Copyright © 2002 by Jeff Gates|
Draft of Nov. 30, 2002
How Wall Street Racketeering Continues to Wreck Baby-Boomer Retirement
by Jeff Gates © As through this world I travel, I meet lots of funny men,
Some rob you with a six-gun, some with a fountain pen.
-- Woody Guthrie
I cut my political teeth as counsel to the U.S. Senate Committee on Finance at the height of Reaganomics. Hired to craft federal law on pensions, 401(k) plans and the like, Louisiana Democrat Russell Long was my boss. Long chaired the committee when I began work in 1980, a post hed held since the Great Society era of Lyndon Johnson who once famously remarked that only three people were needed to get things done in Washington: the president, the chairman of the Finance Committee and a messenger. Elected along with Johnson in 1948, Longs political success was assured as the namesake son of the Bayou States legendary populist Governor and Senator Huey "Share Our Wealth" Long, a widely popular Depression-era presidential contender before his assassination in 1935, when Russell was sixteen.
My duties included the design of tax incentives for employee benefit plans that hold roughly 60 percent of the money now managed on Wall Street. At $110 billion per year in tax incentives, the subsidies provided for retirement security now rank second only to national security as a fiscal commitment. When I joined Senate staff in 1980, money managers oversaw $1.9 trillion. By 2000, they managed $17 trillion, the bulk of that due to fiscal subsidies crafted by the Finance Committee.
With an institutional memory for tax policy that dates back to Harry Truman, Long assured me that pension plans first became popular during World War II when Franklin Roosevelt enacted a 90 percent excess-profits tax. Because employee benefits could be funded before taxable profits were figured, managers promptly set money aside for themselves, taking the funds directly out of otherwise taxable profits. When organized labor heard about it, the bargaining began in earnest for their share of tax favors, setting off a dramatic transformation in the nature of U.S.-style capitalism.
As I will show, those hired to oversee these tax-subsidized funds have allowed them to be ransacked by Wall Street and the well-to-do. As yet, no lawmaker dares concede the full extent of the plunder, even though the largest asset collapse since Herbert Hoover has shattered retirees prospects and worsened a fast-emerging fiscal nightmare. Hastily enacted reforms mask Congress key role in the rip-off as lawmakers rushed to embrace innocuous new rules for accountants and ineffective changes in corporate governance while scolding Wall Street analysts who have long misled investors with corrupt research and ratings.
The greatest danger lies in the pretense that a few bad apples are the source of the heist. Or that a few rule changes are all thats required to correct a system certain to plunder pension plans in the exact same way. None of the reforms either enacted or proposed will help those cheated recover pilfered funds. Even with the hastily embraced reforms, retiree plans will continue to be raided by senior execs who have already skimmed a half trillion dollars.(1) With or without Wall Streets hype, retirees will continue to see their savings decimated by an investment model that, by 2000, had put $1.54 trillion in the hands of just 400 people. The immensity of the funds at stake explains why the scale of the swindle dwarfs any previous crime.
Reform will be meaningful only when those responsible for this plunder are prosecuted, the pilfered funds recovered, and the model reformed. Anything less only confirms Washingtons complicity in historys greatest heist, even as the thieves remain at large and the pace of the plunder is poised to quicken.
Over the next five years, tax incentives for employee plans will drain $553 billion from revenues the Treasury would otherwise collect.(2) Federal law requires that this capital be invested for the "exclusive benefit" of retirees and "solely for the purpose" of financing retiree benefits. Despite a mandate meant to catalyze a new type of fiduciary capitalism, pension trustees opted instead for an investment model that obsesses on short-term financial returns with no concern for who harvests the long-term financial benefits, a practice that remains unreformed in todays post-reform world.
In 1982, Business Week chronicled a 42:1 pay gap between chief execs and employees in the 365 largest firms that account for the bulk of pension assets, a divide already twice the maximum disparity advised by management guru Peter Drucker and even by J.P. Morgan, no stranger to greed. Both insist that 20:1 is the widest workable gap between managers and managed. Pension trustees figured otherwise. By 2000, their investments had converted that gap to a 531:1 chasm. In a bad year, the nations 20 top-paid managers claimed an average $117.6 million, up $5 million from 1999.(3)
In 1975, when a comprehensive federal pension reform bill was signed into law and these tax-favored funds began to swell (pension plan assets then totaled less than $800 billion), General Electric paid its CEO $500,000, an annual salary then equal to the combined earnings of two dozen typical Americans. By 2000, GE was paying Jack Welch more than 3,000 times that benchmark amount, even while GE was being financed largely with retirees tax-subsidized savings. While median family income grew 10 percent since 1970, Welchs pay multiplied 289 times, to $144.5 million.
In retirement, Welch not only received a larger book advance than the pope, he also received a raja-like retirement package to supplement the $900 million he accumulated as CEO. In addition to a $750,000 per month pension, he receives another $2 million per year of in-kind benefits, including use of a condo overlooking New Yorks Central Park (estimated cost: $80,000 per month), lifetime use of GEs Boeing 737, V.I.P. seats for the Metropolitan opera, front-row seating at Wimbledon, courtside seats at the U.S. Open, floor-level seats at the New York Knicks, box seats at Red Sox and Yankee games, fees at his four country clubs, satellite TV, computers and security services at his four homes, limousine service while travelling, plus all the amenities while using the Manhattan condo, including maid service, wine, food, flowers, toiletries and a half-dozen daily newspapers.
GE is hardly unique. At Disney, pension fiduciaries allowed CEO Michael Eisner to pocket a three-year, $637 million pay package, 21,233 times Disneys typical W-2. When Hollywood super-agent Michael Ovitz bolted after just 14 months on the job, Eisner eased his pain with $94 million in cash and stock options, all the while paying women in Bangladesh five cents for every $17.99 Disney shirt they sew. The compensation committee of Disneys board then included Eisners personal attorney, the principal of his kids school and an actor under contract to Miramax, a Disney studio.
At Oracle, another pension-fund favorite, CEO Larry Ellison cashed-in expiring options September 7, 2001 for a $706 million gain. Pension trustees apparently thought that a much-needed incentive in a company where he held only $22 billion in shares after pocketing a $681 million gain two years earlier.(4) By comparison, the Red Cross collected a record $129 million in the first eight days after September 11, 2001. In financial-services firms, a popular pension plan asset, CEOs pulled down 12,444 percent more pay in 2000 than in 1990. After raiding Travelers Insurance Group for several hundred million, CEO Sanford Weill saw his personal portfolio jump $248 million the day Travelers merged with Citicorp. The typical Citigroup teller would need to work 16,067 years to match Weills $482 million compensation from 1998 to 2000.
Academics have long argued that executive pay should be tied to the employers stock price as a way to align the interests of managers and shareholders. Great theory, except it assumes that managers and shareholders negotiate at arms length, a notion that only the ivy-towered would dare suggest. The theorists also assume that managers pay is fully disclosed rather than vaguely described in obscure footnotes, where stock option costs remain in this post-reform world. Ciscos reported profit of $1.35 billion in 1998 would have been a $4.9 billion loss except that Cisco execs treated Ciscos stock options as cost-free.(5)
Management theorists also assume that CEOs are overseen by vigilant boards of directors when, in reality, directors have long been picked and paid by those theyre hired to oversee. Plus board members are routinely compensated in stock and stock options, merging the interests of overseer and overseen while motivating both to bend the rules to boost the stock price. Throughout the booming 80s and 90s, CEOs often chaired the board and appointed the boards three key oversight committees: the nominating committee (picking managers and directors), the compensation committee (paying managers and directors) and the audit committee (overseeing managers and directors). Many execs have dropped even the pretense that their pay bears any relation to performance, confirmed by a USA Today report on large-company pay practices where CEO pay-hikes averaged 24 percent for 2001 while share prices sank 13 percent.
In The Bigger they Come, the Harder They Fall, Boston-based United for a Fair Economy chronicles the financial performance of the nations ten top-paid execs from 1993 through 1999. For anyone who invested $1,000 in 1993 in each of those firms, by 2000 their ten grand was worth $3,585. Much of that value vanished into the long since diversified brokerage accounts of the nations most skillful skimmers. Labeling them the "bankruptcy barons," The Financial Times reports that top execs of the 25 recent largest corporate failures pocketed $3.3 billion before stiffing their shareholders and creditors.(6)
Tax policy plays a key role in the plunder because the tax subsidies allowed retirement plans must be invested somewhere. Both employers and employees can claim tax deductions for funds put aside for retirement and those funds are allowed to grow tax-free, but that money needs to be invested. That makes pension plans a handy market for managers to sell their shares when they exercise their options. Enron is hardly unique, where execs sold their optioned shares to Enrons 401(k) plan. In effect, tax policy both bids up and holds up share prices with $110 billion per year in tax subsidies that are always on the lookout for investments. By comparison, Washington commits $10 billion annually for foreign aid, $8 billion for the Environmental Protection Agency and $1 billion to the Centers for Disease Control.
As financial markets tumbled, several titans in the financial-services industry felt obliged to demonstrate their social solidarity. At Citigroup, "Sandy" Weill proudly announced his intent to pay himself a threadbare $36.1 million for 2001 ($694,231 per week). Thats after collecting a $215 million pay package in 2000 ($4.1 million per week), topping off his decade-long skimming at $1 billion.(7) Likewise, Goldman Sachs CEO Henry Paulson, with a personal net worth of $280 million, agreed to a 15% pay cut for 2001, taking home just $18.9 million ($363,462 per week). Meanwhile, relying on investment advice offered by their firms, the plunder of pension plans proceeds.
Looking back, one can only wonder when pension trustee complacency became outright Wall Street complicity. In April 1999, Aetna acquired U.S. Healthcare and a single employee, CEO Leonard Abramson, was given $900 million in cash and stock plus a $25 million Gulfstream jet along with $2 million a year in operating expenses. Six months later, Sprint employee William Esrey was granted a golden parachute that netted him $470 million when he was pushed out as CEO of Sprint. One can only wonder which cabal of decision-makers agreed to grant employee Eckhard Pfeiffer $410 million in stock options plus $9.8 million in severance when he was forced out as CEO at Compaq in 1999 due to his sub-par performance.
Pension guardians and their Wall Street gurus were on hand when boards of directors nationwide became 60 percent staffed by CEOs, fueling a rapid racheting-up of top-tier pay in a mutual back-scratching that consultants were happy to cover-up as comparable pay as CEOs set each others compensation, each pretending to be independent of the other. That remains standard practice in todays post-reform world where the invisible hand has been displaced by the invisible handshake.
Reflecting on his term as an independent director at United Wisconsin Services, Marquette University professor Tom Bausch seethes when recalling the boards reaction to a senior manager who declined an over-sized pay raise okayed by pay consultants Hewitt Associates. On hearing the CEO protest that the compensation committees proposal was out of line by any measure, "the other CEOs on the board," Bausch recalls, "went catatonic at this anti-free enterprise response of the CEO of the company. After all, if this disease escaped the boundaries of our company, think of the damage that could be done."(8)
Mutual funds played a key role in the cover-up as their holdings skyrocketed to $7.8 trillion, up from $135 billion in just two decades. In 2000, over half of Fidelitys $9.8 billion in revenues came from employee-benefit services it provides to 11,000 firms, making it unlikely that Fidelity would oppose execs who retain their services. At Computer Associates, a Long Island software firm, world-class overseers were on hand to sanction the skimming when three execs were granted 20 million shares valued at $1.1 billion. Director Alfonse DAmato, a former U.S. Senator from New York, previously chaired the Senate Banking Committee, while board member Richard Grasso currently chairs the New York Stock Exchange. Brazen boardroom complicity continued in 2001 when more than half the nations top 200 CEOs were given option grants valued at more than $50 million.(9) Contrary to CEO lore, these mega-grants are not a sign of execs faith in the company, theyre a sign of boardroom-facilitated thievery from shareholders and retirees.
These modern-day marauders bring world-class financial expertise to the art of the heist.. At Oracle, Ellison out-sourced much of the firms compensation costs, relying on capital markets -- composed largely of pension money -- to pay employees with options on their overvalued Oracle shares rather than coughing up more costly cash and thereby reducing the reported earnings that boosted the value of his own lavish cash-outs.
Meanwhile, by politically squashing honest stock-option accounting with a lavishly-funded lobbying campaign, the Big Five accounting firms duped investors into believing that New Economy firms were virtually devoid of salary expense. Because the survival of those firms typically relied on periodic infusions of fresh cash, largely to pay salaries, the bean-counters could have issued qualified opinions to caution investors. But then that warning would have revealed the fudged figures that inflated the stock market bubble that, in turn, enriched their clients and the investment banking firms whose analysts lured the pension funds required to inflate the bubble.
The impact of that faulty disclosure was heightened by option-holding execs who routinely directed their firms to repurchase company shares and retire them, thereby reducing the number of outstanding shares and triggering a short-term boost in earnings per share even if earnings didnt rise. Relying on company-secured loans to fund those stock buybacks means that Disney and other firms now struggle under heavy debt loads, reducing share value for other investors. Given the many ingenious ways that stock options can be abused, Paul Volcker, former chair of the Federal Reserve, announced his opposition to options of any sort. As he knows, even the timing of stock options was routinely abused. Research confirms that companies with good news to report tend to award options just before releasing their quarterly reports, while those anticipating bad news tend to delay option grants until afterwards. In either case, execs are positioned to get the best possible deal, relying on a slick variant of insider trading that has yet to attract a legal challenge.(10)
At dozens of firms whose stock prices plummeted, execs pocketed personal fortunes by cashing out while Wall Street analysts maintained their upbeat ratings for other investors. Jack Grubman, Citigroups fabled telecom shill, advised investors to sell only after Worldcoms shares had fallen from $60 a share to $1. Throughout, tax-subsidized retiree plans remained the largest single market for the shares of telecom, high-tech and dot-com firms, serving as the most reliable source of funds to drive share prices up, and then just as reliably purchasing those shares as insiders bailed out and share prices swooned.
That includes Oracle as its stock soared and Ellison cashed-in. Now other shareholders are crying foul, including Local 144 Nursing Home Pension Fund, claiming that Ellison, number five on the Forbes 400 list, rigged his 1999 windfall by fudging Oracles figures before pocketing his $681 million gain, only then publishing less optimistic projections, causing the shares to drop 21 percent. Billions more were vaporized in overpriced mergers and acquisitions that led to massive write-downs, including $54.2 billion at AOL Time-Warner, the largest ever. By comparison, the FBI reports that, from 1998-2001, bank robbers in the U.S. made off with only $210 million.
In 2000, before Ciscos shares tanked, top execs cashed in options worth $308 million, including $157.3 million by CEO John Chambers, on top of a $122 million gain in 1999. Extolling Ciscos sizzling finances, The Wall Street Journal assured its readers that Chambers deserved every cent. After all, Ciscos stock jumped 91 percent in 1999, leading Worth magazine to rate him Americas top CEO. Now that Cisco has shredded more than $400 billion in market value, the Journal argues that Chambers deserves to share none of the financial pain because he cant be held responsible for "market forces beyond his control" -- the same forces that enabled him to pocket 8,653 times the $8.74 an hour he pays those who clean his office.
Those who challenge the critics of executive pay claim their ire is provoked by envy or by egalitarian yearnings. In truth, the issue is far simpler: how much value should an employee &endash; any employee -- be allowed to strip out of a company in which people have invested their retirement savings and in which the public has invested immense fiscal resources meant to provide broad-based security in retirement? That public investment magnifies the financial carnage because those fiscal subsidies forced taxpayers to forego an opportunity to invest those resources elsewhere &endash; in education, health care, etc.
Federal law remains clear: these fiscal resources are meant "solely for the purpose" of funding future benefits for a broad base of Americans. Instead, as the financial influence of pension trustees grew, so did the fortunes of corporate insiders and those already most well-to-do. In 1982, when Forbes magazine published its first list of Americas 400 wealthiest families, the threshold for inclusion was a personal net worth of $91 million. In 2000, that would have been $161 million, but by that time the cut-off point had risen to $725 million. Forbes reports that in 2000 the U.S. was home to 274 billionaires, up from 13 just since 1982.(11) The wealth of the Forbes 400 richest Americans grew, on average, $1.44 billion each from 1998-2000, for a daily increase of $1,920,000 or $240,000 per eight-hour day, 46,602 times the minimum wage.(12) By 2001, these trustee-favored few had amassed $1,540,000,000,000 ($1.54 trillion). The half trillion-plus skimmed by senior execs moved many of them to within shouting distance of those on the top.
Even these trends barely scratch the surface because funds set aside for retirement are only relevant when paid. Thats why these high-paid money managers routinely strut their stuff as "futurists" because federal law requires when overseeing these funds that trustees take into account the impact on the economy decades hence when paid-in funds are drawn down for retirement. Instead, by opting for Wall Streets traditional rich-get-richer investment model, their oversight funded a future thats both fiscally perilous and politically plutocratic.
For instance, with steady backing from pension fiduciaries, one family alone -- the five heirs of Wal-Mart founder Sam Walton &endash; amassed $100 billion. While its obvious this mega-retailer generated two full decades of alluring returns, its equally obvious that these trustee-futurists are obliged to consider a far broader picture. Wal-Mart operates approximately 3,300 outlets in the U.S. with 2001 sales just shy of $220 billion, up from $1 billion since 1979. For the first time in history, a retailer tops the Fortune 500 ranking of firms by annual revenues, crowding out Exxon Mobil, General Motors and GE.
In other words, those entrusted with baby-boomers financial future elected to commit retirees savings to a build-out where six cents of every dollar in retail spending nationwide builds more capital for a family who already have more wealth than the richest robber barons of the Gilded Age. Meanwhile, retirees are already in such poor shape that Medicare will almost certainly be expanded to cover prescription drugs for seniors. Many of those prescriptions will be filled at Wal-Marts 2,500-plus pharmacies, ensuring that any fiscal subsidy offered todays seniors will worsen a fast-emerging fiscal disaster for tomorrows seniors.
Pension trustees, advised by the financial-services industry, beguiled an entire generation, attuning their investment strategy not to their fiduciary mandate but to Wall Streets seductive sales pitch: "Maximize financial returns and, trust us, everything else will work out fine." If only the future theyre obliged to finance were so formulistic. By choosing to rely on that reductionist model, trustees ensured that retirees now find themselves imbedded in a demographic bubble of 76 million people, aged 39 to 57, barreling toward retirement with inadequate assets to sustain themselves in what is poised to be quite lengthy retirements.
With their savings used to chase dynamite returns and dysfunctional results, baby-boomers have every right to be outraged. In addition to coping with the lousiest health-care system and the lowest life-expectancy of any major developed country, Americans labor 184 hours longer each year than in 1970. Thats an additional 4-1/2 weeks on the job for roughly ten percent more pay, much of which they plowed into retirement plans that were invested to fund a rich-get-richer future.(13) Their need for financial support in retirement is certain to worsen the nations fast-deteriorating fiscal condition while the inflation-fueling pressure of those demands is likely to endanger the financial security of everyone living on fixed incomes, both public and private pensioners.
The full implications of this fiscal train wreck remain just over the financial and political horizon, obscured from view by the pundits and the panderers of Wall Streets returns-myopic model. Social Security, already the largest tax paid by 80% of Americans (90% of GenX), is destined to become the sole pension for a majority of baby-boomers. Thus, after two decades of money-managers attuning their decisions to that simplistic model, the largest pension for most Americans remains the same as before: an assurance that their retirement security depends on the continued willingness of others to pay a job-tax. Meanwhile, the largest tax hike of the past two decades was enacted in 1983 after an Alan Greenspan-chaired presidential commission persuaded Congress to raise the Social Security payroll tax, ensuring that a hugely regressive "flat tax" -- 15.3 percent on the first $80,400 of income &endash; is now the largest levy most families pay.
The last time wealth and income were this concentrated, an upstart presidential candidate emerged on the political scene &endash; Louisiana populist Huey Long. The appeal of his redistributive Share Our Wealth program was confirmed in early 1935 by the nations first-ever scientific political poll conducted by Big Tom Farley, head of the Democratic Party and FDRs postmaster general.(14) The results of his postcard poll found that Longs populist appeal not only resonated nationwide, his candidacy would throw the 1936 election to the Republicans, including New York, Roosevelts home state. Soon after the poll results were compiled, this Hyde Park patrician decided to endorse Social Security, then considered a radically socialist notion. In retrospect, instead of Share Our Wealth, America settled for Tax Our Paychecks. The massive tax subsidies since directed at private pensions were meant to supplement that public safety net for seniors. Instead, theyve become a Reverse Robin Hood, radically redistributing wealth to the well-to-do.
Whats not yet clear is when those most imperiled by this multi-decade heist will fully grasp the all-encompassing extent of the looting. After several decades of attuning public policy to Wall Streets narrow bandwidth of values, even local radio stations, one of the core building blocks of democracy, have been converted from community-anchored assets into capital-market assets as federal rules against media concentration were gradually relaxed. As locale-attuned radio stations morphed into abstract financial holdings, broadcasting was rapidly consolidated, along with the diversity of on-the-air opinions. A single firm, Clear Channel, now controls programming on 1,200 radio stations, one-tenth of all broadcasting nationwide, ranking first in five of the top-10 markets and second in four others. Standardized play-lists are now paired with neoliberal political commentary by HardRight icon Rush Limbaugh, dominating drive-time eardrums and crowding out other perspectives like nothing ever experienced in American politics.
The financial implications of this heist are staggering as boomers retirement needs will emerge on the fiscal horizon just as available budget resources are either receding or exhausted. In large part, thats because a policy of fiscal crowding-out lies at the heart of the GOPs long-term political strategy. That little-known agenda was forced into the open in the 1980s when Reagan-Bush Budget Director Dave Stockman, now a Citigroup investment banker, confessed that his "rosy scenario" budget projections were "absolutely doctored" and crafted solely to rally support for supply-side tax cuts by understating their fiscal impact so that the GOP could shrink the size of government by eroding its financial capacity.
When I joined Senate Finance Committee staff in mid-1980, the total federal debt was $909 billion. During my first year as counsel, with Bob Dole presiding, the Committee approved a $872 billion supply-side tax cut, every cent of it deficit-financed. By the time Reagan and Bush vacated the White House, the federal debt topped $4200 billion. Crowding-out slowed only slightly under Clinton-Gore as they added another trillion-plus to the debt while embracing another rich-get-richer supply-side tax cut with a $268 billion fiscal tab, again 100-percent deficit-financed. Government debt is projected to top $6850 billion during 2003. While taxpayers got the mortgage, the usual few got the house as, from 1982 to 1999, the nations 30 largest fortunes grew more than ten times larger.
The impact of crowding-out is remarkably wide-ranging, its perverse success unexpectedly boosted when government budget forecasters conceded deficits of more than $165 billion for 2002, a dramatic reversal from the $165 billion surplus projected for 2001.(15) That one-year budget swing of $330 billion, the largest in history, heralds a fiscal future certain to further cripple the public sectors capacity to provide oversight, services or financial assistance, a key goal of the market fundamentalists.
For instance, citing fiscal pressure, IRS audits of high-income taxpayers declined by two-thirds since 1995, reaching in 2001 a record-low one in 142 tax returns for those making $100,000 or more. Instead, the audit rate rose on those in the lowest income bracket because, with todays fast-widening economic divide, the earned income tax credit is so widely claimed that the five-year fiscal cost is projected to top $178 billion.(16) Fearful the poor may abuse their subsidy, more than half those audited in 2001 had claimed the low-income credit.
As regulatory oversight was starved of funds or politically intimidated, the SEC became so understaffed that in 2001 it played financial watchdog to a record-low 16 percent of corporate filings. After appointing an accounting industry lapdog to lead the SEC, the GOP failed in its attempt to eliminate 57 corporate oversight positions at a time when stock exchange trading volume had ballooned nearly six-fold since 1993, up 100-fold since 1972. State pension systems lost $3 billion in Enron alone, a cost of crowding-out that states will need to recoup from their fast-shrinking tax revenues as 48 or the 50 states report budget shortfalls. Unfunded liabilities for public-sector pension plans leapt from $50 billion in 2000 to $94 billion for 2001.(17) The shortfall for 2002 could be twice that.
Happily, its impossible for supporters of this crowding-out strategy to hide. Pension trustees have long been powerful political players, typically wielding their influence behind the scenes, their views conveyed instead by those who thrive on their fees, a key reason that money managers and stock brokers now account for 71 of the nations top 400 political contributors.(18) Of the top-ten zip codes for campaign contributors, five run up the posh East Side of Manhattan, home to the nations money-management and media elite. One fifth of the 275,000 households worth more than $10 million live in the New York area, center of the campaign-finance universe.
As TomPaine.com columnist Mike Ryan points out, New York police and firefighters died while drawing annual salaries less than Manhattan investment bankers pay to rent a house in the Hamptons for the flag-waving Fourth of July weekend. While we dont yet know the full extent of the losses suffered by public-employee pension plans, this much we do know: todays rich-get-richer investment model grew steadily more dominant as tax-subsidized money-management fees found their way from Washington to Wall Street before wending their way back into Washingtons campaign-finance coffers.
During his first 19 months in office, Bill Clinton raised a record-breaking $39 million. During his first 19 months, George W. Bushs fundraising topped $100 million while taking off four months following the 9/11 terrorist attack.(19) Thats just the tip of the influence-peddling iceberg. Politically sophisticated organizations routinely spend ten times as much on lobbying as on direct campaign contributions, plus tens of millions more bankrolling think tanks and issue-specific advocacy groups, much of that cost tax-deductible.(20)
The rapid ascendancy of the market-fundamentalist model is directly traceable to the rise of HardRight think tanks, such as the Heritage Foundation, in which the well-heeled were eager to invest, confidently (and accurately) predicting that well-funded intellectual influence could be converted into political influence that would repay their investment many times over. Their successful marketing of supply-side economics was just the start.
These multiple sources of publicly-subsidized political influence make it all the more unsettling to find that those paid to advise pension trustees routinely funneled money to lawmakers who proposed the partial privatization of Social Security, knowing that the leading proposal would redirect $100 billion per year of payroll taxes into an investment model where, from 1983 to 1998, 53 percent of market gains flowed to the top one percent of households.(21) In 1997 alone, IRS figures confirm that 54 percent of capital gains were claimed by the richest 90,000 households, those with incomes of $1 million or more, while the poorest 89% received just 11 percent.(22) Thats also $100 billion per year that wont be available to pay out to current Social Security recipients, assuring more crowding out.
Plus, as Wall Street sophisticates understand far better than the lawmakers they lobby, retirees require a future financial market thats both large enough and liquid enough to absorb the sale of pension assets in order to pay retirees expenses. That makes it all the more troublesome to find that pension trustees paid money-management fees to firms that lobbied for policies certain to raise short-term stock prices for the few while the long-term effect may heighten their fall for the many as pension funds compete with Social Security in liquidating securities to meet retirees needs.
Many of these trustee-funded advisors also backed a $1.35 trillion tax cut enacted in 2001, knowing that the fiscal tab for this latest round of crowding-out, if extended beyond 2010, will total more than twice the long-term Social Security shortfall, putting untold pressure on the nations financial health and thereby endangering the value of pensioners benefits. As Wall Streets best and brightest, they knew better than anyone that the topmost one percent will eventually pocket more than half those tax cuts at a 10-year fiscal cost of $4 trillion, a crowding-out strategy scheduled to commence just when the costs of Social Security, Medicare and Medicaid are certain to soar.(23)
As the campaign-contribution record reflects, many of these trustee-paid advisors also pushed for repeal of the estate tax, knowing that repeal will reduce future tax receipts by an additional $740 billion from 2012 through 2021, a fiscal strategy embraced in June 2002 by a majority vote in the House. If enacted, the effect would zip-up the fiscal straitjacket just as the first baby-boomers turn age 67, while the bulk of the tax relief would flow to the nations richest one-hundreth of one percent.(24) In 1999, half of all estate taxes were paid by 3300 estates, 0.16 percent of the total, while a quarter of the taxes were paid by 467 estates worth more than $20 million each.
Estate tax repeal would also transfer at least $1.54 trillion to the children of 400 families, creating a fiscally induced hereditary elite just when boomers are certain to require fiscal assistance. As these financial sophisticates know, repeal would also gut a key tax incentive for charitable giving, ensuring that bequests fall to foundations, universities, the Red Cross and such, de-capitalizing the nonprofit sector and halting growth in the sole remaining pool of capital dedicated to the general welfare.
As a seasoned craftsman of federal law in this area, I search in vain for any semblance of the prudence, fiscal foresight, or even the simple decency and common sense expected of these financial futurists and those paid to advise them. By law, theyre required to invest with a coherent vision of the future. Instead, what principle of economic distribution guides their oversight -- drink your fill and thirst for more? After two decades of overseeing these enormous funds, preempting vast public resources that crowded out other social priorities, I figure anyone not outraged at the results is out to lunch. Yet Congress and the Bush Administration propose only the most trifling reforms directed solely at smoothing the rough edges of this long-dysfunctional model.
By choosing to embrace Wall Streets cramped measure of success ("Maximize financial returns and trust us ."), pension fiduciaries confirm their lack of concern even if a handful of people capture the bulk of the financial value created by a new industry. By Wall Streets standards, Microsoft is an attractive investment so long as it generates competitive returns, even if the result enables Bill Gates to amass what Wired magazine predicts could become a trillion dollars, possibly even a quadrillion (a million billion).(25) That may not happen, but it could. Whats certain is that Wall Street wouldnt care if thats the use to which retirees savings are put. As Kevin Phillips points out in Wealth and Democracy, by 1999, Gates fortune stood at 1.4 million times the net assets of the median U.S. household, a disparity already well beyond the 1.25 million to 1 ratio achieved by John D. Rockefeller in the early 1900s.
Fast-widening wealth and income disparities steadily fuel one another as households worth $5 million doubled between 1983 and 1998 while those worth at least $10 million quadrupled, all with the help of retiree savings turbo-charged with immense tax subsidies. Citing "unprecedented prosperity," The Wall Street Journal exults that, by 1999, the average American household was worth $270,000. However median family wealth &endash; the wealth of a family in the middle of the distribution -- was $61,000. New York University professor Ed Wolff documents that "living conditions stagnated in the 1990s for American households in the middle, while rapid advances in wealth and income for the elite pulled up the averages." While the Journal is happy to report that average family income grew 28 percent in the two decades to 1997, median family income grew only an inflation-adjusted 10 percent while income fell for the bottom fifth.
By investing in a model that concentrates both wealth and income, pension trustees also fueled an over-capacity recession in which the economy was mired before the market crash made matters worse. Between 1983 and 1998, half the total gain in real income (47 percent) flowed to the topmost one percent while 12 percent trickled-down to the bottom four-fifths.(26) Sixty percent of the income gains captured by the top one percent went to the top 0.1 percent while almost half that flowed to the top 0.01 percent, those 13,000 taxpayers with annual incomes of at least $3.6 million. By 1999, this well-off one percent was pocketing 19.5 percent of national income.(27) The top fifth now claim half of all income (49.2 percent) while the bottom fifth gets by on a record-low 3.6 percent.(28)
At one end of the market-fundamentalists food chain, the annual pace of personal bankruptcies continues to hold steady at 1.4 million for the past five years, an average 7,000 per hour as household debt topped $7.6 trillion in 2001, a record-breaking 73% of GDP, while home mortgage foreclosures reached a 30-year high.(29) At the other end, expecting brisk sales, Chrysler launched over the July 4th 2002 weekend its $300,000 Maybach luxury sedan while high-end boatyards report strong demand for super-luxury yachts, 150-feet or longer. On 9/11, ten of them were berthed in a Hudson River boat basin adjoining the World Financial Center, one block west of the World Trade Center.
Baby-boomers are slowly awakening to the realization that theyre rushing toward a financial future for which theyre perilously unprepared, accompanied by a well-founded suspicion that Washingtons finances also teeter on a precipice, as does the economys capacity to recover any semblance of robustness for anyone other than the long-favored few. Whats not yet known is how this demographically dominant generation will respond politically once they realize that those trusted with their financial future allowed Wall Street to loot their nest-eggs while feathering their own nests.
I crafted federal law in this specialized area for seven years, longer than all but a handful of tax-policy professionals. No pension fiduciary can credibly claim that todays results are consistent with the statutory intent. Likewise, no fiscal expert dares suggest that the past two decades of massive tax subsidies were sensibly deployed in this Wall Street-advised build-out. Common sense requires the removal any fiduciary who uncritically embraced the perverse market-fundamentalist gloss given this crucial area of tax policy. Prudent public-sector oversight requires that the two agencies charged with pension oversight &endash; Treasury and the Department of Labor -- imprison as many trustees, investment managers and advisers as juries can be persuaded to convict.
Historys Greatest Heist simply cannot be allowed to stand. Critics of this diagnosis and prescription will claim that recovery of these misappropriated funds is impossible, akin to unscrambling an omelet. In practical fact, its more akin to untying knots that trace their way through layer upon layer of contracts crafted by the nations most sophisticated network of financial experts. Seventy percent of equities originate in New York, and fully 40 percent of bonds. That financial build-out employs a technically proficient and highly prosperous cadre of attorneys, accountants, bankers ad investment bankers -- all managing Other Peoples Money.
The Big Five charged their accounting clients $28 billion in 2001 while the top 100 law firms billed $35 billion. Average profit per law partner reached $792,500 in 2001, with top-tier Wall Street firms paying senior partners some multiple of that.(30) Relying on their advice and counsel, Manhattans finance-savvy insiders opted for a financial build-out whose effects boomers must now confront. Compare the legislative intent with the economic-distribution result and its clear weve entered a politically charged era as ripped-off boomers ponder how best to rescue Main Street from Wall Street.
Market fundamentalists will be quick to cast recovery of these funds as a dreaded Huey Long-like redistribution of wealth. Or as the first shot in a class war. Or even the first step toward the Gulag. Yet by choosing to invest these trusteed funds in a rich-get-richer investment model, pension fiduciaries chose to redistribute wealth from retirees and taxpayers to the well-to-do while allowing managers, directors, investment bankers and professional service-providers to skim a tidy bundle for themselves. What this massive misappropriation requires is a reallocation of pension funds that belonged to retirees all along, recognizing that whats been offered to date in the guise of reform is too little, too late.
Todays economic divide is already the sharpest since the late-1920s with its Great Gatsby manor homes and its hordes of servants. Without genuine reform, Wall Streets alluring neoliberal investment model will continue to widen todays dramatic divide in both wealth and income, all with the help of tax subsidies meant to remedy the financial insecurity that always accompanies extreme economic polarization. The math is the same now as then: if the rich take a lot, theres a lot less for everyone else.
As a 56 year-old boomer who had a direct hand in crafting many of these long-abused laws, I say with full confidence that the funds set aside, both the savings and the subsidies, were intended for our security in retirement. Federal law has long been clear on that key point. Instead, pension trustees and those they hired knowingly allowed unchecked greed, boardroom abuse and Wall Street racketeering to undermine both the financial welfare of pensioners and the fiscal future of the nation as their plutocratic build-out converted the worlds largest pool of capital into a parody of prudent pension-fund management.
Reformers miss the point. Regardless of whether the corporate books are kosher or cooked, regardless of whether accountants operate as advisors or accomplices, and regardless of whether corporate directors are truly independent or outrageously conflicted, the unacknowledged point remains the same: the Wall Street model -- financial returns-obsessive and economic distribution-indifferent -- is the key source of corruption. Reform the model or other reforms remain largely inconsequential, including those enacted to date. While the absence of boardroom ethics is indisputable, even that disturbing fact is only a distraction. Real reform must be directed at a massive disturbance imbedded in the financial and political structure of the nation, a reform thats become essential now that Wall Street and Washington operate as one.
As American politics waits for America to wake up, taxpayers face record-breaking debt, record-breaking trade deficits, reduced government services, a crumbling and under-funded infrastructure, and three major public-sector programs &endash; Social Security, Medicare and Medicaid &endash; expected to double as a share of the economy, putting unimaginable pressure on tax rates, the economy and the budget. And thats before taking into account the financial burden of waging a faraway war.
When baby-boomers awaken, as they will, the political fallout could be ugly, particularly as those nearing retirement grasp the key role played by those in elective office who continue to embrace this rich-get-richer model and are embraced in turn by those it enriches. Systemic corruption accompanies support for a model that is itself systemically corrupt. The political tipping point awaits boomers awareness that they cannot realistically expect either to catch-up or recover the financial resources they counted on. The implications for Generation X are even more frightening. After two full decades of market fundamentalism combined with a strategy of fiscal crowding-out, the future they face is a form of intergenerational financial terrorism.
In seeking recovery of these funds, how far back must genuine reformers look to right this wrong? Thats for lawmakers and the courts to decide, ever mindful that federal law has since 1975 mandated that these funds be invested exclusively for the benefit of retirees and solely for the purpose of financing their retirement.
Author of The Ownership Solution and Democracy at Risk, Jeff Gates is president of the nonprofit Shared Capitalism Institute.
(1) Citing Roy Smith in "Will Congress Finish the Job ," Too Much (New York: Council on International and Public Affairs), Spring 2002, p. 6.
(2) U.S. Congress Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2002-2006 (U.S. Government Printing Office, January 17, 2002). The IRA estimate includes Keogh plans.
(3) "Executive Pay Special Report," Business Week, April 16, 2001.
(4) Forbes, October 8, 2001, p. 134.
(5) Ron Unz, "Taking Stock," Los Angeles Times, August 25, 2002, p. M6.
(6) John Balzar, "CEOs Gorge, and Everyone Else Gets Sick," Los Angeles Times, August 11, 2002, p. M5.
(7) Riva D. Atlas and Patrick McGeehan, "In Two Days, Citigroup Chief Traded Halo for Headaches," The New York Times, July 27, 2002, p. B1.
(8) Personal correspondence with the author.
(9) Based on research by Pearl Meyer & Partners, New York.
(10) 1997 research by David Yermack at NYUs Stern School of Business, as reported in Journal of Finance.
(12) See www.forbes.com/richlist. Assumes wealth was amassed untaxed over a 40-hour week, 50-week year.
(13) Juliet S. Schor, The Overworked American (New York: Basic Books, 1992) indicating that the annual work year increased by 139 hours from 1969-1989. The Washington, D.C.-based Economic Policy Institute found that the annual hours worked expanded by 45 hours from 1989-1994.
(14) Jeff Gates, The Ownership Solution (Cambridge, Massachusetts: Perseus Books, 2000), p. 53.
(15) Richard W. Stevenson, "White House Says It Expects Deficit To Hit $165 Billion," The New York Times, July 13, 2002, p 1.
(16) U.S. Congress Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2002-2006 (U.S. Government Printing Office, January 17, 2002).
(17) Kara Scannell, "Public Pension Plans Come Up Short," The Wall Street Journal, August 16, 2002, p. C1.
(18) See www.motherjones.com/about_US/pressroom/030501_2.html
(19) Mike Allen, "Whos Been Sleeping At 1600 Pennsylvania Ave.?," The Washington Post National Weekly Edition, August 26-September 1, 2002, p. 16.
(20) Alan Krueger, "Economic Scene," The New York Times, July 14, 2002, p. C2.
(21) Edward N. Wolff, "Where has all the Money Gone?," The Milken Institute Review, Third Quarter 2001, p. 34.
(22) Statistics of Income Bulletin, September 2001 (Washington, D.C.: Internal Revenue Service).
(23) This projection assumes that the tax cut provisions enacted in 2001 are made permanent rather than, as now, assuming they will automatically expire in 2011. Washington, D.C.: Center on Budget and Policy Priorities, August 3, 2001. See www.cbpp.org/8-3-01tax.htm.
(24) Shailagh Murray, "House Backs Permanent Repeal of Estate Tax; Senate Fight Looms," The Wall Street Journal, June 7, 2002, p. A7.
(25) Evan L. Marcus, "The Worlds First Trillionaire," Wired, September 1999, p. 163.
(26) Edward Wolff, Top Heavy: The Increasing Inequality of Wealth in America and What Can Be Done About It, (New York: The New Press, 2002).
(27) IRS Statistics of Income Bulletin, Winter 2002.
(28) See www.census.gov ("income" at Table H-2).
(29) Sandra Fleishman, "When the Mortgage Goes Unpaid," The Washington Post National Weekly Edition, September 23-29, 2002, p. 34.
(30) Jim Schroeder, "The Am Law 100: An Overview," The American Lawyer, July 2, 2002.