Eating Crow

It looks like the Saltwaters are on board with PKE - at least when some schmuck starts agitating for a lower minimum wage again....and when we're in a liquidity trap.

More! More!

Articulating the Exercise of Power: Rent-Seeking

Economist Joe Stiglitz, in his column today, makes some good points about the political and economic repercussions of our intellectual property regime.

As in his book, The Price of Inequality, Stiglitz makes use of a concept called "rent-seeking," i.e.,

some of the most iniquitous aspects of inequality creation within our economic system are a result of “rent-seeking”: profits, and inequality, generated by manipulating social or political conditions to get a larger share of the economic pie, rather than increasing the size of that pie.

We should first note that "rent-seeking" requires one to reject supply-side economics, at least in some circumstances.  Namely, that rents "extracted" from one pie can be added to another, re-invested, and used productively to make something even better (this, in fact, is the view of the patent-holders and, might I add, Schumpeter).   The reasons I reject this supply-side view include:

(1) losses resulting from the anticompetitive behavior (using not free competition but market/political power to distribute resources) often outweigh the gains from any renewed investment.  For example, Stiglitz points out that patents in genomes actually hampered continued research and innovation while making life-saving healthcare unaffordable to many.  There's a good argument that whatever "new" investment enabled by the patents (extraction of rents) is small beans compared to these losses; 

(2) to the extent that the profits are not reinvested into new technology/industry, but instead used to play the speculation game on wall street, it's a dead weight loss;

(3)  I've not seen evidence that the significant size of the rents extracted is absolutely necessary to encourage an optimal level of re-investment.  Maybe we can give investors a bit of a boost - but I have a feeling what they're getting is mostly icing on the cake.

But the larger point that I want to make is the extent to which "rent-seeking" resembles the capital/labor struggle for power so well articulated by many economists.  To illustrate using the "m" word: entrepreneurs can leverage workers' inferior bargaining position and capital-friendly laws to extract "surplus" value from the product of wage labor.  In other words, the exertion of power to usurp value from one party to give it to another.  This sure sounds a lot like Stiglitz is talking about, and it reveals to us that power can manifest through economic coercion, the manipulation of laws and regulations, or the exploitation of social convention.

(In fact, I wonder to what extent "rent-seeking" may serve as a euphemism for....ideas that McCarthy wanted to send us to jail for talking about.  Of course, Adam Smith talks about it too.  And also has a rudimentary labor theory of value.  So.)

At any rate, I'd argue that any manipulation of the "rules of the game," whether we call those rules in our every day conversations "economic," "political," or "social," is an exercise of power over people.  And, at the end of the day, *all* behavior is either enabled, encouraged, or prohibited by law - and therefore, at some point, by our social conventions.  For example, we can make contracts because the law enforces them and permits them.  To call the terms of a contract a simple manifestation of private "market actors" acting freely, divorced from the talk of power, is a canard.

In other words, to divide "power" into three different concepts takes off the table real issues worthy of political attention.

This is not to say there isn't a "sliding scale."  Not every contract is the product of exploitation - sometimes parties come to the table standing on equal ground.

But more and more today, the cards are stacked.  To camouflage the inequalities by calling it a "market" phenomenon is to pass the buck on our civic responsibilities.

A Keynesian Take on the Role of Wages and Finance in Growth and Corporate Governance

A wonderful new journal, The Review of Keynesian Economics, offers some much-needed scholarly research as an alternative to the neoclassical and neokeynesian variety offered in the American mainstream.  Created by, among others, Dr. Thomas Palley - a hero of mine - in 2012, ROKE, I hope, will give us a new way to think about economic policy in general and corporate governance in particular.

As a brief aside - and risking any conceptual confusion that might result from (1) a non-economist attempting to summarize economics; and (2) the offering of summaries in general by someone with an agenda - I thought it might be useful to differentiate what you'll see in ROKE versus from, e.g., Paul Krugman, Brad DeLong, Mark Thoma, etc.

One difference between "Post" Keynesian economics ("PKE") and "neokeynesian" economics ("NKE") - of the variety you see with Paul Krugman - is that PKE advocates policies that assume that wages have an effect on aggregate demand and therefore drive growth.   NKE, on the other hand, accepts a sort of "Say's Law" take on demand, wages and investment (a legacy of the Hicks ISLM model), i.e., that growth and jobs rely more on business investment than on distributing higher wages.  Still, NKEs acknowledge the impact of fiscal stimulus as a way to drive demand.  It seems like splitting hairs at first glance - but the repercussions can be enormous.  For example, if the PKEs are right, we suddenly have a purely economic reason to raise the minimum wage to $20 and to fire Scott Walker.

Anyway, this post will summarize (as best as this non-economist is able) an article from the Autumn 2012 volume by Aldo Barba (Universita di Napoli Federico II, Italy) and Massimo Pivetti (Universita di Roma La Sapienza, Italy) entitled Distribution and Accumlation in Post-1980 Advanced Capitalism (free download available here).

In a nutshell, the article first describes growth levels both pre- and post- 1980, noting that (1) growth was much less in the latter period; and (2) the latter period is characterized by a change from manufacturing to service and technology industries.  The article acknowledges that while "computerization" suggests the loss of jobs, it also argues that because the turnover of capital equipment in tech is much quicker than in "normal" industry, the impact on jobs shouldn't have been so severe, and income inequality shouldn't have become so egregious.  So what gives?

The authors finger the usual culprits - globalization, lack of unions, and the explosion of finance.  But they put it into a perspective, and add a causal mechanism, that you won't find in the Wall Street Journal.    It's a story of bargaining power and the key role played by consumer demand (fueled by wages) in keeping our economy churning.

Specifically:

(1) when the economy transitioned to service and technology, it transitioned to a work force that lacked any sort of union cohesion and, therefore, had less bargaining power;  

(2) Globalization further lowered domestic workers' bargaining power both in the old manufacturing industry and the burgeoning tech/services industry; 

(3) As a result, wages stagnated, reducing consumer demand. 

(4) Meanwhile, privatization (and now, austerity) further weakened consumer demand by (a) cutting benefits and (b) decreasing relative payouts to the consuming public as a "cut" now had to be given to "privatized" government services as profit.

Under PKE, the reduced consumer demand, resulting from an overall relative reduction in wages to profits, discouraged business investment (this is the common sense conclusion - why invest in a few factory if no one is around to buy the products?)

Here is where the circle gets even more vicious:

(1) The lower levels of business investment mean increased worker competition, leading to... you named it, lower wages and even weaker demand; 

(2) Meanwhile, people with money to invest are looking for profitable alternatives, since there's not enough consumer demand to fuel investment in the real economy.  Enter the financial markets; 

(3) Liberalized capital control rules (free trade across borders), Alan Greenspan's cheap money policy (and disregard of employment) and deregulation further encourage investment in financial products;

(4) as a result, workers enjoy even less bargaining power vis a vis a robust and hungry capital market... leading to, ultimately, lower demand and therefore lower growth and higher unemployment.

The authors point out that we were able to dodge the inevitable for a while -- the growing financial markets also permitted consumers to finance their consumption with debt for a time.  But, well, the bubble burst and here we are.

I'd note at this point, too, that the authors give us a different story about the benefit of equity markets from the one we corporate lawyers usually tell.  We learn in law school that hedge funds and KKR and other such entities are good for growth because they discipline management to spend company money wisely.  To quit buying golden toilets and avoid million-dollar executive-office-suit renovation.  So, activist investors load up companies with debt and distribute the company's cash to shareholders.  The shareholders then re-circulate the cash back into the real economy by funding other business ventures, leading to growth, new jobs, and all others sorts of good stuff.  The reader will note that this is supply-side (Say's Law) economics.  But sadly this is the "golden rule" taught to every law student as a Law of Nature....still.  Thus, this is the "economic" justification for shareholder rights.  The more power shareholders have in a company, the more they can do this kind of "house-cleaning."

But there's another version, as pointed out by the authors: the money extracted by activists does not go to build new plants or fund the next silicon valley start-up; rather, much of it remains in the financial market, used to buy and sell other companies.  In other words, it's not used to create jobs and fund new investments.  It's used to speculate.  It's like monopoly, except that instead of building houses and hotels, you trade for someone else's that's already built.

Thus, overall, at least a portion of that money serves as a dead loss to the economy.  Or Joe Stiglitz's "rent-seeking" loss.

This story makes even more sense when you recognize that given the lackluster consumer demand, there's no where else for the money to go.....

If you accept this PKE version of events, we suddenly have an economic (rather than just moral or political) reason to give "stakeholders" more of a voice regarding the distribution of corporate profits.

Or, that maybe Dodge v. Ford Motor should have gone the other way.

In the Fishbowl of Corporate Governance Intelligentsia - Part I: What is "Long Term"?

There are a lot of smart, well-meaning people in corporate governance.  But, like any academic topic, corporate governance perhaps suffers from the occasional ill effects of hyper-specialization.  Sometimes, it might be useful, as least as far as we are able, to peer outside the fishbowl.  The new perspective might help us figure out if we're missing something.  That is what I shall attempt to do here, in this blog.

So... for starters: I'm going to address what's considered "long-term" in the fishbowl.

The New York Times' Deal Professor - Steven Davidoff - recenty had a piece challenging arguments that hold that shareholders' interests force, in one way or another, companies to embrace short-term outlooks that are ultimately bad for growth and for general prosperity.

One of his arguments is fairly simple: even ostensibly short-term shareholders aren't all that short term.  Accordingly, any influence they have on corporate leadership is likewise not short term.

He cites some empirical evidence: hedge funds holding positions for 20 months.  And a paper by Prof. Lucian Bebchuk that addresses shareholders holding for two and up to....even 5 whole years.

Now, 2-5 years sounds like an eternity when compared to the milisecond-long-ownerhip of High Frequency Traders (HFTs), with their algorithms and their willingness to spend dough to get information 2 seconds ahead of everyone else.  But... for the rest of us in the real economy?

Stepping back -- one has to wonder whether Milton Hershey thought a 20month-5 year time frame was "long."  Whether he anticipated building his theme park, his Milton Hershey school, only to dismantle it 5 years later.

Moreover, what is "long-term" for an institutional investor is not the same "long term" for everyone else.  The long term position of....what, exactly? Share price? Worker salaries? Technological improvement?  It's not always the case that a share price acts as an accurate proxy measure of other sources of company value.  In fact, there is a growing consensus that it does not.  Otherwise, there wouldn't be share-price-inflating mechanisms like stock buy-backs; shareholders would be content just to buy, to hold, and to sell.  And analysts regularly add premiums to company values calculated from discount cash flows - to, for example, account for an owner's ability to do things like give itself buybacks.  So the "long-term" maintenance of a share price point does not necessarily mean the "long-term" maintenance of the corporate entity as a whole has been maintained with just as much robustness.

This, of course, is before we get to the "externalities" of firm behavior apart from the well-being of legally recognized and compensated corporate constituents.  What is the "long-term" view of the surrounding communities, the company's contractual partners, the U.S. Treasury Department...?  We might willingly accept a 5-year-long lifetime for an individual company, but what happens 50 years down the road if all of our companies are geared in such a manner? I have visions of Ross Perot's "giant sucking sound."  Yes, that's your jobs going down the toilet.  As well as the necessary consumer demand to keep our economy churning along.

But let's presume that share price is an adequate (if rough) approximation of firm wealth for the moment.  That being so, firms can't discount the present overmuch.  We have to account for the forces of capitalism.  Obviously, no company will survive if it neglects the 2-5 year time frame only to concentrate 10-20 years into the future.

One cannot help but wonder what kinds of risks one would take if one only had 5 years to live.  Call it a "hedge fund bucket list."  We might expect to see saving and investment habits... similar to that of everyday Americans leading up to the housing bubble bust.  I.e., none.  This might work in an environment of easy credit.  But when the carousel stops turning...??  During my time as a litigator, I knew of not a few companies entering bankruptcy shortly after a going-private transaction initiated by a cost-cutting activist.

Thus, there needs to be at least a realistic expectation that the firm will continue indefinitely.  Else corporate America might start looking like Columbia's campus after finals: all the coeds have chucked their cheap dorm furniture onto the sidewalk for starving grad students to scavenge.

Davidoff recognizes the different emphasis on acceptable risk that is implied by the existence of an activist shareholder, but insists that the risk is *good* for company growth.  But what does he cite as evidence? Share prices.  First, this is like measuring the length of your hand....with your hand.  Shareholder activism is meant to inflate stock prices.  That stock prices are, in fact, inflated.... is just as easily evidence of unfruitful shareholder activism as it is of responsible long-term investment.  Arbs may be betting on a merger; the market may be waiting for a one-time big dividend payoff or stock buy-back.... None of these alternatives enhances the long-term chances of the firm.

And even setting aside for the moment the social utility of shareholder activists: that stock prices are riding high right now may not even be a direct result of their "contribution."  Rather, one might point to the Fed's quantitative easing and credit facility.  Wall street sure has a lot of free money right now to buy, buy, buy.  And we all know the law of supply and demand.  It may not be a coincidence that the 5-year ride of relatively high or stable stock prices cited by Davidoff lines up with the duration of the Fed's easy money policy.

So, the fact that Apple distributed $45million to its shareholders is not - as it is for Davidoff - conclusive evidence of healthy firm growth strategy, but instead perhaps a boon to shareholders.  Where that $45million goes, nobody knows.  But it's not going to develop iPhone 235, and it's certainly not going to the improvement of Apple's occasionally feeble supply-chain oversight mechanism.

Atlas Shrugged...and Nietzsche Fell Out

Just wanted to point out a (controversial) but nevertheless enjoyable and challenging article by Corey Robin in the Nation.  Crooked Timber has some great follow up.

In a nutshell, the point I find the most interesting - Friedrich Hayek perhaps didn't value laissez-faire freedom so much for its own sake, but so the "supermen" of society would have room to do their awesome thing -- making us all better off.

An instrumental definition of freedom from the father of neoliberalism....!  So long John Locke.

Lean, Mean Privatization.. Is Bloating the Parts of Government We Aren't Supposed to Trust

We seem to accept the privatization of state action for a few reasons.  First, whatever democratic legitimization enjoyed, however tenuously, by bureaucracy is amply replaced by "market" and "neoliberal" (laissez-faire) legitimacy. Uunder the aegis of the (neo)liberal paradigm, market actors are what the state is supposed to protect.  They, as individuals or as amalgamations of individuals, are the source of state legitimation - it is their votes that make us accept state power.  So to the extent that they can perform (for themselves?) what the state was otherwise doing , it's a good thing.

Second, giving as much freedom to market actors as possible is supposed to enhance the wealth of society in general.  In other words, markets are good -quite apart from democracy, rights and liberalism - insofar as they make us all materially better off.  Thus, privatizing defense, medical, penal, military and other services encourages the kind of growth that "lifts all boats."

Finally, privatization is supposed to be cheaper.  Cheaper means more tax dollars saved, which means more personal freedom for tax-paying citizens to do what they want with their own material resources.  This too, in addition to enabling liberty, also has a utilitarian function: it helps growth.

But if we drill down a little, we begin to see the slippery logic.  If government responsibilities are delegated to some, but not to all, individuals, we're in a position where the few are making decisions for the many.  This invokes the inherent paradox of democracy - how can, in situations where our desires are not unanimous, we justify government in a truly liberal society that values individual freedom above all other things?  (see, e.g., Kelsen)  Viewed in this light, privatizing certain functions of the welfare state (as they do here in New York City) appears no more legitimate than letting "some unelected government bureaucrat" do it.   Or, more simply - the undemocratic exertion of power is made no more democratic through delegation to a private actor.  At least with the 4th branch of government, we can vote yay or nay to congressmen who promise to oversee the bureaucracies.  With companies, we're not even allowed to know who owns them, nevermind how they run their business.  In fact, it's been argued that Vice President Cheney wanted to privatize certain defense activities precisely to keep them secret and away from public oversight.

Secondly, the logic does not account for the fact that the companies to which we delegate government functions are themselves not "individuals," but instead organizations structured through centers of command and control.  "This is not a democracy!" are words spat out by many a boss.  

The legitimacy of corporate action, therefore, depends entirely on whatever "market" legitimacy they might have.  In other words, their ability to encourage growth and to put money back in the pockets of taxpayers is their only saving grace.

Of course, research is emerging that shows that privatization isn't always cheaper.  Reference the recent debates in healthcare.

Regardless, another (perhaps more important question) is whether market legitimacy outweighs our other values.  Or, more specifically, to what extent is market legitimation inherently (and practically) incompatible with those values?  Recent debates regarding the privatization of intelligence, national security, and prisons seems to indicate that privatization might actually bloat, not slimline, the kinds of state action that the Bill of Rights was supposed to put the kybash on.  How could anyone realistically doubt that adding the profit motive to the national security apparatus would inevitably encourage that apparatus to spy on us at an heretofore unimaginable scale?  Or that accepting for-profit prisons might have had something to do with the fact that we have more prisoners than ever, and more so than any other western country?

Privatization and liberty may prove to be fundamentally incompatible.

Schumpeter, the State, and Funding Economic Evolution

In Schumpeter's Capitalism, Socialism and Democracy, we are presented with a vindication of sorts for certain forms of "anticompetitive behavior."  Unless firms can leverage their market power (e.g., to set rather than to accept prices) to extract profits, they will not be able to make the kind of investments necessary to bring about meaningful economic evolution.  Ultimately, it is not the "micro" level price-competition that yields the technological innovation that keeps the economy growing (and therefore improving everyone's living conditions), but rather the monopolistic/oligopolistic buying up of patents, bundling, etc. that funds things like trains, electricity, and the internet.

In the end, then, this kind of behavior is not, for Shumpeter, "social waste," but absolutely necessary for capitalism to work as we want it to.  To make us all better off, at least materially speaking.

Setting aside for the moment that "social waste" can be fairly attributed to situations where capitalists (and their employees) are spending their blood, sweat and tears working tirelessly, endlessly, and desperately -- to prepare for the day the next Facebook, Apple, or whatever comes along to put everyone out of business -- even in conditions of perfect competition and economic equilibria...

And setting aside for the moment that (as Schumpeter recognizes but then dismisses) firms can seek funding from sources other than retained earnings (bank loans, bonds, equity markets, for example)

And also setting aside the fact that I don't know of any evidence that firms couldn't save the requisite funds to invest in new technology if they were forced to do business on more competitive terms....

And further setting aside for the moment that supply-side economics is not exactly uncontested (see, e.g., Keynesianism, or Apple's stock buy-back and dividend programs)

A new paper from EPI points out that it is the government, using tax dollars, and not price-setting business enterprise, that often creates the kind of transformative technology that triggers growth.

So, I suppose I shouldn't cry over the judgment against Apple for fixing the prices of eBooks.

And maybe we don't need companies like Apple to Fund the Future.

Finding Hobbes in Adam Smith -- and the Stylized Neoclassical World View

A wonderful little debate (and here and here ) is currently taking place (and thanks to Prof. Mark Thoma for broadcasting it) among some greats of the History of Economic Thought.  Profs. Brad DeLong (Berkeley), Jeff Weintraub (Penn) and Gavin Kennedy (UCL) consider the impact of Adam Smith's purported failure (Weintraub) to incorporate into his seminal economic theory the fact that human beings do not, in fact, inevitably arrange their behavior according to self-interested exchange relationships.

Of the three stylized classifications of social organization offered by Smith in the Wealth of Nations (exchange relationships, charity, and command-and-control-style power), Smith primarily analyzes economic growth (and political economy generally) in terms of free market "equilibria"(and the impact of state action/collusive group behavior) on that equilibria, rather than the possibility that we might form other sorts of productive arrangements.   The implications are profound -- what might we have missed, over the past 250 years, had Adam Smith suggested that we might do something else - and do it not because it's the "right" thing to do, but because we're naturally rigged to do so?

I want to comment here on a single point that was brought up - that, in the context of exchange relationships, modern economists view themselves as "Lockeans" rather than "Hobbesians."  For example, Prof. Delong writes:

As I wrote back in 2012, your average economist is not a "Hobbesian" believing that humans are motivated by self-interest, but rather a "Lockeian", respecting others and their spheres of autonomy and eager to enter into reciprocal gift-exchange relationships, both one-offs mediated by cash alone and longer-run ones as well:

First, your standard economist is not "Hobbesian". He does not enter a butcher's shop only when armed cap-a-pie and only with armed guards, fearing--as a Hobbesian would--that the butcher will not sell him meat for money but will rather:

*knock him unconscious, * take his money, * slaughter him, * smoke him, and * sell him as long pig.

A Hobbesian does not buy and sell goods and services in mutually-beneficial Pareto-improving exchange relationships. A Hobbesian finds the biggest bad-ass in the neighborhood, and swears liege homage to that bad-ass in return for that bad-ass's promising not to kill him.

Your standard economist is, rather, a "Lockeian"--presumes that there is an underlying order of property and ownership that is largely self-enforcing, that requires only a "night watchman" to keep it stable and secure.

Now it is true that your standard economist is a largely-unreflective Lockeian: does not inquire why one trades rather than takes, affects the tough-guy pose that it is only the repeated-game nature of economic interactions that keep us from always winding up in the bad cell of the prisoner's dilemma, and adopts the reductio that humans are narrowly self-interested only in material acquisition (in order to strengthen the case that the social apparatus of voluntary market exchange produces good outcomes--to make the point that even private vices produce public benefits if they are constrained by the market). But that the standard economist is a largely-unreflective Lockeian does not mean that they are a Hobbesian.

I don't know if I agree that Hobbes can be written off so completely within economic thought - If the various human relationships stylized by Smith as exchange, charity, and command-and-conrol can be understood as standing on a sliding scale (and I do think there is evidence for this in Smith's text - e.g., his reference to the collusion of guilds, differential bargaining power between entrepreneurs and workers, corporations, etc., all of which incorporate elements of command-and-control within exchange relationships), then economics begins to incorporate elements of Hobbes. 

Under a Hobbesian viewpoint, people use the power they find to hand to get what they want. Sometimes all the "power" they have is to convince another an exchange is in their self interest. Sometimes...more is available. It's just that within organized political bodies (unlike Hobbes' state of nature) robbery is not *always* the smartest option. Nevertheless, human beings, with their self interest being what it is, sill seek "power after power" using the tools available, making a judgment call about what kind of power can best be used to accomplish their aims.  Indeed, Hobbes postulated the very formation of a state based on rationality - his absolute monarch was the product of his own kind of cost-benefit analysis: we get more from agreeing to a police state than from battling it out among ourselves. The "rule of reason" suggests that we do so.  So, there is no reason to expect that, under Hobbes' line of thinking, we wouldn't (shouldn't) make the same kind of calculation on a more micro scale.  Regardless, we still, in Hobbes' state, put locks on our doors -- in the event someone still think it's worth the risk to steal from us.   And I haven't noticed recently that anyone is removing the deadbolts from their apartment doors here in Manhattan.

 It's thus not obvious that non (physically) violent exchange enters a realm different from what Hobbes would anticipate. In other words -- if we can understand "power" as including, among other things, our ability to acquire an item that someone else wants and to convince them that exchange is beneficial, then Hobbes slips in quite easily in, for example, situations of unequal bargaining power.

One (of several) problems we now see within economics, I'd argue, is that economists fail to recognize just how very Hobbesian they are. If they called a duck a duck, they would recognize that certain "anticompetitive" behavior (such as, for example, the kind vindicated by Schumpeter, i.e., price fixing, long term contracts, buying up of patents, etc) is not just a manifestation of Smithian/Lockean exchange, but also mixed up with social and market power. That is Hobbes. 

To say it is not Hobbes, I suspect, may work to prevent an honest discussion about what our world really looks like and whether it is something we really want. We start thinking in terms that presume a background of equal exchange, autonomy, and liberty.  But last I checked, equal exchange, autonomy, and liberty -- in so far as we actually have them -- only came about after hundreds of years of bloody revolution.  To assume them away seems an egregious error in thinking.

The overall point is very well summarized in John Weeks' new book, The Irreconcilable Inconsistencies of Neoclassical Macroeconomics: A False Paradigm:

In the European Middle Ages the dogmas of the Catholic Church enforced daunting barriers to scientific inquiry. The pernicious effect of neoclassical economics is worse. It is a virus of the mind. Once implanted in the mental processes, it systematically destroys the ability to conduct rational thought. Its intellectual method does not reveal underlying truths and relationships. Quite the contrary, it renders the complexities of life into ahistorical trivia obscured by cabalistic mathematics.

The Social nature of human existence is rejected by the neoclassicals in favor of the absurdity that each person is an isolated individual, stripped of the inter-personal responsibility that makes people human. ‘Individuals’ are driven by pure personal greed, defined as ‘rational’ behavior. This irresponsible greed allegedly results in the general welfare. It is difficult to imagine a doctrine more flagrantly in the interest of the rich. (pp. 2–3)

Or, perhaps, by the inestimable John Kenneth Galbraith:

In wielding power – in making economics a non-political subject – neoclassical theory destroys the relation of economics to the real world. In that world, power is decisive in what happens. And the problems of that world are increasing both in number and in the depth of their social affliction. In consequence, neoclassical and neo-Keynesian economics regulates its players to the social sidelines. They either call no plays or use the wrong ones. To change the metaphor, they manipulate levers to which no machinery is attached. (John Kenneth Galbraith, Annals of an Abiding Liberal, (New American Library, New York 1980)

(Thanks to Wesley Marshall for pulling these quotes)

Hedge Funds Going Public

Oh, boy.

Hedge funds, i.e., multi-billion dollar investment firms created just to sell exotic stuff to institutional and very rich individual investors (you can't sell such things to the general public, see), are themselves going public.

This means that management won't be on the hook when that exotic stuff makes losses -- rather, those losses will be spun off to shareholders.  I expect that the hedge fund management, meanwhile, will get fixed salaries on top of bonuses for profits made.

This presents something of a moral hazard, to say the least.  This is the now-familiar "private gain, public losses" problem.  Otherwise known as "betting with someone else's money, but keeping the winnings."  Or, as known by more serious writings, "excessive risk-taking."

Theoretically, hedge funds can sell exotic assets, i.e., assets that are non-public and therefore not subject to the SEC's reporting and transparency requirements, to institutional investors and rich people because those folks are savvy enough investors to watch out for their own interest.  At least according to the law.  So issuers cooking up these assets don't need to publish their financial statements (and prepare them in accordance with GAAP), nor distribute 10-Ks and 10-Qs to the market.  

Of course, these investors didn't do such a bang-up job avoiding the subprime mortgage-based assets.  They have their own moral hazards to deal with -- nevermind that anyone might be ill-equipped to deal with the kind of complexity that characterizes capital markets lately.

And nothing's changed to expect they'd do a better job in any other new-fangled, and risky, security to spin around the market.

Add on top of that the hedge fund's reduced incentives to monitor risk itself, due to going public.

I sure hope your pension fund isn't a one of these hedge funds' clients.

Goldman's Diverse Shareholders

Goldman, it seems, is about to shed the last vestiges of its old partnership form.

The New York Times suggests this might be good news, leading to increased transparency as the firm prepared more thorough 10-Ks and 10-Qs for its shareholders.

One could also argue, of course, that the removal of the last 5-10 guys with any "skin in the game" as far as the success in the firm will only increase its risk-taking activities.

Partners tend not to gamble with firm assets, because losses come out of their own pockets.

On the other hand, directors, executives and management who get paid base salaries and bonuses based on profits (with no downside for losses, other than the loss of bonuses) might be more willing to wager the house on the dream of a hefty short term profit.

Of course, this all depends on the fact that Goldman couldn't figure out how to spin-off risk to a bunch of chumps to begin with.

It's good to be a middleman.

Schneiderman Exploits Civil Discovery

It can't be anything other than good news that NY AG Eric Schneiderman picked up the ball that now-governor Cuomo dropped.  He's started to investigate (again? finally?) Wall Street's involvement in formulating toxic mortgage loan portfolios.

Yet, it's not the government that's actually doing its job.  It's the government free riding off the lawsuits brought by institutional investors against big banks for selling them crappy pooled loans:

“Part of what prosecutors have the advantage of doing right now, here as elsewhere, is watching the civil suits play out as different parties fight over who bears the loss,” said Daniel C. Richman, a professor of law at Columbia. “That’s a very productive source of information.”

For anyone out there complaining that American culture is too litigious -- well, it's not like the cops on the beat are doing their job.  Someone has to.

Meanwhile, one can see the power that ordinary folks have because of their pension funds.  It is without a doubt that Schneiderman had a fire lit under his butt by these funds -- and not by anyone else.

Citizens United Fallout: Will Shareholders Step Up to the Plate?

And will Congress help them?

Yesterday in the NYT, a former Vanguard chairman stressed the necessity that shareholders, in the wake of Citizens United, really begin to assert themselves when it comes to corporate political speech.

It's not surprising this kind of comment comes from Vanguard -- it, unlike other private fund managers, operates more like a credit union than like your typical wall street investment bank. Not to do a corporate plug but, if you're lucky enough to have money to invest for retirement, Vanguard, unlike most money managers, is more likely to take your concerns seriously.

Anyway, institutional investors, using their new powers of proxy access, can submit bylaw proposals requiring, for example, that corporations seek the approval of a majority of shareholders before contributing corporate assets to political campaigns.  This sort of reform pulls the rug out of under (at least partially) Citizens United -- in the end, it's the actual people who decide what kind of speech they make.

The problem is, of course, is that it's difficult to get your Fidelity Funds investment manager to get off his tush to represent shareholders actively.   Either he doesn't care, has too short term of an an attitude, or is more worried about pissing off the same corporate management he relies upon to hire him to run its employees' retirement funds.

And, according to this NYT piece, these sorts of managers represent about 70% of American shareholdings.*

But not all institutional investors are so lazy.  Public union pension funds regularly submit bylaw proposals to change corporate policy.

So what makes public union pension funds so different?

First: they're not governed by the part of Taft-Hartley that requires that employers get equal (or greater than equal) say on pension fund investment practices.  Needless to say, this makes it a lot easier for public union funds to swing their weight around on the policies and practices of the companies in which they invest.

Second, public union employees tend to be more aware of where their collective money's going.

These observations give us some simple how-tos to encourage the shareholder franchise in American politics.

First: repeal that part of Taft Hartley.

Second: Promulgate more robust disclosure laws that require fund managers to reveal to their beneficiaries what they're doing about political spending -- and other investment policies.  This movement is already well underway in Europe.

Third (and a little pie-in-the-sky): start educating people regarding the role corporations play in their life -- if they realize that their choices are equally, if not more constrained, by the actions of companies as they are by the actions of government, perhaps they'll take their franchise rights more seriously.

* Note: no one, as far as I can tell, has ever done a serious and comprehensive study on the type and size of various different kinds of investors, both institutional and individual, what kinds of companies they invest in, and what kind of policies they pursue in connection with their shareholdings.  And I've already asked the folks at OECD.  Any ambitious grad students out there???

Today I asked a electrical workers' union member, who's actively involved in a local chapter of a national socialist party, why his union didn't pay more attention to what its pension fund was doing and think more about what it could be doing.  He responded:

I know we own a big chunk of blue cross.  But they haven't done shit for us.  Our benefits keep getting worse.   Our pension fund managers don't do shit and then the union bureaucracy.  And then we also own a big chunk of the philly inquirer -- brilliant investment, that, in this internet age.

Two points here.  One: American unions don't pay enough attention to a source of power and leverage they already have -- the tens of billions of dollars of corporate equity they own.  This could be made even more powerful if there's a movement to get rid of the part of taft-hartley that lets corporate execs have a hand in fund management.

Two: How to handle the perverse incentive of owning a company and wanting to make a profit from it --- while still staying true to labor reform?  Making profits as a shareholder, after all, can mean cuts to wages and benefits.

Legal Personalities and Evildoers

There isn't any bourgeoisie anymore.  If there ever was.  It is the corporation that uses capital now.  And those companies are owned by diversified shareholders -- who often include among their ranks the workers themselves. 

Except "ownership" isn't really the right word.  Diversified shareholders don't look and act like owners.  They don't use their property, don't monitor it, and, in fact, don't really care much what happens to it, so long as they get dividends and can sell their shares for a profit.

In fact, it's fair to say that no one really owns the corporation.  The people who run the corporations, meanwhile, the managers and directors, well, they get paid wages, too.  And the people who decide where capital gets allocated -- they're on wall street, and have motives altogether different than whether a particular business succeeds or not.

So who's the bourgeoisie, then? 

When one goes to think about a Marxist kind of political economy, one has to remember Marx's most important point -- it's concentrating on dialectic relationships.  it's concentrating on materialist history. 

It's the economic system, not the evil, amorphous, unidentified "theys."  It's the social and economic forces that lead to the formation of corporations -- which are, in their essence, social and economic relations among workers and among capital providers (who are, in this age of public corporations, also workers).

So why do socialists hold up banners screaming in outrage that "GE paid no taxes!!!" when GE isn't, in fact, a real person.  It's a group of people doing stuff in concert, hopefully to make a profit.  This entity that didn't pay taxes, well, it's just a social machine.  A machine that hires workers. And pays dividends to its shareholders -- who are also workers.

Rather, what is more despicable about corporations is that they make public messes and they don't pay for the clean up.  Those costs are distributed among all of society, while the profits are kept by the corporation's specific constituencies -- workers, executives, shareholders, and creditors.

The activists, however, aren't the only people who like to personify business organizations.  Our laws treat corporations like they're people, too.  They enter into contracts and they pay taxes.  Recently, our supreme court even granted them free speech rights.

It's time to get back to the nuts and bolts.  We all need to acknowledge what's really going on, so we have a prayer of changing things.  This means we can't string up some goldman sachs insider trader and stone him and call it finished business.

This goes much deeper.

It's illegal for everyone to steal bread...

... but you never find any rich folks in jail. 

Thus, a law perceived to be neutral, e.g., against the stealing of bread, actually hammers down on certain people harder than others and fails to take into account the mitigating circumstances that would lead most people, on further reflection, to conclude that the stealing of bread by poor people ought to be decriminalized or, at the very least, carry punishments less severe than we are wont to apply. 

It's been argued that this aspect of our legal order reflects and mitigates class conflict.  Specifically, its implementation illustrates class conflict (only poor people go to jail) while, on its face, it appears completely neutral (it's not a class thing, it applies to everyone equally).  Thus the law, because of its superficial neutrality, serves to quell moral outrage at the disparate way we treat rich people and poor people.

Well, that's a bit drastic -- there's not some cabal of evildoers sitting around a board table on the 100th floor of some high rise plotting this stuff out.  But there's something to it.

For example.  This phenomenon reveals itself most explicitly when we consider that rich folks who steal stuff -- by peddling assets worth pennies for thousands -- usually get away scott free.  They certainly don't go to prison.  Why's that? Well, the law against stealing stuff doesn't apply to what they're doing.  The laws that apply to this kind of behavior are embedded into our labrynthine codex of securities regulation.

This tendency to apply the same legal standard to vastly different circumstances, or to apply different legal principles to similar circumstances, depending on what those circumstances happen to be and who they happen to most often -- also reveals itself in the securities fraud context. 

In plain vanilla commercial litigation, breach of disclosure cases are more common than Applebees chains in strip mall suburban communities.  In these cases, where one company buys another, there's usually a claim that the seller breached its represesntations and warranties about its financial condition.

Usually there's nothing very nefarious going on.  Usually, there's no outright fraud.  Sure, you get seller representatives "spinning" bad situations, and perhaps not emphasizing the weaker part of their business.  Inevitably, however, when the buyer finds out that its new company isn't as spiffy as it thought it would be, it sues to get some or all of its money back.

It's sort of the same thing as a consumer going to the grocer's to buy a diet drink that promises to remove the extra bags on the saddle.  When, lo and behold, not all the bags are gone after a few weeks, the consumer marches back into the store, with guns blazing and trumpets sounding, to waste a good part of the weekend afternoon stewing in a customer service line. 

But really, no one ever expected the bags to really disappear. 

So it is in deal litigation. Except that in the M&A case, the buyer hires an army of pricy lawyers and spends a couple million bucks litigating the deal before courts.

And courts and the law expect commercial parties, like the diet drink consumer, to figure out what kinds of representations are just commercial fluff and spin, and which are supposed to be hard facts.  You can't lie about those hard facts -- especially if you warranted, in your contract, that you provided all of them, and all of them accurately. 

Does this work the same when it comes to misrepresentation in securities fraud cases?

Well, the courts certainly think it does.  So you get shareholders and bondholders suing because their broker sold them a bunch of toxic assets.  And you get courts saying, well, so long as those brokers didn't make any hard promises and turned over all their balance sheets, you're on your own when it comes to protecting your interests.  you've got to do your own due diligence to figure out if it's a good deal.  The only caveat: the broker can't outright lie.  But they don't have to point out for you the weak parts of their P&Ls for you.

It seems logical or, at least, consistent. 

Until one considers that investors, in reality, trust their brokers to fish out good deals for them. Add on top of that the fact that the "investors" are really just a bunch of working stiffs who rely upon their investment managers to do a good job avoiding risk and fishing out productive investments.  Of course, those managers -- who get paid via bonuses based on short term performance -- perhaps don't pay as much attention to what they're buying with other peoples' money as they ought. 

And suddenly the "buyer beware" mentality, when it comes to securities fraud, maybe isn't such a neutral and objective rule.  The "buyer" -- the auto factory worker with the pension plan -- physically *can't* beware.  He likely doesn't know that his pension fund was even looking to buy anything.  And the two intermediaries standing between him and the bad investment deal -- the broker and the investment manager -- aren't "bewaring" either. 

And "buyer beware" works only if there's a buyer actually, um, capable of "bewaring."

So, just like a law against stealing bread, the law that governs mispreprentation and disclosure cases reflects something about our society.  Its implementation harms working stiffs more than it harms corporate M&A counterparties, and thus reflects a difference between the way our society values workers versus corporations.  And its superficial neutrality -- applying equally to both securities fraud cases and to M&A litigation -- mitigates that tension.