Lenderocracy

The Greek crisis matters for us in the United States too, not just Europeans.

For all the high-minded rhetoric of the European integration project as an effort to bridge together the peoples of Europe in liberal democratic union, the events of the past week have conclusively ripped off the mask and revealed the underlying reality that it has been little more than a neoliberal economic project the whole time. And a poorly designed one at that. But we now can all see that the preservation of investment banking interests will be placed above all other values and principles whenever they come into conflict. This isn’t just rule by corporations — it’s rule by lenders.

The Greek “crisis” — manufactured by the European Central Bank, the IMF, and the German government — is a financial public execution of an entire developed country to make an example of them for all others.

In my more than 30 years writing about politics and economics, I have never before witnessed such an episode of sustained, self-righteous, ruinous and dissembling incompetence — and I’m not talking about Alexis Tsipras and Syriza. As the damage mounts, the effort to rewrite the history of the European Union’s abject failure over Greece is already underway. Pending a fuller postmortem, a little clarity on the immediate issues is in order.
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There’s no reason, in law or logic, why a Greek default necessitates an exit from the euro. The European Central Bank pulls this trigger by choosing — choosing, please note — to withhold its services as lender of last resort to the Greek banking system. That is what it did this week. That is what shut the banks and, in short order, will force the Greek authorities to start issuing a parallel currency in the form of IOUs.

 
If investors made stupid loans to Greece, these lenders – not the Greek people – should suffer for it. A startling lack of due diligence strikes again.

And just as with the subprime mortgage crisis, the lenders are considered “too big to fail” (but not too big to regulate before the bubble bursts). Instead of bailing out the ordinary people who truly got screwed over by the irresponsible lending and the ensuing crash, the banks are the ones who get bailed out. In this case, Greece keeps receiving “bailouts” that are actually earmarked exclusively for repaying debt obligations to lenders (some of which are by now merely the quasi-governmental institutions holding debt they purchased from irresponsible banks in earlier bank bailout rounds).

We’ve seen this kind of thing happen countless times throughout world history. Lenders pretend to assume risk and then wield tremendous political influence to ensure that they never actually face serious consequences when that risk blows up in their faces. That way, investment recipients (including citizens) always lose, while the investor class is guaranteed a payday, before anyone else finds relief.

Social Impact? Deval Patrick joins Romney’s old firm

Former Massachusetts Governor Deval Patrick seems to have decisively ended speculation he had national aspirations in the Democratic Party after announcing he will be going to work for the job-slashing firm Mitt Romney founded to help rich people park their money in “good causes”:

Deval Patrick is joining the Boston investment giant Bain Capital, where the former governor will start a new line of business, directing investments in companies that produce profits but also have a positive impact on social problems. […] Patrick will help give Bain its first foothold in the growing field of “social impact” investing, tackling social problems such as hunger and climate change with for-profit investments.
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During the 2012 presidential campaign, when stumping for Barack Obama against Romney, Patrick declined to join Democrats who vilified Bain and Romney’s work for the firm. On MSNBC’s “Morning Joe,” Patrick called Bain “a perfectly fine company.”
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For Bain Capital, the Patrick hiring goes beyond the common practice of giving a politician a desk and a rainmaker’s role between elections. It is a way for a firm known for hard-core business deals to provide clients such as pension funds and wealthy individuals with a social outlet for their money.

 

Former Massachusetts Gov. Deval Patrick served from 2007 to 2015. (Photo by Scott LaPierre)

Former Massachusetts Gov. Deval Patrick served from 2007 to 2015. (Photo by Scott LaPierre)

This role sounds innocuous, or even positive, and perhaps it will be. But Bain in particular has a fairly nasty reputation, and the general field of “social impact investing” can be fairly shady. Instead of just using money to fix long-term problems, everything becomes a shorter-term profit-seeking investment. Many of these private sector investments aim to replace government functions (or even profit off government) and treat all the problems in profit/loss terms. Whereas a one-way donor or a government program is ostensibly acting in the public interest, all social impact investments are made in the primary interest of the shareholders or company stake-owners. Some of the money that could be re-invested into getting an even bigger impact is instead needlessly siphoned out to create a profit margin.

Moreover, I am specifically concerned because of the recent, very sketchy “social impact” investments of Goldman Sachs in the Massachusetts correctional system, when Gov. Deval Patrick was still in office, which could foreshadow the type of investments he would introduce into the Bain portfolios. Such investments are far more concrete (and financially less abstract or long-term) than amorphous goals like “hunger” and “climate change.” I wrote about them in May 2014:

Recently, in some states, Goldman Sachs has been issuing “social impact bonds,” a new financial instrument that purports to help cure social ills with Wall Street’s “help.”

In this case, they’re loaning $9 million to the state of Massachusetts to help support a Boston organization that tries to help young offenders from bouncing back into prison. (Reducing young recidivism is a good social goal, obviously, and would have a ripple effect on crime prevention.)

If the effort reduces the number of days past inmate spend back in prison — which would save the state money — the savings would go back to Goldman Sachs, up to a million dollars. If the effort really pays off (above and beyond the bond repayment terms), then the state would get to keep the money. Of course, if the effort doesn’t hit the minimum targets needed to generate enough savings, Goldman Sachs would still get interest payments on the bond, but would lose the principal loan ($9 million or however much of it couldn’t be repaid due to insufficient savings).

As private investments in the prison industry go, it’s not the worst thing in the world. At least the profit incentive is toward rehabilitation rather than toward further imprisonment in the way privatized prisons are. But the question is why is it even necessary to involve the private sector middleman in the first place?

The state could pay for the upfront cost of the program through tax revenues (if it were willing to raise taxes, of course), instead of taking a loan, it would keep all the money and not end up paying Wall Street no matter how things turn out. That money could be reinvested into expanding the successful efforts even more, thus benefiting all taxpayers.

In my opinion, the job of corrections and the rehabilitation of young offenders is part of the role of government. The private sector is free to help, but it should be an add-on to the process, not a redundant profit diversion mechanism in the middle.

 
Another problem is the issue of emphasizing data-driven decision-making in government. The profit motive strengthens this trend much faster, even though government is often meant to be performing roles that could not be profitably well executed by the private sector and remain profitable. The data-driven policymaking favored by such approaches presents a false objectivity in place of really subjective questions: Read more

March 18, 2015 – Arsenal For Democracy 120

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Topic: How the Shareholder Revolution is hurting America’s businesses and workers. People: Bill, Nate. Produced: March 16th, 2015.

Discussion Points:

– What happens to companies that borrow money to make shareholder payouts?
– Why aren’t American companies investing in the future as much as they used to?
– Why should American companies tie wages to increases in profits and productivity instead of focusing on dividends and stock buybacks?

Note for listeners: We’re testing a half-hour version of the show over the next few weeks. Let us know whether you prefer this format or the longer format.

Episode 120 (27 min):
AFD 120

Related Links:

AFD: Corporate borrowing diverted to shareholders, not investment
The Roosevelt Institute: Blog post on “Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment”
The Globalist: U.S. Stock Ownership: Who Owns? Who Benefits?
The Globalist: Can the United States Close the International Wage Gap?
The Globalist: Want to Fix Income Inequality? Relink Wages to Productivity

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And don’t forget to check out The Digitized Ramblings of an 8-Bit Animal, the video blog of our announcer, Justin.

Corporate borrowing diverted to shareholders, not investment

A new paper from The Roosevelt Institute examines the “collapse” in the relationship between U.S. corporate borrowing and corporate investment into new projects or operations. Where every dollar a company borrowed prior to the 1980s would lead to 40 cents worth of investment, today more of the money is diverted into payouts for shareholders than is actually invested and there is almost no relationship between dollars borrowed and dollars invested.

In the summary blog post, they write that “very large swings in credit flows to the corporate sector [since the last recession] do not correspond to any similar shifts in aggregate investment,” while payouts to shareholders “appear more strongly associated with variation in cash flow and borrowing.” These relationships to borrowing were reversed in the pre-1980s period and crossed over each other in the 1985-2001 period most associated with significant changes to U.S. corporate governance norms and rules that tended to favor quarterly shareholder interests above all other priorities, including long-term investment.

This practice of borrowing to pay shareholders instead of borrowing to invest, as you might guess, basically means shareholders are profiting against the company’s future financial health, rather than from current (or future) returns on its previous (or current) investments. That means literally raiding the companies’ future earnings to generate payout cash now. The company will eventually have to pay back the borrowed money with interest, but it will not have gained anything from that borrowing because it was used to rain money down on shareholders instead of actually growing the company’s operations. This means companies are putting themselves deeper into a long-term hole, even as wealthy shareholders (the vast majority of American stock is held by a very small number of people with a lot of money to throw around) rake in money in the short-term.

Meanwhile, I would surmise, investment banks stand to make a lot of profits in interest — as long as the borrowing companies don’t collapse from all their unproductive loans. Down the line, a lot of American companies could have very high debt burdens while also being very underdeveloped compared to foreign competitors who invested in keeping up with the times and growing their long-term potential earnings. That will make them vulnerable to bankruptcy and other problems.

Here’s the paper’s abstract:

This paper provides evidence that the strong empirical relationship of corporate cash flow and borrowing to productive corporate investment has disappeared in the last 30 years and has been replaced with corporate funds and shareholder payouts. Whereas firms once borrowed to invest and improve their long-term performance, they now borrow to enrich their investors in the short-run. This is the result of legal, managerial, and structural changes that resulted from the shareholder revolution of the 1980s. Under the older, managerial, model, more money coming into a firm – from sales or from borrowing – typically meant more money spent on fixed investment. In the new rentier-dominated model, more money coming in means more money flowing out to shareholders in the form of dividends and stock buybacks.

These results have important implications for macroeconomic policy. The shareholder revolution – and its implications for corporate financing decisions – may help explain why higher corporate profits in recent business cycles have generally failed to lead to high levels of investment. And under this new system, cheaper money from lower interest rates will fail to stimulate investment, growth, and wages because, as we show here, additional funds are funneled to shareholders through buybacks and dividends.

 
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AFD 64 – The Role of Finance

Latest Episode:
“AFD 64 – The Role of Finance”
Posted: Tues, 19 November 2013

Bill asks what role the financial services sector should have in the U.S. economy. Sarah talks with Bill about Oklahoma’s abortion restrictions which the Supreme Court blocked. Then Bill assesses the UN Congo mission.

Additional:

I wrote this item in The Globalist after recording the finance segment, to expand upon a point I briefly passed over in the show.

Op-Ed: The Problem With Billionaires

My latest op-ed from The Globalist:

In the 1980s, the supply-siders became ascendant in Washington D.C., preaching voodoo economics as “the way, the truth and the life.” Their central claim was that rich people create jobs, while high taxes on the rich leave them with less money to create jobs. Therefore tax cuts for the rich equal job growth.

In reality, this hasn’t borne out. Neither the macroeconomic data nor academic studies have shown much evidence of a direct correlation between rich people having more money and using it to create jobs.

Instead, they mostly just use it to speculate, because it’s essentially extra wealth well above and beyond any other spending or genuine investments they could possibly conceive of.

Read the full op-ed here.