Thursday, July 21, 2011

Watching empires collapse

Considering that I am old enough to have seen the Fall of Saigon and the collapse of the Soviet Union, I really should not be surprised to see a tinhorn dictator like Rupert Murdoch crash and burn as has happened recently in UK.  The bad guys always look invincible until suddenly, they are not.

Here RJ Eskow looks at the world's ultimate bad guys--the banksters--and speculates on whether their evil empires may also be in trouble.

Could Wall Street Ever Face a "Murdoch Moment"? Could Its Empire Ever Fall?
by RJ Eskow | July 20, 2011 
History books record an empire's fall as a series of dates and events. Battles are fought, people resist, elections are called, arrest warrants are issued. But those are just details. An empire really falls in that moment when people stop believing that it's invulnerable. Whenever the spell is broken, whether it's by anger or just by awareness, the end becomes inevitable. It doesn't matter what happens to Rupert or James Murdoch now. They may return to positions of relative wealth and privilege or their lives may take unpleasant turns. Either way, the Murdoch empire has already fallen.
There's a lesson here for anyone who thinks the safest and surest path to success is by serving the seemingly invincible. Sure, it may lead to riches and power, at least for a while. But you may also wind up like those powerful people in Great Britain who now find themselves struggling with scandal, hiding in fear, or facing terrible legal consequences - all because they believed in Murdoch's invincibility and served him accordingly. As Martin Luther King often said (and we've often quoted), "The moral arc of the Universe is long, but it bends toward justice."
And since the Universe is our home, the Murdoch scandal reminds us of another principle too: "Never bet against the house."
Betting against the house. That's what those Scotland Yard officials did (if they're guilty) by taking NewsCorp bribes. It's what the current Prime Minister did by softpedaling bribery rumors and hiring a Murdoch editor as his press secretary. ("Hacking crisis edges closer to Cameron," says one headline.) The previous Prime Minister bet against the house, too - and now says he was effectively blackmailed by NewsCorp in a particularly abhorrent way over a sick child. And yet he said nothing.
Politicians and journalists were afraid to cross the invincible Murdoch, and we're told that Wall Street's power is unassailable, too. It seems impossible to imagine our uncrowned heads of finance facing a Murdoch-like fall, especially after the free ride they've enjoyed for the last few years. Despite a well-documented record of fraud, corruption, and abuse, they're all free as birds (birds of prey, that is). Not content with freedom or unearned wealth, they're even outraged that they don't have more of everything - more power, more money, more prestige. Let the Murdoch story remind them: Don't overplay your hand. And don't be too sure that your day of reckoning isn't coming.
Moral compromise can be seen everywhere in Washington, even among people who undoubtedly think of themselves as ethical and upright. From Sheila Bair, outgoing head of the FDIC: "If I heard that once, I heard it a thousand times. 'Citi is systemic, you have to do this.' No analysis, no meaningful discussion. It was very frustrating." (Peter Orszag left his job as the President's budget director to work for Citigroup.) JPMorgan Chase has a long history of corporate misdeeds and malfeasance leading to large financial settlements (the latest was last week), all without criminal prosecution. Yet its CEO continues to complain about Washington's insufficient fealty. (One of his senior executives recently became the President's Chief of Staff.)
We now know that allowing banks to investigate their own misdeeds and avoid prosecution has been Justice Department policy under both President Bush and President Obama. Murdoch's organization was allowed to investigate itself, too, and suddenly a lot of people are paying a price for that decision.
But if Democrats have blurred the line, at least they've also pushed for some modest regulation of the financial industry. Republicans, on the other hand, have established new land speed records for the fastest delivery of cheap-shot takedowns, phony arguments, and obstructionism in the service of cash-bearing Wall Street bigshots. With a few notable exceptions, their only posture toward Wall Street has been that of an obsequious valet who serves an imperious master. You can't protect the nation from a banker's abuses if you're also shining his shoes and adjusting his cummerbund. more
I, for one, hope Eskow is right about how the empire of finance is in trouble.  Considering that finance is largely a confidence game, there is always the possibility that any one of the bankster schemes will be the trigger that brings down the rule of the moneychangers.  On the other hand, they had a spectacular flameout in 2008 and succeeded in getting the taxpayers to clean up their mess.

There is NOTHING new about crooks in finance doing serious structural damage to the real economy.  This dynamic was one of Veblen's favorite subjects and he devoted his second book to it.  Any empire whose crimes are nearly identical to the crimes pulled off over a century ago tends to look pretty invulnerable.
The theory of business enterprise and Veblen's neglected theory of corporation finance
by William T. Ganley
As the twenty-first century began, the neoclassical models of economics and finance appeared to have inadequate explanations for the stagnancy of financial markets. Theorists turned to the historically dependent bubble models to analyze and explain the collapse of the U.S. stock market in 2000 and its stagnation for the next several years. The collapse was accompanied by news of financial fraud, the corruption of accounting standards, pie-in-the-sky profit projections, and the flow of false financial information. The tendency to treat each case as an aberration from standard finance lost much of its appeal. Yet, if we turned back a hundred years to Thorstein Veblen's The Theory of Business Enterprise we would find an interesting and robust analysis of present-day corporation finance.
This paper will start with an overview of Veblen's theory of corporation finance. Next I will survey the reviews of his analysis in the history of economic thought. Then, a comparison of Veblen's model with the Fisherian model, which eventually became the foundation of the neoclassical theory of capital, will be presented. The applicability of Veblen's financial concepts to present-day corporate financial management will be assessed. Finally, the paper will evaluate the potential of Veblen's theory of corporation finance as an alternative to the current standard model.
Veblen's Corporation Finance
Thorstein Veblen's construction of a theory of corporation finance was intended as a major building block in a theoretical explanation of business behavior and the cyclical movement of industrial economies. The theory was developed in The Theory of Business Enterprise ([1904] 1978) and expanded in later works, especially Absentee Ownership ([1923] 1964). His critiques of Irving Fisher's theory of capital and interest supplemented his approach to corporation finance ([1908] 1996, [1909] 1996). In this paper I will concentrate primarily on his original model in Enterprise, where the theory was spelled out in detail. The relevance for today's world of corporate finance was his focus on large-scale, multifaceted businesses, especially those that grew through mergers and acquisitions.
According to Veblen the giant corporations of the late nineteenth and early twentieth centuries were not primarily interested in profit maximization through the production and sale of products. The primary goal of the corporate managers of such companies was to maximize the value of their common stock. Veblen put corporation finance as the centerpiece of his analysis of large, acquisition-minded companies. In Veblen's analysis, the corporate finance structure was capitalized on the earnings capacity of the corporation as a going concern ([1904] 1978, 137). The capital of the company included not only its material capital but also its immaterial or intangible capital, measured by goodwill. This was one of the criticisms Veblen made about Fisher's theory of capital. He argued that Fisher erroneously excluded immaterial capital from his definition of capital (Veblen [1908] 1996, 154).
Veblen believed economics had to follow the actual practices of business in order to construct a theory of economic activity. Businessmen knew what capital was, and their usage of the term should guide economists (Veblen [1904] 1978, 151). Immaterial capital was as important as physical capital in business decision making. Business often treated intangible assets, or immaterial capital, as goodwill. Goodwill could often be identified with very specific corporate property, such as patents, trademarks, brand names, or exclusive use of special processes protected by law. However, it also included established business relations, reputation for business transactions, and processes protected by secrecy (Veblen [1904] 1978, 138-139). A more general sense of goodwill could go far beyond these matters to include almost any potential for growth the firm could create for itself as a business entity. In the end, for Veblen "the substantial foundation of the industrial corporation is its immaterial assets" ([1904] 1978, 143).
Corporate management had to make sure the "putative earnings" of a company were valued as highly as possible by the securities market. This was to be the case even if there was a substantial discrepancy between the putative earnings capacity and actual earnings. What is now called expected future earnings was the foundation of Veblen's theory of corporation finance. The ability to manipulate perceptions in the stock market was the essence of this management: 
It follows ... that under these circumstances the men who have the management of such an industrial enterprise, capitalized and quotable on the market, will be able to induce the putative and actual earning-capacity, by expedients well known and approved for the purpose, partial information, as well as misinformation, sagaciously given out at a critical juncture, will go far toward producing a favorable temporary discrepancy of this kind, and so enabling the managers to buy and sell securities of the concern with advantage to themselves. (Veblen [1904] 1978, 156-157) 
There was no reason to believe the interest of corporate managers and the permanent interest of the corporation would coincide. Clearly, in Veblen's view, the management self-interest and the broader community interests in efficiently produced output would seldom coincide. The business interest of managers demanded the manipulation of the stock price of the company, not the production and sale of products ([1904] 1978, 159). Stock prices would be pushed up or down by effective management. These manipulations of the value of stock carried a risk to the company but little risk to the managers. Veblen commented that managers had less to risk because they held limited shares of stock (167). From his perspective, such market manipulation was not necessarily difficult: 
Indeed, as near as one may confidently hold an opinion on so dark a question, the certainty of gain, though perhaps not the relative amount of it, seems rather more assured in the large-scale manipulation of vendible capital than in business management with a view to a vendible product. ([1904] 1978, 166) 
The role of investment banking in corporation finance drew special attention from Veblen; he claimed that successful investment bankers had their own unique form of "goodwill," even though it was difficult to quantify ([1904] 1978, 171). J. P. Morgan and Company was the prototype in investment banking, "and more unequivocally, the good-will of the head of that firm" (172). Veblen extended this notion of the goodwill of a captain of finance to a captain of industry like Andrew Carnegie in the steel industry. For Veblen this type of goodwill could be used over and over again and was spiritual in nature: 
But goodwill on this higher level of business enterprise has a certain inexhaustibility so that its use and capitalization in one corporation need not, and indeed does not, hinder or diminish the "extent to which it may be used and capitalized in any other corporation.... Like other good-will ... it is of a spiritual nature, such that, by virtue of the ubiquity proper to spiritual bodies. ([1904] 1978, 173) more

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