Authors: Kurt Andersen
There are plenty of LBO stories worse than this one. Reading the details made me realize that the term
is fair enough.
“After a long dry spell,” the first line of a breathless
New York Times
business story announced in 1980, “venture capital is booming again.” The reporter felt obliged to explain what venture capitalists were, the way articles back then also had to explain what Silicon Valley was. “ The last six months has been the hottest we’ve ever seen,” a VC in San Francisco told the reporter. All at once the three hot species of swinging financial firms—revitalized VCs, legitimized hedge funds, overleveraged takeover artists rationalized as private equity investors—were flooded with investment capital from big commercial banks, investment banks, insurance companies, pension funds, and university and foundation endowments. At the same moment that
became a genre, so did these
alternative asset managers
. Meanwhile, money from merely well-to-do and solvent individuals was gushing into conventional mass-market mutual funds, turning them into far, far more powerful economic institutions than they’d ever been before.
Looking back now, the scale and speed of the growth of the U.S. financial sector from around 1980 through the turn of the century is freakish. It suddenly began growing twice as fast as it had during the 1950s and ’60s and ’70s. Back in 1980, the bit of the American economy in the hands of the “alternative alpha” guys—venture capital, private equity and hedge funds, the for-rich-people-only investment firms—was insignificant.
the invested venture capital and private equity capital combined was around $22 billion in today’s dollars. And all the money in U.S. hedge funds combined was no more than a few tens of billions. By 2007, just before the crash, those sums had grown to the equivalents of $1.4 trillion and $1.8 trillion. The bigger, more familiar business of Wall Street, brokering and advising and being the middlemen between the mass of investors and the plain old stock and bond markets, quintupled as a fraction of the U.S. economy from 1980 to the early 2000s. The growth of mutual funds specifically was even more phenomenal: in 1980 they held the present-day equivalent of about $400 billion in investments, but by 2007 it was $16 trillion, forty times as much.
That has worked out extremely well for people in the money-manipulating professions. Only the people near the top in America have gotten richer, but the well-paid people in finance have led the way. During that one generation, all the fees received by all mutual fund managers increased tenfold, to more than $100 billion a year. As recently as 1990 all the fees that went to all the people running hedge funds and private equity and venture capital firms rounded down to nothing, “near-zero,” according to an exhaustive Harvard Business School study of the industry. By the early 2000s, that smallish group was raking in more than $100 billion a year as well.
I’ve mentioned some of the political choices and government actions (and inactions) starting in the late 1970s and ’80s that allowed for these sums—the looser rules about who may borrow and lend, 401(k)s, the rules encouraging debt, the much lower taxes on investment profits. Here’s another: the government agrees to pretend that those billions paid each year to people running private equity firms and hedge funds aren’t huge salaries but are instead profits on investments—even though those managers don’t actually own the investments. That is the “pass-through income” loophole that currently lets them pay taxes of 20 percent instead of the normal top income tax rate of 37 percent.
Within finance, the rich people in charge do let some of their gusher trickle down to their little people. Back in the old days, the early 1900s, the average employee of banks and investment firms earned a lot more than did people of the same education level who worked in other businesses. But then during the half-century following the Depression and New Deal, that pay premium for people in finance evaporated. Then in 1980 it suddenly reappeared, reverting to what it had been in the 1920s. In 1978 the average employee in finance was paid the same as the average employee in every other field—$53,000 in today’s dollars. By 2000, that average finance person was paid $92,000 and everybody else just $59,000. The new post-1980s premium for
in finance, however, was considerably larger—they started being paid three and four times what the equivalent executives in other fields got.
As financialization was starting, the Yale economist James Tobin, having just won the Nobel Prize, delivered a lecture called “On the Efficiency of the Financial System.” It’s remarkable how clearly he saw in 1984 that the financial tail was suddenly, crazily wagging our economic dog. Tobin said that although as an economist he was supposed to be unsentimental about such things, he felt “uneasy” about the change. “We are throwing more and more of our resources, including the cream of our youth, into financial activities remote from the production of goods and services.” Before the rest of us were talking about America’s refashioned casino economy, Tobin expressed his dismay at the new “casino aspect of our financial markets,” because Wall Street was no longer just the house that always wins, it had started winning more off more suckers by rigging it as “a negative-sum game for the general public.” Tobin also saw clearly how the digital revolution, barely begun, would enable the financial industry’s bookkeeping gimmicks and speculative bets to grow exponentially.
I suspect that the immense power of the computer is being harnessed to this paper economy, not to do the same transactions more economically but to balloon the quantity and variety of financial exchanges…facilitating nth-degree speculation which is short-sighted and inefficient.
I love his phrase
. It covered the range of obsessive-compulsive financial speculation that would be enabled by computers and the Internet, from the mania for derivatives in the late twentieth century to high-speed trading in the twenty-first. With more and more people suddenly in the
of buying and selling stocks for a living, digital technology enabled more and more stock to be bought and sold, an order of magnitude increase in the scale of that churn between the 1970s and 2000. “What is clear,” Tobin concluded in 1984, “is that very little of the work done by the securities industry” these days “has to do with the financing of real investment in any very direct way.”
A decade or so later people had just begun referring excitedly to digital businesses collectively as the New Economy, although there was no Google or Facebook yet. The New Economy was new. In early 1998 I wrote a somewhat skeptical essay in
The New Yorker
called “The Digital Bubble.” Among my arguments was that because PCs and the Internet were already essential tools in journalism and finance, early-adopting journalists and finance people might have gotten overexcited about their potential.
In 1999, however, I found myself eager to dive into this New Economy myself, to help make something cool and have fun before it was too late. I cofounded an ambitious online (and eventually print) publication called
that covered media and entertainment with a special focus on the dawning digital age for both. That experience gave me a spectacular and revelatory first-hand glimpse of the financial industry at the turn of the century.
VCs and Wall Street banks—Chase, Goldman Sachs, and Lehman Brothers, among others—required hardly any convincing to invest. One day in early 2000, an investment banker from Bear Stearns knocked on our door.
Were we financed? Did we need capital?
Incredibly, she was going up and down the grungy halls of the industrial building where we had our office, making cold calls. This, we half-joked, must be a sign of the top of the market. In all, Wall Street and others invested the equivalent of $50 million in our dot-com. That sum, flabbergasting then and even more so now, was only one-twentieth of 1 percent of the capital funneled through the 4,503 VC deals in that peak year of dot-com madness. We finished raising most of that money practically the very day that what I’d called a bubble two years earlier began to pop.
We didn’t pay ourselves much, and the journalists of
did some excellent work, but it lasted only two or three more years. In the end, it was acquired by an established media company, an acquisition that earned me nothing and after which I promptly resigned. The acquirer was called Primedia, the new name for K-III, the media company owned by Henry Kravis’s KKR.
’s evanescence, the millions poured into the venture were, contrary to Tobin’s warning, the financing of real investment. Indeed, as a result of the extreme growth of the financial industry from 1980 onward, its worldview and interests soon had
to do with real investment, the real economy, and the real lives of Americans in very direct ways.
How did that happen? The short answer: as Wall Street’s financial approach became more casino-like, that short-term, jackpot-ASAP focus also became the overriding focus of big business executives, which helped lock in as never before Wall Street’s dominance of American business and American life.
And now for the longer answer. Like so much of this story, its wellspring is Milton Friedman’s 1970 announcement of the new American gospel that maximizing profit was the one and only responsibility of people running any business. In the early 1970s at the University of Rochester, whose right-wing economics program was Avis or Budget to the University of Chicago’s Hertz, a libertarian professor specifically commissioned two business school colleagues, both University of Chicago–trained, to write a paper elaborating on the Friedman Doctrine.
That became, when it was finally published in 1976, “Theory of the Firm,” which made the new callousness seem scientific and which became the first or second most cited business and economics paper ever. “The modern understanding” of how corporate managers should run companies, a Harvard Business School professor and
Harvard Business Review
editor declared in 2012, “has been defined to a large extent” by that paper. Its authors took a two-hundred-year-old observation of Adam Smith’s—that the insufficiently “anxious vigilance” of hired company directors could result in management “negligence”—and extended it to 357 pages with impressive-looking equations and language of the “manager’s indifference curve is tangent to a line with slope equal to –u” kind.
The argument was that if corporate executives were mere salary-earners, their interests inevitably diverged too far from the interests of the company’s owners. Instead of doing their jobs with absolute financial single-mindedness, executives might start being too fair and decent, so they would overspend on “charitable contributions,” get lax on “employee discipline,” concern themselves too much about “personal relations (‘love,’ ‘respect,’ etc.) with employees” and “the attractiveness of the secretarial staff.”
The authors’ 1983 follow-up to the paper was a much shorter, more accessible one in which they dumped the math and any pretense of scholarly neutrality. “The right of managers to use corporate assets in the interest of stockholders has gradually been eroded away,” they wrote, so that “special interest groups thereby transfer wealth from [shareholders] to themselves.” Because they provided no examples of “erosion” or plundering by “special interests,” it’s unclear if they meant safety or environmental regulations or corporate taxes or what. “Big business has been cast in the role of villain” by “the intellectually unwashed,” the “anti-war protesters, consumer advocates, environmentalists, and the like,” who “wish to use the power of the state to pervert” the corporate status quo and to spread “the cliché that corporations have ‘too much’ power.” That “attack on the corporation” starting in the 1960s, the two professors asserted without evidence, was the reason for “the poor performance of the stock market” during the decade or two since.
Most consequentially, they posited as a kind of scientific fact that a public company’s stock price
was the only meaningful measure of a company’s value.
Friedman had said maximizing profits was everything. Profits, at least, are a real, objective measure of a company’s success. However, this new, supposedly absolute gauge and guiding star, a stock price, is just the momentary average of all the hunches and biases of a high-strung mob of buyers and sellers, most of whom have a very superficial understanding of the company. Yet it
objective, and in any case is so irresistibly simple. Plus: democracy! Giving the high-strung ill-informed mob absolute power, letting them vote every day—every hour, every minute—was maximum democracy.
By the 1980s this approach had turned into a movement with a new name and mantra:
. Unlike Friedman’s contemptuous bah-humbuggery or Gekko’s
Greed is good,
it sounded neutral, uncontroversial, practically self-evident—like Law and Economics. Victory for the new dogma was fast and total. Back in 1981, the official scripture of the Business Roundtable, the big business politburo, still held that “corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices” and to “provide jobs, and build the economy.” The term
’s first apparent use in
New York Times
came the following year.
according to an economist who specializes in U.S. business history, “no one was talking about ‘shareholder value’ ” in 1984, but then boom, by 1986, “everyone was talking about it.” In the 1990s the Business Roundtable doctrine was amended accordingly, professing the new faith that the point of a business enterprise “is to generate economic returns to its owners,” period, by being “focused on shareholder value.” By then a more pointed and accurate term had been coined for the new stock-price monomania: