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Clark, Where Have You Been? Or The American Disconnect Between History, Law, and Economics: An Exposition
What I want to do, quickly here, is talk about the American disconnect between history, law, and economics . It is this disconnect, among other things, that gives us an effectively two-tier legal system as far as class goes (race too but that is not the subject of this hub). We seem to have a problem, in America, of recognizing the same behavior as it changes form. We outlaw something under one guise but then permit it, even celebrate it under another.
The economic and financial crisis that hit America and the world in 2008 got many tongues wagging about: a lack of regulation, oversight, deregulation, regulators being 'asleep at the switch,' 'captured' regulatory agencies, 'This is the worst economic crisis since the Great Depression in the 1930s,' the consequences of the financialization of the American and world economy that began in the 1970s, the actual criminal behavior of corporate executives even under the lax deregulatory standards of Reaganism (or neoliberalism). And so on and so forth, etc., etc., ad infinitum.
But I want to look at history, law, and economics to say that there are practices permitted in the sphere of elite finance -- perfectly legal, legitimate (though morally dubious) -- that should be illegal because they were already outlawed in a different form.
You know how Superman comes around to save the day... like Mighty Mouse? Then he ducks back into that phone booth, changes back into his suit and glasses. Then everybody says, "Clark, where have you been?" Nobody ever seems to notice that Clark Kent and Superman look a lot alike, that they have very similar body builds, the same hair and shape of face. The glasses seem to change everything.
Actually, the problem is a little worse with He-Man. Prince Adam, who transforms into He-Man, doesn't even wear glasses! What I'm saying, then, is that this is a problem we have in American intellectual culture.
I want to relate this to history, law, and economics by talking about one example, which is piracy. It is against international law and American law to commit piracy, the formal act of piracy. It is illegal for you (whoever 'you' may be) to gather a group of thugs together, get some kind of fast-moving speed boat, and then stop and rob ships sailing the waters. You stop the ship, board it, incapacitate the crew and get control of the passengers, and then you leave with everything you can carry, and whatever is not nailed down. You loot the vessel. In the old days the loot you came away with, the plunder, was called booty.
That activity is called piracy. Now, if I read the political-economist Kevin Phillips correctly, privateering is when you (whoever 'you' may be), this time as a wealthy merchant or landowner of some kind (some kind of person of means), secretly back and finance a pirate operation.
Now, we know that for a long time in Europe this was not criminalized activity. It was considered to be just one of those things that happened in the course of war. And of course, European governments benefitted from that activity. But in time, as something approaching the global order that prevails today, began to be shaped and stabilized, the European powers decided that piracy should be universally illegal.
And now, just a little history.
The Fortunes of War in the American Colonies and in the New Nation 1776-90
Kevin Phillips, the political-economist I mentioned, noted that "... war itself remained the principal pathway to new territory and grandeur for rulers as well as principal contractors and commissaries, naval officers in search of prize money, an commissioned privateers" (Phillips, p.9).
There is some fluidity with terminology, but I hope you noted the bit about "commissioned privateers." Sometimes what we would think of as pirate operations (special operations or 'dirty tricks,' if you like) were officially sanctioned.
Continuing with the importance of war, historically, to building the fortunes of the ONE PERCENT, Phillips went on to say that "... all six of the major waves of inflation that have swept the United States have come in its wake, from Bunker Hill to the Vietnam build up." Furthermore, "[t]he money in circulation has always had to be increased sharply, and each new flood that sluiced through a wartime economy has left expanded enterprises and huge profits in sectors from transportation and food to munitions" (ibid, pp.9-10).
Even before the American Revolution, says Phillips, some of the richest men in Massachussetts, after King George's War (1744-1748), were those who had managed, financed, and supplied privateering campaigns launched from New England. "Something like a hundred thousand pounds sterling stuck to the collective hands of the governor, William Shirley, the Louisborg expedition's commander, Sir William Pepperrell, and three merhcants who controlled provisioning -- Thomas Hancock, Charles Apthorp, and John Erving" (Phillips, p.10).
The French and Indian War (1754-1763) was even more profitable to prominent people on both sides of the Atlantic, says Phillips. "Senior eighteenth-century government officials, were expected to enrich themselves, especially those who had purchased their positions" (Phillips, p.10). That's the sticky fingers of government officials, there end of the looting.
Keeping our focus on piracy, we note that Manhattan certainly accrued riches through seaborne commerce-raiding. Both in the 1740s and again during the period of 1754-1763 New York-based privateers like the Royal Hester "earned lucrative returns for merchant investors" (ibid). Note that term, friends -- INVESTORS.
Phillips made reference to two historians -- Edwin Burrows and Mike Wallace -- who estimated that two million pounds sterling of legalized plunder went to about two hundred local 'investors,' local New York 'investors' (Phillips, p.10). Indeed, "[s]ome economists," wrote Phillips, "have ranked thinly disguised piracy behind only the East India Company as a seventeenth century English overseas investment" (ibid, p.11). And so "... many a substantial seventeenth-century English family enjoyed occasional sub-rosa proceeds from piracy" (ibid).
The piracy operations ranged far and wide. "Merchants in the American colonies of the 1690s often funded covert expeditions to plunder gold, silk, and ivory in the faraway waters off India, Arabia, and Madagascar" and "As of, say, 1763, it is reasonable to suggest that many of the thirteen colonies' richest merchant families owed 30 to 40 percent of their wealth to the fruits of war, privateering, and earlier piracy" (Phillips, p.11).
Thirty to forty percent! That's pretty big!
Phillips noted that from about the fall of 1775 to 1782 some two thousand vessels -- brigs, barks, brigantines, ketches, sloops, and a few frigates, -- sailed under the auspices of the United States or from one of the 13 colonies (Phillips, pp.12-13). He wrote: "Collectively they would capture three thousand British ships, valued -- including cargoes -- at the then huge sum of $18 million." Rebel privateering activity, as well as postwar capital concentration, focused around Philadelphia and the open ports of New England: Boston (after March 1776); Marblehead, Salem, Gloucester, and Newburyport in Massachussetts; Providence, Rhode Island; Portsmouth, New Hampshire, and New London, Connecticut (ibid, p.13).
New England backed 1200 of the two thousand rebel piracy operations. And just so we don't misunderstand Phillips states plainly that "[b]ooty underpinned postwar preeminence everywhere in New England." For example, Asa Clapp, who had been a privateer, became the richest man in Maine. New Hampshire's most successful commerce raider, John Langdon of Portsmouth, became governor and then a U.S. senator. John Brown, had been a privateer and slaver. His family gave money and their name to Brown University in 1804 (ibid).
We're almost done our history lesson
Kevin Phillips wrote: "In 1780, men with privateering and war supply connections were climbing into the upper ranks. By 1784 they were moving to the top. And by 1790 they were the Boston business elite." And "In the 1790s, fortunes derived from privateering and government finance represented the biggest pot of money in the United States" (Phillips, p.14).
This period -- the run up to the American Revolution and its aftermath -- was a convulsive time in the U.S. economy. The political shake up of wealth patterns was widely remarked upon at the time. Robert Treat Paine of Boston said: 'The course of the war has thrown property into channels, where before it never was, has increased little streams to overflowing rivers...' The historian David Ramsey wrote, that in Charleston, the new men had replaced the old and 'rapidly advanced their interests' (ibid, p.15).
Mr. Phillips made a crucial point that I will return to. He wrote that the effect of all this, the economic convulsions before, during, and after the Revolutionary war was to ".... seed misperceptions of the fluidity of U.S. society itself" (ibid). But, as we've seen, those who benefitted from this environment of what the Italian economist, Loretta Napoleoni, calls 'rogue economics,' were the people who were already wealthy to start with. What we've been looking at is little more than a relative reorganization of what we today call the top one percent.
It would certainly appear that Balzac called it when he wrote: 'Behind every great fortune lies a crime. The late Mario Puzo used those words to open his 1966 novel, The Godfather. You know, The Godfather? About the Mafia?
Let's have a look at corporate finance!
I want to talk about the leveraged buyout. I am going to try to persuade you that it is piracy, nothing but piracy; it should have been recognized as piracy and should have been disallowed as such in the sphere of corporate finance, because it had already been outlawed as piracy!
The reason you have periods of what is called 'innovation' in corporate finance is because "[f]inding ways to create new value in a sophisticated modern economy is seldom easy. Finding ways to create new value that will produce returns in the amount and with the speed demanded by a predatory financial system many times larger than the productive economy is virtually impossible. The quickest way to make the kind of profit the system demands is to capture and cannibalize existing values from a weaker market player" (Korten, p.207).
The first thing we need is a corporate raider, aka 'investor,' aka PIRATE!
Step one: The corporate raider identifies a company that has a 'break up' value that is in excess of the current market price for its shares. Sometimes the prey can be troubled companies. More often they are not (ibid, p.208).
Since corporations are legal persons in our society, put it this way: What you, the corporate raider, are doing is looking for a corporate 'person' who is, in effect, 'worth more dead than alive,' as it were. Therefore you, said corporate raider, are going to 'kill' it for the 'insurance' payout. Of course you're going to be careful to make it look like an 'accident,' like the market did it..
Step two: Once the target company is identified the raider may create a new 'corporation,' a shell company, actually, to act as a receptacle for the acquired company. Often the receptacle corporation is financed almost entirely with borrowed money and has little or no equity (ibid, p.207).
Every pirate needs his pirate vessel for himself and his crew, with which they will attack their victim.
Step three: The borrowed money is used to quietly buy up the shares of the targeted company, up to the amount allowed by law (ibid).
Step four: The pirate crew, I mean corporate raiders, I mean investors tender an offer to the company's board of directors for the outstanding shares. The offer is above the going market price but below the anticipated breakup value (Korten, p.207).
Step five: If the takeover bid is successful, the acquiring company consolidates the purchased company into itself; and in this way, the very debt is passed to the acquired company, that was used to buy it (ibid, pp.207-208).
By the way, where does the borrowed money come from?
Well, you have your corporate raider, aka, investor -- pirate.
You have the shell company, which will receive the targeted company -- the pirate vessel.
You have the raider's quiet acquisition of shares -- the pirate's pursuit of the targeted company.
You have the raiders open offer for the outstanding shares to the board of directors -- "Prepare to be boarded!"
Just one more thing. Where on Earth does the borrowed money come from? The borrowed money usually comes from banks and investment houses. "During the 1980s," wrote David C. Korten, "some large banks, awash in petrodollars that they were lavishing on indebted Southern countries in the 1970s, sought out that deal makers ((corporate raiding pirates -- Italics mine) with offers of financing at the first rumor that a new takeover strike might be in the offing. Normally, the final financing package involves a combination of bank loans and funds realized from the sale of high-interest bonds -- commonly called 'junk bonds' because they are issued by shell corporations with no assets" (Korten, p.209).
The banks and investment houses financing the raider --- the privateers that financed the old pirates.
With this we have the precise structure of piracy and pattern of victimization that we looked at in the first part of this essay.
But wait! You may be thinking something like this: Come on, wingedcentaur. This talk about corporate piracy is a bit far fetched. I'm not convinced. After all, we're talking about a free market, free will transaction between a buyer and a seller.
To my way of thinking, however, the corporate board, in this situation, is more like an inside collaborator of a heist, rather than a respectable seller of property in a capitalist system. For example, suppose I was the head of a crew of thug bank-robbers, and we came to rob your bank (whoever 'you' may be).
Now suppose a few of your bank employees, unbeknownst to you, have collaborated with our gang. They've given us plans of the inside layout of the bank, told us where the vaults are and given us the combinations, and maybe arranged to have the alarms deactivated or at least delayed somehow, and so on.
Question: Would anyone say that the actions of these inside collaborators, somehow, constitute a collective consensus of the bank's personnel authorizing the heist of the bank?
Answer: Of course not. The idea is preposterous! The inside collaborators work with us, the bank-robbers, because they wish to have a 'cut' of the 'take' from the heist. I can't believe the the board of directors of a targeted company for a leveraged buyout, are not similarly motivated. Call me cynical.
I haven't quite convinced you yet, have I? But wait, there's more!
Mr. Korten wrote: "Through a bit of financial sleight of hand, the acquired company has been purchased by using its own assets to secure loans to buy it" (ibid).
Did you get that part? The corporate raider (aka, investor, aka, pirate) goes to the banks and investment houses (aka, privateers), using a collateral the victim's own assets, to get the privateers to give the raider and his 'commerce-raiding' crew, loans with which to capture and break up the targeted company. This is nothing but conspiracy to commit piracy.
The raider and his crew go to the financial institutions and convince him to finance his predatory operations based on the promise of lots and lots and lots of 'booty' for everyone involved. But let's continue. We're almost done.
The 'new' company (the aquired company consolidated into the shell company of the corporate raider) now has a lot of debt. The new management will pay off this debt by drawing down the cash reserves and pension funds, selling off profitable units for quick cash returns, bargaining down wages, moving production overseas, stripping natural resource holdings, and cut back on maintenance and research expenditures. They will do just about anything to maximize short-term profits at the expense of long-term viability (Korten, p.209).
By the way, I forgot to mention something. The way the 'deal makers' get the banks to participate in these pirate operations, is to offer an unusually high rate of interest to offset the raider's lack of collateral (ibid).
We're almost done. I am relying on data from the early-to-mid 1990s, but by 1995 [when Mr. Korten's book was published] "[n]early 2,000 cases [have] been identified in which the new owners [had] virtually stolen a total of $21 billion of what they declare[d] to be 'excess' funding from company accounts to apply to debt repayment" (ibid).
What we're talking about is elite financial predators using debt as a weapon, a battering ram against good companies and their employees. This goes on all the time. In fact, you may remember the Sara Lee case from a few years ago. A private equity firm -- that's what the organizations, who specialize in this activity are called -- bought Sara Lee; and they were making all kinds of changes to the organization, to, it seems obvious now, pay down the very debt that the private equity firm had taken on to acquire Sara Lee.
The Sara Lee bakers ended up going on strike, if you remember. Now, the lawyer for the labor union gave an interview in which he said, among other things, that the private equity firm had promised their 'investors' (piracy conspirators) a rate of return on their 'investment' that was utterly unreasonable, bearing not the slightest resemblance to reality.
At one point the attorney said that the struggle between the Sara Lee workers and the private equity firm had gotten so ugly, so mean-spirited, so low-down and petty, that the private equity people were working to have the union label removed from the packages of cookies. Its not a bottom line issue, at this point. Its a matter of control....
I saw this case covered on an episode of DemocracyNow! with Amy Goodman and Juan Gonzales. Its a radio, television, and Internet progressive, independent news program. I have been looking for YouTube clips of the show but haven't been able to find any. But perhaps you remember the case, it wasn't so long ago. There are other articles you can read to refresh your memory, if you like. Anyway, moving on.....
Now, we should just note in passing that the Republican Presidential candidate, Mitt Romney used to work for (or was a partner in) Bane Capital, a private equity firm that does the kind of thing we're talking about here. That's why you could have a couple of arch-capitalists like Newt Gingrich and Rick Santorum, attacking Romney for that, in the primaries.
I just want to wind up this hub, quickly with one example of how this kind of financial piracy operation is pulled off, so you can begin to get an idea about the massive transfer of wealth upwards that takes place in the wake of these speculative attacks, in which debt is used as a weapon against "weaker market players."
Now, the objective of the kind of speculative onslaught I've been describing is not always to break up the targeted company. Sometimes all you, the corporate raider, wants to do is clear up the 'debt,' and then re-sell it or 'float' it on the stock market (Chancellor, p.256). Here we go.
Summer of 1983
The case of Gibson Greeting Cards
This story involves a former U.S. Secretary of the Treasury, William Simon. With a partner, Simon bought Gibson with $1 million in equity and $79 million in debt (ibid). I take this to mean that Simon and his partner borrowed seventy-nine million dollars, from somebody, somewhere, to make the purchase -- LEVERAGE is the name of the game, remember, debt used as a weapon!
Simon and his partner did their thing with Gibson Greeting Cards, which, no doubt, involved the cost-cutting, worker layoffs, and asset-stripping we've been discussing.
When they put the company on the stock market, its market capitalization was $290 million. William Simon had put in an initial investment of his own money of $330,000, which became a fortune of over $66 million. Good timing was required. Simon and his partner had bought the company when the market was in a slump. Then they sold it when the interest rates were coming down and the market revived (Chancellor, p.256).
You know, as is often the case when you're writing something, you find that there is so much more you could say, want to say, should have said. But this hub is already far too long, so I shall have mercy on you. If you'll permit me, I would just like to cite one more passage, which I will just quote without comment, and then we will be absolutely done. I promise!
Edward Chancellor, the author of an excellent book, Devil Take the Hindmost: A History of Financial Speculation (1999), wrote: "The boom in leveraged buyouts [or, as I like to call it, financial piracy -- Italics mine] became the driving force behind the bull market of the mid-1980s. Conventional measures of value gave way to LBO valuations known as 'private market value,' which were calculated by examining how much cash ('free cash flow') a company generated and how much debt it could support. Professional 'risk arbitrageurs,' on the look out for the next takeover, became the medium through which private market value was established in the stock market. Acting in unofficial collusion, arbitrageurs searched for vulnerable companies and took large stakes in them, thus putting them 'in play.' Members of the public followed the arbs' operations and imitated them, just as their forebears had followed stock market pools in the 1920s. Because the arbitrageurs and their followers had no loyalty to the company whose shares they owned, their activities made life simpler for corporate raiders. When a bid was publicly announced, the raider's broker need only call round members of the arbitrage club to acquire control of a company. This process, known as a 'street swap' was most dramatically displayed in Robert Campeau's takeover of Allied Stores when, with a single telephone call, a Los Angeles broker named Boyd Jefferies acquired thirty-two million shares, or more than half the shares in circulation, giving Campeau control of the $4 billion company" (Chancellor, p.262).
Okay? Thank you for reading.
Phillips, Kevin. Wealth and Democracy: A Political History of the American Rich. Broadway Books, 2002. pp.9-15.
Korten, David C. When Corporation Rule the World. Kumarian Press, Inc./Berret-Koehler Publications, 1995. pp.207-209.
Chancellor, Edward. Devil Take The Hindmost: A History of Financial Speculation. Farrar, Straus, & Giroux, 1999. pp.256, 262.