Originally published Saturday, April 18, 1998 in The International Herald Tribune
DOUG HENWOOD, editor of the Left Business Observer and author of a new book, “Wall Street,” approaches financial markets from the opposite direction of many analysts, questioning whether much investment capital is really raised on stock exchanges. He spoke recently with Ann Brocklehurst.
Q. You say stock markets advertise themselves as institutions that promote investment and allow businesses to grow when, in fact, that is only a minor part of what they do. How minor?
A. I’d say it’s a very, very small portion of what the market’s all about. Firms fund very little of their investment programs on the markets, especially the stock market. When they do go outside for capital, they go first to banks, then the bond market, and the stock market is at the very bottom of the list. Between 1901 and 1996, net flotations of new stock amounted to just 4 percent of nonfinancial corporations’ capital expenditures in the United States.
Q. So why do companies go public?
A. To an extent, it’s an exit strategy for firms with venture capital. They see it as a way of cashing out, not a way of raising new capital. It’s mostly to let the original set of venture capitalists out with a very substantial profit and to line the pockets of the management team.
Q. But venture funds are investors themselves. Don’t they reinvest?
A. The venture funds do look for other opportunities to invest in, but the amount of venture capital is relatively small. Last year was the record year for venture-capital commitments, and it was $12 billion, so I would say in crucial qualitative terms that the actual amount is much, much smaller than anyone would probably think from a superficial reading of the papers.
Q. What about the idea that companies that are valued highly by the stock market will tend to invest more and, as a result, grow more than less-admired competitors?
A. The stock market and real investment will both tend to rise when interest rates are falling and profits are rising. But if you strip away the effects of things like cash flow or increase in profits or the decline in interest rates, the stock market actually offers no additional explanatory power in statistical terms.
Q. You say that no one on Wall Street cares that orthodox economics does not explain the stock market and why historically it has outperformed other investments. Why?
A. Well, I think for one thing it is easier not to figure out how the two relate to each other. It is very rare that you see serious kind of investigation of how these two systems — the financial and the real — work together, certainly not any investigation of a kind of the sociological role or political role of financial markets of the sort that I am interested in.
Q. Why have so many of the people involved in the stock business — analysts, chartists, economists — performed so poorly?
A. I think it is an impossible job. It is not possible consistently to beat the market. I have a lot of doubts about efficient-market theory as a whole, but I think that insight is 95 percent correct. It has been shown that the more actively managed a portfolio is, the lower its return is likely to be. And I think most newsletters and investment advisers do rather badly. Most professional portfolio managers do a little less well than the market averages, which isn’t surprising, since they are the market, and because fees and commissions shave a bit off their returns.
Q. You are critical of the high salaries people on Wall Street earn. Given their performance records, why do investors support those high salaries?
A. People are not aware of it. It is not palpable. It is not like when you go to the store and see a price tag of how expensive this is. They don’t realize that management fees of 1 percent for a pension fund are making a small group of people very rich.
I think the stock market is very seductive and it charms people into believing they can get rich without having to do a lot of work or save, so they are willing to plunge in and play these games. The brokers and analysts make money this way because people are willing to pay them to get a piece of the action.
Q. This bull market has made a lot of people quite a bit richer.
A. This latest cycle has been a way for the shareholder class to extract immense amounts of money from the productive side. Between dividends and buybacks and takeovers, they are just getting oodles and oodles of money out of the productive sector. From 1984, when the modern era of corporate finance really got going, through the third quarter of 1997, nonfinancial firms borrowed a total of $2.06 trillion, and retired a total of $818 billion in stock. Together, these add to combined outside financing of $1.24 trillion
On the other side of the ledger, firms paid out $1.50 trillion in interest and $1.74 trillion in dividends, for a total outflow of $3.24 trillion. The balance: $2.00 trillion in Wall Street’s favor. The traffic runs mainly from the real side to the financial side and not the other way around, as people generally think.
I think stock markets really need to be thought of more as social organizations of class consolidation rather than conduits of savings and investment as they are usually thought of. The stock market is really about arranging ownership and control, whether we are talking about one corporation buying up another or a small group of rich folks and their portfolio managers exercising control over a country’s economy.
Q. But are stockholders a small group of rich folk? Aren’t they also people with pension funds invested in stocks?
A. Even if you want to include pension assets in wealth distribution figures, it doesn’t change all that much because the majority of pension assets are really claimed by fully upper- and upper-middle income people. Only 40 percent of the U.S. labor force is covered by a pension plan. It reduces the concentration figures somewhat but not all that dramatically.
Q. How do you react to seeing the U.S. model embraced by so much of the rest of the world?
A. There is a lot of amnesia around these things. It was less than 10 years ago that people thought that Japan was taking over the world and the U.S. was washed up. People are forgetting that Japan had a 45-year history of extremely rapid growth of a sort really unprecedented in the history of capitalism.
The same thing is true, although not quite as dramatically, of Germany. I think Europe’s current problems are in a large part the result of the Maastricht criteria, with its punishingly tight fiscal and monetary policies, and a lot of that is quite a conscious desire on the part of the European political and business elite to emulate the U.S. They want to break down all the union structures and the welfare state and all those things that stand in their way. And one of the ways of doing that is to set up a U.S.-style set of financial markets, a U.S.-style labor market. When we talk about the relative success of the U.S. versus other models, we have to define what we mean by success. The people who define success don’t include 20 percent poverty rates as a criteria of failure.
DOUG HENWOOD’S book, “Wall Street” is to be published in May by Verso (hardcover, $25; paperback, $17). Order it from the Left Business Observer’s Web site: http://www.panix.com/~dhenwood/LBO-home.html The monthly publication costs $22 per year for individuals and $55 for institutions in North America; $32 and $65 in other countries. Order at 250 West 85th St., New York, N.Y. 10022-3417; Telephone: 1 212 874 4020; fax: 212 874 3137. Contact Mr. Henwood by e-mail at email@example.com