializing capital through taxation or somo othor lorm ol
oxpropriation, looso-monoy Jogma simply roJucos to a Josiro lor loans
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on oasy torms. Tho notion ol c:~u:I :uIu:I, inciJontally, is only a hypo-
critical, philistino anJ anxioty-riJJon lorm ol tho saying: proporty is tholt.
lnstoaJ ol tho vorkors Iu:u tho capitalists` capital, tho capitalists aro
supposoJ to lo compolloJ to ::~ it to thom` (Varx 193, p. 123). Or in
tho caso ol tho Amorican populist, compolloJ to lonJ it on oasy torms.
Whilo it`s cortainly tho caso that tho vorking class is lottor oll vith a con-
tral lank that targots a 5/ unomploymont rato than ono that targots 6/,
tho Jilloroncos aro not that lunJamontal.
Pocontly, vo`vo soon a grovth in calls lor local monoys - chits ropro-
sonting lalor timo that circulato in small tovns alongsiJo national monoy
- most lamously tho lthaca Hours schomo in that tovn in upstato Nov
\ork. Prospocts lor such schomos soom sovoroly limitoJ: at lost, thoy soom
applicallo to haircuts, lut prolally not scissors, anJ cortainly not rav
stool. As soon as oxchango lroaks loyonJ tho moroly local, capitalist com-
potition is cortain to roplaco ogalitarianism as tho prico-sotting principlo
unloss lunJamontal changos in ovnorship anJ tho moans ly vhich ontor-
prisos rolato to oach othor aro maJo. Ialour timo cannot Jiroctly lo
monoy.procisoly locauso in lact lalour timo alvays oxists only in tho
lorm ol particular commoJitios` (Varx 193, p. 168). Tho proJuct ol a
larlor can`t lo oxchangoJ vith that ol an stoolvorkor: thoy oxchango as
haircuts anJ motal, pricoJ inovitally in monoy. Tho lorm ol that monoy -
lthaca Hours, loJoral Posorvo notos, or oloctronic llips - may not lo as
important as pooplo think.
So any call lor linancial translormations has to lo consiJoroJ only as a
part ol a lroaJor attack on tho lorms ol capitalist social povor. As this is
vritton, that sooms almost unimaginallo. What onco soomoJ liko milJ
social rolorms - ovon tho laro minimal aspocts ol a social Jomocratic
vollaro stato vo`vo soon in tho U.S. - aro viovoJ ly our rulors as an
intolorallo trospass on thoir GoJ-givon rights. Tho intonsilication ol tho
attack on tho vollaro stato in tho U.S. anJ Wostorn Europo sinco 1989 has
maJo it cloar that tho loss vill grant such concossions only as long as
thoro`s a croJillo throat ol total oxpropriation, vhich is vhat tho USSP, lor
all its countloss laults, alvays roprosontoJ to thom. As impossillo as ox-
propriation may soom toJay, it pays to romomlor tho olJ slogan lrom
Paris 1968: lo practical, JomanJ tho impossillo.
ln liou ol a 10-point rocipo lor social translormation, l ollor a montago
ol critiouo anJ suggostion. lirst a look at a vory laJ iJoa: thon a roviov ol
somo mixoJ iJoas: anJ linally a lov moro amlitious proposals.
But lirst, it`s important to romomlor that not all attompts to roin in glo-
WHAT lS (NOT) TO BE DONE7
303
lalizing linanco in tho namo ol tho local aro politically progrossivo. Horo,
lor oxamplo, is ono vritor`s viov:
Thus, tho task ol tho stato tovarJ capital vas comparativoly simplo anJ
cloar: it only haJ to mako cortain that capital romain tho hanJmaiJon ol tho
stato anJ not lancy itsoll tho mistross ol tho nation. This point ol viov coulJ
thon lo JolinoJ lotvoon tvo rostrictivo limits: prosorvation ol a solvont,
national, anJ inJoponJont oconomy on tho ono hanJ, assistanco ol tho
social rights ol tho vorkors on tho othor.. Tho sharp soparation ol stock
oxchango capital lrom tho national oconomy olloroJ tho possilility ol op-
posing tho intornationalization ol tho Gorman oconomy vithout at tho samo
timo monacing tho lounJations ol an inJoponJont national soll-maintonanco
ly a strugglo against all capital. Tho Jovolopmont ol Gormany vas much
too cloar in my oyos lor mo not to knov that tho harJost lattlo voulJ havo
to lo lought, not against hostilo nations, lut against intornational capital.
That vas Hitlor (1943, pp. 209, 213), in M~:u KuujJ Ono shoulJ alvays
lo carolul ol critiouos ol linanco that stop short ol loing critiouos ol capi-
tal - ospocially onos that locus on intornationalization as an ovil in itsoll.
1
Social Security privatization: a truly horrible idea
Nothing illustratos tho sovority ol tho attack on tho vollaro stato lottor
than tho omorgonco into popular Jiscourso in tho U.S. ol iJoas alout priva-
tizing tho Social Socurity systom. Until ouito rocontly JoscriloJ as tho thirJ
rail` ol Amorican politics - touch it anJ you Jio - magazinos liko T:u~
anJ TI~ N~u R~juII:c anJ ovon a commission appointoJ ly a Domocratic
prosiJont havo signoJ onto a privatization agonJa that vas onco an ol-
sossion ol tho lilortarian right. Whon Barry GolJvator suggostoJ in 1964
that Social Socurity lo maJo voluntary, it vas consiJoroJ oviJonco ol his
maJnoss: nov, tho National Buroau ol Economic Posoarch pullishos hov-
to papors (Kotlikoll 1995), anJ tho moJia aro Joing tho important vork ol
solling tho plan to tho pullic.
Sinco tho iJoa prolally coulJn`t lo solJ on its morits - vhy Jostroy a
systom that is univorsal, succosslul, anJ Jooply popular? - it has to lo
solJ Joviously. At tho coro ol tho Jocoption is tho lino that tho systom
lacos inovitallo lankruptcy vhon tho Baly Boomors login rotiring alout
10 or 20 yoars into tho noxt contury. Tho ollicial sourco ol thoso projoc-
tions is tho annual roports ol tho Trustoos ol tho Social Socurity Systom
(BoarJ ol Trustoos, loJoral OlJ Ago anJ Survivors lnsuranco anJ Disalil-
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ity lnsuranco Trust lunJs 1995). As is common vith such ollicial ollorts,
tho Trustoos prosont throo sots ol projoctions, a gloomy ono, an optimistic
ono, anJ a supposoJly moJorato ono. Though thoro aro a host ol intorro-
latoJ assumptions involvoJ in oach, tho saliont lact, lurioJ in tho roport`s
tallos, is that tho Trustoos assumoJ an oconomic grovth rato ovor tho
noxt 5 yoars ol 1.4/ (Jovn lrom 1.5/ in tho 1994 annual roport) - hall
tho rato soon in tho provious 5 yoars, anJ a rato matchoJ in only ono
JocaJo in this contury (1910-1920). Evon tho 1930s sav a lastor grovth
rato (1.9/).
2
Vy ovn simulations, using highor grovth ratos, shov that
vith moro roasonallo grovth assumptions - ovon a moJost 2.0/ grovth
rato, lolov tho 2.3/ avorago that provailoJ lotvoon 193 anJ 1995 - tho
systom is not lacing insolvoncy. So oithor tho Trustoos aro using Jolilor-
atoly loarish grovth assumptions to promoto pullic Joult ol tho systom
(a chargo tho Systom`s actuary, Stovo Goss, strongly Jonios), or aro loro-
sooing 5 yoars ol Joprossion ahoaJ ol us. Big novs, oithor vay.
Brokors anJ insuranco companios aro taking conscious aJvantago ol
this uncortainty surrounJing Social Socurity to try to snag nov accounts.
AJman Bill Wostlrook tolJ tho !:IIu~ !:c~s Ioslio Savan (1996) that his
rosoarch lounJ that tho groving pullic Jistrust ol govornmont moant a
groving Jistrust that institutions liko VoJicaiJ or Social Socurity vill lo
thoro to tako caro ol pooplo.` His rosoarch also JisclosoJ a groving sonso
ol ompovormont, tho iJoa that l`m a smart, capallo porson, anJ l can
mako my ovn Jocisions.` Thus JiJ Wostlrook`s agoncy, lallon VcElligott,
como up vith tho Bo \our Ovn Pock` slogan lor its cliont, PruJontial, a
company that, ovon as tho nov slogan vas unloashoJ on tho vorlJ, vas
unJor invostigation in 30 statos lor viJosproaJ Jocoptivo salos practicos,
incluJing misloaJing consumors alout tho cost ol tho policios` anJ churn-
ing` ol policios to gonorato nov promiums anJ commissions (Scism 1996).
lt`s all vory surroal: tho linancial markots, charactorizoJ ly nothing il not
volatility anJ scanJal, aro portrayoJ as rock soliJ, anJ govornmont, vhich
has paiJ its ponsionors vithout intorruption anJ minimal scanJal lor ovor
60 yoars, is soon as vollly.
Tho privatizors` moJol is tho Chiloan ponsion systom, a croation ol Gon-
oral Augusto Pinochot`s Chicago-school Jictatorship. Tho moJol, toutoJ
ly loth tho Cato lnstituto anJ tho WorlJ Bank, is contoroJ on a kinJ ol
compulsory lPA schomo, in vhich all covoroJ omployoos put 10/ ol thoir
oarnings into ono ol sovoral approvoJ mutual lunJs, vhich invost thoir
holJings in tho stock anJ lonJ markots. (Employors voro roliovoJ ol hav-
ing to mako a contrilution.) Tho inlusion ol monoy has Jono vonJors lor
305
tho Chiloan stock markot, lut projoctions aro that as many as hall ol luturo
rotiroos vill Jrav a povorty-lovol ponsion. lor thoso at tho lov onJ, thoro
romains a minimal pullic ponsion chock, vhich ollors rocipionts tho
oouivalont ol unJor $2 a Jay (Collins anJ Ioar 1995: Paul anJ Paul 1995:
lrank Solovoy, porsonal communication).
Though propononts lovo to aJvortiso ollicioncios` ol privatizoJ sys-
toms, tho Chiloan systom is harJly a moJol. Tho compoting mutual lunJs
havo vast salos lorcos, anJ tho portlolio managors all havo thoir vast loos.
All in all, aJministrativo costs lor tho Chiloan systom aro almost 30/ ol
rovonuos, comparoJ to voll unJor 1/ lor tho U.S. Social Socurity systom.
Evon tho 12-14/ avorago aJministrativo costs lor tho U.S. lilo insuranco
inJustry look olliciont ly comparison (DiamonJ 1993).
linally, tho oconomics ol a privatizoJ systom, vhich is inovitally con-
toroJ on ploving monoy into tho stock markot, aro protty JoJgy. Whon
ouostionoJ, llacks lrom tho lilortarian Cato lnstituto - vhich is aJvisoJ
ly tho lormor Chiloan calinot ministor vho guiJoJ tho translormation -
mako tvo points: tho historical roturns on stocks aro highor than tho im-
plioJ roturn on Social Socurity, anJ monoy put into tho stock markot vill
promoto roal invostmont. As vo`vo alroaJy soon, linancial thoory can`t
oxplain stock roturns vory voll (tho oouity promium puzzlo), anJ virtually
no monoy put into tho stock markot goos into roal invostmont. Whon con-
lrontoJ vith thoso Jotails, Cato`s llacks sputtor anJ muttor, lut thoy havo
no soliJ ansvor othor than to Jonounco tho managorial skills ol govorn-
mont luroaucrats.` llacks also proloss groat laith in tho pullic`s alility to
manago its rotiromont portlolio, lut ovon pooplo vith aJvancoJ Jogroos
Jon`t roally unJorstanJ tho lasic arithmotic ol intorost ratos, much loss tho
comploxitios ol moJorn linancial markots.
lt`s a mystory vhy tho stock markot shoulJ Jo any lottor at solving tho
Jomographic prollom ol Baly Boomor rotiromont than tho pullic sys-
tom. Ovor tho long torm, tho stock markot shoulJ grov roughly in lino
vith tho ovorall oconomy: tho only vay it coulJ groatly oxcooJ tho unJor-
lying grovth rato is il tho prolit sharo ol GDP voro to incroaso continu-
ously, or valuations voro to grov to Ponzi-liko lovols. Historical roturn
liguros - ono ol tho privatizors` lavorito argumonts - assumo that Jivi-
JonJs anJ capital gains aro ro-invostoJ, vhon in lact thoy vill lo Jravn
Jovn to linanco pooplos` rotiromonts: lor linancing rotiromont, tho stock
markot is liko a giant rovolving lunJ, much liko tho pullic systom, that
linancos not salos ly ono sot ol partios vith lrosh purchasos ly anothor.
Woro tho Boomors to start solling stocks to linanco thoir rotiromont, pricos
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306
voulJ lall unloss thoro vas ovon moro coming in lrom Gonorations X, \,
anJ Z. AnJ ol courso any timo lotvoon nov anJ thon, il ono has tho laJ
luck to rotiro in tho miJst ol a loar markot, thon ho or sho may laco a lairly
misorallo rotiromont.
But tho vholo notion ol privato ponsion lunJs, oithor ol tho sort that
provail nov or voulJ provail unJor a privatizoJ systom, JoponJs on an
oconomic illusion. ln ono ol tho moro prolounJ passagos ol tho ~u~:uI
TI~:), Koynos (W Vll, pp. 104-105) maJo an argumont that has loon
virtually lost to moJorn oconomic thought:
Wo cannot, as a community, proviJo lor luturo consumption ly linancial
oxpoJionts lut only ly curront physical output. ln so lar as our social anJ
lusinoss organisation soparatos linancial provision lor tho luturo lrom physi-
cal provision lor tho luturo so that ollorts to socuro tho lormor Jo not nocos-
sarily carry tho lattor vith thom, linancial pruJonco vill lo liallo to Jostroy
olloctivo JomanJ anJ thus impair voll-loing..
lnJiviJuals may lo allo to sot asiJo monoy lor tho luturo, lut not a soci-
oty as a vholo: a socioty guarantoos its luturo only ly roal physical anJ
social invostmonts. But tho linancial markots aro JomanJing cutlacks in
loth pullic anJ privato invostmont in tho namo ol linancial pruJonco.`
ToJay, anyono making an argumont liko Koynos`s at an Amorican Eco-
nomics Association mooting or on :::J::~ voulJ lo rogarJoJ as insano.
This is vhy you von`t linJ anything in this chaptor on tho progrossivo
uso` ol ponsion lunJs. Potor Druckor`s loars ol ponsion lunJ socialism`
ol tho 190s havo roalizoJ thomsolvos in tho portlolio managor capitalism
ol tho 1990s - vhich is no surpriso, sinco it`s ouito natural that capital
shoulJ appropriato tho pooloJ savings ol vorkors lor managomont.` Tho
vholo iJoa ol croating hugo pools ol linancial capital shoulJ lo tho locus
ol attack, not tho usos to vhich thoso pools aro put. lnstoaJ ol lunJing
inlrastructuro Jovolopmont through croativo ponsion-lunJ-lackoJ linan-
cial instrumonts, linanco it vith a voalth tax instoaJ.
Tho losson ol tho SvoJish vago-oarnor lunJs shoulJ lo chastoning to
ponsion-lunJ rolormors (Pontusson 1984: 198: 1992). Tho lunJs voro
originally concoivoJ ly social Jomocratic oconomists as a schomo lor so-
cializing ovnorship ol corporations. ln tho original miJ-190s proposal,
lirms voulJ havo loon roouiroJ to issuo nov sharos, in amounts ooual to
20/ ol thoir annual prolits, to lunJs roprosonting vago-oarnors as a col-
loctivo. ln tho spaco ol a JocaJo or tvo, thoso lunJs voulJ acouiro Jomi-
nant, anJ ovontually controlling, intorosts in corporato SvoJon.
307
This iJoa scanJalizoJ lusinoss, vhich launchoJ a groat campaign to
JiscroJit it - a task that vas groatly simplilioJ ly tho lact that tho lunJs
novor attractoJ lroaJ popular support. Tho Social Domocrats anJ tho
unions vatoroJ tho plan Jovn, anJ a voak vorsion vas aJoptoJ in tho
oarly 1980s. Tho lunJs ouickly logan lohaving liko orJinary ponsion lunJs:
thoir managors, in a vain attompt at logitimation, logan traJing stocks in
an ollort to loat tho markot avoragos. Evontually, lato in tho JocaJo, tho
vago-oarnor lunJs voro outhanizoJ.
Why JiJ thoy lail? lor at loast tvo roasons. lirst, lusinoss corroctly sav
tho initial vorsion as a challongo to capitalist ovnorship, a rominJor that
linanco is contral to tho constitution ol a corporato ruling class. AnJ soc-
onJ, thoy novor attractoJ popular support - ossontial to any sorious chal-
longo to a corporato ruling class - locauso thoy voro so alstract. As
Pontusson (1992, p. 23) put it, vhon colloctivo sharoholJing lunJs aro
roJucoJ to JociJing vhothor to luy sharos in Volvo or Saal,` it`s harJ to
mustor popular onthusiasm. Voro Jiroct intorvontions aro roouiroJ - ac-
tivo pullic inJustrial policy anJ groator vorkor control at tho lirm lovol -
il orJinary pooplo aro to got intorostoJ. Tho stock markot, on tho othor
hanJ, is tho homo turl ol linanciors, anJ any gamos playoJ on thoir turl
usually onJ up loing playoJ ly thoir rulos.
democratizing the Fed
linancial populists olton proposo to Jomocratizo tho loJ,` oponing up
its procooJings to pullic scrutiny, anJ making momlorship on tho BoarJ
ol Govornors into an oloctivo ollico. lunJamontally, this is a lino iJoa.
But, in tho spirit ol this chaptor, its limitations havo to lo acknovloJgoJ.
Congross is an oloctivo ollico, too, anJ its procooJings aro tolovisoJ in
narcotic Jotail on C-SPAN, lut tho loJy still proJucos innumorallo insults
to Jomocracy. Tho monoyoJ anJ povorlul onjoy an accoss to Congross
that moro citizons lack, a Jisparity that is voll knovn: vhy shoulJ apply-
ing similar stanJarJs to tho loJ proJuco any lottor rosults - ospocially
vhon it comos to tho contral lank, vhoso issuos aro Joar to tho hoarts ol
rontiors? Tho spoctaclos ol Congrossional tax-vriting anJ luJgot-making
Jon`t ollor an inspiring procoJont.
ProcoJuro asiJo, tho naturo ol tho contral lank may lo loss important
than tho lroaJor institutions in vhich it is omloJJoJ. A comparison vith
othor countrios Jomonstratos tho point. Tho most inJoponJont ol tho major
contral lanks is tho Gorman BunJoslank (knovn as Bula` to its lrionJs):
WALL STREET
308
it Joos vhat it ploasos vith an insoucianco that ovon Alan Groonspan must
onvy. Tho loast inJoponJont ol tho Europoan contral lanks is tho Bank ol
EnglanJ: though it logan its lilo in tho sovontoonth contury as a privato
institution that sorvoJ as lankor to tho stato, it vas nationalizoJ in 1946 ly
tho Ialour govornmont anJ still takos policy Jiroction lrom tho Chancol-
lor ol tho Exchoouor. Nov it must lo aJmittoJ that Bula has kopt intorost
ratos vory high ovor tho past sovoral yoars, out ol loar ol tho inllationary
consoouoncos ol Bonn`s takoovor ol tho lormor East Gormany. \ot ovor
tho long torm, ly any stanJarJ - vhothor ly harJhoaJoJ onos liko grovth
ratos anJ invostmont lovols, or souishy-humanist onos liko povorty ratos
anJ incomo Jistrilution - tho Gorman oconomy has porlormoJ lar lot-
tor than tho British ono lor JocaJos.
lt voulJ lo tompting to concluJo lrom that comparison that maylo an
inJoponJont contral lank is a protty gooJ thing altor all. But tho Bank ol
Japan is largoly sulorJinato to tho Japanoso linanco Vinistry, anJ ly tho
samo stanJarJs, tough or solt, Japan`s oconomy has Jono lar lottor than
ovon Gormany`s ovor tho long torm. So maylo an inJoponJont contral
lank isn`t such a gooJ thing altor all.
Or maylo tho importanco ol tho contral lank is oxaggoratoJ. Unliko
Britain anJ tho UnitoJ Statos, vhich sullor lrom loosoly rogulatoJ linan-
cial systoms anJ a shoot-lrom-tho-hip stock markot montality, Japan anJ
Gormany havo rathor tightly rogulatoJ systoms in vhich stock markots
play a rolativoly unimportant rolo in loth invostmont linanco anJ corpo-
rato govornanco. ComparoJ vith thoso lroaJor linancial structuros, tho
contral lank`s (in)JoponJonco isn`t ouito so important.
Populist critiouos ol tho loJ tonJ to concontrato oxcossivoly on its au-
tonomous povors vhilo ovorlooking tho inlluonco ol tho linancial mar-
kots on tho contral lankors: tho loJ lollovs intorost rato tronJs as voll as
loaJing thom. Tho 1994 tightoning ollors a gooJ oxamplo. CroJitors lo-
gan solling thoir lonJs, Jriving up long-torm intorost ratos, sovoral months
loloro tho loJ jackoJ up tho short-torm ratos in lolruary. Thoy roinlorcoJ
tho mossago vith ropoatoJ crios urging tho loJ to tighton. Evon altor tho
loJ logan tightoning, Wall Stroot layoJ lor moro. Similarly, Groonspan`s
urging ol Jolicit-cutting on Clinton vas Jono in tho namo ol ploasing tho
lonJ markot, a task tho nov ProsiJont took to vith groat pullic lorvor,
Jospito tho privato rosorvations roportoJ ly WooJvarJ. Woro somo ro-
constructoJ loJ to shilt policy into a pormanontly stimulativo moJo, it
voulJ havo to laco tho prospoct ol a capital striko on tho part ol croJitors:
it might lo allo to lorco short-torm ratos Jovn, lut long-torm ratos coulJ
309
riso tovarJ 20/. Any Jomocratization ol tho loJ that JiJn`t simultanoously
tako on tho linancial olito voulJ ouickly laco such a Jisastor.
Suro, tho loJ shoulJ lo oponoJ up - its socrocy onJoJ: its ovn li-
nancos lrought into tho gonoral loJoral luJgot: its porsonnol maJo moro
lroaJly roprosontativo in torms ol gonJor, raco, anJ class: anJ its narrov,
austoro critorion ol oconomic managomont put on pormanont lurlough.
But that kinJ ol translormation coulJ succooJ only as part ol a lroaJor
translormation ol linancial rolations.
investing socially
Ovor tho last JocaJo - ossontially sinco tho campaign to purgo stock port-
lolios ol companios Joing lusinoss in South Alrica startoJ in tho oarly
1980s - vo`vo soon an oxplosion in invostmont lunJs JovotoJ to goals
loyonJ moro prolit-maximization. Ono can traco tho movomont`s history
lack lurthor - to tho oarly 190s, vhon somo VothoJist clorgy lounJoJ
tho Pax WorlJ lunJ, anJ tvo portlolio managors, Polort Schvartz in Nov
\ork anJ Polort Zovin in Boston, startoJ managing monoy lor a lov inJi-
viJuals anJ institutions concornoJ alout vhoro thoir prolits camo lrom
(KinJor, IynJonlorg, anJ Domini 1992).
BosiJos South Alrica, tho principal concorns motivating social invos-
tors in tho oarly Jays voro nucloar povor anJ voapons-making. That is,
tho lounJing impulsos voro to avoiJ tho noxious. ln moro rocont yoars,
thoro`s loon a grovth in tho Josiro to Jo activo gooJ vith ono`s invost-
monts - to lostor Jovolopmont in poor communitios, lor oxamplo, or
lunJ onvironmontally lrionJly tochnologios. Tho unilying loaturo ol social
invosting (Sl) is tho Josiro to accomplish somo social goals along vith
making a roturn on ono`s monoy.
As might lo oxpoctoJ, tho liolJ is populatoJ ly a lull rango ol pooplo,
lrom cynics looking lor a markot nicho to somo lino pooplo looking to
translorm tho vorlJ. Tho mainstroam ol tho Sl inJustry is charactorizoJ ly
somo lorm ol social scrooning. Tho llavor ol that scrooning can lo samploJ
in an aJ in tho Vay-Juno 1995 issuo ol tho Iu~ R~uu~: lor Working As-
sots, tho Sl mutual lunJ giant. Working Assots toutoJ its No-IoaJ Citizons
lnJox lunJ thus: Unliko tho S8P 500, hovovor, vo havo a lov concon-
tration in Jirty, Jying inJustrios liko hoavy oouipmont, oil anJ chomicals,
voapons, utilitios, alcohol anJ tolacco. lnstoaJ, vo`vo concontratoJ on
WALL STREET
310
cloan inJustrios ol tho luturo, such as communications, consumor proJ-
ucts anJ sorvicos, lusinoss oouipmont, high-toch, linanco, hoalthcaro anJ
looJ proJuction.` Whilo ovory inJiviJual company is socially scroonoJ,
tho oconomic analysis unJorlying this portlolio soloction romains happily
unoxaminoJ. lorgot that tho Jying inJustrios` aro gonorally high-vago,
anJ tho cloan inJustrios` olton loss so. AnJ vhoro voulJ communica-
tions, lusinoss oouipmont, anJ othor high-toch inJustrios lo vithout tho
chomicals usoJ in tho manulacturo ol computor harJvaro, anJ tho lov-
vago lalor oxploitoJ in tho procoss? Don`t tho proJucts ol tho high-toch
inJustrios contriluto to tho constant choaponing ol lalor anJ tho much-
lamontoJ glolalization ol tho assomlly lino? Whoro voulJ any ol thoso
glistoning inJustrios lo vithout tho oloctricity proJucoJ ly tho nasty oil-
povoroJ utilitios, or tho oarth movoJ anJ tho concroto pouroJ ly tho
proJucts ol tho hoavy oouipmont inJustry? WoulJ uppor-miJJlo-class
Amoricans, Working Assots` targot population, havo incomos 50 timos tho
ThirJ WorlJ avorago il it voron`t lor all thoso nasty voapons? Doosn`t
looJ proJuction prolit nicoly lrom tho constant choaponing ol rav agri-
cultural commoJitios, a tronJ that has savagoJ ThirJ WorlJ oxporting na-
tions anJ inJigonous proJucors?
3
lsn`t it tho choapost sort ol moral lomlast
to got oxorcisoJ ly tolacco proJuction, ono that inJucos a varm glov in
tho vooJ-o-pholo, lut involvos no signilicant challongo to tho social or-
Jor? AnJ vhat sorvico Joos linanco ollor oxcopt tho multiplication ol richos
lor thoso alroaJy llossoJ vith plonty?
But tho social invostors aro, in largo moasuro, part ol that linancial in-
Justry - ono that skims tho croam, lrom loth tho moral anJ nicho mar-
koting points ol viov, lut ono that nonotholoss novor troullos itsoll vith
tho largor ouostions ol vhy somo havo linancial assots vhilo most Jon`t,
or, moro raJically, hov that translatos into tho povor ol croJitor ovor Joltor,
anJ vhy somo shoulJ prolit lrom tho JisguisoJ lalor ol othors.
ln an intorviov lroaJcast on Vay 9, 1995 on CNBC, tho callo TV lusi-
noss novs channol, Sophia Collior, tho lig chooso at Working Assots, saiJ
that 40/ ol tho S8P 500 stocks aro socially rosponsillo.` That assumos
that you havo no prollom vith tho giant multinational corporation itsoll,
just somo inJiviJual malolactors. Tho loaJing inJox ol socially rospon-
sillo stocks, that pullishoJ ly KinJor, IynJonlorg, anJ Domini, incluJos
alout hall tho S8P 500, prosumally tho samo lirms Collior haJ in minJ.
Tho political thinking ol mainstroam Sl is unJorJovolopoJ. ln its prag-
matic laith in inJiviJual action, it`s classically Amorican. Social invostors
also mako somo oJJ alliancos. An issuo ol TI~ :~~uuu~) {u:uuI (1995)
311
approvingly ouotoJ mutual lunJ kingpin (Sir) John Tomploton rollocting
on othics, unavaro ol or inJilloront to tho lact that his Tomploton Prizo lor
Progross in Poligion in 1994 vont to Vichaol Novak, lamous lor his vari-
ous thoological apologias lor Poaganomics, nucloar voapons, anJ
Argontina`s Jirty var against JissiJonts (HonvooJ 1994l) - a prizo
avarJoJ ly a loarJ that incluJoJ JistinguishoJ othicist Vargarot Thatchor.
A contraJiction no social scroon can aJJross is that invostmont prolits
originato ultimatoly, no mattor hov you Jross thom up, in tho uncompon-
satoJ lalor ol vorkors, anJ that thoy JoponJ on a social orJor in vhich
somo pooplo havo monoy to sparo anJ othors Jon`t. Whon askoJ to com-
mont on this, tho lormor raJical acaJomic turnoJ social lrokor Vichaol
Vollitt concoJoJ, lt`s a prollom.` Vollitt`s past makos him avaro ol tho
prollom,` lut most social invostors Jon`t ovon think alout it.
With South Alrica no longor an issuo, tho most popular social scroons
rolloct tho concorns ol upscalo lilorals: tolacco, vomon in tho loarJ-
room, animal tosting, anJ tho grossor onvironmontal crimos. Concorns liko
vomon on tho assomlly lino, unionization, anJ vorkplaco injurios raroly
appoar. Ono ol tho lavorito stocks ol mainstroam Sl has loon that ol tho
Washington Post Co., a liorcoly anti-union lirm that pullishos tho Jaily
journal ol rocorJ lor tho DC lranch ol tho status ouo.
But tho Sl univorso is not all so convontional, anJ somo aspocts aro ox-
porimonting vith tho actual translormation ol proporty rolations. Iot`s start
vith tho convontional anJ movo graJually avay lrom it. Along vith tho
grovth in Sl has como an incroasing intorost in altornativo` linancial insti-
tutions, liko community Jovolopmont lanks (CDBs) anJ loan lunJs. Tho
most prominont ol tho CDBs is tho South Shoro Bank ol Chicago, vhoso
promotors say it has rovivoJ a Joclining urlan noighlorhooJ vhilo turn-
ing in a storling linancial porlormanco. lt is toutoJ ly somo as a moJol lor
tho lroo-markot ora, a privato-soctor altornativo to JiscroJitoJ olJ social
programs, though IynJon Comstock, lounJor ol Brooklyn`s Community
Capital Bank, ouickly concoJoJ in an intorviov that a lank, ovon ono
vith social goals, is still no sulstituto lor pullic soctor sponJing.
South Shoro, lounJoJ in 193, is tho olJost anJ richost ol its kinJ. lt has
attractoJ talontoJ lankors anJ lots ol outsiJo Jopositors. ll you roaJ its
pross, it`s Jono vonJorlully voll. ln vhat appoars to lo tho lirst outsiJo
ollort to auJit its claims, Bonjamin Esty (1995) ol tho HarvarJ Businoss
School lounJ that South Shoro`s actual rocorJ is loss improssivo than its
WALL STREET
312
PP. Whon moasuroJ against noarly lanks ol comparallo sizo, its linancial
porlormanco has loon lairly unJorvholming. That voulJ lo lino il it voro
accomplishing its social goals, lut it appoars not to lo. Whon Esty com-
paroJ social inJicators lor tho South Shoro noighlorhooJ vith contigu-
ous communitios using Consus Jata lrom 190, 1980, anJ 1990, ho lounJ
tho rosults to lo JociJoJly mixoJ at lost.` Whilo unomploymont in tho
South Shoro noighlorhooJ vas lovor, incomos havo lallon moro rapiJly
than in tho noighloring communitios: ovorall, concluJoJ Esty, South
Shoro`s rolativo porlormanco has loon vorso than tho contiguous noigh-
lorhooJs.` Nov thoro may lo all kinJs ol prolloms, mothoJological anJ
concoptual, vith this comparison, Esty aJmits, lut thoso rosults aro nono-
tholoss vory Jamaging to tho CDB causo.
Closoly rolatoJ to tho South Shoro moJol aro various nonlank lorms ol
local lonJing liko community Jovolopmont lunJs. Though not strictly com-
morcial lanks, thoy too accopt monoy lrom socially minJoJ invostors anJ
thon mako loans to lunJ housing rohalilitation, nonprolit housing Jovol-
opmont, anJ small lusinossos. Tho inJustry is still ouito small. AccorJing
to tho National Association ol Community Dovolopmont Ioan lunJs (1996),
as ol tho onJ ol 1995, tho inJustry haJ $108 million in loans outstanJing,
anJ $204 million in capital, a thirJ ol tho capital pormanont anJ tho rost
lorrovoJ. ln tho nino yoars altor thoir 1986 lirth, NACDIl momlor lunJs
linancoJ 56,243 housing units, 3/ ol thom pormanontly allorJallo lor
lov-incomo rosiJonts, anJ croatoJ or prosorvoJ 11,313 jols, 59/ ol thom
lor lov-incomo pooplo,` 51/ lor vomon, anJ 3/ lor minoritios. Thoir
loan loss oxporionco vas an improssivo 0.92/.
Ol courso all thoso numlors aro lottor than nothing. But so lar thoy
laroly rogistor on tho national scroon. Tho total numlor ol jols croatoJ
or prosorvoJ` ovor tho ontiro 10-yoar history roprosonts loss than tvo Jays
ol normal U.S. omploymont grovth: ol housos linancoJ, alout 10 Jays ol
normal U.S. housing proJuction.
4
AnJ somo loans oxtonJoJ unJor tho namo ol community Jovolopmont
look rathor oJJ inJooJ. ln its 1995 annual roport, tho Northorn Calilornia
Community Ioan lunJ lraggoJ alout a $25,000 loan to ostallish a Bon 8
Jorry`s ico croam storo in San lrancisco that vill train anJ proviJo om-
ploymont lor lov incomo youth lrom San lrancisco`s TonJorloin noigh-
lorhooJ.` A siJolar, illustratoJ vith a picturo ol smiling, lroshly omployoJ
toons, claims that tho lusinoss supports youth programs in sovoral vays:
jol training takos placo in tho ico croam parlor, vhilo tho prolits go to-
varJs croating nov lusinoss ontorprisos to lonolit homoloss youth.`
313
Bon 8 Jorry`s is a lavorito ol tho soullul capitalism crovJ. Unlortunatoly,
as its ovn social auJitor, tho soullul catalog morchant Paul Havkon, aJ-
mittoJ in tho lirm`s 1994 annual roport, roality JiJn`t support tho claims
that tho Brazil nuts usoJ in B8J`s Painlorost Crunch voro harvostoJ ly
inJigonous pooplo lor thoir lonolit:
Tho lalol on Bon 8 Jorry`s Painlorost Crunch lco Croam givos tho impros-
sion that tho harvost ol tho nuts lonolits inJigonous lorost pooplos. ln lact,
tho nuts aro not harvostoJ or solJ ly inJigonous pooplos lut ly tho rullor
tappors ol Brazilian anJ Portuguoso ancostry vho havo vorkoJ tho lorosts
lor a contury. Ono might ask vhat constitutos inJigonous status anJ this
might lo a minor point il not lor tho lact that somo oxports on inJigonous
pooplos loliovo that tho llov ol monoy to thoso projocts has haJ a Jamag-
ing olloct on trilal culturos. Tho inllux ol cash has croatoJ inoouitios, rival-
rios, anJ an appotito lor vostorn gooJs vhilo roJucing tho attontion paiJ to
tho roal issuo: lanJ ovnorship. Ouoting lnJian Unity: .Our communitios`
inJoponJonco is . voakonoJ as our voll-loing is maJo JoponJont on
vostorn markots.. Solling proJucts is moaningloss il vo oursolvos Jo not
control tho markoting projocts anJ tho natural rosourcos, il vo oursolvos Jo
not control our lanJs anJ havo tho right to say vhat vo vant..` A soconJ
point rogarJing lalol accuracy is that tho lulk ol tho nuts usoJ in Painlorost
Crunch havo loon commorcially rathor than altornativoly sourcoJ.
5
Thoso lailings aro omllomatic ol tho voaknoss ol Sl in gonoral: it too oas-
ily locomos just anothor markoting gimmick, vhilo Joing littlo to aJJross
inoouitios ol voalth anJ povor.
ln tho ThirJ WorlJ, similar small-scalo lonJing schomos aro prolloroJ
as curos lor povorty in placos vhoro convontional Jovolopmont has lailoJ.
6
Tho lavorito oxamplo, tho South Shoro ol tho altornativo Jovolopmont
crovJ, is tho Gramoon Bank ol BanglaJosh, vhich ollors tiny loans only
to vomon, vho supposoJly luilJ lusinossos vith tho procooJs anJ oxit
povorty. Gramoon has oarnoJ gloving roviovs, lasoJ mainly on its ovn
tostimony anJ citation ol proviously pullishoJ gloving roviovs: in lact,
harJly a nogativo vorJ alout tho lank appoaroJ anyvhoro in tho pross
until Gina Noll invostigatoJ Gramoon lor 1~JI 1u::u~:: I:~::~: (Noll 1996).
Dospito claims ol povorty roJuction, ovor hall ol Gramoon`s long-torm
lorrovors can`t moot lasic nutritional nooJs. Dospito claims ol commor-
cial vialility, tho ontorpriso is kopt going only ly philanthropists` sulsi-
Jios. Dospito claims ol ompovoring` vomon, Gramoon loans lormalizo
vomon`s inlormal housoholJ lalor (vhilo llocking thoir ontry into po-
WALL STREET
314
tontially moro lilorating - vith all tho appropriato oualilications - vagoJ
vork), typically vithout incroasing thoir autonomy vithin tho housoholJ
(voll unJor hall havo signilicant control ovor tho lusinossos holJ in thoir
namos). By contrast, tho Soll-EmployoJ Womon`s Association ol lnJia
(SEWA) ollors croJit, lut as part ol a packago ol oJucation anJ political
organizing. With Gramoon, malo lonJing ollicors roally call tho shots.
Tho appoal ol microcroJit schomos liko Gramoon - vhich havo loon
aJoptoJ onthusiastically ly tho likos ol tho WorlJ Bank, Hillary Clinton,
anJ Citilank - is that thoy aro a lov-cost, nonthroatoning sulstituto lor
roal soll-organization, liko SEWA, anJ lor oxponsivo pullic programs liko
oJucation, hoalth caro, anJ inlrastructuro invostmont.
lt may lo that tho losson ol tho WorlJ Bank`s oxporionco ovor tho last
50 yoars is ol noar-univorsal applicalility: it`s vory Jillicult, il not impos-
sillo, to lorrov your vay out ol povorty.
Voro promising than Nov Ago lanks aro stratogios that altor tho naturo ol
proporty rolations. lor oxamplo, community lanJ trusts (CITs) aro Jomo-
cratically controlloJ non-prolit corporations, vith opon momlorship anJ
oloctoJ loarJs. Tho purposo ol a CIT is to acouiro lanJ anJ holJ it porma-
nontly lor tho lonolit ol tho community. Tho lanJ is thon maJo availallo
through long-torm loasos to inJiviJual lamilios, cooporativos, anJ othor
organizations vho may ovn luilJings on tho lanJ. Posalo rostrictions in
tho grounJ loaso koop tho proporty availallo lor luturo purposos` (Com-
munity lnvostmont Vonitor 1995). CITs voro JovolopoJ ly tho lounJors
ol tho Vassachusotts-lasoJ lnstituto lor Community Economics (lCE), Palph
BorsoJi anJ Bol Svann, in tho 1960s. Iossors on CIT lanJ can lo com-
ponsatoJ lor improvomonts thoy mako to thoir luilJing, lut thoy cannot
soll it on tho opon markot: tho iJoa is to romovo tho parcol ol lanJ lrom
tho proporty markot lorovor. A similar concopt, limitoJ oouity co-ops, can
lo usoJ in citios: rosiJonts can luy an apartmont lrom tho co-op, anJ soll
it lack vhon thoy loavo - vith appropriato componsation lor any im-
provomonts thoy might havo maJo anJ gonoral inllation, lut vith no pos-
silility ol signilicant traJing prolits.
A lormor Jiroctor ol tho lCE, Charlos Vatthoi (porsonal communcation)
arguos that incroasos in proporty valuos aro claimoJ ly inJiviJuals, lut,
asiJo lrom improvomonts maJo ly tho occupant, aro typically tho rosult
ol social action liko pullic inlrastructuro Jovolopmont or gonoral oconomic
grovth. lt`s lunJamontally unlair, Vatthoi says, that thoso social gains
315
shoulJ lo capturoJ mainly ly privato inJiviJuals - ospocially unlair il
thoy contrilutoJ littlo or nothing to thoir noighlorhooJ`s upscaling ox-
copt having loon thoro at tho right timo.
Still, CITs aro a spock on tho horizon: as ol lato 1995, thoro voro only
90 ol thom in tho U.S. Tho lCE, a loaJor among loaJors,` accorJing to tho
novslottor ol tho National Association ol Community Dovolopmont Ioan
lunJs (Community lnvostmont Vonitor 1995) haJ oouity capital ol
$531,000 anJ haJ lont a total ol $26 million lotvoon its lounJing in 199
anJ 1995. With tho total valuo ol lanJ, luilJings, anJ othor tangillo assots
in tho U.S. noarly $20 trillion in 1994, accorJing to tho loJ`s llov ol lunJs
accounts, CITs havo a long, long vay to go.
Ono ol tho roasons to lo skoptical alout institutions that Jon`t altor
proporty rolations is that institutions anJ pooplo that start out vith nollo
goals olton onJ up roproJucing tho ills thoy voro moant to corroct. Tho
U.S. is lull ol community organizations anJ nonprolit housing Jovolopors
that nov soom inJistinguishallo, oxcopt maylo in mattors ol stylo, lrom
convontional roal ostato Jovolopors anJ lanks. lt is no acciJont that tho
lorJ lounJation has omlracoJ community Jovolopmont schomos: no
institution in Amorica is lottor at spotting potontial troullomakors anJ
Jomosticating thom (not only in tho U.S., lut arounJ tho vorlJ).
taes: soak the fat boys!
Vany ol tho approachos l`vo just JiscussoJ aro attompts to cralt markot-
lrionJly rosponsos to social prolloms. Thoy`ro olton roprosontoJ as lrosh
approachos to olJ prolloms, vhon in lact thoy`ro roally convontion tartoJ
up as innovation. l`m rominJoJ ol Karl Kraus`s commont alout psycho-
analysis - that it`s tho Jisoaso ol vhich it purports to lo tho curo.
ll olJ thinking can lo succosslully passoJ oll as nov, vhy not rovivo
somo lottor olJ iJoas than tho onos nov loing ro-animatoJ? Capital con-
trols, lor oxamplo, onco a cornorstono ol social Jomocratic thinking, aro
nov JismissoJ as hopolossly olsoloto. But vhy? Why not roouiro govorn-
mont approval ol inlounJ anJ outlounJ loroign invostmont? lt vorkoJ
ouito voll lor Japan anJ South Koroa: vhy can`t capital controls lo put in
sorvico ol an agonJa moro humano than tho rapiJ grovth in GDP anJ
oxports? To thoso vho say that moJorn tochnology makos it oasy to ovaJo
such rostrictions ono can oasily roply that it also makos it oasior to imposo
thom. Tho principal olstaclos aron`t tochnical, lut political (not that tho
political olstaclos aro minor).
WALL STREET
316
Porhaps tho most unlashionallo iJoa ol all is taxing tho rich - or soak-
ing tho lat loys, as Jack BurJon, tho journalist turnoJ political consultant,
put it to Willio Stark, tho Huoy Iong-ish horo ol Polort Ponn Warron`s .II
II~ K:u: M~u Soriously loosting tho incomo tax rato on tho richost 1-
2/ ol tho population coulJ lunJ all mannor ol pullic programs, lrom lroo
oJucation anJ chilJcaro to pullic jols programs. AnJ taxation ol voalth
itsoll, along vith incomo, voulJ lo a vonJorlul vay to raiso lunJs lor,
say, tho upgraJing ol tho pullic physical anJ social capital stock - li-
nancing urlan roconstruction, mass transit, altornativo onorgy rosoarch,
anJ onvironmontal ropair. Both lorms ol taxation voulJ also havo tho
lovoly siJo-olloct ol roJucing tho voalth anJ social povor ol tho vory rich.
lncomo taxos aro lamiliar, lut voalth taxos aron`t. Washington taxos
voalth only on tho Joath ol tho vory voalthy, anJ ovon thon ostato taxos
aro ouito porous, anJ aro olton rolorroJ to as voluntary,` locauso anyono
vith timo anJ a clovor lavyor can protty much JoJgo thom.
As ol 1990, olovon OECD countrios, all in Europo, haJ somo lorm ol
voalth taxation in olloct, although tho lurJon on tho voll-oll vas in gon-
oral ouito light. Simulations ly EJvarJ Wolll (1995, chaptors 8 anJ 9)
shov that aJopting tho Sviss systom ol voalth taxation voulJ havo raisoJ
$34 lillion in 1989: tho Gorman systom, $68 lillion, anJ tho SvoJish (sinco
ropoaloJ ly a consorvativo govornmont), $329 lillion - in a yoar vhon
total rovonuos lrom loJoral incomo taxos voro $446 lillion, anJ tho much-
lomoanoJ Jolicit vas $152 lillion.
All throo moJols oxcluJo housoholJ ollocts (though not ovnor-occu-
pioJ housing) anJ ponsions lrom voalth taxos, anJ tho Gorman anJ SvoJ-
ish vorsions also sparo lilo insuranco. So all throo loavo tho poor anJ tho
miJJlo class largoly unscathoJ. Only a SvoJish-stylo tax voulJ lito tho
uppor miJJlo class: thoso vith voalth in tho $5,000-100,000 rango (in
1989) voulJ laco a nov tax ooual to alout 15/ ol thoir prosont incomo
tax: thoso in tho $100,000-250,000 rango, 39/ ol thoir incomo tax, anJ
thoso alovo $250,000 voulJ tako a hit closo to or largor than thoir prosont
incomo tax lialility. Olviously such a tax voulJ havo vory Jramatic oco-
nomic, liscal, anJ Jistrilutional ollocts, unliko tho othor tvo national
moJols. A Sviss-stylo systom voulJ lo laroly noticoallo to non-million-
airos, anJ Gorman-stylo systom voulJ harJly touch thoso vith voalth
holJings unJor $250,000. Evon so, tho amounts ol rovonuo raisoJ voulJ
lo moro than notional in an ora vhoro pullic sorvicos aro starvoJ lor lunJs.
Thoro aro lov sorious argumonts against voalth taxos oxcopt tho pros-
orvation ol privilogo. Woalth taxos voulJ tonJ to hit olJor lamilios harJor
317
than youngor onos, ovon though somo olJor lamilios may havo lovor in-
comos than thoir moro youthlul lollov citizons, lut carolul Josign ol tho
tax coulJ mitigato thoso ollocts il that voro JosiroJ.
But ol courso, a voalth

tax ly Jolinition voulJ hit only thoso vith a lot ol commas in thoir lank
lalanco. Pich lolks anJ thoir hiroJ pons voulJ no Joult claim vory Jamag-
ing ollocts on saving anJ invostmont, lut tho U.S., vhich taxos voalth anJ
incomo vory lightly, has ono ol tho lovost ratos ol saving anJ invostmont
in tho lirst WorlJ - lovor than SvoJon in tho Jays ol its tax. Voro gon-
orally, thoro appoars to lo no strong oviJonco that tho prosonco ol a voalth
tax inhilits savings` (Wolll 1995, p. 54). AnJ, as Wolll points out, tho lact
that SvitzorlanJ taxos voalth makos capital llight argumonts a lit harJ to
sustain, sinco that country is tho targot, not tho sourco, ol a not insignili-
cant sharo ol tho vorlJ`s llight capital.
Anothor lovy, JosignoJ moro to chango lohavior than to raiso rovonuo,
voulJ lo to tax socuritios traJing. Tho iJoa ol a transactions tax to cut
traJing volumo goos lack at loast as lar as Koynos (W Vll, p. 160), vho
Jrov a contrast lotvoon Britain, vhoro lrokorago commissions anJ traJ-
ing taxos voro high, anJ tho U.S., vhoro loth voro lov: Tho introJuc-
tion ol a sulstantial Govornmont translor on all transactions might provo
tho most sorvicoallo rolorm availallo, vith a viov to mitigating tho pro-
Jominanco ol spoculation ovor ontorpriso in tho UnitoJ Statos.` Koynos
lurthor arguoJ that tho purchaso ol a socurity lo maJo pormanont, anJ
inJissolullo, liko marriago, oxcopt ly roason ol Joath or othor gravo causo.`
NovaJays, ol courso, marriagos aro JissolvoJ lor roasons othor than Joath
or gravo causo, anJ lov civilizoJ pooplo voulJ arguo that Jivorco lo maJo
as Jillicult as it vas 60 yoars ago. But il you loliovo that hoavy traJing
incroasos tho volatility ol assot pricos anJ oncouragos all mannor ol point-
loss or malignant linancial hyporactivity, thon transactions taxos aro a simplo
lut potontially povorlul romoJy. lt`s not tho outhanasia ol tho rontior ox-
actly, lut it`s tho lirst prick ol tho latal nooJlo.
Stock traJing costs in tho U.S. lor largo institutional invostors aro tho
lovost ol any major markot ly a consiJorallo margin. AccorJing to 1992
Jata lrom lrank Pussoll Socuritios (citoJ in Camploll anJ lroot 1994),
U.S. traJors paiJ 0.30/ ol tho valuo ol a transaction in commissions anJ
loos, or 30 lasis points (lp) in markot jargon: noxt-choapost vas Britain,
at 50 lp: in othor markots, tho liguro vas 60 lp or highor. ln aJJition,
oight ol tho 10 countrios imposoJ taxos or othor loos on top ol tho lro-
kors` tako. British taxos voro ooual to anothor 50 lp, making tho cost ol
moving a sharo ol stock lrom ono sot ol hanJs to anothor moro than throo
WALL STREET
318
timos as oxponsivo as tho U.S. So, not only Joos tho U.S. havo tho vorlJ`s
largost capital markot, it also has tho choapost.
Transactions taxos aro oasior to imposo than colloct, locauso invostors
vill Jo ovorything thoy can to avoiJ paying thom. Thoy anJ thoir lankors
vill invont nov instrumonts not covoroJ in tho tax, or Jiscovor loopholos,
or movo thoir traJing alroaJ. ll thoy can`t ovaJo tho tax, thoy vill cut lack
on traJing. That`s not nocossarily a laJ thing: tho aim ol a transactions tax
is to chango lohavior as much as it is to raiso rovonuo. But achioving loth
goals roouiros that tho tax lo carolully JosignoJ.
Ono thing is cloar: a transactions tax must lo lovioJ on tho traJors, not
tho traJo: on tho transaction, not tho spocilic socurity. As Camploll anJ
lroot shov, a SvoJish tax on lrokorago sorvicos vas oasily avoiJoJ ly
Joing traJos in IonJon anJ Nov \ork. But tho U.K.`s transactions tax vas
lovioJ on changos in ovnorship, making it vory Jillicult lor British invos-
tors to avoiJ. Similarly, local taxos on tho Nov \ork or Pacilic Stock Ex-
changos, vhich havo loon proposoJ ly troullomakors on loth coasts,
coulJ lo vory oasily ovaJoJ, lut a national tax on U.S. rosiJont luyors
anJ sollors coulJn`t lo. A tax on stocks alono coulJ lo avoiJoJ through
traJing options: a tax on rogistoroJ socuritios coulJ lo ovaJoJ vith cus-
tom ovor-tho-countor Joals: a tax lasoJ on logal Jomicilo coulJ lo avoiJoJ
ly moving tho logal hoaJouartors to a taxloss Carilloan islo. lor onco,
clovor lavyors coulJ Jo somothing socially usolul ly Jralting tho transac-
tions tax to lorocloso thoso JoJgos.
A lroaJ, voll-JosignoJ tax coulJ raiso not insignilicant amounts ol
monoy. Doan Bakor, Polort Pollin, anJ Varc Schalorg (1994) ostimatoJ
that, lasoJ on 1992 traJing liguros, a moJost tax ol 50 lp on stock salos, a
1 lp por yoar to maturity tax on lonJs (so that a 30-yoar lonJ voulJ lo
suljoct to a 30 lp tax), anJ comparallo ratos on Jorivativos coulJ raiso
$60 lillion a yoar assuming no Joclino in traJing, or $30 lillion il traJing
loll ly hall. That voulJ still loavo tho costs ol traJing stocks voll lolov
British lovols, anJ Britain is not knovn as a placo vhoro tho linancial
soctor is unJorJovolopoJ. Bakor ot al. aJmirally proposoJ that tho pro-
cooJs ol tho tax lo usoJ to linanco oJucation, military-to-civilian convor-
sion, anJ onvironmontal rosoarch anJ ropair.
Voro moJostly, Jamos Tolin (1995) has proposoJ a 0.5/ tax on intor-
national curroncy transactions, to Jampon oxchango markot volatility.
Pooplo transacting roal-vorlJ lusinoss voulJ linJ tho tax nogligillo, lut
thoso trying to prolit lrom ovory ouivor ol ovory oxchango rato voulJ lo
inconvonioncoJ. (ll 0.5/ isn`t a high onough rato to Jo tho trick, thon it
319
shoulJ lo vhatovor`s roouiroJ to accomplish tho task.) Tolin voulJ tax
only spot markot transactions, oxompting Jorivativos, arguing that pricos
aro sot in spot markots, anJ Jorivativos pricos only rolloct, thoy Jon`t shapo,
tho courso ol spot pricos - though ho aJmits that ho`s not lully suro ol
this.
8
AsiJo lrom Jamponing volatility, Tolin also voulJ liko to rostoro
moro national Jiscrotion to oconomic policymaking. l am not ono,` saiJ
Tolin, vho thinks that tho markots aro alvays imposing upon any con-
tral lank oxactly tho Jisciplino it ought to havo.` Varkots, through igno-
ranco, porvorsonoss, or Jolusion, can imposo policios on countrios that
aro inappropriato to national circumstancos, anJ Tolin thinks his tax might
roJuco this prossuro. Attompts to ovaJo tho tax, ho arguoJ, coulJ lo man-
agoJ ly having it aJministoroJ ly tho lVl - ovon making complianco
vith tho tax a conJition ol momlorship. ProcooJs ol tho tax coulJ lo
usoJ lor vorthvhilo intornational purposos` - lunJing tho UN, tho WorlJ
Bank, anJ tho lVl, lor oxamplo. Tho lattor institutions havo contrilutoJ
groatly to croating tho lorJorloss vorlJ Tolin lomoans, lut lilorals raroly
soom to havo prolloms vith contraJictions liko this.
Tolin has also arguoJ lor a similar tax on stock traJos. Tolin loJgoJ a
Jissont lrom tho tamo ollicial rocommonJations ol tho Tvontioth Contury
lunJ`s (1992) Task lorco on Varkot Spoculation anJ Corporato Govor-
nanco. Tho roport`s contorpioco vas a long ossay ly Polort Shillor (1992)
on markots` oxcossivo volatility, anJ tho Jangors ol taking guiJanco on
hov to run roal corporations lrom movomonts in thoir stock pricos. But
having raisoJ that intorosting ouostion, tho vorthios on tho lunJ`s panol
JociJoJ against a transactions tax, prolorring instoaJ a rovolution in tho
consciousnoss ol institutional invostors - tho sprouting ol a nov culturo
ol pationco anJ soll-Jisciplino, as incroJillo as that may sounJ to any
stuJont ol tho markots. Ovor hall tho vorthios voro lrom linanco, lav, or
tho loJ: tho lalanco voro mainly salo acaJomics. Nonlinancial corpora-
tions voro conspicuously alsont. Tolin vroto, politoly, that tho Task lorco
vas vrong to givo such short shrilt to sanJ in tho vhools` ol tho linancial
markots` (Tvontioth Contury lunJ 1992, p. 23). Tolin novor rollocts on
vhat social purposo sharoholJors sorvo - lut il ho voro tho kinJ to Jo
that, tho Tvontioth Contury lunJ voulJ novor havo haJ him on thoir panol.
lov things, asiJo lrom tho throat ol Jiroct appropriation ol thoir prop-
orty, mako Wall Strootors scroam moro louJly than tho assortion that thoir
pursuits aro pointloss or malignant, anJ that thoir activitios shoulJ lo taxoJ
liko a noxious ollluont. Iistoning to thoso scroams voulJ lo anothor posi-
tivo lonolit ol a transactions tax.
WALL STREET
320
refusing money
Voro raJical than taxation is vhat Harry Cloavor (1995) has calloJ tho
sulvorsion ol monoy-as-commanJ.` ll, as Varx holJ (anJ Nogri ompha-
sizoJ), monoy anJ croJit aro lorms ol social povor - anJ Jolt anJ liscal
crisos aro usoJ to intonsily tho lorco ol capitalist rulo - thon tho rolusal ol
that rolation voulJ striko sharply at tho orthoJox orJor. Cloavor arguoJ
that Koynosian vollaro stato policios, through thoir oxcossivo gonorosity,
roJucoJ tho capitalists` povor anJ incroasoJ that ol tho vorking class:
rising vagos anJ lonolits Juring tho GolJon Ago also contrilutoJ to this.
Among tho virtuos ol this lino ol analysis aro that it politicizos apparontly
tochnical aspocts ol luJgot-making, anJ clarilios tho importanco ol tho
Nov \ork liscal crisis in introJucing tho ora ol capitalist countorattack -
still in lull sving as thoso vorJs aro vritton moro than 20 yoars lator.
Postoring tho vollaro stato is ono lino ol action - a lit loring, porhaps,
lut ossontial to any moro raJical projocts, sinco nothing loosts tho lroo-
Jom ol manouvor lor nonolitos liko a hospitallo saloty not. A moro raJical
vorsion ol tho sulvorsion ol monoy is tho organizoJ, political rolusal to
pay Jolts, a tochniouo that vas usoJ vith groat succoss in South Alrica
Juring tho linal assault on aparthoiJ lt`s harJ to imagino tho Amorican
massos, onorgizoJ vith rovolt, colloctivoly scravling Nu :~:::uu` across
thoir VlSA lills, lut strangor things havo happonoJ.
transforming corporations
linally, sinco most ol this look is alout tho socuritios ol largo privato
corporations, that`s vhoro this chaptor shoulJ concluJo. Tho long-torm
goal shoulJ lo to roJuco tho linancial anJ govornanco rolo ol tho stock
markot vith an oyo tovarJs its ovontual olimination. Corporations shoulJ
lo placoJ incroasingly unJor a comlination ol vorkor, community, cus-
tomor, supplior, anJ pullic control. Ol courso, it`s oasy to say that in a
roasonallo-sounJing sontonco or tvo, lut tho actual task, tochnically anJ
politically, voulJ lo Jillicult as holl.
9
Tho prosont lashion lor putting moro outsiJo Jiroctors on loarJs, in
tho namo ol inJoponJont` suporvision, rulos out union roprosontativos,
vho aro consiJoroJ insiJors (Blair 1995, p. 81). lt also rulos out lirms`
signilicant suppliors anJ customors. This is tho opposito ol Japanoso gov-
ornanco structuro, vith thoir olalorato cross-holJings anJ monitoring.
That Japanoso structuro, vith its cross-holJing anJ monitoring mocha-
321
nisms, sooms liko a promising moJol lor a moro socializoJ moJo ol ovn-
orship ol largor lirms (smallor onos coulJ lo run as cooporativos). lnstoaJ
ol a lank at tho contor run on prolit principlos, ono coulJ oasily imagino a
pullicly ovnoJ ono, run on social principlos: various socializoJ groups
voulJ lo organizoJ arounJ various pullicly ovnoJ lanks, oporating unJor
a lroaJ, pullicly Jravn macrooconomic plan. Tho lanks voulJ colloct
monoy lrom inJiviJuals anJ institutions vith sparo lalancos, anJ lonJ
thom at lov ratos ol intorost to ontorprisos in thoir constituoncios. Doposi-
tors, thon, voulJ lo paiJ intorost on tho lasis ol thoso oarnings. lirms
voulJ lo govornoJ ly loarJs roprosonting all thoso constituoncios, vith
tho lank oxorcising long-torm suporvision. Tho lanks thomsolvos voulJ
lo ansvorallo to a contral lank, vhich voulJ proviJo lunJs anJ Jiroct
invostmont accorJing to Jomocratically agrooJ on prioritios. Tho nooJ lor
outsiJo stockholJors, vho proviJo littlo or no capital anJ loss gooJ aJ-
vico, voulJ lo oliminatoJ.
l roalizo that this proscription - somothing liko markot socialism - is
at onco spotty anJ granJioso. But tho point is not to proviJo an olalorato
lluoprint lor a luturo socioty, in tho stylo ol John Poomor. Oll-tho-sholl
utopias may lo usolul thought oxporimonts, lut thoy`ro ol limitoJ politi-
cal uso, oxcopt maylo as long-torm inspiration. A luturo socioty has to
omorgo out ol this ono, on tho lasis ol oxporimontation anJ strugglo. l`vo
outlinoJ tho lunJamontal principlos ol vhoro l think vo shoulJ go. Con-
siJor thoso closing pagos lragmonts ol a lirst Jralt lor a projoct aiming to
onJ tho rulo ol monoy, vhoso tyranny is somotimos a littlo harJ to soo.
notes
1. Olviously, capitalist intornationalization, as practicoJ ly multinational corporations, is
somothing to lo criticizoJ. But puroly localist critiouos that viov cosmopolitanism it-
soll as Jangorous aro tingoJ vith xonopholia, anJ lroouontly sontimontalizo pro-oxist-
ing local hiorarchios out ol oxistonco.
2. Ono rationalo somotimos olloroJ lor tho slov grovth ratos is that tho lalor lorco vill
grov moro slovly ovor tho noxt sovon JocaJos than it has ovor tho past sovon: this is
procisoly tho roason olloroJ ly tho Trustoos anJ tho Systom`s actuary, Stovo Goss. Tho
oconomic oviJonco is, hovovor, that a slovJovn in lalor lorco grovth vill lo ollsot
ly an incroaso in proJuctivity grovth (Cutlor, Potorla, Shoinor, anJ Summors 1990).
Cutlor ot al. also arguo that an aging population is a roason lor a Iu~: savings rato
rathor than a highor ono - tho oxact opposito ol convontional aJvico.
3. This is not to arguo that moJornization is nocossarily laJ anJ that inJigonous proJuc-
tion mothoJs shoulJ romain unchangoJ lor all timo. But thoso villing to prolit oll tho
tronJ vhilo lasking in moral suporiority shoulJ tako somo notico ol tho contraJiction.
4. Tho NACDIl logan lonJing in 1986. Botvoon tho onJ ol 1985 anJ tho onJ ol 1995,
WALL STREET
322
thoro vas a not grovth ol 19.6 million jols in tho U.S., an avorago ol 164,000 por month,
or alout 8,000 por lusinoss Jay. Ovor tho samo porioJ, housing starts avoragoJ 1.4
million a yoar, or 5,00 por lusinoss Jay.
5. lor moro on Bon 8 Jorry`s, anJ tho lailings ol socially rosponsillo lusinoss in gonoral,
soo tho lino sorios ol articlos ly Jon Entino citoJ in tho lilliography. Entino`s lirst claim
to lamo vas his oxposuro ol tho lrauJ lohinJ tho BoJy Shop, anothor Jarling ol tho
tonJor commorco crovJ.
6. lailoJ, that is, il you think tho goal ol Jovolopmont is tho omorgonco ol poor countrios
lrom povorty. ll tho goal ol Jovolopmont` is to oxtract rosourcos, monoy, anJ lalor
lrom tho vorlJ`s poor, thon Jovolopmont has loon ouito succosslul.
. Social sciontists lovo to spoak ol tho intorgonorational transmission ol vollaro Jopon-
Joncy` - tho likolihooJ ol vollaro moms having Jaughtors vho thomsolvos locomo
vollaro moms. Thoy aro loss intorostoJ in stuJying tho intorgonorational transmission
ol privilogo, lut a sharp voalth tax voulJ go a long vay to roJucing that olito lorm ol
JoponJoncy.
8. Sinco spot anJ Jorivativos markots aro nov so intortvinoJ, it`s harJ to imagino hov
thoy coulJ lo troatoJ so Jillorontly lor tax purposos. AnJ il tho aim is to chango lohav-
ior as voll as raiso rovonuo, tho oxomption makos no sonso at all.
9. This is not to say that HillorJing`s iJoa that soizing a lov lig lanks in tho namo ol tho
pooplo voulJ loaJ to socialism vas right. Polations vithin ontorprisos (i.o., gonuino
vorkor control) anJ rolations lotvoon ontorprisos (moaning plannoJ linkagos that ro-
placo markotcompotitivo onos) must also lo translormoJ.
323
Appendi
interest rates
U.S. long-term interest rates, 1857-1998
25'
20'
!5'
!0'
5'
0'
5'
!0'
!5'
20'
!
3
5
7
!
3
6
2
!
3
6
7
!
3
7
2
!
3
7
7
!
3
3
2
!
3
3
7
!
3
9
2
!
3
9
7
!
9
0
2
!
9
0
7
!
9
!
2
!
9
!
7
!
9
2
2
!
9
2
7
!
9
3
2
!
9
3
7
!
9
4
2
!
9
4
7
!
9
5
2
!
9
5
7
!
9
6
2
!
9
6
7
!
9
7
2
!
9
7
7
!
9
3
2
!
9
3
7
!
9
9
2
!
9
9
7
noninal
real
rai|road bonds, !857-!9!7, US Treasuries, !9!9-98
(!998 is !irs! quar!er on|v)
rea| ra!e is nonina| ra!e |ess !rai|ing vear CP change
WALL STREET
324
interest rates (cont.)
U.S. long-term interest rates
real noninal
decades
!350s 7.2' 9.5'
!360s 3.! 7.7
!370s !0.6 7.!
!330s 5.3 5.0
!390s 5.! 4.3
!900s 3.2 4.0
!9!0s !.2 4.6
!920s 5.! 5.2
!930s 5.3 3.3
!940s 3.2 2.4
!950s !.0 3.0
!960s 2.2 4.5
!970s 0.2 6.9
!930s 4.3 !0.4
!990s 4.! 7.3
periods
!370-!9!3 5.7' 5.0'
!9!4-!949 !.7 4.0
!9!4-29 2.2 5.!
!930-33 5.9 3.9
!939-44 !.2 2.6
!945-49 4.! 2.3
!950-73 !.5 4.!
!974-97 3.! 3.5
!974-3! 0.9 3.5
!932-97 5.0 3.5
As wilh lhe graph on lhe previous page, lhe longlern rale is lhal on railroad bonds
lron!357 lo !9!7, aller !9!7, ils lhe average rale on longlern U.S. Treasurv bonds.
Feal rale is conpuled bv sublracling lhe vearlv change in lhe consuner price index
lron lhe noninal rale. Periods are based on Angus addisons (!995: lhe period ol
high Viclorian capilalisn - ol lhe gold slandard, lhe Brilish enpire, and lree lrade and
lree capilal llows (!370-!9!3, lhe periods ol war, lroubled recoverv, depression, nore
war, and a less lroubled recoverv (!9!4-!949, lhe poslwar Colden Age (!950-73,
and lhe recenl Bronze Age. ve divided lhe recenl period inlo lhe vears ol inllalion,
labor and Third vorld rebellions, and U.S. inperial erosion (!974-3!, and lhe period
since, lhal ol nore asserlive inperial power, consolidaled linancier rule, and lree lrade
and lree capilal llows.
APPENDlX
325
stocks and the economy
These charls lrv lo show lhe relalion belween lhe slock narkel and lhe real econonv.
On lop is a longlern view, showing lhreevear real (inllalionadjusled changes in slocks
(lhe S&P 500 index and CDP. The slock narkel nore or less lollows econonic lrends
- ils hardlv inlallible as a leading indicalor - and ollen overdoes il in bolh direclions.
The lendencv lo overreacl is nore visible in lhe second charl, which plols vear lo vear
changes in quarlerlv averages. For lhe poslvorld var U.S., lhe narkel leads lhe
econonv bv aboul lwo quarlers, bul is slill no nalch lor lhe vield curve as a leading
indicalor (see p. !22.
stock prices and GDP, real three-year change, 1900-1997
30'
60'
40'
20'
0'
20'
40'
60'
30'
!00'
!900 !9!0 !920 !930 !940 !950 !960 !970 !930 !990
CDP
slocks
stock prices and GDP, real yearly change,
1950-1997
40'
30'
20'
!0'
0'
!0'
20'
30'
40'
!950 !955 !960 !965 !970 !975 !930 !935 !990 !995
CDP
slocks
WALL STREET
326
financial performance, long-term
total real stock returns by decade, 1825-1997
5'
+0'
+5'
+!0'
+!5'
+20'
!325-!997 average: 7.2'
total real bond returns by decade, 1860-1997
!0'
5'
+0'
+5'
+!0'
+!5'
!
3
6
0
s
!
3
7
0
s
!
3
3
0
s
!
3
9
0
s
!
9
0
0
s
!
9
!
0
s
!
9
2
0
s
!
9
3
0
s
!
9
4
0
s
!
9
5
0
s
!
9
6
0
s
!
9
7
0
s
!
9
3
0
s
!
9
9
0
s
!357-!997 average: 3.7'
APPENDlX
327
real total returns and change in consumer prices by decade
real lolal relurns
slocks bonds CP
!320s 5.0' 2.7'
!330s 5.3 0.6
!340s !6.0 !.3
!350s 5.3 0.3
!360s 9.6 4.9' 3.5
!370s !0.4 !3.5 2.7
!330s 5.6 7.7 0.7
!390s 6.4 6.7 0.3
!900s 7.3 2.2 !.!
!9!0s 4.! 6.0 7.9
!920s !5.9 !!.9 !.3
!930s 2.3 9.6 !.7
!940s 4.9 !.! 5.6
!950s !4.2 4.! 2.!
!960s 4.4 2.7 2.3
!970s 4.2 7.4 !0.3
!930s !0.2 7.4 4.7
!990s !!.0 9.2 3.0
average 7.0 3.3 2.!
!950-97 7.5 0.! 4.!
Feal lolal relurns lor slocks and bonds are conpuled lron index
nunbers represenling cunulalive real lolal relurn (lhal is, inleresl
and dividends are reinvesled. For slocks, lhe index nunber is equal
lo lhe sun ol a vears dividend vield plus price change (expressed
as a percenl less lhe inllalion rale (consuner price index lines
lhe prior vears index, or
ndex
v
=ndex
v!
X (!+DividendYield
Y
+PriceChange
Y
+CP
Y
|.
For bonds, lhe index equals a vears average inleresl pavnenl plus
price relurn (on a bond nornalized so lhal an 3' vield is priced al
!00 less lhe change in CP. Ol course, laxes and lransaclion cosls
would nake il nearinpossible lo duplicale lhese neasures, lhev
represenl nol an aclual porllolios perlornance, bul lhe conpara
live lendencies over line. Source: alional Bureau ol Econonic
Fesearch web sile (hllp://www.nber.org,
Bicenlennial Edilion, Shiller (!99!, Coelznann and
bbolson (!994, various vears,
slandard sources ciled in inlroduclion lo Bibliographv.
financial performance, long-term (cont.)
WALL STREET
328
owners and issuers of financial instruments, 1997
(billions ol dollars and share ol lolal
credit market debt
lolal oulslanding $2!,!!3.9 !00.0'
debtors
doneslic nonlinancial !5,!94.! 7!.9
U.S. governnenl 3,304.9 !3.0
nonlederal !!,339.3 53.9
households 5,57!.5 26.4
nonlinancial corporalions 3,232.3 !5.5
nonlarn noncorporale business !,250.! 5.9
larn !56.2 0.7
slale and local governnenls !,!23.7 5.3
resl ol world 553.3 2.6
linancial 5,366.0 25.4
connercial banks 309.7 !.5
savings inslilulions !60.3 0.3
lile insurance conpanies !.3 0.0
governnenlsponsored enlerprises 995.9 4.7
lederalrelaled norlgage pools !,325.3 3.6
asselbacked securilv issuers 993.4 4.7
norlgage conpanies 36.4 0.2
realeslale inveslnenl lrusls 73.7 0.3
brokers and dealers 35.3 0.2
lunding corporalions 373.3 !.3
olher 0.6 0.0
creditors
doneslic nonlederal nonlinancial 2,753.7 !3.0
households !,326.9 3.7
nonlinancial corporalions 296.3 !.4
nonlarn noncorporale businesses 39.! 0.2
slale and local governnenls 59!.5 2.3
U.S. governnenl 20!.4 !.0
resl ol world 2,270.0 !0.7
linancial seclors !5,393.3 75.3
nonelarv aulhorilv (Fed 43!.4 2.0
connercial banking 4,03!.9 !9.!
U.S.charlered 3,450.3 !6.3
loreign banks, U.S. ollices 5!5.4 2.4
bank holding conpanies 27.4 0.!
banks in U.S.allilialed areas 33.3 0.2
savings insilulions 925.5 4.4
bank personal lrusls 242.3 !.!
lile insurance conpanies !,775.4 3.4
olher insurance conpanies 5!4.4 2.4
privale pension lunds 33!.7 3.9
slale and local governnenl relirenenl lunds 577.5 2.7
nonev narkel nulual lunds 7!3.3 3.4
closedend lunds 99.5 0.5
lederalrelaled norlgage pools !,325.3 3.6
asselbacked securilv issuers 359.5 4.!
norlgage conpanies 47.9 0.2
realeslale inveslnenl lrusls 24.0 0.!
brokers and dealers !33.6 0.9
lunding corporalions !30.3 0.6
APPENDlX
329
owners and issuers of financial instruments, 1997 (cont.)
U.S. Treasury
lolal $3,773.3 !00.0'
by type
savings bonds !36.5 4.9
olher 3,59!.3 95.!
creditors
households 304.6 3.!
olher !!3.! 3.!
nonlarn noncorporale business !5.7 0.4
nonlianncial corporalions 54.3 !.4
slale and local governnenl 279.3 7.4
resl ol world !,265.6 33.5
nonelarv aulhorilv (Fed 430.7 !!.4
connercial banking 269.3 7.!
U.S.charlered !66.3 4.4
loreign 94.6 2.5
bank holding conpanies 4.0 0.!
banks in U.S.allilialed areas 4.4 0.!
credil unions !5.7 0.4
bank personal lrusls 39.4 !.0
lile insurance conpanies 96.9 2.6
olher insurance conpanies !23.0 3.4
privale pension lunds 323.9 3.6
slale and local governnenl relirenenl lunds 2!3.6 5.7
nonev narkel nulual lunds 36.2 2.3
nulual lunds 2!9.0 5.3
closed end lunds !0.6 0.3
governnenlsponsored enlerprises !5.6 0.4
brokers/dealers 5.0 0.!
U.S. agency securities
lolal $2,343.2 !00.0'
by type
budgelarv agencies 26.5 0.9
lederalrelaled norlgage pools !,325.3 64.!
creditors
households 499.3 !7.5
nonlinancial corporalions !0.0 0.4
slale and local governnenls 95.4 3.4
resl ol world 259.2 9.!
nonelarv aulhorilv (Fed 0.7 0.0
connercial banks 57!.0 20.0
U.S.charlered 497.! !7.5
loreign banks, U.S. branches 62.0 2.2
bank holding conpanies 5.5 0.2
banks in U.S.allilialed areas 6.3 0.2
bank personal lrusls 33.7 !.4
olher insurance conpanies 5!.2 !.3
WALL STREET
330
privale pension lunds !59.9 5.6
slale and local relirenenl lunds !03.2 3.3
nonevnarkel nulual lunds 96.3 3.4
nulual lunds !22.9 4.3
governnenlsponsored enlerprises 3!4.6 !!.0
asselbacked securilv issuers !4.! 0.5
brokers and dealers 50.4 !.3
corporate and foreign bonds
lolal oulslanding $3,333.4 !00.0'
debtors
nonlinancial corporalions !,439.5 44.6
U.S. holdings ol loreign issues 332.6 !!.5
linancial seclors !,466.3 43.9
connercial banks !92.7 5.3
savings inslilulions 2.3 0.!
asselbacked securilv issuers 742.2 22.2
realeslale inveslnenl lrusls 20.2 0.6
brokers and dealers 35.3 !.!
lunding corporalions !44.2 4.3
creditors
households 349.3 !0.5
slale and local governnenls 44.5 !.3
loreign holdings ol U.S. issues 53!.7 !5.9
connercial banks !43.! 4.3
savings inslilulions 53.4 !.3
bank personal lrusls 3!.4 0.9
lile insurance conpanies !,025.7 30.7
olher insurance conpanies !43.5 4.4
privale pension lunds 23!.7 3.4
slale and local governnenl relirenenl lunds 202.0 6.!
nonev narkel nulual lunds 33.4 !.0
governnenlsponsored enlerprises 33.4 !.0
brokers and dealers !00.7 3.0
lunding corporalions 53.! !.6
U.S. agency securities (cont.)
APPENDlX
331
stocks
lolal narkel value $!2,953.6 !00.0'
issuers
nonlinancial corporalions 7,793.7 60.!
loreign issues held bv U.S. residenls !,!33.9 9.!
linancial corporalions 3,93!.0 30.7
hoIders
households 5,737.6 44.3
slale and local governnenls 79.9 0.6
loreign holdings ol U.S. issues 33!.7 6.3
connercial banks 2.6 0.0
savings inslilulions 23.4 0.2
bank personal lrusls 259.3 2.0
olher insurance conpanies !76.9 !.4
privale pension lunds !,765.4 !3.6
slale and local governnenl relirenenl lunds !,295.2 !0.0
nulual lunds 2,049.4 !5.3
brokers and dealers 50.3 0.4
portfolio allocations of households & pension funds, 1997
households
assets $27,108.7 100.0%
deposils 3,334.9 !4.!
loreign deposils 49.3 0.2
checking deposils and currencv 426.! !.6
line and savings deposils 2,722.3 !0.0
nonev narkel lunds 636.7 2.3
credil narkel inslrunenls !,326.9 6.7
open narkel paper !22.6 0.5
U.S. governnenl securilies 304.3 3.0
Treasurv 304.6 !.!
olher !!3.! 0.4
agencv 499.3 !.3
nunicipal securilies 443.9 !.7
corporale and loreign bonds 349.3 !.3
norlgages !0!.3 0.4
slocks 5,737.6 2!.2
nulual lunds !,937.5 7.!
securilv credil 2!0.7 0.3
lile insurance reserves 650.3 2.4
pension lund reserves 7,453.9 27.5
bank personal lrusls !,050.7 3.9
equilv in noncorporale businesses 4,037.6 !5.!
niscellaneous 3!3.0 !.2
WALL STREET
332
portfolio allocations, 1997 (cont.)
households (cont.)
IiabiIities 5,827.1 100.0
credil narkel inslrunenls 5,57!.5 95.6
hone norlgages 3,757.6 64.5
consuner credil !,265.4 2!.7
nunicipal debl !37.5 3.2
bank loans 6!.2 !.0
olher loans and advances !93.5 3.3
connercial norlgages !06.4 !.3
securilv credil !23.3 2.2
lrade pavables !06.3 !.3
lile insurance preniuns, delerred and unpaid 20.! 0.3
private pension funds
financiaI assets $3,577.8 100.0%
checking deposils and currencv 2.9 0.!
line and savings deposils 25.9 0.7
nonev narkel lunds 43.! !.2
securilv repurchase agreenenls (repos 42.0 !.2
credil narkel inslrunenls 33!.7 23.2
open narkel paper 42.0 !.2
U.S. governnenl securilies 433.3 !3.5
Treasurv 323.9 9.!
agencv !59.9 4.5
nunicipal securilies !.0 0.0
corporale and loreign bonds 23!.7 7.9
norlgages 23.3 0.7
slocks !,765.4 49.3
nulual lunds 457.0 !2.3
niscellaneous 409.9 !!.5
unallocaled insurance conlracls 24!.3 6.7
pension lund conlribulion receivables 33.4 0.9
olher !35.2 3.3
state and local government retirement funds
financiaI assets $2,099.7 100.0%
checking deposils and currencv 4.2 0.2
line and savings deposils 2.! 0.!
securilv repurchase agreenenls (repos 35.! !.7
credil narkel inslrunenls 577.5 27.5
open narkel paper 35.! !.7
U.S. governnenl securilies 32!.3 !5.3
Treasurv 2!3.6 !0.2
agencv !03.2 5.2
nunicipal securilies 0.9 0.0
corporale and loreign bonds 202.0 9.6
norlgages !7.6 0.3
slocks !,295.2 6!.7
niscellaneous !35.7 3.3
333
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Joromo Iovy Economics lnstituto at BarJ Collogo, Working Papor No. 86 (Varch).
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counting,` u::~) J u::~uI 1u::u~::, 65 (April), pp. 59-6.
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357
lnde
accountants, 100-101
AJlor, Bill, 299
aJvisors, invostmont, poor rocorJ ol, 104, 163
Akorlol, Goorgo, 12
AlJrich, Nolson, 95
allocation, assot, 126-12
intorost ratos anJ, 119
Koynos`s notion ol liouiJity proloronco, 20
altornativo lonJing moJos, 311-314
.u~::cuu j~cIuI:, 98
Amorican Stock Exchango, 20-21
AmstorJam, 13
oarly luturos anJ options traJing, 29
oarly stock markot, 13
analysts, lrokorago, 99-101
Anglo-Saxon moJol, 5, 1, 13
animal tosting, 311
aparthoiJ
golJlugs` lovo ol, 48
movomont against
anJ sharoholJor activism, 288
anJ social invosting, 309
apologists, 23, 293
arlitrago, 1
arlitrago pricing thoory, 168-169
Aristotlo, 41, 54
art markot, 49
Asia, rocorJ grovth, 8
assot-lackoJ socuritios (ABS), 2
assumptions
olliciont markot thoory, 164-165
Jonson anJ Vockling`s moJol, 265-266
VV thoory, 151
ol rationality, 15
auJitors, outsiJo, 100-101
austority
croJit systom as larrior to grovth, 23
Koynos`s Jonunciation ol, 195-19, 208
olJ monotary roligion anJ, 224-225
rontior JomanJs lor, 4, 23
:~~ uI: crisos, linancial: rontiors
Ayala, Cosar, 251, 260
Bacholior, Iouis, 163
Bagohot, Waltor, 102
lailouts
intornational comparisons, 234
Varx vrong on, 235
Vinskian viov, 223
privato, pro-statist, 93
savoJ us lrom Joprossion, 1989-92, 161
ThirJ WorlJlirst WorlJ contrast, 235
thrilt, 90
Bakor, Doan, 318
lalanco ol paymonts, 114
BanglaJosh, 313
lank-contoroJ systoms, 14
lank lailuros, stocks` lailuro to anticipato, 135
Bank lor lntornational Sottlomonts, 45, 116
lank holiJay (1933), 156, 15
Bank ol EnglanJ, 43, 44, 116, 245, 308
Bank ol Japan, 308
Bank-Sphoros school, 251, 260
Bankors Trust, 262
lanking
commorcial vs. invostmont, 81-84
transaction vs. rolationship, 82
lankruptcios, 3, 286-288
lusinoss, 286-288
costs ol, 28-288
Jonson on, 28-288
Johns-Vanvillo, Vorgan rolo in, 265
lato 1980soarly 1990s, 159, 28
porsonal, 115
Baran, Paul, 258
Bartloy, Polort, 103
BastarJ Koynosianism, 210
BatcholJor, DaviJ, 288
BauJrillarJ, Joan, 2, 243
BCCl, 101
loar markot, lack ol, 128
Boll, G.V., 224
Bon 8 Jorry`s, 312-313, 322
lonchmarks, intorost ratos, 23, 25
anJ CAPV, 163
WALL STREET
358
Bontham, Joromy, 231
Bonthamism, Koynos on, 203, 211
Bontson, IloyJ, 131
Borlo, AJolph A., 246, 252-258
Bornanko, Bon S., 155, 159
lota, 163, 16-169
Black, lishor, 162
Black 8 Scholos option pricing moJol, 30
Blair, Vargarot, 269, 293, 299
loarJs ol Jiroctors. ~~ uuu~: corporations,
govornanco
Boosky, lvan, 99
lonJ markots, 22-28
assot-lackoJ socuritios (ABS), 2
commorcial papor, 28
corporato, 2-29
loar ol vago inllation, 134
govornmont anJ innovation, 54
govornmont Jolt, 22-24
stato anJ local, 114
U.S. Troasury, 24, 25
intornational corrolations, 10
junk lonJs, 28
collapso ol, 158
Jonson`s cololration ol, 21
anJ troo Joath, 24
anJ lalor markots, 12, 128
lovo ol sluggishnoss, 101, 122-123, 128, 232
municipal, 26-2
typos ol lonJs, 22
lonJholJors, conllicts vith stockholJors, 248
Borio, ClauJio, 13
BraJloy lounJation, 185
BraJshor, Koith, 134
BrainarJ, William, 144
Brazil nuts, 313
Brotton WooJs systom, 43-44
BroJorlunJ, 131
lrokorago-houso analysts, 99-101
lrokors, salarios, 8
Bronlman lamily, 21
Brooks, John, 101
Brovn, Norman O., 22-228
lulllos, 18
Bullott, Warron, 21
lulgo lrackot, 82
BunJoslank, 30
Bush, Goorgo, 90
Bush, Noil, 89
1u::u~:: uu:I:u: 1:~:I, 136
lusinoss cyclos
changos in, 94
Jisappoaranco` ol, 136
Juration, 54
linancial markots anJ, 121-123
1990-92 vs. oarlior cyclos, 158-161
stock markots anJ, 148
luylacks, stock, 2, 4
Calilornia Pullic Employoos Potiromont Systom
(Calpors), 289-290, 293
calls, 30
campaign contrilutions, 98
Cantor, PicharJ, 152, 153
capacity utilization, 124
capital
cost ol, 298
Jilliculty moasuring, 140
as lactor ol proJuction, 23
lictitious, 13
as imaginary (Poss), 23
vs. rovonuo (Varx), 245
capital assot pricing moJol, 162-163
llavs in, 16-169
political aspocts, 185
capital controls, 315
lVl on, 10
capital oxponJituros, 2
oxplaining, 148
anJ linancial structuro, 153-155
intornal linanco, 3
anJ o ratio, 145-148
:~~ uI: o ratio
capital llovs. ~~ Glolalization
capital, human, lirm-spocilic, 248
capital markots
anJ lormation ol rontior class, 238
importanco ol railroaJs to, 188
prolor V8A to intornal grovth, 281
anJ roal oconomy, 121-126
social ollocts, 8
capital structuro
anJ invostmont, 153-155, 14
lovoragoJ luyouts, 298
pocking orJor, 149
transactions-cost analysis, 249
:~~ uI: VoJigliani-Villor thoorom
capitalism
alolition vithin capitalism
Borlo anJ Voans on, 255
Varx on, 240
potty, Amorican naturalization ol, 251
as systom, 245
capitalist triumphalism, 18
capitalization ol incomo stroams, 13, 22
luilJings as capitalizoJ ronts, 80
capitalization ol misory, ly WorlJ Bank, 49-50
caps, 36
CarJ, DaviJ, 141
Caso Shillor Woiss, 186
Cavos, PicharJ, 280
contral lanks, 23
anJ class strugglo, 219, 308
control ol short-torm intorost ratos, 25-26
Jo oconomics lottor than acaJomics, 13
history, 116
inJoponJonco`, 30-308
Koynos`s criticism ol 1920s tightnoss, 196
lNDEX
359
markot prossuros on, 308-309
:~~ uI: loJoral Posorvo
contralization, luturosoptions markots, 32-33
CEO salarios, 239
Champion lntornational, 288
chartists, 105
Chaso group, 262
Chomical Bank, 262
Chornolyl, 54
Chicago, oarly luturos markots, 29
Chicago BoarJ ol TraJo, 32
Chicago BoarJ Options Exchango, 33
Chilo, 201
ponsion privatization, 304-305
Chinoso papor, 282
Chinoso vall, 99
Chryslor, 286
churchos, 288
Ciancanolli, Ponny, 235
Citilank, 296-29, 314
class strugglo
anJ lonJ markots, 122-123
anJ contral lanking, 219, 308
inJoltoJnoss anJ, 232
Jonson on armoJ supprossion, 26
lovoragoJ luyouts as, 24
Clayton 8 Dulalior, 21
Cloaring Houso lntorlank Paymont Systom, 45
cloaringhousos, luturos anJ options, 32-33
Cloavor, Harry, 320
Clinton, Bill, 104
accoptanco ol slov grovth, 134
Clinton, Hillary, 314
clustoring, 182
Coaso, PonalJ H., 249-251, 29
Colly, William, 104
Colgato-Palmolivo, 113
Collogo Potiromont Eouitios lunJ (CPEl), 289
Collior, Sophia, 310
Columlia Savings, 88
commorcial lanks, 81-84
commoJity pricos, luturos markots anJ, 33: :~~
uI: luturos markots
common stock, 12
Community Capital Bank, 311
community Jovolopmont lanks, 311-314
community Jovolopmont organizations, co-
optation ol, 315
community lanJ trusts, 314-315
componsatory lorroving, 65
compotition
managorialist viov ol, 260
roturn ol, 190s, 260
Comstock, IynJon, 311
Conant, Charlos, 94-95
Conloronco BoarJ, 136, 291
consciousnoss
croJit anJ, 236-23
rontior, prolit vith passago ol timo, 238
consonsus, 133
consumor croJit, 64-66,
in a Varxian light, 234
in 1930s Joprossion, 156-15
raro in Koynos`s Jay, 242
:~~ uI: housoholJs
Consumor ExponJituro Survoy, 0
consumption, 189
contracts, 249: :~~ uI: transactions-cost
oconomics
control. ~~ corporations, govornanco
cooporativos, 321
managors hiroJ ly vorkors, 239
voaknossos ol ovnorship structuro, 88
corporato control, markot lor, 2-282
Vanno on, 28
corporations
Jolt
Jistrilution ol, 1980s, 159
anJ oarly 1990s slump, 158-161
Jovolopmont, anJ stock markot, 14
omorgonco, anJ loJoral Posorvo, 92-96
omorgonco ol complox ovnorship, 188
ovolution, 253
lorm as prosaging vorkor control (Varx),
239-240
importanco ol railroaJs in omorgonco, 188
localist critiouo ol, 241
managors` concorn lor stock prico, 11
multinational
ovolution, anJ linancial markots, 112-113
invostmont clustors, 111-112
nonlinancial, 2-6
linancos (tallo), 5
linancial intorosts, 262
rolinancing in oarly 1990s, 161
rolo in oconomic analysis, 248
sharoholJors conriluto nothing or loss, 238
soullul, 258, 263: :~~ uI: social invosting
stock markots` rolo in constitution ol, 254
translorming, 320-321
virtuos ol sizo, 282
corporations, govornanco, 246-294
Baran anJ Svoozy on, 258
Borlo anJ Voans on, 252-258
aluso ol ovnors ly managors, 254
intorost-group moJol, 25-258
Borlo on colloctivo capitalism, 253-254
loarJs ol Jiroctors, 2-29, 246, 25, 259, 263, 22
linancial roprosontativos on, 265
~::~I:u, 25
ol a VorganizoJ` lirm, 264
rontior agonJa, 290
structuro, 299
compotition`s olsolosconcoroturn, 260
Jolt anJ oouity, Jilloroncos, 24
EV thoory anJ Jonsonism as unilioJ liolJ
thoory, 26
linancial control
WALL STREET
360
moaning, 264
thoorios ol, rolirth in 190s, 260-263
linancial intorosts assortoJ in crisis, 265
linancial upsurgo sinco 1980s, 263-265
litchOpponhoimor controvorsy, 261-262
Gallraith on, 258-260
GolJon Ago managorialism, 258-260
Horman on, 260
inlluonco vs. ovnorship, 264-265
Jonsonism. ~~ Jonson, Vichaol
markot lor corporato control, 2-282
narrovnoss ol Jolato, 246
Pathonau on, 256
sharoholJor activism ol 1990s, 288-291
Smith on, 255-256
Sponcor on, 256-25
stockholJor-lonJholJor conllicts, 248
thoorotical taxonomy, 251-252
transactions cost oconomics, 248-251
translormation, 320-321
usoloss sharoholJors, 291-294
corrolation coolliciont, 116
corrolation vs. causation, 145
cost ol capital, 184, 298
Council ol lnstitutional lnvostors, 290
Covlos, AllroJ, 164
crack sproaJ, 31
Cramor, Jamos, 103
crank, 243
croJitcroJit markots
assots, holJors ol, 59-61
as larrior to grovth, 23
as lounJary-smashor (Varx), 235
contrality ol, 118-121
anJ consciousnoss, 236-23
Europoan vs. U.S. thoorios ol, 13
lunction, 59
as lunJamontal` (Varx), 244
inlormation asymmotry, 12
markot sharo ly lonJing institution, 81
structuro, 58-62
sulorJination to proJuction (Varx), 23
U.S. intornational position, 61
:~~ uI: lonJ markots: Jolt: monoy,
psychology ol
croJit crunch (1989-92), 158-161
c:~u:I :uIu:I (ProuJhon), 302
croJit rationing, 12
in Koynos`s T:~uI::~, 193-194
crimo, lusinoss, 252
crisos, corporato, linancial intorosts assort povor
Juring, 265
crisos, linancial, 265
linanciors` political usos ol, 294-29
incroasing prominonco starting in 190s, 222
monoy anJ, 93-94
Koynos, 202-205
Varx, 232-236
ThirJ WorlJ, 110, 294-295
:~~ uI: lailouts
Crotty, Jamos, 229
crovJ psychology, 16-1, 185
curroncy markots, 41-49
crisos, oconomic causos, 44
golJ, 46-49
history, 41-44
mochanics anJ traJing volumo, 45-46
Juring traJing vook, 130-131
unJorlying valuos, 44-45
curroncy svaps, 35
Dalo, Jamos DaviJson, 104
DaviJson, Paul, 242, 243
Dolrou, GorarJ, 139
Jolt
appropriato unJorlying assots, 24
as consorvatizing lorco, 66
iJoal lovol, pro-VV, 150
anJ 1930s Joprossion, 155-158
anJ political povor, 4, 23
roasons to shun, 149
ly soctor, 58-59
ly typo (tallo), 60
:~~ uI: croJitcroJit markots: :j~c:J:c :~cI::
Jolt Jollation (lishor), 15
moJorn alsonco ol, 234-235
vhy thoro vas nono in oarly 1990s, 158-161
Jolicit linancing, 29
Jollations. ~~ Jolt Jollation (lishor)
Dolanoy, Kovin, 265
Domocratic Party, 8
Joposit insuranco, 88
Dopository lntormoJiary Dorogulation anJ
Vonotary Control Act ol 1980, 8
Joprociation, 140
Doprossion, 1930s
linancial mochanisms, 155-158
lrioJman anJ Schvartz on, 200
Jorivativos, 28-41
custom, 34-3
JolinoJ, 28
oarly, 29
oconomic logic, 3-41
markot-traJoJ
stanJarJization anJ contralization, 32-33
tochnical Jotails, 29
moro complox stratogios, 31
motivos lor, 31
anJ risk, inJiviJual anJ systomic, 40-41
short solling, 29-30
traJing provoss, 32
vinnors, long-torm, 32
Jovolopmont, 322
protoctionism anJ, 300
Dickons, EJvin, 219
DiNapoli, Tom, 180
Jiroct invostmont
lNDEX
361
vs. portlolio invostmont, 109
ThirJ WorlJ, 110-111
in U.S., Jismal roturns, 11
Jisclosuro roouiromonts, corporato, 91
Jiscounting, intorost ratos anJ, 119-120
Jistrilution
Gini inJox, 115
incomo
CEO vs. vorkor pay, 239
Vanhattan`s inoouality, 9
polarization in 1920s, 200
voalth, 4, 64-68
JiviJonJs, 3, 135
changos in, anJ oxcoss volatility, 15
payout ratios, anJ invostmont, 154
rotontion ratio, 5
unoxpoctoJ changos in, 169
yiolJs, 125
Jollar, U.S.
markot sharo, 46
policy, 44, 54
as rosorvo curroncy, 43-44
Juring traJing vook, 130-131
Dov Jonos lnJustrial Avorago, 21
Jovnsizing, 4
rontior rosponsilility lor, 290
unthinkalility in GolJon Ago, 259
Droxol Burnham Iamlort, 83, 100, 101, 21
Jonson mourns collapso, 286-28
Druckor, Potor, 306
Juml monoy, 53
Dutch East lnJia Co., 13
Eastman KoJak, 130
oconomotrics, 139
lailuros ol, 142
thoory procoJos olsorvation, 140
oconomic lorocasting, poor rosults, 141-142
oconomics
appoal to privilogoJ, 183
lanality ol, 138
assumption ol rationality, 15: :~~ uI:
assumptions
contrality ol soll-intorost, 143
Jovolution lrom political oconomy, 139
institutional
limits ol, 250
raJical, 250-251
lack ol intorost in institutions, 24
raJicalhotoroJox,` math-happinoss, 183
rolo ol lirm in, 248
stuJy ol, makos you moanor, 143
supply-siJo, 4, 103, 24
transaction-cost, 248-251
oconomic statistics
improcision ol, 139
privatization ol, 136
rovisions ol, 133, 19
Wall Stroot vulgarization ol, 133
TI~ Ecuu::I, 102, 103, 168
oconomists, Wall Stroot
anJ salos ollort, 101
silly proJictions, 12
ollicioncy, lig lusinoss, 252
olliciont markot thoory, 143, 161-10
anomalios, 164
assumptions, 164-165
anJ Jolinitions ol ollicioncy, 162, 166
ovont stuJios, 169
lama`s roviovs ol
190, 161-166
1991, 166-10
inlormation in, 166
Jonsonism anJ, 26, 26
joint hypothosis prollom, 166
Vanno`s proliguration ol, 28
markotoors` soll-Jolonso, 19
privato inlormation, 169-10
roturn proJictalility, 166-169
throo lorms
190s torminology, 162
1990s torminology, 166
Eloctronic Arts, 131
Elliott, Karon Houso, 103
omorging markots, 15, 110
omployoo stock ovnorship, 298
omploymont, lull, political olstaclos, 211
onJogonous monoy. ~~ uuu~: monoy
English East lnJia Co., 13
ontortainmont, Congrossional, 132
Entino, Jon, 322
onvironmontal costs ol IBOs, 24
onvironmontal scroons, 311
Epstoin, GoralJ, 230
Tho Eouitallo, 262
oouity, homo loan, 63
oouity promium puzzlo, 126
anJ Social Socurity privatization, 305
:~~ uI: stock markots
Esprit Clothing, 245
ostato taxos, 316
Esty, Bonjamin, 311
ovont stuJios, 166, 169
ovil as oconomic stimulant (VanJovillo), 210
oxcoss volatility, 300
Exchango Stalilization lunJ, 44
oxpoctations
anJ tho consonsus, 133
irrational, 15-19
Wall Stroot proloronco lor moJiocrity, 291-292
oxpoctoJ roturns, 163
oxpropriation, 302
1uII~ J II~ 1~~: (VanJovillo), 208-209
laJJishnoss, 16-1
lallon VcElligott, 304
laluJi, Susan, 23
lama, Eugono, 161-10, 24
WALL STREET
362
lamily structuros, 228-229
lazzari, Stovon V., 154
loJoral Doposit lnsuranco Corp., 91
loJoral lunJs rato, 25-26
loJoral Homo Ioan Bank BoarJ, 8
loJoral Homo Ioan Vortgago Corp. (lroJJio
Vac), 91-92
loJoral National Vortgago Association (lannio
Vao), 91-92
loJoral Posorvo, 92-98
loigo look, 131-132
BoarJ ol Govornors, 96
chair`s Jominanco, 96
concorn vith strongth ol lalor, 219
Congrossional posturing ovor, 132
Jomocratizing, 30-309
Jollar activitios Juring traJing vook, 130
anJ Jollar policy, 44
loJoral Opon Varkot Committoo, 9, 132
minutos, 218
loJ-vatching, 9
llov ol lunJs accounts, 56-58: :~~ uI:
:j~c:J:c :~cI::
history, 92-96
monotary policy, 25-26
Jolilorations, 9
policy, anJ onJogonous monoy, 220
prolits on curroncy intorvontion, 44, 54, 136
protoction ol lonJholJor intorosts, 123
socrotivonoss, 9
soll-linancing, 96
structuro, 95-96
Survoy ol Consumor linancos, 64, 69, 9, 114, 115
Wall Stroot prossuros on, 308-309
loJoral Posorvo Bank ol Nov \ork, 96
loJoral Savings anJ Ioan lnsuranco Corp., 8
loJoral TraJo Commission, 29
loos, invostmont lanking, lor V8A, 23, 281, 299
laJ structuro in IBOs, 284
high ovon in lailoJ Joals, 299
Pohatyn`s inspiration to Porolla, 285
loronczi, SanJor, 226
louJalism, usury as killor ol, 23
lictitious capital, 13
linanco
llonJing vith inJustry, 135, 262
hov it mattors, 153-161
vs. monoy, 183
linanco capital. ~~ HillorJing, PuJoll
linanco-inJustry split, alsonco ol, 95, 123-124
linancial capacity (Gurloy anJ Shav), 153, 158
linancial onginooring, 52
linancial rolorm, Jilliculty ol, 302
linancial slack, 298
linancial structuros, social aspocts
institutional Jilloroncos lotvoon Jolt anJ
oouity, 24
stockholJor-lonJholJor conllicts, 248
linancial systom
costs ol, 6-
omployoos, Jomographics, 8
institutional ovorviov, 6-86
lorJors, 56
output`, 6
prolits anJ taxos, 8
salarios, 8-9
systomic risk, 40-41, 85, 86
:~~ uI: llov ol lunJs accounts
linancial thoory, assumptions, 138
linlanJ, 235
lirm. ~~ corporations
lirm-spocilic human capital, 248
lirst Boston, 263
lirst National Bank ol Nov \ork, 261: :~~ uI:
Citilank
lishor, lrving
omlarrassing 1929 proJiction, 184
lishor Jollations, 15
moJorn alsonco ol, 234-235
vhy thoro vas nono in 1990s, 158-161
litch, Polort, 230, 296
llight capital, 295
lloors, 36
llov ol lunJs accounts, 56-58: :~~ uI: :j~c:J:c
:~cI::
llovs vs. stocks, 58
loloy, Duncan, 230, 244
1:I~: 400, 69
lorJ lounJation, 315
loroign assots, intornational comparisons, 108
loroign Jolt, U.S., 61
loroign oxchango rosorvos, 23
lorstman, ToJ, 98
lorstman, Iittlo, 264
loucault, Vichol, 213
lounJation lor Doop Ecology, 245
lounJations, 96, 185
lrank Pussoll Socuritios, 31
lroo cash llov (Jonson), 269-20
Blair anJ Schary ostimato ol, 269-20
uso ol Jolt to capturo, 20
lroo riJo, 143
lroo traJo thoory, 113
lrouJ, SigmunJ, 226: :~~ uI: monoy,
psychology ol
lrioJgut, Jac, 296-29
lrioJman, Vilton, 191, 199-202: :~~ uI:
monotarism
lunJamontal vs. tochnical traJors, 105
luturos contract, JolinoJ, 29
luturos markots
lottor than motoorologists, 135
in macro` risks, 19
:~~ uI: Jorivativos
Gallraith, John Konnoth, on corporato
govornanco, 258-260
gamo thoory, 11
lNDEX
363
Garn-St. Gormain Act ol 1983, 8
Gonoral Votors, Jonson`s ostimato ol ovorstall-
ing, 299
goography, invostmont clustors, 111-112
Gormany, 8
BunJoslank, 30
linancial structuro anJ invostmont, 14
voalth tax, 316
Gortlor, Vark, 152
Gosoll, Silvio, 208, 214
GilJor, Goorgo, 2
Gingrich, Novt, 98
Gini inJox, 115
Glass-Stoagall Act, 56
Glonn, P. HullarJ, 154
glolalization, 4, 14, 106-114, 290
critiouo ol, not progrossivo, 302-303
llovs into U.S., 1980s, 109
Jismal roturns lrom, 11
loroign assots (chart), 108
historical pattorns, 106-10
anciontnoss ol, 113
VNCs anJ linancial markots, 112-113
portlolio vs. Jiroct invostmont, 109
pullic soctor rolo, 23
U.S. Troasury lonJ markot, 25
golJ, 46-49
HillorJing`s maJ omlraco ol, 231
in Varxian crisis, 221
politics ol, 4
roal prico, 48
Wanniski on, 103
:~~ uI: monoy, psychology ol
golJlugs
lovo ol aparthoiJ, 48
psychology ol, 244
golJ stanJarJ, 42-43
anJ capital llovs, 108-109
GolJman, Sachs, 263
Gonzaloz, Honry, 9
GooJhoart`s Iav, 140
GorJon, Polort, 15
Gotlaum, Victor, 296
govornmont(s)
Jolt. ~~ lonJ markots
linancior inlluonco ovor, 294-29
rolo in linancial systom, ovorviov, 90-99
Gramoon Bank, 313-314
Gramm, Phil, 0
:~~uuu~) {u:uuI, 310
Groonspan, Alan, 191
charactor vitnoss lor Charlos Koating, 89
on oarly 1990s croJit crunch, 158
lunny languago, 186
inlatuation vith Ayn PanJ, 4
grovth
oconomic, Asian rocorJs, 8
prolit vs. rovonuo, 259
Gull Oil, 288
Hansoll, Saul, 40
Hu::u:u 1u::u~:: R~::~u, 246
Harvoy, DaviJ, 230
Havkon, Paul, 313
Hayok, lrioJrich, 199
hoJgo lunJs, 41, 84-86, 116
hoJgoJ structuro (Vinsky), 221-223
hoJging
oconomic logic, 3-41: :~~ uI: Jorivativos
soloctivo, 39
Horman, EJvarJ, 260
HillorJing, PuJoll, 230, 244, 261
hit lists, rontior, 290
Hitlor, AJoll, 244, 303
hoarJ, 233
Holmos, Alan, 220
HouJaillo lnJustrios, 298
housoholJs, 62-1
lalanco shoots in 1930s, 156-15
lankruptcy, 114
lorroving, roasons lor, 65
consumor croJit,
consumption anJ savings (tallo), 1
Jistrilution ol voalth anJ Jolts, 64-68
inhoritanco ol voalth, 68-9
ponsion assots, 64
savings, roasons lor, 0-1
housing, 63
human capital, lirm-spocilic, 248
Humo, DaviJ, 199
Hussoin, SaJJam, 135
Hyman, EJ, 101
Hymor, Stophon, 112
hyporinllation, 25
lago, 255
lcahn, Carl, 21
iJoology
linancial moJia, 102-103
looso-monoy, 301
Wall Stroot, 98
imporialism, 95, 109
import sulstitution, 295
incomo Jistrilution. ~~ uuu~: Jistrilution
incomo stroams, capitalization, 13, 22
inJoxos, stock markot, 21-22
social invosting, 310
lnJian Unity, 313
inJustrial proJuction, 125
inJustry anJ linanco, llonJing, 135
inJustry-linanco split, alsonco ol, 95, 123-124
inllation
anJ lonJ markots, 101, 122-123, 128, 232
anJ stock roturns, 124
unit lalor costs anJ, 192
inlormation, 99-104
asymmotry, 10-15
JolinoJ, 11
in olliciont markot thoory, 162, 166
WALL STREET
364
linancial moJia, iJoological rolo, 102-103
insiJo, 99, 105
privato, in EV thoory, 166, 169-10
psouJo-, 1
using moJia to ono`s prolit, 105
Wall Stroot vulgarization ol novs, 133
inlrastructuro anJ privato gain, 314
inhoritanco ol voalth, 68-69
taxos, 316
initial pullic ollorings, 6
connoctions anJ, 14
soll-Jocoption anJ, 13-14
innovation, linancial, 49-55, 233
as coro ol capitalism (Schumpotor), 52, 214
list ol rocont oxamplos, 51
Vinsky on, 219-220
political implications, 301
principlos, 50-52
pullic soctor rolo, 54
insiJo inlormation, 99, 105
insiJors, corporato, stock porlormanco, 165
lnstituto lor Community Economics, 314
institutional oconomics
limits ol, 250
raJical, 250-251
1u:I:IuI:uuI 1u:~:I:, 101
institutions, oconomists` lack ol intorost in, 24
lnsuranco, 115
lnsuranco inJustry, 80-81
lntor-Amorican Dovolopmont Bank, 294
intorost rato svaps, 35
intorost ratos
lonchmarks, 23, 25
anJ CAPV, 163
contrality ol, 118-121
Koynos on, 204-205
IlBOP, 35
Varx on, 244
natural, 191, 193, 194-195, 204: :~~ uI: Koynos,
John VaynarJ, T:~uI::~ u Mu~)
anJ prolit ratos, classical thoory, 198
Protostant-moralizing thoory ol, 205
short- vs. long-torm, 26
yiolJ curvo, 25-26, 122, 125
:~~ uI: lonJ markots: croJitcroJit markots
intorost-loaring capital (Varx), 23-238
intorost-group politics, 258
intorost, translormation ol prolit into, 238
intormoJiation, lroakJovn in 1930s, 155-158
intornal linanco, 2, 4-6
capital oxponJituros, 3
anJ invostmont, 14
proloronco lor, 149
intornational comparisons, 5, 8
lailouts, 234
lonJ markot porlormanco, 10
ovolution ol lig lusinoss, U.S. vs. UK, 252
loroign assots, 108
govornanco, 248
HillorJing`s viovs, 230
managors` concorn lor stock prico, 11
stock markots, 15
capitalization, 16
anJ invostmont, 3
traJing costs, 31
lntornational linanco Corporation, 15, 295
lntornational lorum on Glolalization, 241
lunJing, 245
lntornational Vonotary lunJ
on capital controls, 10
lorocasing rocorJ, 141
invontorios, 190
invostmont
aJvico,
linancial systom`s tako rolativo to, 6
incontivo to linancial slack, 298
Koynos`s Jolinition in T:~uI::~, 193
rontiors snull social payoll, 292
:~~ uI: savings anJ invostmont
invostmont aJvisors, poor rocorJ ol, 163
invostmont lanks, 81-84: :~~ uI: loos,
invostmont lanking
invostors vs. traJors, 104
irrationality, 15-19, 185
ltaly as markot pionoor, 12
Jacols, lrvin, 21
Jacolson, Anna Schvartz, 199
Jamoson, lroJric, 3
Japan, 8
Bank ol Japan, 308
~::~I:u structuro, 24-25
roots in zu:IuI:u, 299
stock markot`s rolo, 1, 11
Jonson, Vichaol, 265-2
anticipatoJ ly Varx, 245
on armoJ supprossion, 26
laJ proJiction on lankruptcy, 28-288
curious uso ol ollipsis, 23
Jonunciation ol laluJi, 23
Jonunciation ol vorkors anJ consumors, 22
EV anJ, 26
ostimato ol GV`s ovorstalling, 299
lroo cash llov, 269-20
on IBO as nov lorm, 20-21, 24
moJol ol vorlJ as alvays up lor auction, 269
196 moJol, vith Vockling, 265-268
crucial ouostion alout corporato lorm, 266
Jismissal ol IBOs, 268
roaction to collapso ol Joal JocaJo, 286-28
rosponso to, 22-23
on tochnical chango, 25-26
turns up hoat in 1980s, 268-269
Jovs, Koynos on, 213
jol loss, IBOs anJ, 24
Johns-Vanvillo, 265
lNDEX
365
Johnson, Vanuol, 104
Johnson Smick, 104
junk lonJs, 28
collapso ol, 158
Jonson`s cololration ol, 21
anJ troo Joath, 24
KalJor, Nicholas, 218, 242
Kalocki, Vichal, 242
Kann, Potor, 103
Kaplan, Stovon, 284
Kaulman, Honry, 5
Koolo, John, 100
~::~I:u, 24-25, 299
KonnoJy, Joo, 53
KonnoJy, Potor, 139, 140
Korkorian, Kirk, 83, 286
Koynos, John VaynarJ, 113, 18
alsonco ol consumor croJit, 242
aosthoticization ol invostmont, 211
lasis ol o thoory, 144
on Bonthamism, 211
capitalism has no tonJoncy to lull omploy-
mont, 204
anJ tho contraJictions, 214
olloctivo JomanJ, 203
oxpoctations in, 203-204
on linancial markots, 18
lirms in it lor monoy, 204
crilloJ lrom Varx, 212
~u~:uI TI~:)
chaptor on spoculation, 205-206
Jolonso ol Vanchostor systom, 210
outhanasia ol tho rontior, 210
oxpansivonoss ol, 208, 209
liloration ol Vanchostor systom, 216
liouiJity proloronco, 205
markots as casino, 206
natural rato junkoJ, 204-205
on Gosoll, 214
on golJ, 4
as immoralist, 210
inJilloronco to oljoct ol invostmont, 210
intorost rato Jotormination, 205
loss raJical than ho sooms, 215
anJ Varx, 212-214
oouatos Varx vith PicarJo, 213
monotary thoory ol proJuction, 199
monoy invaliJatos Say`s lav, 202-205
navoto alout monoy, 215
output, grovth ol intorost in, 198
partial horotic anJ class rolol, 20-21
on pro-1914 iJyll, 106
rontiors` rosistanco to snulling, 214
rovival ol JisgracoJ liguros, 208-209
as PicarJian, 214
risk vs. uncortainty, 202-203, 211
Nogri on, 216-21
sontimont, contrality ol, 205-20
on soparation ol savings anJ invostmont, 18-188
snollishnoss anJ racism, 212
spurious oouililria, 198
stalilizing soll-Jocoptions, 203
stato invostmont loarJ, 210
on transactions costs, 31
T:~uI::~ u Mu~), 190, 191-199, 195-199
contral lank rolo, 194
classical comlorts, 19-205
croJit rationing, 193-194
Jynamism ol, 191
oxpansivo tono, 195-19
hoarJing vs. invosting, 192-193
intorost rato in lalancing savings anJ
invostmont, 193
natural rato in, 194-195, 19
savings anJ invostmont JolinoJ, 193
unit lalor costs anJ inllation, 192
viovs ol Wall Stroot conlirmoJ, 291-292
:~~ uI: post-Koynosianism
Koynosianism, BastarJ, 210
KiJJor PoaloJy, 261
KinJor, IynJonlorg, anJ Domini, 310
KnooJlor, Janot, 251
Kohllorg Kravis Polorts, 83, 264, 21-22
Kolko, Galriol, 93
Koppos, PicharJ, 290
Kothari, S.P., 185
Kotz, DaviJ, 261, 262-263
Kovol, Jool, 228
Kraus, Karl, 315
Kravis, Honry, 83, 264, 21-22
Kruogor, Alan, 141
KuJlov, Iarry, 4
Kuhn, Iool, 261
lalor costs, unit, 192
lalor markots
contrality ol, 12
loJ`s concorn vith, 219
jol loss, IBOs, 24
tight, throat to Jisciplino, 232
unomploymont claims, 132
lalor, unproJuctivo, 236
Iallor, Arthur, 184
IazarJ lroros, 52, 21, 285-286, 299
loaJing oconomic inJicators, 129
Ioo, Higginson 8 Co., 261
Ioggatt, Charlos, 49
Iohman-GolJman, Sachs Group, 263
lomons prollom, 12
Ionin, V.l., 261
Ioontiol, Wassily, 141
loprosy, 9
lovorago. ~~ capital structuro
lovoragoJ luyouts, 181-182, 264
capital structuro, 298
costs to naturo, 24
importanco ol pullic ponsion lunJs, 21
WALL STREET
366
Jonson anJ Vockling`s Jismissal in 196, 268
Jonson`s lator onthusiasm lor, 20-21
jol loss in PJP Joal, 24
proJuctivity gains lrom closuros, 299
tho rocorJ, 283-285
soparation ol cash anJ carcass, 22
anJ stock valuations, 284
Iovinson, Joromo, 294-295
Iovis, Vichaol, 180
Ioxocon lnc., 182
lilorals
incorroct position on loJ, 123
upscalo, 311
Iintnor, John, 162
Iiscio, John, 102, 104
Iitan, Polort, 88
Iivingston, Jamos, 93-94
localism olton not progrossivo, 302-303
IonJon lntorlank OlloroJ Pato (IlBOP), 35
IonJon Stock Exchango, 13
Iong, William, 283-284
looso-monoy iJoology, 301
Valkiol, Burton, 105
Valthus, Thomas Polort, 209
Valthusianism, groon, 245
Vanagorial school, 251
managorialism, 258: :~~ uI: corporations,
govornanco
managors hiroJ ly vorkors, 239: :~~ uI:
corporations, govornanco: monoy
managors
VanJovillo, BornarJ, 208-210
Vanhattan, incomo Jistrilution, 9
Vanno, Honry, 2, 28
manulacturing, llPE output` surpassos, 6
margin, 30
markot(s)
apologists, 19-183
cloaring vs. noncloaring, 138
inlormation asymmotry anJ, 12
costlossnossoxponso ol, 138, 139
lailuros, 138
lrooJom ol (Varx), 231
incomploto, 19
manipulation ol, 53, 105
roligious loliol in, 150
soll-rogulating, anJ govornanco issuo, 24
Varkovitz, Harry, 19
Varx, Karl, 13, 135, 18, 229-241
anticipation ol govornanco litoraturo, 246
on croJit
as lounJary-smashor, 235
as lunJamontal, 244
corporato lorm as prosaging vorkor control
(Varx), 239-240
critiouo ol PicarJo`s soll-roalization, 213-214
as onJogonist, 220-221
golJ in a crisis, 221
on govornmont Jolt, 24
on intorost ratos, 244
on intorost-loaring capital, 22
anJ Koynos, 212-214
on monoy
anJ crisis, 232-236
as oljoct ol grooJ, 236
anJ povor, 231-232, 320
no alolition ol intorost alono, 23
primitivo accumulation, 252
rovonuo vs. capital, 245
on unproJuctivo lalor, 209
vrong on lailouts, 235
Varxian viovs ol linanco, 244
Varxism as Bonthamism (Koynos), 212
mathomatics roouiroJ lor oconomics, 139
Vatthoi, Charlos, 314
Vaxxam, 24
Vayor, Vartin, 89
VcDonough, William, 40
moan rovorsion, 18
Voans, GarJinor C., 246, 252-256, 25-258
moJia, linancial. ~~ inlormation
Vollon group, 263
Vonckon, H.I., 6
VonJoza, Polorto, 2-28
morcantilism, 208
morgors anJ acouisitions, 2-3, 4, 2-282
corporato control, markot lor, 2-282
loos, 281, 299
history
Jismal porlormanco rocorJ, 29-282
vavos, 28
rolo ol oxotic socuritios, 282
anJ stock valuations, 148, 284, 299
takoovors` roturn in 190s, 260
vhy thoy happon, 281
Vorrill Iynch, 83
Orango County lavsuit, 182
Vosa Potroloum, 288-290
motoorologists outporlormoJ ly markots, 135
Votropolitan Iilo, 262
Voxico, 23, 110, 128, 135
poso crisis, 1994, 44
Voyor, AnJro, 52, 285-286
microlonJing, 313-314
military contractors, 309
Vilkon, Vichaol, 88, 152, 224, 21
Villor, Vorton, 150
JolonJs lovorago, olton lor a loo, 181-183
:~~ uI: VoJigliani-Villor thoorom
minimum vago, 140
anJ rulo ol monoy, 232
Vinsky, Hyman, 21, 221-224
Joath ol, 243
psychosocial intorprotation, 229
stalility is Jostalilizing, 222
Vishkin, lroJoric S., 156
Vitsulishi, 299
lNDEX
367
Vitsui, 299
VVS lntornational, 133
mol psychology, 16-1, 185
moJols
lotishizoJ in oconomics, 138-144
traJing, 183
VoJigliani, lranco, 69, 150
VoJigliani-Villor thoorom, 143, 149-161
attractivonoss ol, 151-152
huckstors` uso ol, 152
Jonsonism contra, 2
markotoors` soll-Jolonso, 19
rolutation ol, 153-161
Vollitt, Vichaol, 311
monotarism, 13, 191, 199-202
ompirical rocorJ, 201-202, 242
part ol tho apparatus ol crackJovn, 201
Volckor`s laux, 201
Waltors` outlurst, 242
monotary crank, 243
monotary policy, o thoory anJ, 144-145: :~~ uI:
contral lanks: loJoral Posorvo
monotary thoory ol proJuction, 199, 231
monoy
coorcivo aspocts, 232
anJ crisis
Koynos, 202-205
Varx, 232-236
Jolinitions, 191
oconomists` troatmont ol, 10
onJogonous, 200, 21-221
Varx on, 220-221
political implications, 220
:~~ uI: post-Koynosianism
oxogonous, 21
laco ol tho loss, 301
vs. linanco, 183
in lormation ol capitalism as systom, 245
as gonoral voalth (Varx), 233
as a kinJ ol pootry, 224
local, 302
noutrality ol, 13
classical position, 199
anJ Groonspan, 158
hov linanco mattors, 153-161
origin ol torm, 199
as oljoct ol grooJ, 236
political strugglo ovor Jolinition, 93-94
anJ povor, 11
psychology ol, 224-229
anal roots, 225-226
ascotic cultism, 224-225
intorost rato ollocts on sontimont, 119
Varx anJ, 236-23
mol psychology, 16-1, 185
golJlugs, 244
rolusing, 320
roticonco alout, 52
rulo ol, 232
onJing, 321
smart vs. Juml, 53
as social lonJ (Varx), 231
ultimatoly a stato thing, 232
volocity ol, 191
monoy-contor lanks, 82
monoy managors
Jamning soll-ovaluation, 291
got othors to savo lor thom, 239
poor porlormanco ol, 3, 165
Vonks, Polort, 293, 299
MuIII) R~::~u, 230, 261
Vooro, Basil, 218
moral hazarJ, 88
moralizing, 0
Vorgan, J.P., 82, 93, 260
Vorgan (J.P.) Bank, 262, 265, 2
Vorgan Stanloy, 83, 263, 21
mortgago Jolt, 63
Vullin, John, 125
Vunicipal Assistanco Corp., 295
municipal lonJs, 26-2
mutual lunJs, , 84
gain in markot sharo, 81
shynoss in govornanco issuos, 291
mutual savings lanks, 86
nakoJ shorts, 31
NasJao, 12, 19-22
hiros Nololist to JolonJ itsoll, 182
National Association ol Community Dovolop-
mont Ioan lunJs, 312
National Association ol Socuritios Doalors
(NASD), 19: :~~ uI: NasJao
National City Bank ol Nov \ork, 261: :~~ uI:
Citilank
national incomo anJ proJuct accounts (NlPA),
56, 189-190
natural` in social scioncos, 242
naturo, costs ol IBOs to, 24
nocossitous lorroving, 65
Noll, Gina, 313
Nogri, Antonio
on Koynosian uncortainty, 216-21
monoy has loss`s laco, 231, 301, 320
Noo-Calvinism, 195
noutrality ol monoy. :~~ uuu~: monoy
Nov \ork City
llPE inlluonco on, 9
liscal crisis, 195, 295-29
Nov \ork City Employoos Potiromont Systom
(Nycors), 289
Nov \ork Stato, rogulatory importanco, 91
Nov \ork Stock Exchango (N\SE), 11, 12, 13, 56
structuro, 1-18
N~u : T:u~:, organ ol roassuranco, 40
Niotzscho, lrioJrich, 22
noiso traJing, 1-18
nonlinancial corporations. ~~ uuu~: corporations
WALL STREET
368
nonprolit housing Jovolopors, 315
Norvay, 235
Novak, Vichaol, 311
nucloar povor, 309
I~cI::::I, 89
O`Connor, Jamos, 81
oJJ lottors, 83
oll-lalanco-shoot activitios, 81
Ollo, Claus, 21
ollshoro, 116
oil pricos, 143, 148, 243
OPEC, 143
opportunism, 25
options contracts, JolinoJ, 29: :~~ uI:
Jorivativos
Orango County, Calilornia, 28, 182
Organisation lor Economic Cooporation anJ
Dovolopmont, 141
ovorhoating, 123
ovnorship
lonJs anJ, 22
cooporativo, voaknossos ol, 88
linancial markots in class lormation, 238
soparation lrom managomont
ovolution, 188
as spur to grovth (Varx), 240-241
:~~ uI: corporations, govornanco
stock markot anJ, 4, 12
vorkor, 5, 293-294, 320-321
Pacilic Iumlor, 24
panic ol 190, 93, 95
parallol loan agroomont, 34
Parsons, Wayno, 102
patriarchy, 228-229
pavn shops, 84
pocking orJor, 149, 150
ponsion assots as housoholJ assots, 64
ponsion lunJs, 41
anothor layor ol agoncy, 292
oconomic illogic ol, 306
gain in markot sharo, 81
political alstraction ol, 30
pullic
roason lor prominonco in govornanco
movomont, 291
rolo in lunJing KKP, 21
rolo in sharoholJor activism, 4, 288-291
Porolman, Vichaol, 13, 215
Porolman, PonalJ, 21
porlormanco, invostmont, 105-106
PorolJ, AnJro, 40
Potorson, Bruco, 154
Pickons, Boono, 83, 288-290
Pinochot, Augusto, 304
Plaza agroomont, 44
Plossor, Charlos, 138
pootry, monoy as a kinJ ol, 224
poison pills, 288, 299
polarization. ~~ Jistrilution
political action committoos (PACs), 98
political campaigns anJ sharoholJors, 256
politics
liasos, in oconomic rosoarch, 140
CAPV controvorsy, 185
linancial moJia, iJoological rolo, 102-103
anJ markot thoorizing, 143
Wall Stroot, 98-99
:~~ uI: loJoral Posorvo: iJoology
Pollin, Polort, 21, 230, 318
Ponzi, Charlos, 243
Ponzi structuro (Vinsky), 221-223
poor, lonJors to, 83
populism, 260, 301
changing attituJo tovarJ golJ, 4
position on loJ, 123
portlolio managors. ~~ monoy managors
portlolio vs. Jiroct invostmont, 109
Post Koynosian Thought (PKT) computor
notvork, 243
post-Koynosianism, 21-224
JolinoJ, 241-242
:~~ uI: monoy, onJogonous
postmoJornism, 23, 245
prosont valuo, 119-120
priost, lankor`s aJvico moro usolul than, 225
primitivo accumulation, 252
prisonors` Jilomma, 11, 183
Pritzkor lamily, 21
privato placomonts, 5
privatization, 110
ol oconomic statistics, 136
roturning capital llight anJ, 295
Social Socurity, 303-30
proJuction, 241
socialization ol, 240
proJuctivity, 299
lailuro to loom in 1980s, 183
prolit(s)
maximization
Gallraith on, 259
Horman on, 260
anJ moJorn corporation, 254
translormation into intorost, 3-4, 238
Progrossivo Era, 94
proporty rolations anJ social invosting, 314-
315
prostitutos, Wall Strootors as customors, 9
protoctionism, 295, 300
ProuJhonism, 301
Tho PruJontial, 262
invostigations ol, 304
psychoanalysis, 315
psychology anJ stock pricos, 16-18: :~~ uI:
Koynos, John VaynarJ: monoy,
psychology ol
pullic gooJs, 143
lNDEX
369
pullic rolations, 116
pullication lias, 141
Pujo Committoo, 260
Pulitzor Prizo, 298
puritans ol linanco, 196
puts, 30: :~~ uI: Jorivativos
o ratio
anJ capital oxponJituros, 145-148
anJ IBOs, 283
anJ V8A, 148, 284, 299
as stock markot proJictors, 148
Ouan, Tracy, 9
raco
linancial vorkors, 8
anJ voalth Jistrilution, 69-0
racism, 98
among golJlugs, 48
Koynos`s, 212
railroaJs anJ moJorn corporation, 188
Painlorost Crunch, 313
PanJ, Ayn, 4, 89
ranJom valk, 164
Pathonau, Walthor, 256
rational oxpoctations, 161: :~~ uI: olliciont
markot thoory
rationality, assumption ol, 15
Pavonscralt, DaviJ, 29, 283-284
Poagan, PonalJ, 8
roal ostato, 80
roal soctor proJicting tho linancial, 125-126: :~~
uI: lusinoss cyclos
Poconstruction linanco Corp., 286
rolorm, linancial, Jilliculty ol, 302
Pogan, EJvarJ, 2
rogulation, govornmont, ovorviov, 90-99
Poich, Polort, 131
Polational lnvostors, 289
rolationship invosting, 293
roligion
lanking anJ, 225
anJ loliol in markots, 150
monotarism as, 242
anJ monoy, 225
rostrictions on usury, 42
rontiors
apologists, 293
appropriation ol vorkor savings, 239
capturo ol Clinton aJministration, 134
consciousnoss, 23, 238: :~~ uI: monoy,
psychology ol
corporato cash llov sharo, 3-4
Jominanco ol political Jiscourso, 294
oarly 1990s riot, 288-291
outhanasia ol, 210
ovolutionary rolo, 8
lormation through linancial markots, 238
groving assortivonoss, 20
prolilorato ovor timo, 215, 236
vho nooJs thom?, 291-294
:~~ uI: sharoholJor(s)
ropurchaso agroomont, 53
rosoarch anJ Jovolopmont, 283, 292
rosorvos, loroign oxchango, 23
Posolution Trust Corp., 235
rostructuring, ouasi-Trotskyist thoory ol, 152
roturn proJictalility, 166-169
roturns, oxpoctoJ, 163
rovonuo vs. capital (Varx), 245
rovisions, statistical, 133, 19
PicarJo, DaviJ, 113, 11
intorost anJ prolit ratos, 198
Koynos sots ooual to Varx, 213
proliguration ol inlormation asymmotry, 13
vorsion ol Say`s lav, 202
rigiJitios, 138
Pikslank, 116
risk
-avorsion anJ lovorago, 154
in linancial thoory, 162
-rovarJ rolations, CAPV, 162-163
sharoholJors` sharo ol, 293
systomic, 40-41, 85, 86
vs. uncortainty, 211
PJP Nalisco, 23, 24
Pollor Baron school, 251-252, 282
Polortson, D.H., 195, 205, 249
Polinson, Joan, 110, 242
Pocho, 129
Pockolollor intorosts, 93
Poomor, John, 185, 321
Pollman, Varvin, 100
Pohatyn, lolix, 52, 285-286, 295
Pna, Potor, 22
Poosovolt, lranklin D., 156, 15
Poson, Pao, 9
Poss, AnJrov, 23
Poss, Stovo, 285
ruling class, omorgonco, 94
Pussians, Koynos on, 213
Pyrio, William, 295
saJomasochism, 115
Salovay, IBO ol, 23
salarios
CEO, 239
llPE, 8-9: :~~ uI: loos, invosmont
lanking
Salomon Brothors, 19-180
Saltor, Arthur, 249
Samuolson, Paul, 11, 242
Sarlanos, Paul, 133
Savan, Ioslio, 304
savings
JolinoJ, 189
Koynos`s, in T:~uI::~, 193
moralizing sultoxt, 0
WALL STREET
370
ponsion lunJs, oconomic illogic, 306
savings anJ invostmont, 188-190
Koynos`s T:~uI::~ on, 192-193
soparation ol, 18-188
:~~ uI: Say`s lav
savings anJ loans. ~~ thrilts (S8Is)
Say`s lav
Koynos on, 202-205
Varx on, 232
scanJals
Emorging Company (Amox), 21
loJoral Posorvo`s Jonial ol transcripts, 9
luturos markots, 33
lPOs anJ politicians, 14
municipal lonJ, 26-2
NasJao collusion, 19-20, 182
Nololist Villor`s purchasoJ tostimony, 182
Orango County, Calilornia, 28, 182
Tho PruJontial, 304
Whitovator, 104
Schalorg, Varc, 318
Schary, Vartha, 269
Schoror, l.V., 29
SchilJor, Paul, 22
Schumpotor, Josoph, 52, 194, 212, 214
Scorsoso, Vartin, 231
scroons, social, 309-311
socurity markot lino, 163
Soloctivo hoJging, 39
Soll-EmployoJ Womon`s Association (lnJia), 314
sontimont. ~~ Koynos, John VaynarJ: monoy,
psychology ol
sox
linancial vorkors, 8
roticonco alout, anJ monoy, 52
Wall Strootors 8 SV, 115
Shacklo, Goorgo, 204
Shaikh, Anvar, 244
Shakospoaro as lull markot author, 195
Shankon, Jay, 185
sharoholJor(s)
activism, 288-291, 299
conllicts vith lonJholJors, 248
contriluto loss than nothing, 238
grovth in inlluonco, 4
hit lists, 290
rociprocal, Japan, 25
as risk-loarors, 293
vho nooJs thom?, 291-294
:~~ uI: corporations, govornanco: stock
markots
sharoholJor valuo (rontior var-cry), 288
Sharpo, William, 162: :~~ uI: capital assot
pricing moJol
Shorman Act, 94
Shillor, Polort, 15-1, 185, 300, 319
lantasy ol luturos markots in ovorything, 19
Shiploy, Waltor, 40
shocks, oxogonous, 143, 18
short solling, 29-30
chock on optimists, 116
Jitty, 54
nakoJ, 31
short-tormism, 291
Siglor, AnJrov, 288
SilvoraJo, 89
Simmol, Goorg, 226
Simon, William E., 185
Slits, 244
uu:I Mu~) (magazino), 103
smart monoy (positoJ group), 53
Smick VoJloy, 104
Smith, AJam, 19, 208
intorost anJ prolit ratos, 198
on joint-stock company, 255
proliguros inlormation asymmotry, 12-13
Smith, Barnoy, 263
social invosting, 309-315
altornativo lonJing, 311-314
oconomic thinking, 310
part ol linancial inJustry, 310
anJ proporty rolations, 314-315
scroons, 309-311
Social Socurity privatization, 303-30
Chiloan moJol, 304-305
lov grovth assumptions, 303-304
socialization ol proJuction, 240
sociology, Wall Stroot, 83
Solomon, I.D., 29
soullul lankor, 285: :~~ uI: Pohatyn, lolix
soullul corporation, 258, 263: :~~ uI: social
invosting
South Alrica, 288, 309
anJ tho golJ markot, 48
South Shoro Bank, 311-312
spaco, 188
Spain, 235
spocialists, stock
suporior roturns ol, 165
systom (stocks), 18
spoculation
contrality ol croJit markots to, 118-121
Koynos on, 205-206
spoculativo structuro (Vinsky), 221-223
Sponcor, Horlort, 256-25
Stack, Jamos, 124
StanJarJ 8 Poor`s 500 inJox, 21
stanJarJization, luturosoptions markots, 32-33
statistical Jiscropancy, 190
Stoin, Joromy, 284
Storling, 131
Stovons, Wallaco, 224
Stovart, Jamos, 103
Stiglitz, Josoph, 12
ignoranco ol classic toxts, 13
in tho roal vorlJ, 19
Stillman, Jamos, 93
stock luylacks, 2, 4
lNDEX
371
stock markots, 11-22
activo invostors, 6
anJ allocation ol capital, 162: :~~ uI:
olliciont markot thoory
appropriato unJorlying assots lor, 24
loar markot, lack ol, 128
anJ lusinoss cyclos, 148
capitalization, tallo, 16
anJ constitution ol moJorn corporation, 254
anJ consumor sponJing, 144-145
countorcyclical lohavior, 124-125
anJ Jovolopmont ol corporation, 14
Jistrilution ol ovnorship, 6
JiviJonJs, unoxpoctoJ changos in, 169: :~~
uI: JiviJonJs
oconomic JoJginoss ol Social Socurity
privatization, 305-306
omorging`, 15
oouity promium puzzlo, 126
oxcoss roturns, anJ Social Socurity
privatization, 305
lailuro to anticipato lank lailuros, 135
lunction, 3-4
lunnoling lunJs to rontiors, 3-4
anJ govornanco issuos, 24: :~~ uI:
corporations, govornanco
history, 12-15
inJoxos, 21-22
social invosting, 310
inoxplicalility ol roturns, 126
inlormation asymmotry in, 13-14
initial pullic ollorings, 6
intornational comparisons, 15-1
anJ invostmont sponJing, 144-148, 20
invostmont a misloaJing motric, 20
minimal sourco ol lunJs, 11, 2-3, 6
kinJs ol stock, 12
nov issuos
laJ lor pricos, 169
connoctions anJ, 14
soll-Jocoption anJ, 13
unattractivonoss ol stock linanco, 149
uso ol procooJs, 161
ovor-tho-countor traJing, 18-20
proJictoJ ly oconomy, 125-126
o ratios proJict, 148
sharos as ovnorship claim, 12
spocialists, 18
suporior roturns ol, 165
stul stock, 20
tochnical Jotails, 1-24
N\SE spocialist systom, 18
NasJao, 19-22
ThirJ WorlJ, 110
traJing costs, intornational comparisons, 31
valuation, , 119-120
Koynos on, 205-20
anJ IBOs, 283, 284
anJ roturns, 16, 10
volatility, 16
volumo, 14
:~~ uI: corporations, govornanco: rontiors:
sharoholJors
stock pricos
anJ iJoal Jolt lovol, 150
tronJs in, anJ olliciont markot thoory, 164
stockholJors. ~~ sharoholJor(s)
stocks vs. llovs, 58
I:uI~:c 1u:~:I:u, 104
Stronach, lrank, 113
Stuart, John Vill, 199
stul stock, 20
Sumitomo, 299
Summors, Iavronco, 1, 186
in tho roal vorlJ, 19
supply-siJo oconomics, 4, 103, 24
Survoy ol Consumor linancos, 64, 69, 9, 114, 115
u::~) J u::~uI 1u::u~::, 136
Svann, Bol, 314
svaps, 34-3
svaptions, 36
SvoJon, 235
taxos on lrokorago sorvicos, 318
vago-oarnor lunJs, 306-30
voalth tax, 316
Svoozy, Paul, 258, 261
SvitzorlanJ, voalth tax, 316
Syntox, 129
Systom ol National Accounts, 114
taxos
lroak lor municipal lonJ intorost, 2
consumption, 0
inhoritanco, 316
invostmont tax croJits, 184
on socuritios transactions, 31-319
voalth, 315-316
tochnical vs. lunJamontal traJing, 105
tochnostructuro (Gallraith), 259
Tomploton, Sir John, 311
Thatchor, Vargarot, 108, 311
ThirJ WorlJ
Jolt crisis, 110
political usos ol, 294-295
Jovolopmont linanco anJ capital llovs, 110
stock markots, 15
Thomas, Vichaol, 286
thrilt campaigns, Koynos`s Jonunciation ol, 196:
:~~ uI: austority
thrilts (S8Is), 81
crisis, 1980s, 86, 101
anJ oarly-1990s croJit crunch, 158
Wall Stroot lloocing ol, 180-181, 186
tolacco, 311
Tolias, AnJrov, 81
Tolin, Jamos, 143, 318-319: :~~ uI: o ratio
WALL STREET
372
Tompkins, Doug, 245
traJo, morchanJiso, anJ curroncy traJing, 42
traJors vs. invostors, 104-105
traJing provoss, 32
traJing stratogios, 104-106
traJing vook, 12-135
transactions-cost oconomics, 248-251
linancial applications, 249
transactions costs
anJ olliciont markot thoory, 164
ostimato ol, 249
transactions taxos, 31-319
Troasury lonJs. ~~ lonJ markots
TriaJ, 111
triumphalism, capitalist, 18
Trump, DonalJ, 100, 239
truth, Wall Stroot, 12
Turnor, Philip, 108-110
Tvontioth Contury lunJ, 144, 260, 293, 300, 319
uncortainty. ~~ risk
unJorconsumption, 208, 234
unomploymont, 132, 200
union roprosontativos on loarJs, 320
UnitoJ Airlinos, 299
UnitoJ lor a lair Economy, 69
UnitoJ KingJom
corporato structuros, 252
inolliciontly small lirms, 298
UnitoJ Nations Contro on Transnational
Corporations, 111-112, 11
UnitoJ SharoholJors Association, 289
univorsitios, 288
Univorsity ol Chicago, 143
unproJuctivo lalor, 236
apologists lor, 209-210
upscalo lilorals, 311
Usoom, Vichaol, 290, 292-293
U.S. Buroau ol Ialor Statistics, lorocasting
rocorJ, 141
U.S. CommoJitios luturos TraJing Commission, 91
U.S. Comptrollor ol tho Curroncy, 91
U.S. Congross
posturing ovor loJ, 132
Pujo committoo, 260
U.S. Dopartmont ol Commorco, privatization ol
oconomic inJicators, 136
U.S. Socuritios anJ Exchango Commission, 90
U.S. Troasury
Comptrollor ol tho Curroncy, 91
rolo in Jollar policy, 131
usury
anJ Joath ol louJalism, 23
rostrictions on, anJ ovolution ol curroncy
markots, 42
Valuation, intorost ratos anJ, 119-120: :~~ uI:
stock markots, valuation
Valuo Iino lnvostmont Survoy, 10
vohiclo traJing, 46
volocity, 191
vonturo capital, 86
Viotnam var, 44
volatility, 54
oxcoss, 15-19, 300
anJ markot incomplotonoss, 19
paraJox, 16
volumo, Jaily linancial llovs, 10, 45
vago inllation, 134
vago-oarnor lunJs (SvoJon), 306-30
WuII I:~~I {u:uuI, 95, 100
laluJi, Wanniski, anJ propaganJa, 23
lorvont oJitorializing, 181
anJ supply-siJo oconomics, 103, 24
Waltors, Sir Alan, 242
Wanniski, JuJo, 4, 103, 24
Warron, Polort Ponn, 316
voalth Jistrilution. ~~ Jistrilution
voalth taxos, 315-316
voapons-making, 309
vollaro stato, 232, 302, 320
Whitovator scanJal, 104
Whitvorth, Palph, 289-290
Williamson, Olivor, 24, 250
Wohlsottor, Charlos, 292
Wolll, EJvarJ, 64, 68-69, 114, 316
vork Jisciplino, 211
vorkor ovnorship, 5
vorkors, Koynos on, 213
Working Assots, 309, 310
WorlJ Bank, 15, 23, 49, 92, 295, 314
Wriston, Waltor, 224
xonopholia, 321
yiolJ curvo, 25-26, 122
ZaJoh, Norm, 32, 105
zu:IuI:u, 299
Zvoig, Vartin, 124

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