Saturday, April 20, 2019

Financialization of the U.S. Economy

"Finance is the buying and selling of assets rather than the production or exchange of goods. Beginning in the 1970's the U.S. economy began a shift from the production and exchange of goods to the buying and selling of assets."
"In the 70's manufacturing made up more than a quarter of the national economic output. Finance, insurance and real estate contributed about 15%. By 2001 the relative position of these two sectors had reversed. In that same time frame the share of corporate profits from finance, insurance and real estate went from 20% to 50%."
"Starting in the 70's finance changed from being the servant of larger corporate aims to being more and more the driver of them."
Source: American Amnesia - How the War on Government Led Us to Forget What Made America Prosper by Jacob Hacker and Paul Pierson. 

Beginning in the 1970's we also began to see the rise of corporate raiders like Carl Icahn who specialized in hostile takeovers of businesses. The basic playbook was to gain control of a business by purchasing a controlling interest, drive the stock price up with promised efficiencies, and then sell off assets, layoff workers and oftentimes liquidate the original company. You probably already know that Carl Icahn was chosen by Donald Trump to be his adviser on financial regulations - until Carl had to step down for what appeared to be breaking the laws regarding insider trading. Time will tell if there are any legal penalties - any bets?

I had an occasion to temporarily work with some TWA employees in Kansas City about thirty years ago. Things were looking fairly bleak for that once great airline after having been taken over by Carl Icahn. TWA had been laying off workers and had been saddled with debt in accord with the corporate raiders playbook. The employees I worked with from executive types, engineers, to guys in the shop and the flight line - didn't have any kind words for Carl.

TWA was having trouble attracting skilled workers due to the instability of the company under Carl's ownership. Ray, the super nice guy I was working with most, offered me a full time job. Kansas City was nice but I already had a job, so I had to pass. In 2001 TWA filed for it's third and final bankruptcy and was acquired by American Airlines.


The shift in the economy from producing and exchanging goods to buying and selling assets resulted in major changes in who ran businesses, and how they were run.

Prior to the changes that began in the 1970's, leaders of corporations were often people who had worked their way up in the business and as a result were familiar with what they produced, how it was produced and who produced it. 

As the economy became more financialized these types of CEO's were replaced by professionals who didn't know anything specific about the particular business but had demonstrated more generalized financial skills.

You might call this the rise of the "professional manager". Jim McNerney an ex-CEO of Boeing serves as an example - started at Proctor and Gamble in brand management, moved on to McKinsey and Company a worldwide "management consulting firm", went to GE to become president and later CEO, hopped over to 3M where he was chairman of the board and CEO...before he became the CEO of Boeing in 2005. That's quite an impressive career, for Jim McNerney - how impressive it is for the core business of individual companies, the people who work in those companies and the country as a whole - is open for debate. It's interesting to look at the acquisitions and divestments GE has made and ask yourself what benefit that frenetic buying, selling and trading of assets provides for our society. Mad money indeed for some but at what cost to society as a whole?

A comparison of Mitt Romney and his father George Romney also illustrates this trend. George Romney spent 20 years working in the automobile industry, learning it from the ground up, eventually becoming CEO of American Motors Company (AMC) and later Governor of Michigan. George Romney was able to work with union leaders and successfully fended off a corporate raiders attempted takeover of AMC way back in 1957. Mitt Romney spent his years working his way up the financial management-consultant industry, eventually becoming head of Bain Capital - specializing in leveraged buyouts.

It doesn't take much imagination to see that there is a big difference in a leader with expertise in what his company produces and knowledge of the people involved in the production, and someone who jumps from company to company making them more efficient by laying off workers and profiting on the buying and selling of assets.

This new type of CEO realigned corporations from a broad set of goals - profit, product quality, worker satisfaction, civic responsibility,  to a single narrow goal - increasing the stock price.

This occurred partly due to CEO's compensation being heavily dependent on stock options but it was aided by the idea that a corporation exists solely to maximize return to investors (stock price and dividends).

I remember decades ago my Mom telling me the newly re-opened mine in her neck of the woods in Montana had installed a digital sign at the entrance to the mine with the current stock price. It seemed funny that a miner entering a mine would want to know how the corporate stock price was doing - but the sign illustrated the single minded emphasis the owners of that mine put on stock price.  I can only assume the miners, had some way to impact the stock price (which seems fairly unlikely) or at least that they benefited when the price went up.


Eating the seed corn.

Have you ever heard that phrase? It's when a shortsighted or desperate farmer eats his seeds thereby destroying his future source of food. A similar phrase might be used in the case of a misguided effort to make a business more efficient when we say - they not only cut the fat but the muscles, bone and sinew as well. Killing the goose who laid the golden egg would be another example.

The financialization of the economy is a case of "eating the seed corn". It also explains why wealth in the United States has gravitated to entities that buy and sell assets, and away from people involved in the production and distribution of actual products or services (ie. something a human being can use as opposed to say a collateralized debt obligation).

I'm going to quote from my latest favorite book American Amnesia - How the War on Government Led Us to Forget What Made America Prosper by Jacob Hacker and Paul Pierson to wrap this up. I bolded the second paragraph because it was surprising to me and makes a critical point about eating the seed corn.

"When might supersizing finance hurt growth? Well, there's the ugly truth that big financial sectors beget big financial crises. Big financial sectors may also divert productive investments in the real economy that could produce faster growth, into activities that reward mostly shareholders and executives."
"For example, over 90% of the profits earned by companies that were in the Standard and Poor's (S&P) 500 from 2003 to 2012 went to stock buybacks (54 percent) and dividends (37 percent). That left less than 1 in 10 dollars of profit to be invested in future growth or higher worker pay."
"And lets not forget about human capital. Even if financial activities were net neutral economically, Wall Street would still be sucking some of the nation's best and brightest from science, education and other fields that clearly make our society more prosperous."
"We are very far from the corporate world described by Peter Drucker in chapter 6, in which the top college and graduate degree holders shunned Wall Street for Main Street. At Harvard for example the share of college graduates entering finance rose from 4% in the 1960's to nearly a quarter in recent years.
"The story is the same or more extreme at other top universities. Even recipients of the Rhodes scholarship, once the quintessential path to public service, have been going into finance at record rates. The American secretary of the Rhodes Trust, Elliot Gerson, explains, "Nothing is wrong with this picture if one believes that changed career paths of a few privileged people is not of any larger significance. Never mind that some have gifts that realistically could be expected to lead to world-changing breakthroughs, cures, or innovations; to greater respect for politics; or to hundreds of profoundly moved and inspired students."

On a pretty much totally unrelated topic. I was happy to be able to see Arlo Guthrie perform up in Bellingham awhile back. B got to meet him and some of his family who were staying in the same motel we were. 

Arlo's father, Woody wrote a song about Donald Trump's father Fred in the early 1950's. The song was about racial discrimination in a housing project owned by Fred Trump. The apple doesn't fall far from the tree in Arlo or Don's case. Arlo is a talented singer and songwriter like his dad. Don is a racist crook like his dad.

If you have some time on your hands I recommend reading the New York Times piece about Fred Trump's businesses and the amazing amount of fraud and apparently criminal activity that the "family" engaged in for decades. Times reporters spent over a year researching the article - it's either fake news, eye-opening, about what you'd expect, or exactly what you'd expect depending on your perspective, I suppose.