Last March we expressed concerns about the Fed’s failure to anticipate the subprime mortgage meltdown. As we said at the time:
We don’t expect the Fed to be omniscient. But we can expect it to see and act on the obvious. It failed to react to the looming subprime disaster. Which begs the question: What else is the Fed missing?
We got the answer last week, when the world’s central bankers led by the Fed’s own $62 billion injection, poured hundreds of billions into the global economy following huge reversals on key North American stock markets and the unraveling of portfolios deep into mortgage backed securities.
This is the largest amount central bankers have put out since the terrorist attacks in 2001 and it comes in the wake of major fears for the stability of the world’s economy. The injections are a substantial gift to banking and investment institutions which, by the way, make huge fees from the sale of securities to central bankers. They are also a lifeline to hedge funds and LBO firms, which need billions in low interest loans to complete their deals and where the payout to their partners is astronomical. What is being done for the homeowners who are the real casualties of these events is less immediately clear.
Several months ago Fed chairman Ben S. Bernanke told a committee of the U.S. Congress that he didn’t expect the meltdown would spread to other parts of the economy. It’s a good thing he isn’t in the business of forecasting the weather, or we might be dealing with snowstorms in August. One concern is that these highly unusual moves suggest a larger problem that has not been disclosed to the public and that some players are cleaning up even from the mess they helped to create. The other is that the Fed lacks the foresight to know what is really happening now, just as it did a few months ago.
In too many ways, the primacy of the ordinary individual —as citizen, employee and investor— which has long been the backbone of modern social progress, is being left to disappear amid an onslaught of privileged special interests, civil rights-invading bureaucrats, unwatchful corporate guardians and greedy financial contortionists.
In Canada, it was the no-fly list, which the Harper government created to ban certain individuals from flights inside or leaving the country. In the United States, it was the no-sue list, which directors, executives and corporations now find themselves on courtesy of the Supreme Court’s 8-1 decision raising the bar for shareholders to commence litigation in respect of civil fraud. While they may seem unrelated, these two decisions share a common connection with an unsettling trend in the exercise of corporate and government power.
In too many ways, the primacy of the ordinary individual —as citizen, employee and investor— which has long been the backbone of modern social progress, is being left to disappear amid an onslaught of privileged special interests, civil rights-invading bureaucrats, unwatchful corporate guardians and greedy financial contortionists. We call this the Vanishing Stakeholder. Left unchecked, it is a trend that threatens to undermine the fabric of our society, our prosperity and our freedoms.
The U.S. decision, which was handed down this week, imposes standards that most investors, because they do not have the power to subpoena documents or to interview corporate parties such as directors and executives, can never meet. As a result of the Court’s ruling, investors must show “cogent and compelling” evidence of intent to defraud. Some, including Justice John Paul Stevens who dissented from the decision, believe the standard being set for this kind of civil litigation is as high as, if not higher than, that applied in criminal prosecutions. The decision pleased Bush administration officials and a large platoon of business lobbyists who have been moving toward a general loosening of post-Enron era reforms of the kind found in the Sarbanes-Oxley Act of 2002.
Under the Canadian program, which came into force this week, the government will identify people who pose “an immediate threat to aviation security” and place them on its no-fly list, without due process or prior notice. They might be part of a terrorist group, or, as Senator Ted Kennedy found himself after the U.S. introduced its version, someone with the same name as an embargoed passenger. They will only find out that they are on the list —or that they have been confused with some other person of the same name— just as they are about to board a plane. And the onus rests upon innocent people improperly placed on the list (has there ever been a major government effort that has not been bungled by bureaucratic incompetency or twisted by the vanity of some power drunk official?) to prove their innocence while being interrogated by law enforcement officials at the airport, in a closed room and without legal counsel. We thought that only happened in authoritarian regimes and in George Orwell’s fictional world.
But in the world that is becoming all too real for the treatment of individuals, shareholders are regularly seen as an inconvenience who need to be treated like annoying children instead of the owners of the corporate enterprise which they actually are. Citizens are viewed as suspects and potential lawbreakers in a time when even the library reading habits of young children cannot escape the alarmed and ever watchful gaze of law enforcement officials.
No sensible person wants to make it easier to clog the courts with frivolous lawsuits or for terrorists to plot their evil plans. But there has been a rising tendency of late to allow big corporations and big governments to become even more powerful and to make more difficult the ability of ordinary stakeholders to hold them to account. When that happens, fewer individuals, whether investors, employees or citizens, are inclined to stand up and assert their rights. Many fear the fix is in and that it is impossible to challenge the excesses and abuses of either government or business.
Last month, the U.S. Supreme Court made it more difficult for workers to sue in cases of pay discrimination under Title VII of the Civil Rights Act of 1964. In a 5-4 opinion, the Court held that such lawsuits —which almost invariably involve lower paid women— must be brought within 180 days of the initial alleged discriminatory act, not when the worker discovers it. And finding out what others in a factory or office are paid is not the easiest thing. Workers should not have to become pay stub sleuths in order to ensure that they are being fairly treated.
Ordinary investors, like average workers, are also getting the back of the hand from those in charge. Just look at the number of shareholder resolutions that have failed to win a bare majority in recent months when boards and management have opposed them —even resolutions like say on pay, which would have had only an advisory influence upon compensation committees. As for shareholder lawsuits —frivolous or otherwise— they are hardly an epidemic. Their numbers are considerably down in the years since Sarbanes-Oxley.
An equally disturbing trend is seen in the swallowing up of North American and European business icons by the elusive and expanding private equity whale. The stake that individuals have had as investors, and the benefits that come from being able to witness transparently the use of economic power and how it is wielded, seem now to be regarded by many commentators as only a passing fad in the natural evolution of a more concentrated form of capitalism —concentrated in fewer and richer hands, that is.
The current model of the publicly traded, widely-held, corporation, and its espoused link to the well-being of individuals, developed over a considerable period of time. Symbolized by the huge American flag that drapes the facade of the New York Stock Exchange, the motivating idea was that individuals could be something more than cogs in the wheel of capitalism; they could be the owners of its engines as well. Under this vision of the capital markets system, Wall Street and Main Street were inseparably linked. This idea was taken even further in the aftermath of the attacks of 9/11 with the posting of military personnel around the New York Stock Exchange. An attack on Wall Street was generally considered to be an attack on the financial nerve center of America itself.
Corporate leaders have consistently expressed the view that individuals have a genuine stake in American business —through pensions funds or mutual funds or as direct investors—and that such roles create a level of harmony between what’s good for most folks and what’s good for the modern corporation. As more and more companies begin to be taken over by essentially anonymous actors, or become absorbed by entities controlled by a few multi-billionaires, those interests may be starting to diverge. Indeed, there is some concern now as to exactly what role countries like China, headed by a dictatorial and communist regime, will have as their level of investment and alliance with private pools of corporate gobbling capital expands. Is this in the long-term interests of either democracy or society? Are policy makers and business leaders even pondering these kinds of questions? Again, the role of the individual in these new equations of commerce and capital seems essentially overlooked, if not regarded as entirely disposable.
The trend in this regard is paralleled by another significant phenomenon in the United States: widening economic division as reflected in the fact that the top one percent of households controls more wealth than at any time since 1929. As we have noted previously, it was a gap that ended abruptly –some might say catastrophically– at that time. There is little evidence that those at the top today are giving much thought to the impact of the current trend or exactly how much further it can be permitted to advance before serious damage is done to the social contract that has existed between the class of ordinary individuals and those in the upper tier of power and wealth. The average stakeholder has been just as absent from the cares of the corridors of privilege as he and she has been from participation in the income gains enjoyed in recent years. And, as we have documented repeatedly on these pages, few inside major corporations, much less the wider workforce, have seen anything approach the soaring level of pay advancement or galloping annual increases that CEOs and senior executives have received over the past decade.
Bear Stearns’s $3.2 billion bailout this week of a troubled hedge fund, and the sudden decline in the Dow Jones average as a result, is just one more in a series of telling reminders of how dependent individuals are on the guardians of capitalism and the watchdogs of sound business practice, including the credit rating agencies that seemed to miss the red flags. Recent testimony at the trial of Conrad Black from the high profile directors on Hollinger International’s audit committee, who admitted under oath that they did not read documents put before them, provides a vivid illustration of how boards so often fall short in their duties as stakeholders’ sentries. We would not be surprised to see further disturbing developments over the next several weeks as the world discovers (again) that the hedge fund kings and Wall Street wizards have not entirely rewritten the laws of market physics and may not be quite the extraordinary wonders their publicity departments or their huge fees would suggest.
As the Outrage of the Week prepares to take some time off for the summer, we think it is appropriate to leave on the larger note of concern for what we see as the receding role of the individual in society. We view this trend, where leaders in business and government are a little too quick to trample on a right here or remove a benefit there because it is the expedient or profitable thing to do when it comes to dealing with average stakeholders, as emerging on too many fronts to ignore.
Some of us actually believe that we live in a democracy. We like it that way. We take its freedoms and responsibilities seriously, including the idea of a market economy where individuals ultimately control even the mightiest pools of power. We are mindful of the continuing sacrifices made by men and women in countless battles around the world who have made our freedoms possible. If we wanted a different system, we would be living under any number of regimes that do not share a respectful belief in the role of the individual and who take a dim view of the rights of citizens or investors when they are exercised. The worry is that too many entrusted with power here are apt to forget that under our concept of democratic government and accountable markets, they are answerable to the people, not the other way around.
The Outrage may drop in from time to time, but will otherwise return to its regular weekly slot in early September. In the meantime, we thank our readers —affectionately known as our Outrangers— for your many suggestions for this well-read feature at Finlay ON Governance. We understand it is a frequent topic of conversation around the water cooler and at the kitchen table and has caught the eye of a few tycoons and political shakers on more than one occasion.
We wish them and everyone a safe and pleasant summer. There is much in the use and abuse of power and leadership that properly warrants our indignation. But there is also a good deal in the world around us among families and hard working people and in the wonders of nature that commends itself to our admiration and our gratefulness.
We hope you all have a chance to experience the latter to the fullest over the next several weeks, and that our many readers in the southern hemisphere have an equally pleasant winter.
The Wall Street Journal’s Alan Murray suggested a rather novel idea this week. He argued:
Hedge funds — at least the five percent of them who pursue activist investing strategies — look to me like the saviors of capitalism. They are in the best position to hold CEOs accountable – and someone other than regulators, trial lawyers and left-leaning public pension funds needs to play that role.
I like Alan, but I’m glad he isn’t slugging for the Yankees this week. Because, this time, he really struck out.
An important part of the evolution of modern capitalism has been its wide and dynamic base of stakeholder participation —of share owners as well as consumers. That model has given people a stake in supporting key drivers of the economy along with a sense that they are benefiting from them. It is a system that requires public consent as well as efficiency.
The fact is that too little is known about most hedge funds and how they will affect all the stakeholders who have come to depend upon the modern, transparent corporation. Its often secretive practitioners seem to want to keep it that way. We know a great deal about their economic prowess. Much less is understood about their concepts of responsibility, their vision for the future of capitalism and how they plan to govern. And there is that little thing called derivatives that can see huge fortunes wiped out overnight.
Some hedge funds efforts, like those involving Carl Icahn, have proven mixed in terms of results and rather destabilizing to large groups affected. An occasional shake-up can be good for organizations, especially those run by the smug and self-satisfied. A regular series of earthquakes probably is not.
One can debate whether or not capitalism needs a savior. I am fairly certain, however, that hedge funds are an unlikely candidate for that task. Some might argue that the best way to ensure an efficient and accountable market is to have more and better informed shareholders —and a system of governance that allows investors a meaningful role in exercising the privileges and responsibilities that go with ownership. I distinguish here from the Wal-Mart approach, which seems to regard shareholder involvement and proxy initiatives as some kind of subversive activity requiring extensive background checks, and goodness knows what else, of the proponents.
A century or so ago society was promised a new approach to capitalism which was also supposed to make companies and managers more efficient. It was dominated by a handful of actors on a stage where J.P. Morgan had the leading role. It didn’t end so well, as I recall. Concentrations of power, in the long run and very often sooner, generally produce more suspicion, political outrage and public discontent than widespread improvements in progress and prosperity.
I will be the first to admit that there are serious weaknesses with the way most boards work. Management self interest often saps performance and makes companies far less productive, accountable and responsible than they need to be. Think of recent experiences with Home Depot and Hollinger, for instance. But before we throw out the concept of the widely held, shareholder owned, stakeholder dependent corporation, let’s understand better what we are getting with the inheritors of this tough-minded approach that seems to be the defining hallmark of hedge funds.
It would be unwise to adopt a cure —or a savior— that could prove more costly than the illness.