Foroohar makers and takers; the rise of finance and the fall of american business (2016)

Copyright © 2016 by Rana Foroohar All rights reserved Published in the United States by Crown Business, an imprint of the Crown Publishing Group, a division of Penguin Random House LLC, New York crownpublishing.com CROWN BUSINESS is a trademark and CROWN and the Rising Sun colophon are registered trademarks of Penguin Random House LLC Library of Congress Cataloging-in-Publication Data is available upon request ISBN 9780553447231 ebook ISBN 9780553447248 Cover design by Christopher Brand v4.1_r1 ep Contents Cover Title Page Copyright Dedication Author’s Note Introduction Chapter 1: The Rise of Finance Chapter 2: The Fall of Business Chapter 3: What an MBA Won’t Teach You Chapter 4: Barbarians at the Gate Chapter 5: We’re All Bankers Now Chapter 6: Financial Weapons of Mass Destruction Chapter 7: When Wall Street Owns Main Street Chapter 8: The End of Retirement Chapter 9: The Artful Dodgers Chapter 10: The Revolving Door Chapter 11: How to Put Finance Back in Service to Business and Society Acknowledgments Notes Bibliography For John, Darya, and Alex Ideas take shape over time, but they often crystallize in a single moment This book is in many ways the culmination of my twenty-three years in business and economic journalism, during which time I have often wondered why our market system doesn’t serve American companies, workers, and consumers better than it does But I can also track the moment when I knew I had to write Makers and Takers It was back in 2013, and I was sitting in an off-the-record briefing with a former Obama administration official who had been a key player in the financial crisis of 2008 A group of journalists, mostly financial beat reporters, had been gathered together in New York to hear this former official’s post-game analysis of the crisis, part of the administration’s efforts to bring closure to the most painful economic event in seventy-five years in this country (as well as to tie a neat bow around the Obama team’s handling of it) At one point, a reporter pressed the former official on whether he thought that the Dodd-Frank bank reform regulation, which was still only half finished at the time, had been unduly influenced by Wall Street lobbying efforts The official insisted that this wasn’t the case I was taken aback—I had recently done a column for Time citing some academic research showing that 93 percent of all the public consultation taken on the Volcker Rule, one of the most contentious parts of the Dodd-Frank regulation, had been taken with the financial industry Wall Street, not Main Street, was clearly the primary voice in the room as the regulation was being crafted I raised my hand and shared the statistic, and then asked why so many such meetings had been done with bankers themselves, rather than a broader group of stakeholders The official looked at me in a way that seemed to show honest befuddlement, and said, “Who else should we have taken them with?” That moment, more than any other, captured for me how difficult it is to grapple with the role of finance in our economy and our society Finance holds a disproportionate amount of power in sheer economic terms (It represents about percent of our economy but takes around 25 percent of all corporate profits, while creating only percent of all jobs.) But its power to shape the thinking and the mind-set of government officials, regulators, CEOs, and even many consumers (who are, of course, brought into the status quo market system via their 401(k) plans) is even more important This “cognitive capture,” as academics call it, was a crucial reason that the policy decisions taken by the administration post-2008 resulted in large gains for the financial industry but losses for homeowners, small businesses, workers, and consumers It’s also the reason that the rules of our capitalist system haven’t yet been rewritten in a way that would force the financial markets to what they were set up to do: support Main Street As the conversation detailed above shows, when all the people in charge of deciding how market capitalism should operate are themselves beholden to the financial industry, it’s impossible to craft a system that will be fair for everyone That tension and that challenge are the subjects of this book The view from Wall Street has over the past forty years or so become the conventional view of how our market system and our economy should operate And yet, it’s a view that is highly biased and distorted While we think about the financial industry as the grease for the wheels of our capitalist system, the interests of Wall Street and of American business (not to mention its workers and consumers) often don’t line up at all Finance has become a headwind to economic growth, not a catalyst for it As it has grown, business—as well as the American economy and society at large—has suffered The financial crisis of 2008 was followed by the longest and weakest economic recovery of the post–World War II era While the top tier of society is now thriving, most everyone else is still struggling We need a dramatically different balance of power between finance and the real economy—between the takers and the makers—to ensure better and more sustainable growth It’s a conversation that has been hard to have, given how much control finance has in our economy and our society But it’s crucial to crafting a better future This book is an attempt to start that conversation—to illustrate how takers came to dominate makers in our economy, and how we can change things for the better It wasn’t the way Steve Jobs would have done it In the spring of 2013, Jobs’s successor as CEO of Apple Inc., Tim Cook, decided the company needed to borrow $17 billion Yes, borrow Never mind that Apple was the world’s most valuable corporation, that it had sold more than a billion devices so far, and that it already had $145 billion sitting in the bank, with another $3 billion in profits flowing in every month So, why borrow? It was not because the company was a little short, obviously, or because it couldn’t put its hands on any of its cash The reason, rather, was that Apple’s financial masters had determined borrowing was the better, more cost-effective way to obtain the funds Whatever a loan might normally cost, it would cost Apple far less, thanks to a low-interest bond offering available only to blue-chip companies Even better, Apple would not actually have to touch its bank accounts, which aren’t held someplace down the street like yours or mine Rather, they are scattered in a variety of places around the globe, including offshore financial institutions (The company is secretive about the details.) If that money were to return to the United States, Apple would have to pay hefty tax rates on it, something it has always studiously avoided, even though there is something a little off about a quintessentially American firm dodging a huge chunk of American taxes So Apple borrowed the $17 billion This was never the Steve Jobs way Jobs focused relentlessly on creating irresistible, life-changing products, and was confident that money would follow By contrast, Cook pays close attention to the money and to increasingly sophisticated manipulations of money And why? Part of the reason is that Apple hasn’t introduced any truly game-changing technology since Jobs’s death in 2011 That has at times depressed the company’s stock price and led to concerns about its long-term future, despite the fact that it still sells a heck of a lot of devices It’s a chicken-and-egg cycle, of course The more a company focuses on financial engineering rather than the real kind, the more it ensures it will need to continue to so But right now, what Apple does have is cash Which gets us to that $17 billion Apple didn’t need that money to build a new plant or to develop a new product line It needed the funds to buy off investors by repurchasing stock and fattening dividends, which would goose the company’s lagging share price And, at least for a little while, the tactic worked The stock soared, yielding hundreds of millions of dollars in paper wealth for Apple board members who approved the maneuver and for the company’s shareholders, of whom Cook is one of the largest That was great for them, but it didn’t put much shine on Apple David Einhorn, the hedge fund manager who’d long been complaining that the company wasn’t sharing enough of its cash hoard, inadvertently put it very well when he said that Apple should apply “the same level of creativity” on its balance sheet as it does to producing revolutionary products.1 To him, and to many others in corporate America today, one kind of creativity is just as good as another I’ll argue differently in this book The fact that Apple, probably the best-known company in the world and surely one of the most admired, now spends a large amount of its time and effort thinking about how to make more money via financial engineering rather than by the old-fashioned kind, tells us how upside down our biggest corporation’s priorities have become, not to mention the politics behind a tax system that encourages it all This little vignette also demonstrates how detached many of America’s biggest businesses have become from the needs and desires of their consumers—and from the hearts and minds of the country at large Because make no mistake, Apple’s behavior is no aberration Stock buybacks and dividend payments of the kind being made by Apple—moves that enrich mainly a firm’s top management and its largest shareholders but often stifle its capacity for innovation, depress job creation, and erode its competitive position over the longer haul—have become commonplace The S&P 500 companies as a whole have spent more than $6 trillion on such payments between 2005 and 2014,2 bolstering share prices and the markets even as they were cutting jobs and investment.3 Corporate coffers like Apple’s are filled to overflowing, and America’s top companies will very likely hand back a record amount of cash to shareholders this year Meanwhile, our economy limps along in a “recovery” that is tremendously bifurcated Wage growth is flat Six out of the top ten fastest-growing job categories pay $15 an hour and workforce participation is as low as it’s been since the late 1970s It used to be that as the fortunes of American companies improved, the fortunes of the average American rose, too But now something has broken that relationship That something is Wall Street Just consider that only weeks after Apple announced it would pay off investors with the $17 billion, more sharks began circling Corporate raider Carl Icahn, one of the original barbarians at the gate who attacked companies from TWA to RJR Nabisco in the 1980s and 1990s, promptly began buying up Apple stock, all the while tweeting demands that Cook spend billions and billions more on buybacks With each tweet, Apple’s share price jumped By May 2015, Icahn’s stake in Apple had soared 330 percent, to more than $6.5 billion, and Apple had pledged to spend a total of $200 billion on dividends and buybacks through March 2017 Meanwhile, the company’s R&D as a percentage of sales, which has been falling since 2001, is creeping ever lower.5 What these sorts of sugar highs portend for Apple’s long-term future is anyone’s guess, but one thing is clear: the business of America isn’t business anymore It’s finance From “activist investors” to investment banks, from management consultants to asset managers, from high-frequency traders to insurance companies, today, financiers dictate terms to American business, rather than the other way around Wealth creation within the financial markets has become an end in itself, rather than a means to the end of shared economic prosperity The tail is wagging the dog Worse, financial thinking has become so ingrained in American business that even our biggest and brightest companies have started to act like banks Apple, for example, has begun using a good chunk of its spare cash to buy corporate bonds the same way financial institutions do, prompting a 2015 Bloomberg headline to declare, “Apple Is the New Pimco, and Tim Cook Is the New King of Bonds.”6 Apple and other tech companies now anchor new corporate bond offerings just as investment banks do, which is not surprising considering how much cash they hold (it seems only a matter of time before Apple launches its own credit card) They are, in essence, acting like banks, but they aren’t regulated like banks If Big Tech decided at any point to dump those bonds, it could become a market-moving event, an issue that is already raising concern among experts at the Office of Financial Research, the Treasury Department body founded after the 2008 financial crisis to monitor stability in financial markets.7 Big Tech isn’t alone in emulating finance Airlines often make more money from hedging on oil prices than on selling seats—while bad bets can leave them with millions of dollars in losses GE Capital, a subsidiary of the company launched by America’s original innovator, Thomas Alva Edison, was until quite recently a Too Big to Fail financial institution like AIG (GE has spun it off in part because of the risks it posed) Any number of Fortune 500 firms engage in complicated Whac-A-Mole schemes to keep their cash in a variety of offshore banks to avoid paying taxes not only in the United States but also in many other countries where they operate But tax avoidance and even “tax inversions” of the sort firms like the drug giant Pfizer have done—maneuvers that allow companies to skirt paying their fair share of the national burden despite taking advantage of all sorts of government supports (federally funded research and technology, intellectual property protection)—are only the tip of the iceberg In fact, American firms today make more money than ever before by simply moving money around, getting about five times the revenue from purely financial activities, such as trading, hedging, tax optimizing, and selling financial services, than they did in the immediate post–World War II period.8 It seems that we are all bankers now It’s a truth that is at the heart of the way our economy works—and doesn’t work—today Eight years on from the financial crisis of 2008, we are finally in a recovery, but it has been the longest and weakest recovery of the postwar era The reason? Our financial system has stopped serving the real economy and now serves mainly itself, as the story above and many others in this book, along with copious amounts of data, will illustrate Our system of market capitalism is sick, and the big-picture symptoms—slower-than-average growth, higher income inequality, stagnant wages, greater market fragility, the inability of many people to afford middle-class basics like a home, retirement, and education—are being felt throughout our entire economy and, indeed, our society Stiglitz, Joseph E The Roaring Nineties: A New History of the World’s Most Prosperous Decade New York: W W Norton & Company, 2004 ——— The Price of Inequality: How Today’s Divided Society Endangers Our Future New York: W W Norton & Company, 2013 ——— The Great Divide: Unequal Societies and What We Can Do About Them New York: W W Norton & Company, 2015 Stone, Amey, and Mike Brewster King of Capital: Sandy Weill and the Making of Citigroup New York: John Wiley & Sons, 2002 Stout, Lynn The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public San Francisco: Berrett-Koehler Publishers, 2012 Taylor, Paul, and the Pew Research Center The Next America: Boomers, Millennials, and the Looming Generational Showdown New York: PublicAffairs, 2014 Tett, Gillian Fool’s Gold: The Inside Story of J.P Morgan and How Wall St Greed Corrupted Its Bold Dream and Created a Financial Catastrophe New York: Free Press, 2010 ——— The Silo Effect: The Peril of Expertise and the Promise of Breaking Down Barriers New York: Simon & Schuster, 2015 Thaler, Richard H Misbehaving: The Making of Behavioral Economics New York: W W Norton & Company, 2015 Thorndike Jr., William N The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success Boston: Harvard Business Review Press, 2012 Tobe, Chris, with Ken Tobe Kentucky Fried Pensions: Worse Than Detroit Edition 2nd ed Middleton, DE: CreateSpace, 2013 Tse, Edward China’s Disruptors: How Alibaba, Xiaomi, Tencent, and Other Companies Are Changing the Rules of Business New York: Portfolio/Penguin, 2015 Turner, Adair Between Debt and the Devil: Money, Credit, and Fixing Global Finance Princeton, NJ: Princeton University Press, 2015 Turner, John D Banking in Crisis: The Rise and Fall of British Banking Stability, 1800 to the Present Cambridge: Cambridge University Press, 2014 USB, “The New Global Context: Could Economic Transformations Threaten Stability?” USB White Paper for the World Economic Forum January, 2015 Warren, Elizabeth A Fighting Chance New York: Picador, 2015 Weill, Sandy, and Judah S Kraushaar The Real Deal: My Life in Business and Philanthropy New York: Warner Business Books, 2006 Whitney, Meredith Fate of the States: The New Geography of American Prosperity New York: Penguin Press, 2013 Wilkinson, Richard, and Kate Pickett The Spirit Level: Why Equality Is Better for Everyone London: Penguin Books, 2009 Wolf, Martin The Shifts and the Shocks: What We’ve Learned—and Have Still to Learn—from the Financial Crisis New York: Penguin Press, 2014 Zingales, Luigi A Capitalism for the People: Recapturing the Lost Genius of American Prosperity New York: Basic Books, 2012 Zweig, Phillip L Wriston: Walter Wriston, Citibank, and the Rise and Fall of American Financial Supremacy New York: Crown Publishers, 1995 What’s next on your reading list? 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Get personalized book picks and up-to-date news about this author Sign up now Table of Contents Title Page Copyright Contents Dedication Author’s Note Introduction Chapter 1: The Rise of Finance Chapter 2: The Fall of Business Chapter 3: What an MBA Won’t Teach You Chapter 4: Barbarians at the Gate Chapter 5: We’re All Bankers Now Chapter 6: Financial Weapons of Mass Destruction Chapter 7: When Wall Street Owns Main Street Chapter 8: The End of Retirement Chapter 9: The Artful Dodgers Chapter 10: The Revolving Door Chapter 11: How to Put Finance Back in Service to Business and Society Acknowledgments Notes Bibliography ... isolate because of the tremendous number of variables at play But the depth and breadth of correlations between the rise of finance and the growth of inequality, the fall in new businesses, wage... crash of 1929 and the Great Depression, just as they were part of the crisis of 2008 and the Great Recession There are the causes of the problem, of course, and then there are the symptoms, which... percent of GDP.15 With the rise of the securities and trading portion of the industry came a rise in debt of all kinds, public and private Debt is the lifeblood of finance; it is where the financial