Inside Job (3 page)

The first is that well-run, successful companies are indeed investing, but not in people, and not at home. CEOs see far better opportunities
in purchasing information
technology systems and in using inexpensive overseas labour.

Large companies such as GE, Boeing, Caterpillar, Ford, and Apple now have, on average, about 60 percent of their sales overseas. (For Intel, it’s 84 percent.) Since the days when Ronald
Reagan was its spokesman, GE has seemed like the quintessential American company. But more than half of GE’s employees, revenues, and assets are on distant shores. The heavy equipment
manufacturer Caterpillar’s foreign revenues are about 68 percent of its total. Its recent major acquisitions and investments include two engine plants, a backhoe plant, and a mining equipment
factory, all in China; an engine plant in Germany, a truck plant in India, and a pump and motor factory in Brazil. Ford, GM, IBM, and almost any other top manufacturing or services company have
much the same profile. Of the $2 trillion in cash sitting on American corporate balance sheets, about $1 trillion is actually parked overseas.
⁷

GE was a pioneer in outsourcing, starting with data-processing services, using low-cost vendors like India. President Obama’s choice of Jeffrey Immelt, the company’s CEO, to head a
new White House economic advisory council in early 2011 came just a few months after Immelt had shut down a string of American lightbulb factories to shift production to China. Like many other
firms, GE has also used its global operations to shield income from taxes, helping it to pay no US corporate income taxes for the last several years despite having billions of dollars per year in
profits.

Over the last decade, moreover, what is still called “outsourcing” has become something else. The shift to overseas purchasing and investment has spread from low-wage,
labour-intensive activities to extremely high-technology, high-skill activities in both manufacturing and services. This development has serious implications for our economic future.

It would probably not surprise many people to learn that most personal computers, laptops, tablets, and smartphones are now manufactured
in Asia, not in Silicon Valley,
California. However, most of those devices are also now
designed
in Asia, and by Asian firms, not American ones. The US retains its high-technology lead in advanced research, systems design,
software, and systems integration, but has largely lost the capability to design and manufacture information-technology hardware. The employment and competitive implications of this development are
profound. For example, Apple has about 70,000 employees worldwide, including its retail stores. But its largest supplier, Foxconn, a Taiwanese company, has
1.3 million
employees. The US has
already become a net importer of high-technology goods, and high technology actually employs a smaller fraction of the total domestic workforce than it does in many other nations.

But canopy-economy executives don’t care about any of that. They see the whole world not only as their market but also as a source of products, services, labour, and components. For them,
the workforce available to nominally “national” companies is much bigger, and much less expensive, than it was ten or twenty years ago. The canopy is a world of calculation: Indian and
Chinese workers have much lower living standards than Americans or Britons or Europeans, so they will work for lower wages. Increasingly, many nations also have broadband systems and logistics
infrastructure (such as ports, airports, and rail systems) superior to those of the US or UK, if not all of the EU. But it doesn’t make sense for CEOs, either personally or professionally, to
lobby for government policies that would improve their national educational or infrastructure systems, particularly if this would also increase their taxes. The benefits of such public investment
are society-wide and long-term, not specific to the elite or their companies. And CEOs and bankers have the money and connections to send their children to expensive private schools, to use private
jets, to invest their assets globally, and to otherwise avoid the problems of economic decline.

But how did the new financial oligarchy get so amazingly rich, particularly during a period of relatively low economic growth and stagnant income for everyone else? Here we come to the second
profound
consequence of the new power structure that rules America and shapes the world.

The full answer involves a series of economic and political processes that began in the 1970s and are the subject of the final part of this book. But in one regard the answer is very clear. With
a few major exceptions—most notably high technology—we can say with great confidence that the principal source of the new canopy elite’s wealth was
not
providing greater
value to society. In fact, a significant fraction of our economic decline can be attributed directly to the entrenched power of American executives who destroyed their own industries. Thanks to
many excellent studies, some of which I describe in this book, we now know beyond any doubt that for most of the last forty years America’s car, steel, mainframe computer, minicomputer, and
telecommunications industries were very incompetently run. Their oblivious and/or self-interested senior management was protected from replacement by complacent boards of directors, lax antitrust
policy, political influence, and outdated, ineffective systems of corporate governance.

And then there’s the financial services industry. What do we think of the quality of management in an industry that not only destroys itself but nearly brings down the world economy with
it? Do we think that these people deserve great wealth for their achievements? And how about their lobbyists, lawyers, and accountants?

In other words, the new elite has obtained much of its extreme wealth not through superior productivity, but mainly via forced transfers from the rest of the world’s population. These
transfers were frequently unethical or sometimes even criminal, and were enormously aided by government policies that reduced taxes on the rich, allowed industrial consolidation through lax
antitrust enforcement, protected inefficient firms, impeded protests from trade unions, kept workers’ wages low, permitted massive financial sector frauds, bailed out the financial sector
when it collapsed, and shielded corporate crime from law enforcement action. Those government policies were, with varying degrees of subtlety, bought and paid for by their beneficiaries.

In this process, one industry stands above all others: the US financial services. In no other industry has the amorality, destructiveness, and greed of the new elite been
so naked. Much of the new wealth of the US financial sector was acquired the old-fashioned way—by stealing it. With each step in the process of deregulation and consolidation, American
finance gradually became a quasi-criminal industry, whose behaviour eventually produced a gigantic global Ponzi scheme—the financial bubble that caused the crisis of 2008. It was, literally,
the crime of the century, one whose effects will continue to plague the world for many years via America’s economic stagnation and Europe’s debt crisis.

The majority of this book is devoted to describing and explaining this pillaging in considerable detail, but a short overview is in order.

ALTHOUGH SEVERAL LARGE
, concentrated, and politically powerful industries have benefited enormously from deregulation and political corruption, the
2000s were undeniably the decade of the banker. The era of deregulation pioneered by the administrations of presidents Ronald Reagan and Bill Clinton had removed virtually all restrictions on
trading, mergers, and industry consolidation; the few remaining restrictions were then quickly stripped away by the administration of George W. Bush, along with any threat of sanctions from either
criminal prosecution or civil suits to recoup illicit gains.

Many steps of the deregulatory process were taken openly, often even proudly, for a majority of academic economists and finance experts were insisting that, once freed from obsolete regulatory
constraints, the bankers would allocate the world’s capital flows with such skill and precision as to usher in a new golden age. Many of the professors doubtless believed in their
recommendations, although as we shall see later, many of them also were paid handsomely to support the
bankers’ positions. Doctors who are on retainer with
pharmaceutical companies may also believe in the products they are pushing, but the money doubtless counts too, and it is wise to be sceptical.

And in fact, bad things started to happen almost immediately. Beginning in the 1980s, the US began to experience financial crises and scandals on a scale not seen since the 1920s. But
deregulation continued, culminating in major laws passed in 1999 and 2000. Once completely freed, the bankers very quickly ran their institutions off the cliff, taking much of the global economy
with them. Not only did they create and sell a huge amount of junk, but they turned the financial system into a gigantic casino, one in which they played mainly with other people’s money.
Consider the position of six large banks at the end of 2007—Citigroup, JPMorgan Chase, Goldman Sachs, Lehman Brothers, Bear Stearns, and Merrill Lynch. Their own proprietary trading accounts,
in which traders and financial executives were risking their banks’—or more properly, their shareholders’ and bondholders’—money for their own profit, were in excess
of $2 trillion. Indeed, their assets had grown by $500 billion in 2007 alone, almost all of it financed with borrowed money.

Leverage—the use of borrowed money to expand the investment banks’ businesses—roughly doubled between 2000 and 2007. Three of the largest banks—Lehman Brothers, Bear
Stearns, and Merrill Lynch—were leveraged at more than thirty to one at year-end 2007. This meant that only 3 percent of their assets, many of which were very risky or even fraudulent, were
paid for with their own money. This
also
meant that a mere 3 percent decline in the value of their assets would wipe out all of their shareholders’ wealth and throw these firms into
bankruptcy. And, indeed, by early 2008 Bear Stearns was within days of bankruptcy and sold itself to JPMorgan; in September, Merrill sold itself to Bank of America, and Lehman Brothers went
bankrupt. Many others failed too—Countrywide, New Century, Washington Mutual—and other even larger institutions, such as Citigroup and AIG, survived
only by virtue
of massive bailouts. Even Goldman Sachs, one of the strongest of the banks, could not have survived if the government had not saved AIG, and then forced AIG to pay its debts to Goldman and other
major banks.

How could so many bankers be so reckless? Money and impunity, is the answer. The structure of personal compensation in the financial system had become completely toxic, and bankers correctly
assumed that they would not be prosecuted, no matter how outrageous their conduct. Until the 1980s a combination of tradition, reputation, and tight regulation governed bankers’ compensation
and prevented major systemic abuses. For example, investment banks were structured as partnerships, with the partners required to invest their own personal money, which constituted the firm’s
entire capital. In fact, until 1971,
only
partnerships were allowed to join the New York Stock Exchange.

But starting in the 1980s, all that began to change, and by the 2000s, both the structure of the financial sector and its compensation practices would have been unrecognizable to a banker of
1975. At every level from individual traders to CEOs to boards of directors to transactions between firms, people and companies were now rewarded immediately (and usually in cash) for producing
short-term profits, with no corresponding penalties for producing subsequent losses. This was fatal. In finance, it is extremely easy to create transactions that are initially profitable, but are
disastrous failures in the longer term. But by the 2000s, the bankers didn’t have to give any money back if that happened, so they didn’t care. In fact, they were
actively
incented
to be destructive—to their customers, to their industry, to the wider economy, even frequently to their own firms.

While the party lasted, it made banking look like paradise. During the bubble of the 2000s, financial sector profits soared to nearly 40 percent of all US corporate profits. The average pay of
people working at US investment banks jumped from about $225,000—already an amazingly high number—to over $375,000, where it has stayed, even after
the crisis. And
that was just the cash; those numbers do not include stock options.

And that’s the
average.
Consider what happened to the pay of “named executive officers”, or NEOs, the highest-paid senior officers (although in any given year, the
hottest traders may make more). According to their 2008 proxy statement, the top five officers at Goldman Sachs averaged $61 million
each
in compensation in 2007. Pay levels like that
disorient moral compasses; so did the private lifts, the private jets, the partners’ private dining rooms and personal chefs, the helicopters, the cocaine, the strip clubs, the prostitutes,
the trophy wives, the mansions, the servants, the White House state dinners, the fawning politicians and charities, and the multimillion-dollar parties. There is no denying that in chasing all
these things, many bankers not only destroyed the world economy but also sabotaged their own institutions and, in some cases, even themselves.

Nor has financial sector compensation changed greatly since the crisis. In 2008, when all banks were gasping for their last breath, the average NEO compensation dropped back only to the 2005
level, and in January 2009, in the depths of the crisis that they had caused, the New York investment banks awarded their employees over $18 billion in cash bonuses.

But the banks are also guilty of two other, even larger, crimes. The first of these is that they used their wealth to acquire and manipulate political power, to their own advantage but to our
enormous, long-term detriment. It was in large measure the financial sector’s political activities (through lobbying, campaign contributions, and revolving-door hiring) that gave us
deregulation, abdication of white-collar law enforcement, tax cuts for the wealthy, huge budget deficits, and other toxic policies.