Sep 8, 2002
In mid-October, big headlines announced a rapid descent in the price of Ford Motor Company stock prices. The business section of the New York Times reported on the situation thus: "What made shares of the Ford Motor Company plummet...? The answer, investors and credit analysts say, was nothing and everything. Nothing because there was no bad news about car sales in general or Ford's operations in particular to prompt yesterday's decline. Everything, because investors seem to be awakening to a host of weaknesses in Ford's financial position." The Times went on to add that Ford "carries a staggering debt load. It faces lingering questions from investors about how it presents its cash position...."
In other words, one of the very biggest, longest established industrial companies in the country is also suspected of cooking its books. The Times article goes on to explain that it had been doing so in order to attract sufficient capital during the period when the rapidly advancing prices on Wall Street attracted capital to speculative investments, away from investments in production.
Indicating that this is not just a brief hiccup on the stock exchange, Standard and Poor's bond rating agency downgraded the bonds, not only of Ford, but of GM also. And while, it did not yet reduce either company's paper to "junk bond" status, there already were some independent analysts who did so.
We reprint below an article that deals with the imploding of the speculative bubble that has already brought about the bankruptcy of a number of big companies. This article originally appeared in issue #46 (September-October) of the Class Struggle, the publication of Workers' Fight, our comrades in Great Britain.
At the end of July, the U.S. Congress passed and Bush signed into law a so-called reform of the financial system. Bush called it a "sweeping corporate fraud" law and proclaimed to the nation that there would be "no more easy money for corporate criminals, just hard time." Pictures of smartly-dressed company executives held handcuffed by FBI agents began to appear on newspapers' front pages.
By that time, some of the biggest companies in the country were forced to admit they had falsified their books. And no fewer than 155 large U.S. companies had filed for bankruptcy in just 18 months, ten times more than the annual average over the previous twenty years. U.S. workers had been laid off by the hundreds of thousands in just about every industry. Many more had seen the value of their pension schemes reduced to peanuts as a result of the stock market's on-going meltdown and this was now getting even worse, with yet another 20% drop in Wall Street since the end of May and no upturn in sight. For a large section of the U.S. public, which had been fed for so long with fairy tales about an ever-growing so-called "new economy" with its prospects of unlimited affluence reflected by a buoyant stock market, it seemed as though the whole system was collapsing.
For the Bush administration, it was becoming urgent to find some way of preventing the capitalist system itself from becoming the target of predictable discontent.
That Bush and his Republican administration should pose as champions of the "little guy" against corporate crime (i.e. greed) was, of course, both ironical and a monument of hypocrisy. Indeed, if the scandal surrounding the collapse of the energy giant Enron, last December, exposed anything, it was precisely the greed and corruption of U.S. politicians in general (and Bush and his own clique in particular) and their close involvement in the shady dealings of big business, legal or not.
However despite this (but also probably partly because of this) Bush had no option but to appear as if he was now turning against his corporate pals. This does not mean, of course, that he has any serious intention of cracking down on the cynical profiteering of business high-flyers who lined their pockets and stashed their gains securely away, leaving the final bill for their employees to pay by in lost jobs and pensions. The odds are that only a handful of company executives will be singled out for prosecution. These individuals will undoubtedly be seasoned profiteers and no-one should shed any tears over their fate. At best they will be mere scapegoats.
But this is precisely the aim of the exercise: to substantiate the myths already widely circulated by the capitalists' politicians and commentators who blame the present economic meltdown in the USA and across the world on "rogue executives," in order to divert the attention of the working population and jobless away from the real culprit, the capitalist system itself.
Fraudulent practices are just as much part and parcel of the workings of the capitalist system as the speculative frenzy which has finally resulted in today's economic meltdown. They are "normal" devices in the pursuit of capitalist profit. As long as society is ruled by profiteering, no amount of "tighter regulation," "transparency" or "better corporate governance" to list the so-called "remedies" officially advocated today will ever be able to prevent the kind of economic chaos and threatening social catastrophe that we are seeing now.
What we are seeing today is indeed the protracted implosion of a speculative bubble which developed in the second half of the 1990s. Over the five years up to the end of 1999, average share prices increased by 208% in New York (and 125% in London). In the meantime, U.S. Gross Domestic Product increased by a much lower 30% (half of which was due to inflation), while company profits increased by just under 60%.
The rapidly growing gap between company profits and the price of their shares reflected the frenzy of speculation which took over the stock market. Market traders were not buying shares on the basis of the actual profits of the underlying company but in the expectation that share prices would rise and allow them to make a tidy gain. And they were encouraged in this gamble by the fact that overall, in the U.S. at least, profits were increasing twice as fast as national production itself, thereby making such expectations even more credible.
Financial speculation i.e. making a profit by buying and selling financial instruments like company shares is nothing new, of course. It is as old as the stock market itself and plays a decisive role in allowing the large mass of existing capital to be made available (at least in the rich countries) to the productive sphere where and when it is needed. A considerable proportion of this capital is available only for a relatively short period of time (like the cash reserves held by large companies to pay bills or wages). Without the possibility of making fast speculative gains, it would never enter the stock market. Besides, a large part of the financial industry (insurances, pension funds, banks, etc.) operates by "investing" the premiums, pension contributions, money accounts, etc., deposited with them so as to be able to pay back larger sums in return at some point in the future (in theory at least). And if they can increase these deposits faster, by resorting to short-term speculation rather than by relying on the dividends of long-term holdings, this is obviously what they will choose to do.
In other words, just like the stock market, financial speculation is part and parcel of the "normal" workings of the capitalist system. Without these two mechanisms, the system would soon be paralyzed since it lacks any other way for instance a centralized planning system to make resources available to the sphere of production.
However, there are periods in which these mechanisms contribute to the exacerbation of the chaos of the capitalist system instead of oiling the cogs of the economy, as they should. And the fact that during the 1990s the astronomical rise of share prices was completely out of proportion to the growth of real wealth in the economy showed that this was such a period. The very reason for the stock market to exist to provide capital to companies that need it had become secondary. Instead its main function was to allow the enormous masses of capital that the capitalist classes of the rich countries were no longer prepared to risk in productive investment to generate profits at a low risk, as a parasite on the back of the productive sphere and feeding from it.
There were many warnings issued against the dangers of this growing speculative bubble. Most famously, Alan Greenspan, the chairman of the U.S. Federal Reserve Bank, warned, in December 1996: "How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged corrections?"
Despite this warning, however, even Greenspan chose to go along with "irrational exuberance" when, in July 1997, he announced "a new era" of affluence for the U.S. economy in an issue of Business Week whose front page title was "Alan Greenspan's Brave New World."
Almost at the same time a major financial crisis broke out in South East Asia. The world's stock markets were abruptly shaken by the ripples of this crisis. The consequences were dramatic for many poor countries as foreign investment fled back to the safety of the industrialized world. But the IMF's intervention allowed Western banks and financial institutions to cut their losses and the stock markets of the rich countries resumed their upward march.
The following year, another financial crisis in Russia this time threatened the world financial system and resulted in another brief hiccup on the rich countries' stock markets. On this occasion, the shockwave hit so close to Wall Street that the U.S. Federal Reserve Bank took it upon itself to organize the rescue of a large American investment fund thereby showing that the U.S. authorities themselves had little confidence in the resistance of their own financial system.
Once again the rise of the U.S. and European stock markets resumed as if nothing had happened. In fact, speculation on Wall Street and in European markets was actually fed by these two crises, as fund managers were now more reluctant to gamble on the so-called "emerging markets" and focused their activity on the rich countries. More than ever before, the rich stock markets were awash with capital seeking to make a fast buck.
The late 1990s was the era of the so-called "new economy," comprising everything related to computers, electronics, mobile and satellite communications, internet services, bio-engineering, etc. in other words relatively new activities which covered untapped markets. There were still only a few players in these markets and competition was therefore limited. As a result any new upstart could join the game and hope to stay in it long enough to be among the few lucky winners once the dust of the initial competitive "big bang" had settled down. But most stood to be crushed at some point. In the meantime, market traders did their best to bet on the right horses without any hard facts on which to base their choices.
Companies which had no assets and had never made a penny in profit were suddenly valued at billions of dollars on the stock market. The American economist Robert Schiller quotes, for instance, the edifying case of the now defunct company eToys, a "start-up" set up in 1997 to sell toys over the internet. Its initial stock offering was floated in 1999; shortly thereafter, its market value reached eight billion dollars more than the six billion dollar value of the long-established chain of toy retail shops Toys "R" Us. Yet in 1998, eToys had recorded a 29 million dollar loss on 30 million dollars in sales while Toys "R" Us was making 376 million dollars in profit on 11.2 billion dollars in sales. Or there's the case of Yahoo!: it may be the world's largest internet portal, but the fact that its value reached 132 billion dollars at one point i.e. more than oil giant Texaco was no less ridiculous.
The frenzy reached by the speculative bubble can be measured by the fact that in 1999 the prices of the so-called "technology shares" increased by a massive 400% on average. In the same year, the stock value of internet companies was 600 to 1000 times their annual profits that is for the small minority among them which actually made a profit.
This frantic speculation was not confined to the so-called "new economy." It infected the stock market as a whole and, through it, the economy as a whole. The huge profits that could be made through financial speculation became the general norm by which returns on investment were measured across the economy the 15% or so annual earnings per share that were now demanded by the capitalists. Companies which failed to provide such returns risked being unable to use the stock market to raise fresh capital, or even to borrow from banks.
During this whole period, the exploitation of the working class was stepped up. To achieve what they called "savings," most large companies closed down facilities which were not profitable enough, cut jobs, reduced real wages and increased the workload of the remaining workforce. Other "savings" were achieved through massive mergers which, by eliminating duplicate facilities, resulted in yet more "savings" in the form of closures and job cuts.
But this was still not enough to deliver returns that were anywhere near the magic level of 15% earnings per share. As a result, companies had to make up for the shortfall by intervening directly to push up the price of their own shares, and they became increasingly dependent on the ups and downs of the stock market.
This dependence increased considerably with the rapidly growing wave of enormously expensive mergers and takeovers, a large part of which had to be financed with existing shares or by issuing new shares on the stock market. The amount of capital required just for these operations is illustrated by their total annual value, which increased from 495 billion dollars in 1996 to reach a peak of 1.74 trillion dollars in the year 2000.
In most large companies, therefore, directors became primarily concerned with boosting their share prices artificially. All kinds of tricks were used. The most widespread device involved the buying back of its own shares by a company, which resulted in an artificial shortage of these shares on the market and usually a sharp increase of their price. But of course, this required fresh cash, which had to be borrowed at a cost from banks. Together with the capital requirement due to the merger and takeover fever of that period, this resulted in an enormous growth of companies indebtedness. To the extent that, by the end of the 1990s, it was estimated that the average U.S. company spent an unprecedented 53% of its profit to service its debt.
But then, this artificial boosting of share prices locked companies into a vicious circle, since as the price of their shares increased, so did the 15% earnings they had to deliver. Hence the use of legal tricks in order to conceal certain debts or expenditure so as to boost profit figures. Just as British companies hire, quite legally, the services of accountants who specialize in helping them to take advantage of the numerous loopholes in the tax code, U.S. companies hired specialists to use loopholes in accounting standards to dress up their balance sheets in such a way as to boost their share prices, by making their performance more appealing to stock market speculators. There is nothing surprising in the fact that Arthur Andersen, one of the world's largest international accounting firms, agreed to do this for Enron and WorldCom, among many other firms. These are "normal" practices in a system in which the final profit made matters much more than the method used to make it. As long as share prices kept increasing, allowing investors to cash in on such tricks, who would have objected? And the fact is that no- one did, despite such practices being an open secret.
In the end, the speculative bubble did burst. Rather than collapsing abruptly, however, share prices followed a prolonged downward slide. Stock markets in the rich countries peaked and started declining almost simultaneously. London led the way in December 1999, Wall Street followed and by April 2000 the fall reached the whole of Europe. Between then and the end of 2001, share prices fell by one third on average and by 80% in the case of technology shares. Since then share prices have fallen by an additional 20 to 40%, depending on the country, amidst hectic movements up and down.
At first this implosion resulted mostly in cutting down to size the astronomical paper value of the so-called "dotcom" companies, pushing all share prices down. Hundreds of billions of dollars disappeared into thin air but then, these billions had never really existed except in the fictitious world of the stock market. But even fictitious, they had come from the very real over exploitation of the workers, who were asked to make sacrifice after sacrifice to produce more profit. It is in the nature of capitalist competition that those sacrifices were imposed on the workers in order to keep on attracting more capital. As to the many "dotcom" businesses that went to the wall, they were mostly service companies that employed relatively few people. Their disappearance had only a limited social impact.
However, this was "merely the warm-up, the telecom crash is many times bigger," as The Economist pointed out with a certain amount of cynicism in a survey published in July this year. Indeed, starting from the beginning of 2001, the meltdown began to take wholly different proportions. Most telecom and electronic equipment companies launched massive job cutting programs across the world, including giants like Lucent, Nortel and Motorola in North America and, in Europe, the likes of British Telecom, Ericsonn, Siemens and Alcatel.
In the U.S., a number of these companies in the so-called TMT (telecom and media technology) sector filed for bankruptcy. But others which did not belong to this sector, and therefore were not directly affected by the "dotcom" crash, went down the same road like, for instance, metal processors Bethlehem Steel and Kaiser Aluminum, discount stores chain Kmart and a series of air travel-related companies, not to mention the infamous energy company Enron.
The long list of large failing companies was not confined to the U.S. either. British financial institutions, although a lot more secretive than their U.S. counterparts, have been unable to prevent some of the City's (Britain's financial district in London) heavy weights from joining this list. So Marconi in other words what was left of the old GEC giant went to the wall and was taken over by its creditors, with the former shareholders retaining less than one percent of its capital. So did NTL, which, despite having its main listing in New York, remains Britain's largest optical fibre and cable company and is mostly British-owned. And, judging from the latest developments, it looks as though British Energy, the privatized nuclear power generator, could soon become Britain's very own version of Enron.
Most of these bankruptcies followed more or less the same pattern falling share prices resulting in the inability of these companies to borrow fresh cash to meet payment deadlines. But behind this common pattern lie deeper economic problems, which existed already in the late 1990s, when these companies were still among the stars of the stock market. At the time, however, their problems were hidden by the speculative bubble and the continuing belief of the capitalists that nothing was likely to stop the rise of share prices.
Indeed, a study of business investment in industrialized countries, published by the investment banker Goldman Sachs, shows that the increase in investment during the 1990s was mostly confined to computers, electronics, telecommunications and software, while productive investment went down in most other industries. What this shows is that the economy as a whole was not in the "ever-expanding" mode that the advocates of the "new economy" claimed at the time.
The so-called high-tech sector benefitted from a virtually unlimited supply of capital attracted by the speculative bubble, which allowed the rival companies involved including many purpose-built outfits to invest massively in new facilities. This massive investment, however, was made blindly, to occupy the space in anticipation of a market which did not yet exist, and whose size was therefore unknown. As a result, a large part of this investment will have been wasted for lack of customers.
In the telecom industry, for instance, The Economist estimates that 500,000 workers have already been laid off in the U.S. alone. Many of the bankrupted companies had something to do with fibre optic and cable networks. Goldman Sachs' study reckons that as much as one trillion dollars worth of investment has been wasted in such facilities, which will never be used because they would not be profitable. According to The Economist, between 1998 and 2001, total transmission capacity via fibre-optic cables multiplied by 500, while demand increased only four times. And this business weekly adds: "The problem was not that individual firms laid too much fibre, but that there were so many firms building almost identical networks. In the US, more than a dozen national fibre backbones were constructed; a similar duplication happened in Western Europe."
Ironically, The Economist, usually a vocal champion of what it calls capitalist "free entrepreneurship," is putting in a nutshell the root cause of the chaos generated again and again by the capitalist system. It is the irrational nature of a system in which production (in this case the building of optical fibre networks) is left in the hands of rival capitalists, competing against each other for a larger share of profit, without the actual needs of society being taken into account. Eventually, the capitalist market has sorted out the problem it has created itself in its own brutal way, but at what cost! A few of the largest companies will survive while most have been forced to the wall. It is indeed the very basis on which the capitalist system itself operates which is responsible for the present enormous waste of resources for society as a whole as well as the plight of half-a- million U.S. workers who are now out of a job.
And as this speculative bubble showed, instead of organizing production rationally, the mechanisms through which the capitalist system allocates resources to the productive sphere the stock market and its built-in speculation only contribute to exacerbating the general chaos and wastefulness of the system.
This is why Bush's scapegoating of "rogue executives" is merely a smokescreen. It is also a worn-out trick. Whenever the capitalist system breaks into chaos, official wisdom produces some convenient scapegoats to whitewash the system.
Today's "rogue executives" are the successors of Michael Milken, the "junk bond king" of the 1980s. At that time, Milken and his Drexel bank were at the center of the so-called "junk bonds" explosion i.e. short-term debt carrying very high interest rates, usually for risky operations on the stock market which generated fabulous profits for a few years. The hefty returns offered by "junk bonds" depended primarily on a constant flow of new capital and rising share prices. So, when the 1987 stock market crash reduced the capital available, "junk bonds" became true to their name junk! Everyone turned against Milken, who, by the same token, was blamed for the stock market crash. Soon he was arrested on a long list of charges. But thanks to a deal with the prosecution, the main charges against Milken were dropped (including that of racketeering) and he was sentenced to ten years in jail and a 600 million dollar fine. Thus, he never stood a full trial and the role played by the really big players in the "junk bond" fever the largest banks, insurance companies and non-financial companies, not to mention the financial authorities themselves was never revealed.
Thereafter, the term "junk bond" ceased to be fashionable. But as soon as the stock market recovered, other types of speculative high-risk instruments re-appeared.
So, for instance, the mid-1990s saw the meteoric rise of the so-called "derivatives" another type of financial instrument which can result in considerable losses if things go wrong. This was the era of the "golden boys" recruited straight from university to join the trading floor of financial companies. Their job was to gamble and gamble they did. As long as they were lucky, no bonus was considered too large for them, no matter what risks they took. However sometimes things turned ugly. In February 1995, the ancient British bank, Barings, was forced into bankruptcy, allegedly due to 1.3 billion dollars of losses incurred by its chief trader in Singapore, Nick Leeson. Many local councils which had entrusted their funds to Barings paid dearly for this. And Barings was by no means an isolated case. But rather than admitting that the financial system had become a gigantic casino which could produce either fabulous profits or spectacular bankruptcies, the latter were blamed on so-called "rogue traders" (i.e. unlucky "golden boys"). And some of them, like Nick Leeson, were made to pay by spending time in jail.
A few years later, the financial crisis in Asia in 1997 and in Russia the following year, caused the emergence of another scapegoat the so-called "hedge funds," whose main activity is precisely to produce profits for their rich customers by speculating on derivatives. These "hedge funds" were accused of being responsible for the downfall of the Thai currency, which triggered the Asian financial crisis. Never mind the fact that all the major banks were using the same speculative techniques in order to make a fast buck on the same financial markets only they were hiding their speculative activities behind the cover of more "legitimate" businesses. In fact as the bailing out of the American "hedge fund" LTCM revealed in 1998, some of the world's largest banks (including some central banks) were either customers or creditors or both of the dreaded "hedge fund."
In the aftermath of each one of these crises, financial regulations of some sort were introduced in order to "prevent a repetition" of the identified cause of the crisis. But the root cause the pursuit of private profit by individual capitalists through the financial system was never addressed because it is an integral part of the capitalist system itself. And each time the same problem came back under a different packaging. The regulations now being introduced will be just as useless as the scapegoating of a few "rogue executives." As long as capitalism is allowed to rule the world, nothing will prevent the economy from running amok due to speculative bubbles of some sort or another.
At the time of writing, many commentators are still warning that even at these low prices, shares remain overvalued by an average 50% thereby implying that stock markets may still be far from having reached the bottom.
This means that the risk of a brutal crash, involving even more dramatic consequences remains. This is all the more true given the deep economic crisis that has already settled in a number of South American countries, starting with Argentina last December, whose economy has now virtually collapsed. The "rescue package" volunteered by the IMF in August, in order to prevent Brazil from defaulting on its debt to Western banks, certainly shows the fears of Western leaders that a shockwave coming from South America could precipitate a stock market crash or a banking crisis or both in the rich countries. In the meantime, Western leaders can only carry on groping in the dark and crossing their fingers, in the hope that the latest storm caused by their capitalist system will go quietly without collapsing the entire economy.
Yet even at the present stage, after nearly three years of relatively slow implosion of the speculative bubble, the damage is considerable. In the USA, Britain, Germany and probably in other European countries, the economy is now described officially as being in a state of recession. The list of bankrupt companies will probably grow, judging by the number of companies issuing profit warnings lately and their general level of indebtedness. This means that unemployment stands to increase, as it has already done in the U.S. and in Germany although, in Britain, Blair still manages to conjure the layoffs of the past year out of the official unemployment figures.
As a direct consequence of the implosion of the speculative bubble, many American workers, whose pension savings were invested in individual stock plans (often in shares of their own company) without any guarantee of a final pension, have lost a large part of their contributions.
In Britain the growing number of workers who have been forced into so-called "Defined Contribution" schemes for their occupational pension face the same predicament. And so will those who choose to join one of Blair's "stakeholder pensions." But even those workers who still belong to a so-called "Defined Benefit" scheme are not safe. A number of British companies, in the steel industry in particular, seem ready to use the pretext of the stock market meltdown to opt out of their contractual duty to guarantee their employees' pension entitlement. Already workers in the three Carparo Steel plants had to take strike action to oppose such plans and strikes are planned at Corus over the same issue.
Not everyone has lost out in the debacle of this speculative bubble. A recent survey published in the Financial Times showed that the 181 highest-paid executives in the 25 largest U.S. bankrupt companies grossed a total 3.3 billion dollars over the two years 1999-2001. Out of this total, 2.9 billion dollars came from selling share options (which they had often awarded themselves) before their companies' shares had lost their value. Predictably, this survey does not say anything about the compensation won by the 94,182 workers who have been sacked so far by these companies. But one can guess that it is nothing remotely comparable.
In Britain, such figures are more difficult to come by, since they are covered by what the bosses call "commercial secrecy." However a survey published by the trade-union sponsored Labour Research shows that in 2001 Britain's highest paid executives enjoyed their 8th consecutive year of double-digit salary increases (a 16.1% average). Since 1995, the average executive salary has increased by 172%, to reach about 1.2 million dollars a year without taking into account additional perks, like pensions, share options or golden handshakes. And these are the parasitic fat cats who would like to deprive working people of the decent pension to which they have contributed all of their working lives!
The truth is that no matter what the capitalists claim about their losses, they have done quite well through this latest crisis of their system. They have even managed, in most rich countries, to increase their share of the national wealth. Their system is irrational, unmanageable and criminal and it will have to be overthrown to stop it from plunging the entire planet into catastrophe. But in the meantime, the capitalists will have to be stopped from making the working class foot the bill once again. It is their system and their crisis, let them pay for it!