Sunday, September 28, 2008

When Wall Street Abandoned Its Mission to Finance New Investments

Thanks to Dr. Bob Crane for sending me an article by Ron Chernow, whose knowledge of the J.P. Morgan era helps us to understand the mindsets that are trying to deal with the symptoms of a fatally flawed system of global capitalism today.

Global capitalism is a system based on a flawed paradigm. In contrast to the binary economic paradigm, here are the defective concepts and policies in all capitalist societies that have caused and aggravated the current global economic crisis:

1) Problem: "Full employment"(increasingly supported, as labor-saving technology expands, by government income redistribution through non-productive "created jobs" and welfare checks).

Binary solution: "full production" directly tied to accelerated growth of advanced labor-saving technologies that are financed through "pure credit" and "asset-backed money" (the real bills doctrine and the quantity theory of money) to achieve "universal access to capital ownership" and links system growth by balancing aggregate supply and aggregate demand. (Otherwise known as the binary economic version of Say's Law of Markets).

2) Problem: Misleading Savings Limitation on Growth. Limits growth rate of new productive capital to "existing savings" (interpreted to mean current or past accumulations of earnings, which by definition favors the most wealthy citizens whose property incomes far exceed their capacity to consume and thus widens the wealth and economic power gaps between economic haves and the increasing more insecure have-not wage slaves and welfare slave majority of the population).

Binary solution: 100% leveraged financing through Capital Homesteading vehicles of newly added capital assets for growth of advanced labor- and energy saving technologies, new plant and equipment, new rentable space and new infrastructure, with private loan default insurance and designed to be repayable with "future savings." Passage of the Federal Reserve monetary, banking, tax, inheritance and other reforms under the proposed Capital Homestead Act. (

This requires a shift in the source of financing new productive capital to "new Fed-created money to be backed by and repayable with the future profits expected to be produced by new growth assets. This new asset-backed money would be converted into self-liquidating bank loans (supported by 100% reserves, rather than fractional reserves) to facilitate expanded local bank capacity to make "pure credit" based on asset- and insurance-secured promises to repay the loans out of "future savings" from the productiveness and profits added by the new assets being financed. By channeling this new money into such tax-sheltered Capital Homesteading vehicles like Capital Homestead Accounts (CHAs), Employee Stock Ownership Plans (ESOPs), multi-home Homeowners Equity Corporations (HECs), Community Investment Corporations/Citizens Land Cooperatives, regional Natural Resource Banks (NRBs), Consumers Stock Ownership Plans (CSOPs), and cooperatives, every American citizen would be on a level playing field with super-rich Americans for the "social means" to purchase newly issued shares from well-managed private sector companies of all sizes for financing their expansion assets, uniquely without reducing their current consumption incomes.

This would create a nation of dividend-earning capital owners, create many more private sector job opportunities that are competitive in global markets, reduce trade deficits, balance the Federal budget and begin to pay down the existing debt of nearly $10 trillion, supply each citizen with a growing accumulation of dividend-yielding capital accumulations for retirement, and gradually eliminate the unsustainable projected deficits in Social Security, Medicare, Medicaid and other entitlement programs now estimated at over $50 trillion over the next 75 years. Based on current rate of newly-added capital formation in the U.S. economy of roughly $2 trillion each year, with passage of the Capital Homestead Act a newborn child could accumulate after-taxes by age 65 an estate of almost $500,000, an annual dividend income of close to $50,000 at age 65, and about $1.6 million in dividends to supplement job incomes over his or her lifetime.


"A New Look at Prices and Money: The Kelsonian Binary Model for Achieving Rapid Growth Without Inflation, by Norman Kurland (The Journal of Socio-Economics (Vol. 30, 2001) and;

The Formation of Capital by Harold Moulton (Brookings Institution, 1935);

The New Capitalists: A Proposal for Freeing Economic Growth from the Slavery of Savings by Louis O. Kelso and Mortimer J. Adler (Random House, 1961 and;

Binary Economics: The New Paradigm by Robert Ashford and Rodney Shakespeare (University Press of America, 1999);

Capital Homesteading for Every Citizen by Norman Kurland, Dawn Brohawn and Michael Greaney (Economic Justice Media, 2004); and

"How We Can Create Green Growth, Economic Prosperity and Global Peace" by Norman Kurland, Dawn Brohawn and Michael Greaney at

3) Problem: Blindness or Indifference to Institutional and Legal Monopoly Barriers to Universal Participation in Capital Ownership as a Basic Right of Citizenship in a Democratic Society and a Fundamental Human Right. (See section 17 of the UN's Universal Declaration of Human Rights.

Binary Solution: Lift the Barriers through Adoption of Comprehensive System Reforms under the Capital Homestead Act.

4) Problem: Misleading definition by academic economists of "productivity," which attributes growth due to advanced technologies to the productiveness of human labor, rather than the ever-advancing productiveness of capital, resulting in government-induced distortions in market values of labor contributions, wasteful and conflict-inducing income maintenance policies, dangerous American trade imbalances caused by the outsourcing of jobs and transfer of critical industries and technologies to low-wage countries.

Binary Solution: Separate the Declining Relative Productiveness of Labor and the Rising Productiveness of Productive Capital in the Interdependent Process of Creating Marketable Goods and Services, for National Income Maintenance Policy. Thus, as American workers gain rising capital incomes from the productive contributions of their growing capital accumulations, pressures to increase artificially the costs of labor contributions will be reduced and the prices of American goods, technologies and services will again become more competitive in global markets, increasing the stability of incomes from the American private sector. Labor unions can increase their constituencies from 7% of the private sector work force to virtually 95% of the population by being in the vanguard of this transformation of the U.S. economy, transforming themselves from democratic labor unions to bottom-up democratic ownership unions and beginning to negotiate and protect rights of all shareholders as well as workers in the economy.

Just before his untimely death in an airplane crash, Walter Reuther, the head of the United Auto Workers and the last of the great labor statesmen, confirmed this point in his testimony to the Congress:

"Profit sharing in the form of stock distributions to workers would
help to democratize the ownership of America's vast corporate wealth
which is today appallingly undemocratic and unhealthy. The Federal
Reserve Board recently published data from which it is possible to
estimate the degree of concentration in the ownership of publicly
traded stock held by individuals and families as of December 1962.
Preliminary analysis of these data indicates that, despite all the
talk of a "people's capitalism" in the United States, little more
than one percent of all consumer units owned approximately 70
percent of all such stock. Fewer than 8 percent of all consumer
units owned approximately 97 percent—which means, conversely, that
the total direct ownership interest of more than 92 percent of
America's consumer units in the corporation-operated productive
wealth of this country was approximately 3 percent. Profit sharing
in a form that would help to correct this shocking maldistribution
would be highly desirable for that reason alone.… If workers had
definite assurance of equitable shares in the profits of the
corporations that employ them, they would see less need to seek an
equitable balance between their gains and soaring profits through
augmented increases in basic wage rates. This would be a desirable
result from the standpoint of stabilization policy because profit
sharing does not increase costs. Since profits are a residual,
after all costs have been met, and since their size is not
determinable until after customers have paid the prices charged for
the firm's products, profit sharing as such cannot be said to have
any inflationary impact upon costs and prices." [Testimony before
the Joint Economic Committee of Congress on the President's Economic
Report, February 20, 1967.]

5) Problem: Failure to Distinguish between Credit for Investment and Credit for Non-Productive Uses and Speculation.

Binary Solution: Under Capital Homesteading, national credit policy would establish a two-tiered credit system, encouraging through interest-free, asset-backed, privately-insured, self-liquidating productive capital credit ("pure credit") the funds to finance non-inflationary green growth to the American economy and broad-based ownership of the wealth-producing assets needed to restore the global competitiveness of a more economically just American free enterprise system, while reducing the burdens of the public sector. By focusing on future growth through pure credit, a social good that in a just free market economy should be equally accessible to all, Capital Homesteading would make have-nots into haves without threatening the property rights over existing capital assets owned by current owners of capital.

Credit for non-productive uses, such as consumer loans, government deficits and loans for projects that could be developed more efficiently through the private sector, and loans for speculation and gambling, loans to the already affluent (in other words, loans that are not procreative and pay for themselves or loans that do not increase the productive assets and capital incomes for the 95% of non-affluent Americans) would have to financed exclusively out of past savings, at interest rates reflecting the alternative market yields from the uses of past savings. This would protect the property rights of those who have accumulated savings. Under a Capital Homesteading economy, the poor and middle-income would have less need for consumer loans often at usurious rates as a faster growing private sector generated more jobs and distributed labor as well as ownership incomes. Because of the historic problems associated with the law of compound interest associated with consumer loans -- the foundation of usury condemned by all traditional religions and the cause of indentured servitude, debt slavery and inhuman pressures on propertyless family in many countries -- the government should consider policies that discourage consumer loans for those whose incomes are insufficient to meet their debt obligations.

Dr. Robert Crane, wrote:

Old style capitalism operating out of the hip pockets of moguls concentrated wealth but for a hundred years it also facilitated the creation of asset-backed money and vast sums of real wealth. Then came 1913 and the issuance of money for debt, which survived for another century and dismantled America's global power base. What is coming next? A new global currency based on binary economics and the return to pure credit and the return to real wealth? Too bad we can't go into a time machine and emerge in 2108 to see the answer. Or maybe we'd rather not.

New York Times, September 28, 2008
Op-Ed Contributor
The Lost Tycoons By RON CHERNOW

With breathtaking speed, the world of large Wall Street investment banks has vanished. Fabled firms, some more than a century old, have been merged out of existence (Bear Stearns, Merrill Lynch), gone bankrupt (Lehman Brothers), or sought asylum as commercial bank holding companies (Goldman Sachs, Morgan Stanley).

Why on earth did this happen? The death of Wall Street has been a long-running, slow-motion crisis, barely discernible to participants who had still booked huge profits in recent years. Beneath the razzle-dazzle of trading desks and the wizardry of esoteric finance lay the inescapable fact that these firms had shed their original reason for being: providing capital to American business.

The dynastic power exercised by Wall Street tycoons in the late 19th and early 20th centuries was premised on scarce capital. Only a handful of European countries and their private bankers had surplus capital to finance overseas development. In this cash-poor world, J. Pierpont Morgan and other grandees exerted godlike powers over American railroads and manufacturers because they straddled the indispensable capital flows from Europe.

With their top hats, thick cigars and gruff manners, these portly tycoons scarcely qualified as altruists. As Morgan liked to warn sentimental souls, “I am not in Wall Street for my health.” Yet he and his ilk rendered America an invaluable service by reassuring European investors that they would receive an adequate return on their investments, securing an uninterrupted flow of capital.

To safeguard those returns, old-line investment bankers became all-powerful overlords of their exclusive clients. When they issued company shares, they retained a large block for themselves. Some clients chafed at these gilded shackles, while others gloried in their servitude. As the head of the New Haven railroad, a Morgan client, boasted to reporters, “I wear the Morgan collar, but I am proud of it. If Mr. Morgan were to order me tomorrow to China or Siberia in his interests, I would pack up and go.”

In the sunless maze of Lower Manhattan, the old Wall Street houses were miniature temples of finance. Elite, all-male and lily-white, rife with snobbery and bigotry, they didn’t bother to hang a shingle outside, and the tacit message to pedestrians was clear: keep on walking. This reflected the banks’ patented formula of serving only the most creditworthy clients: industrialized nations, blue-chip corporations and wealthy individuals. In London, these small partnerships were called “issuing houses” because they issued stocks and bonds but didn’t trade or distribute them.

In their risk-averse culture, J. P. Morgan and his breed considered the stock market a faintly vulgar place, better left to Jews and assorted ethnic groups outside the top ranks of investment houses. This bias would later give predominantly Jewish firms like Lehman Brothers and Goldman Sachs a marked competitive edge.

Even in the 1920s, patrician Wall Street firms stayed somewhat aloof from the stock market mania. Securities laws during the New Deal, mandating fuller disclosure of corporate accounting, eroded the Wall Street moguls’ power. The new transparency reduced the need of many companies for a banker’s imprimatur to certify their soundness.

The Glass-Steagall Act of 1933, which forced full-service banks to choose between commercial and investment banking, further shrank the investment houses’ influence. After World War II, as capital markets revived, Wall Street investment banks remained tiny partnerships with outsize power over corporate America.

Morgan Stanley demanded exclusive banking relations with the cream of corporate America: AT&T, General Motors, United States Steel, General Electric, DuPont, I.B.M. and Standard Oil of New Jersey. The essence of the business was still the traditional underwriting of stocks and bonds. The era’s emblem was the solemn, rectangular “tombstone” ad in newspapers for share offerings, listing the dozens of firms involved, with Wall Street’s rulers in the top tier.

Underwriting bred a sociable culture of “relationship” banking in which a smooth golf swing, Ivy League credentials, glib patter over a martini and family connections counted for more than financial ingenuity. Firms didn’t advertise and paid publicists to keep them out of the press. They disdained hostile takeovers, stock trading and other activities that might threaten their coveted underwriting business. And they enforced more rules of etiquette than a debutante’s ball. It was considered bad form to poach an employee or raid another firm’s client. Whatever their flaws, these elite firms still played a vital role in the economy, floating stocks and bonds to create new factories and businesses.

The old Wall Street began to die a lingering death in 1979 when I.B.M. told Morgan Stanley that it wanted to have Salomon Brothers co-manage a $1 billion debt issue. Fearing that its stable of captive clients would likewise revolt, Morgan partners insisted on sole management of the issue. They were flabbergasted when I.B.M. sent back word that Salomon Brothers would be lead manager for the issue.

What accounted for this startling shift? For the first time since the heyday of J. P. Morgan, traditional corporate clients had outgrown their bankers. With Europe and Japan devastated by World War II, American companies had enjoyed unrivaled supremacy in world markets. They had grown big enough to finance expansion from retained earnings and had many more borrowing options than before. Many had developed their own financial subsidiaries with triple A credit ratings and scarcely needed Wall Street bankers to vouch for their solvency.

Trading firms like Salomon Brothers and Goldman Sachs were using their prowess to cultivate relations with powerful institutional investors like pension funds and insurance companies, eating into the profits of white-shoe houses. Underwriting deteriorated into a low-margin business as traders trumped blue-blooded bankers in the Darwinian struggle.

The demise of traditional underwriting would create in the coming decades a vacuum filled by a host of volatile, risky businesses. The cozy world of relationship banking yielded to the brutal world of “transactional” banking. Stock, commodity and derivatives trading, hostile takeovers, leveraged buyouts and prime brokerage for hedge funds required ever-larger balance sheets, forcing investment houses to become huge, publicly traded companies. Firms that once remained distant from the stock market were now its storm-tossed creatures, as investors demanded ever-higher profits amid cutthroat competition, forcing bankers to take risks that would have horrified their Wall Street ancestors.

Where the old Wall Street stuck to the most prestigious clients, the new Wall Street engaged in an unseemly rush to the bottom. Investment houses that once dealt only in grade-A bonds became swept up in junk bond mania in the 1980s. Firms that once snubbed companies beyond the Fortune 500 flocked to Silicon Valley in the 1990s, eager to take fly-by-night companies public. And, in the final reductio ad absurdum, Wall Street during the past decade gorged on mortgage-backed securities, tying its fate to America’s least creditworthy borrowers.

Addicted to colossal amounts of leverage, the onetime arbiter of scarce capital had become the most profligate borrower. The large investment banks that once allocated precious capital now exist in a world awash with money, crisscrossed by capital flows from many continents, with financial markets deep and liquid as never before.

Once the current crisis is past, investment banking services will eventually flourish again inside diversified financial conglomerates. Stripped of excess leverage and more tightly supervised by regulators, investment bankers may even rediscover the old-fashioned virtues of corporate finance. And small boutique firms will continue to offer trusted advice as of old. But the storied investment houses of Wall Street, trailing their glorious past, have now earned tombstone ads of a very different sort.

Ron Chernow is the author of “The House of Morgan” and “Alexander Hamilton.”

Contributions to CESJ are tax deductible in the United States under IRC § 501(c)(3).


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