“Thy money perish with thee, because thou hast thought
that the gift of God may be purchased with money.”
The Big Board’s 508-point market meltdown was investigated by presidential commission, Congress, the SEC, and the major stock exchanges. Each of these bodies concluded that stocks fell because they were already much too high. But the unanimity of these financial Newtons is frightening. By blaming the stock market crash on the law of gravity, each avoided pointing a finger at themselves. And their collective irresponsibility raises the fear of even greater financial chaos, as the global greed machine crashes to a halt.
That’s why Ravi Batra’s prophecy of economic disaster made it to the bestseller lists. Panned by economists, called quackery by the financial establishment, it has still sold like hotcakes. Batra’s dark millenarianism sells because it reflects the growing public suspicion that financial irresponsibility is rampant. The public thinks the economic end is near because its sense of morality has been outraged by a society dedicated to living on nothing a day. (The phrase is Thackeray’s, and it comes from Vanity Fair, where it signifies living on a credit line as big as Uncle Sam’s $500 billion twin deficits. That’s why the public is reading less about Soviet Premier Gorbachev and more on U.S. real estate wheeler-dealer Donald Trump.)
Never have so many owed so much to so few. Widespread debt coexists with an incredible increase in the concentration of wealth. Wall Street Journal chief economist Alfred Malabre targets the concentration of wealth as a root cause of our national wish to live the high life on nothing a day. Twenty percent of the population now controls 44 percent of total personal income, choking aggregate demand and perhaps forcing the U.S. into stagflation first and depression second. Meanwhile, the rest of the population borrows insatiably to keep pace with TV-touted images of the rich and super rich. And opinion polls continue to show that the public wants more government spending, a balanced budget, and no tax increases. No wonder Uncle Sam is a deadbeat!
In 1987 the U.S. got three sharp warnings that its economic imbalances make it highly vulnerable to financial panic. The dollar’s slide, an early interest rate spike, and the stock market crash were all saying that greed must stop and the deficits come down. But politicians failed to seize any of these opportunities for an aggressive assault on the budget overrun. The government has reached a stalemate in its efforts to achieve fiscal stability. Gramm-Rudman never took effect; instead a combination of smoke and mirrors allowed big government to spend as much as it cut. Meanwhile stocks crashed and a Japanese art dealer paid the highest painting price ever—$53.9 million—for Van Gogh’s Irises. The connection between those two economic record breakers is just what has made Batra’s The Great Depression of 1990 a bestseller. No individual and no nation can live on nothing a day forever.
The trouble starts at school, specifically the Harvard Business School, according to J. Paul Mark’s The Empire Builders. This inside exposé tries to do for the B School what ex-Supreme Court nominee Ginsburg attempted for Harvard Law. And if you don’t trust Mark’s account of drugs and sex in the MBA program, keep in mind that this is the book Harvard refused to sell in its own bookstore, giving banned in Boston a new meaning. Lurid prose and sensationalism detract from Mark’s exposé, but they don’t invalidate his point. The faculty cares more about a consulting buck than anything else, while the aim of its consulting is a permanent retainer. The famous case method is exploited for consulting purposes, and students are used as shills in the quest for fees. All they learn is that a fast buck is the fastest way to the top.
With an education like’ that what can you expect? The answer is spelled out in Douglas Frantz’s Levine & Co., a fully documented account of the largest Wall Street insider trading scandal ever. Levine’s was the fall that tripped up big-time financier Ivan Boesky, whose prosecution continues to shake the street. Boesky was wired by the Feds and disclosed insider trading, stock price manipulation, unlawful takeover activity, brokerage firm undercapitalization, false bookkeeping, failure to disclose controlling interests, and hiding stock to cover up a takeover attempt by parking it with cooperative brokers. Boesky “revealed that rampant criminal conduct has permeated the securities industry”—millionaires stole to become hundred millionaires!
In the 70’s only 12 percent of the Harvard Business School graduates went into investment banking. But by the mid-80’s more than a third of the graduating class was entering that field. Mergers and acquisitions were where the biggest action is. For every billion-dollar takeover in the 70’s, five were done deals (as the M&A boys like saying) in the 80’s. Traditionally securities firms make their money on both sides of the street. They charge corporate customers for investment banking, meaning arranging financing for expansion, acquisitions, hostile takeovers, and new issues. And they make commission profits when they sell that financing (as bonds or shares) to investors. But when commission profits dried up as negotiated rates replaced Wall Street’s fixed fees, spawning discount brokerage, investment banking mushroomed.
Traditionally, a so-called Chinese Wall separates the investment banking and brokerage functions of securities firms. Levine, Boesky, and company turned that wall into a leaky dike and eventually bulldozed right through it. To appreciate the passions at work in the insider trading scandal you have to understand just how logically the megabucks operators turned the current financial mania to their own advantage. In a typical insider trading situation involving a takeover, someone who knows about the deal in advance—a corporate insider, investment banker, merger lawyer, securities analyst, legal printer, or cab driver with a good ear—uses what he knows to make a sure buck. That’s done by buying up stock in the takeover target company while it’s still cheap because the deal’s a secret, and then selling it after the price has skyrocketed on the announcement of the takeover.
Since it all begins with a takeover, the first important development is conceptualizing not a simple acquisition, nor even a hostile one, but the possibility that the investment bankers themselves could, in their words, put a company into play. It’s one of the revelations of the story told by Frantz that an ordinary company showing its books to the street because it wants further financing can turn out to be a takeover target months later, when its bankers have sold it down the river to a corporate raider. Levine and company’s first refinement on typical insider trading was to create their own target company. In other words, instead of waiting for a large corporation to swallow another, it saves time if you finance a raider to launch a takeover, and all the better if you’ve already accumulated a substantial holding in the unaware target in advance.
While greenmail payoffs and overvaluing a target company’s assets help, what really swells a raider’s saddlebags are high-risk, big-coupon bonds that promise to return your capital with a single balloon payment at maturity. Investor yen for high yields fuels the raider’s desire for arbitrage profits made on the takeover. And if you want to know who buys junk bonds, just ask those bankers who are so fond of Third World debt—they have to make money somehow! By turning greed into a financing weapon, investment bankers can put their own targets into play and reap arbitrage profits through insider trading in advance.
But that’s not the only innovation which makes the greed machine run so well. Since SEC disclosure requirements mean revealing an investment stake greater than 5 percent, a big position taken in advance could be exposed. Parking is what solves that problem. An investment-bankerbacked arbitrage-style takeover artist doesn’t have to ask his brother-in-law to buy stock for him, though some still do. He uses his connections to have a friendly broker hold his stake in Street name. Since brokers frequently work with large blocks of stock, who’ll notice a few million shares parked temporarily with Jeffries Group Inc., whose chairman pleaded guilty to aiding Boesky in his trading schemes?
Just as junk bonds help the arbs get started in the first place. Wall Street has another new technique for helping turn ill-gotten millions into really serious money. Don’t buy shares—buy calls instead! How can you lose when you know a planned-in-advance takeover will be attempted? The answer is by not winning big enough. And a call is the difference between a winner and a big winner. That’s because a call is an option which grants you the right to purchase stock at a fixed price. Let’s say GM is selling for $80 a share. You think it’s going to $85. So you buy five calls costing $2 each, which allow you to buy five shares of GM for $80 each. The investor selling the calls expects GM to stay at $80 or less. But if GM goes up to $85 each of the calls you bought for $2 will be worth $5 because you can use them to buy something that’s selling for $85 for only $80 each. So you make a $3 profit on each of your five calls.
You paid $10 for them and sold them for $25. That’s a profit of 150 percent. And notice that you can buy a lot of $2 calls for the price of a single share of GM. Options mean big leverage, and the lever is sure to move mountains when you know in advance that many investors are planning on making a lot with a little.
Boesky and the boys had it all rigged. They created the deals they took advantage of using the very games that greed itself has created. More than fixing the race, they stacked the odds and sold themselves the only winning ticket. Why didn’t the SEC get onto Levine until it received an anonymous letter about his Caracas connection? The operation run by Boesky et al. indicts the morality of how the Wall Street game is being played today. Program trading is the newest Big Board sport. And arbs like Boesky, as well as institutional traders and mutual fund managers, are out to win big with it.
You’ve probably heard about the Dow Jones Industrial Average because the Dow is what tells Americans whether the stock market is up or down. The average is no more than a statistical indicator of the state of the market, and you can pick and choose among a handful of other indices that do the same, like the Standard & Poor’s 500, which measures the market by indexing the prices of 500 stocks. These statistical tools were once inviolate, and traders made their money buying and selling the shares of individual companies. That was before the relatively recent arrival of index options. These give investors a chance to bet on the average itself Instead of investing in 100 shares of IBM because you think the company is going to do well, you can buy a call on the S&P 500 index, speculating that the market will rise. That’s the difference between investing and gambling, because the IBM stock conveys a piece of the rock, while the index option must eventually expire.
Now here’s the catch. Since it’s stock prices that move the index, a trader with enough money can influence the index by purchasing or selling million-dollar baskets of the stocks used to compute the index. It’s currently legal to bet on the index and then trade stocks large-scale to make your index bet come true. That’s what program trading is all about; it’s another sophisticated arbitrage scheme designed to reward the appetites of the biggest and the most powerful traders. It makes the tail (or index) wag the dog (or market); which means program trading can cause big swings in stock prices. That volatility can cream small investors and trigger a market collapse—so, restrictions are in store for program trading. But there’s a little talk from regulators about the actual morality of program trading itself, or about junk bonds and other greed machine mechanisms.
But the U.S. Supreme Court didn’t pass the buck on insider trading when it upheld the conviction of R. Foster Winans. Winans is another hustler who was quick to grasp the operating principle of the new greed machine. You can make money by trading on insider information, but you can make a great deal more by creating the information yourself Boesky et al. had the money to generate their own deals. But Winans was only a poor reporter whose homosexual lover needed dental work. So he used his Wall Street Journal stock market column to create the information which only he could trade on in advance. Winans’ boyfriend did the trading, but the game was masterminded by superstar Kidder Peabody stockbroker Peter Brant along with a lawyer pal and another Kidder associate.
Just who seduced whom isn’t very clear in Winans’ own account of his crime, but what’s more important is why the scheme produced more than a million. Since Winans knew what would be puffed in his column, Brant could get his orders in ahead of time. But even then the effect of the Heard on the Street column isn’t a lasting one. To make money Winans needed a market as greedy as he was, one ready to blow up stocks on the slightest shred of media hype. And because the price blips caused by the column weren’t great, Brant wouldn’t have made big bucks without stock option leverage. The market’s own greed helped Brant and Winans make out. And Winans is still pulling the machine’s levers—his own book puffs his own crime to make more money. That’s why the State of New York is after the book’s profits.
The greed machine exposed by too few SEC insider trading prosecutions helped inflate the speculative bubble which burst in the market crash of October ’87. The House addition of antitakeover proposals to its tax bill stuck a pin in the ballooning market. And when most of the antitakeover provisions were killed in conference, the market rallied from its lows. Portfolio insurance, another program-trading-type gimmick, and massive selling by mammoth overinvested mutual funds turned a greedy rout into a full-scale financial panic. That panic may lead us directly to what Ravi Batra calls The Great Depression of 1990 because the stock market crashed from within and without both. Speculation and rampant insider trading corrupted the market from within, and the nation’s oversize twin deficits weighed it from the outside. The September ’87 Federal Reserve discount rate hike, the first since ’84, and a big October rise in the U.S. trade deficit also triggered the crash. When financial irresponsibility becomes a cultural fact of life, the greed machine operates as much in the public sector as the private.
Deep in public consciousness is the lesson of the seven lean years that followed Joseph’s seven good ones. The public knows that rampant greed and endless borrowing cannot continue indefinitely. That’s the truth which Batra confirms. He may be cycle crazy, but it’s our own fiscal irresponsibility which will make his historical determinism come true. In spite of Batra’s economic mysticism, readers of his short book get three important reminders.
First is the message that economic ups and downs are real. How many Americans under 35 would believe that 5,000 people lived in tar-paper shanties in New York’s Central Park in 1933, much less remember what “A Shanty in Old Shanty Town” was about, even if they’d been to Annie? The second message Batra makes plain is that all the king’s men couldn’t help Humpty Dumpty. The Great Depression started less than 60 years ago, and no group of economic advisors could stop it. So much for the safety nets we hear about regularly. The U.S. can’t prop up failed banks forever.
Batra’s third valid conclusion is that the seeds of his predicted depression have been sown. First comes the concentration of wealth resulting from “the richest 5 percent of Americans having more income than the entire bottom 40 percent.” Then “the concentration of wealth . . . increases the number of banks with shaky loans, and fuels the speculative frenzy in which eventually even the banking system is caught. . . . Wealth inequality is a prerequisite for manias and bubbles. The greater the inequality, the bigger the bubble and the more painful its eventual bursting.” Finally, “a depression, in a nutshell, is the result of a financial panic accompanying a recession.” So what will the government do? Here’s Batra’s answer: “This country has never, in all its history, had an inflationary depression. Yet whenever business falters nowadays, the government’s first recourse is to raise the budget deficit and increase the growth of money. We have been addicted to policies of easy money and credit for a long time and are not likely to abandon them in the near future.”
The moral tenor of Batra’s jeremiad can’t be refuted regardless of his data. If we’ve never had an inflationary depression, we also were never before a debtor nation with a budget so far out of balance. All the never befores plus the Third World debt add up to global economic crisis. We live in an economic web that’s no longer of our own making. The dollar affects trade and trade affects inflation and production, both of which are tied to interest rates that bring us back to the budget deficit, and that means big taxes and foreign investment both, which gets us back to the dollar. Start anywhere you like, there’s no way out of the web except harder times. That’s why the subtitle of Alfred Malabre’s Beyond Our Means is “How America’s Long Years of Debt, Deficits, and Reckless Borrowing Now Threaten to Overwhelm Us”!
If you read one book, read this one. Mark, Frantz, and Winans put faces on market greed, while Batra makes clear its connection to the current economic crisis. Recessions are real, they run out of control and become depressions, and greed has taken us far down the path which makes that happen. But Wall Street Journal economist Malabre’s sermon might get us to do something about it. Malabre understands President Reagan’s failed economic gamble. The President believed that tax cuts would create, via deficits, the political pressure to reduce government spending. But the Reagan administration wasn’t able to get the spending cuts it needed to balance the budget while cutting taxes and boosting defense spending. “The President tried to starve government to death, but all it did was get deeper in debt.” Gramm-Rudman was supposed to save us from the deficit, but at the time of the ’87 market crash. Congress was in full flight from its automatic cuts. Instead we acquired a deficit reduction package that spends more than it raises in real money terms. Every tax increase exempts as much as it takes in. Mondale went down on taxes, but Congress can’t close the pork barrel. Caught between a rock and a hard deficit, government can only spend and borrow. The more we do, according to Malabre, the more certain that others will do the trimming for us. And we may not like the result.
Malabre’s short, well-written, and not at all sweet account tells us at once that our tendency to live Beyond Our Means is rooted in debt. “Massively, debt permeates our economy at all levels—personal, corporate, and governmental. There is, unfortunately, no economic prescription to deal in an orderly fashion with the trouble that is emerging from our ingrained tendencies—our determination—to borrow too heavily, to insist on too much pay for too little work, and whenever things don’t turn out, to look to [highly wasteful] Washington for instant relief” But there is a way out: “It’s to spend less, save more, and work harder.” The question is, does the national will to do so exist? Here’s Malabre’s sad answer: “So far, there is little if any evidence that it does.” The depression will do it instead. Money novelist Paul Erdman followed The Crash of ’79 with The Panic of ’89. Reviewing that story in Barron’s, Malabre guessed it would be followed in turn by The Collapse of ’99.
[The Great Depression of 1990, by Ravi Batra (New York: Simon and Schuster) $17.95]
[The Empire Builders: Inside the Harvard Business School, by J. Paul Mark (New York: Wm. Morrow) $19.95]
[Levine & Co.: Wall Street’s Insider Trading Scandal, by Douglas Frantz (New York: Henry Holt) $19.95]
[Trading Secrets: Seduction and Scandal at the Wall Street Journal, by R. Foster Winans (New York: St. Martin’s Press) $17.95]
[Beyond Our Means: How America’s Long Years of Debt, Deficits, and Reckless Borrowing Now Threaten to Overwhelm Us, by Alfred L. Malabre (New York: Random House) $17.95]