Many people would call Milton Friedman the most influential conservative economist of the 20th century, but you could make a case for Michael Jensen too. In the late 1990s Jensen got a phone call from his daughter Stephanie, who hadn’t spoken to him in years. She had just attended a seminar based on techniques developed by Werner Erhard, a popular self-help guru who set up est (short for Erhard Seminars Training), where participants would stand up and share their personal issues, then engage in public therapy with the session leader. During the session she realized she loved her father—and she told him he should come to a seminar.
Three weeks later, he was there. He was coaxed to the microphone, where he mostly bragged about his accomplishments and status. But he also ventured some personal revelations: “most people think I’m an asshole,” Nicholas Lemann recounts him saying, and his personal life was littered with human debris, though he didn’t understand why.
The seminar leader wondered, Could arrogance be the problem? No, absolutely not, Jensen replied. He sat down. He didn’t know it yet, but the episode would soon change his life.
BOOKS DISCUSSED IN THIS ESSAY
Transaction Man: The Rise of the Deal and the Decline of the American Dream, Nicholas Lemann (FSG; September 2019) · The Economists’ Hour: False Prophets, Free Markets and the Fracture of Society, Binyamin Appelbaum (Little, Brown and Company; September 2019) · Organized Money: How Progressives Can Leverage the Financial System to Work for Them, Not Against Them, Keith Mestrich and Mark Pinsky (The New Press; October 2019)
Lemann’s excellent Transaction Man: the Rise of the Deal and the Decline of the American Dream explores how Jensen helped change the business world, around the world. Until around the 1970s, leaders of large industrial corporations had tended to serve two masters: owners and profits, on the one hand, and on the other, guided by government, workers and society at large.
Two main schools of thought sought to tackle concentrated corporate power. One was championed by Supreme Court Justice Louis Brandeis, who fretted about a “curse of bigness” and argued that large firms were always a political (and economic) threat and should be broken up, creating diverse and competitive economic ecosystems.
The other was “Clash of the Titans liberalism,” which Lemann explores through its most prominent advocate, Adolf Berle, Franklin Roosevelt’s chief economic theorist. Large corporations were tolerated as an inevitable fruit of progress, Berle reasoned, but they should be tamed by powerful government (and strong labor). FDR’s New Deal, heavily influenced by Berle, underpinned nearly a quarter-century of broad-based prosperity after the Second World War, and by the end of Berle’s life in 1971 he reckoned the “unlimited voltage” of government had been successfully deployed to check and shape corporate power sufficiently to turn them into central social institutions in the good society.
The problem, alas, was not solved. Strong currents were astir beneath the surface, which would overthrow this consensus. Those currents typically involved economists, occupying a “narrow portion of the ideological spectrum,” as Binyamin Appelbaum explains in his deeply researched The Economists’ Hour: False Prophets, Free Markets and the Fracture of Society.
By the early 1970s, economists and bankers were storming the ramparts of power and influence.
Economists didn’t used to be influential: in 1952, Appelbaum recounts, Republicans tried unsuccessfully to close down the Council of Economic Advisers, and at that time William McChesney Martin Jr., head of the Federal Reserve, had relegated them to the basement of the building, because, he said, “they have a far greater sense of confidence in their analyses than I have found warranted.” The financial sector, for its part, was not especially powerful or profitable either (in 1970, Lemann notes, Morgan Stanley had just 230 employees—compared to 500,000 employed by General Motors.)
This period when economists were left neglected in basements, and banks and bankers were heavily constrained by high taxes and powerful New Deal regulations, was also an era of high, broad-based economic growth around the world.
But revolution was coming. By the early 1970s, economists and bankers were storming the ramparts of power and influence. Friedman threw a bomb into Berle’s consensus about large corporations delivering the good society with a now-famous article in the New York Times magazine in 1970, entitled “The social responsibility of business is to increase its profits.”
It was “pure and unadulterated socialism,” he thundered, to think that business leaders should fret about providing employment, eliminating discrimination or avoiding pollution. No, he argued, corporate bosses should attend to profits and profits alone, with clear accountability to shareholders and owners. Government could look after namby-pamby social issues: but for corporate bosses, “shareholder value” should be the north star.
Jensen liked Friedman’s ideas, but said he hadn’t gone far enough. In a series of articles starting with his “Theory of the Firm” in 1976, he argued that corporations weren’t hyper-efficient, profit-maximizing microeconomic atoms in a free market, but sprawling bureaucracies whose chief executives ensured corporate boards were stuffed with their cronies, and ruled their fiefdoms based on friendships, whims, and on “the attractiveness of the office staff”.
This was the “principal-agent problem”: managers weren’t accountable to owners. The solutions to this soggy state of affairs, he wrote, were threefold. First, tie managers’ remuneration closely to the share price, with stock options and other incentives to make them act in line with shareholders’ wishes. Next, sharpen their anxiety to squeeze out profits by raising the stakes, with large dollops of debt.
The third, grandest prescription was to relax laws to allow for the development of a full-blooded “market for corporate control,” where financial players would buy and sell companies across the global economy as if they were cartons of orange juice. The free market, thus unleashed from above onto the corporate landscape, would magically dismantle and rearrange the corporate world in a blur of dealmaking to deliver a great surge of efficiency to the economy.
Some might call these the prescriptions of an asshole. But Jensen, who was, for Lemann, the emblematic “Transaction Man,” was in lockstep with where the money wanted to go—and also with a new generation of economists for whom efficiency trumped considerations of justice or the rule of law. (And, whisper it quietly, a spigot of hefty business consultancy fees was opening up, from which many would thirstily drink.)
These people were also inspired by the Austrian thinker Friedrich Hayek, whose influential book The Road to Serfdom, published in 1944, argued that prices in open markets could handle information far more efficiently than any government bureaucracy could, and that markets should therefore be enabled to penetrate into as many spheres of economic and even political life as possible. Economists would be the handmaidens of this transformation. An exchange in 1983 between the lawyer Robert Bork, the economist Richard Posner, and Henry Manne, another economist who worked with Charles Koch to help build a network of free-market think tanks, illustrates the rise of this “economics imperialism.”
Bork: As far as I know, the economists have not yet done any damage to constitutional law.
Posner: We are working on that.
Manne: We’ll chase you out of that too. [laughter]
On Jensen’s and Friedman’s narrow terms, the results have been spectacular. Jensen’s “market for corporate control” roared to life, as the Reagan-era relaxation of antitrust rules encouraged a frenzy of mergers and takeovers. During the 1980s alone, over a quarter of the Fortune 500 companies were subject to takeover attempts, led by the barbarians of the Leveraged Buyout (LBO) industry, nowadays known as “private equity”. They hoovered up profitable and successful firms across the economic landscape, then subjected them to financial engineering, to extract more “value” for shareholders.
So they might, for instance, run their corporate subjects’ financial affairs through tax havens (to extract wealth from taxpayers); or crush labor unions or employee benefits or pensions (to extract from the workforce); or buy up all the players in a market niche to create monopolistic power (to extract from consumers, suppliers or workers).
Integrity wasn’t where the big money wanted to go. It still isn’t.
Little of this contributed to genuine productivity. Jensen’s revolution was transforming a business world dedicated to creating wealth on behalf of wider society, into one focused on extracting wealth on behalf of an increasingly small class of wealthy owners. And the LBO/private equity titans wielded limited liability laws to take huge, profitable, debt-enhanced risks from which they could take the winnings, then shovel all the consequences of those risks onto wider society. Jensen’s recommendations hadn’t solved the principal-agent problem: they had shifted it to a different terrain and made it worse.
The results of these shifts have been soaring inequality, widespread fraud, monster monopolies, an explosion of tax haven activity, too-big-to-fail banks, and the generalized rigging of markets on shareholders’ behalf, against wider societies. Appelbaum notes that “a bloated financial sector is weighing on growth in developed nations,” partly because so many talented people are engaged in “toll collecting” rather than productive activity, and notes, more surprisingly, that while U.S. growth has outstripped France’s during the 1970s, this picture flips the other way if you exclude the top 1% in each country. (All this is part of a generalized and seemingly paradoxical phenomenon I call the “finance curse, where more finance seems to have made many of our countries poorer.)
The blending of personal narratives with rich, deep analysis in both Transaction Man and Economists’ Hour felt a tad overwhelming at times, as character after character popped up with a cameo, then disappeared again. But ultimately this approach is a strength, for no history can be properly understood without the human foibles and motivations that so many mad-scientist economists like Jensen airbrushed out of their elegant, math-heavy models.
Lemann, who interviewed Jensen more than once, brings us back to that seminar his daughter asked him to attend, and a plane flight he took a few days later. He found himself grasping the tray table, gripped by a fear that the plane was about to crash. It was the start of an epiphany. He could stop being an asshole. He eventually teamed up with Erhard, est’s founder, who had settled in the Cayman Islands.
Jensen reckoned Erhard’s teachings were just as important as the revolution in financial economics he had fostered: they urgently needed to get it into universities. In 2002, his about-face reinforced by the bursting of the internet bubble, along with the Enron, WorldCom and Nortel scandals, which exposed in lurid public detail the failings of unfettered markets, he co-authored an article with Erhard entitled “Just Say No to Wall Street.” The mantra now was to push “integrity” as the inviolable principle for business managers.
Lemann tracks Jensen down to a windowless room in a resort hotel in Bermuda, where he’s co-hosting a seminar for paying customers with name tags. He rails against the “lying, cheating and stealing” in the financial sector and pushes his audience to embrace his version of integrity. (In Bermuda, of all places, one of the world’s biggest corporate tax havens, where ‘integrity’ has been distilled into the purest possible version of shareholder value: extract profits, at the expense of every stakeholder you can imagine.)
Jensen and Erhard had spent years trying to wrangle their ideas into a systematic body of philosophy, to revolutionize business thinking again. But by the time they finally got their paper into an academic journal in 2017, five years after posting a first draft online, it had gotten fewer than 50 academic citations. His earlier “Theory of the Firm” had 66,000. Good ideas aren’t enough, Lemann writes. “There has to be a confluence between the ideas themselves, the spirit of the times, and the interests of powerful players who find the ideas congenial.” Integrity wasn’t where the big money wanted to go. It still isn’t.
A third book offers a novel approach to fighting against where the big money wants to go. It is Organized Money: How Progressives Can Leverage the Financial System to Work for Them, Not Against Them by Keith Mestrich, a senior banker, and Mark Pinsky, a strategist who has advised big financial institutions and nonprofits. “Most of the time the financial industry’s power and influence spreads unseen, like a root system, connecting people, communities, towns, cities, states and nations,” they write. “It works through economic leverage, social norms, civic thought, political access, policy change, and technological transformations.” And the problem, they continue, is that this system “taps your money to pay for a conservative agenda.”
So far, so good. But their big solution will, for many people, stick in the craw. To push back against conservative finance, they argue, progressives need to muster “progressive money muscle,” a financial counterweight to “push back against conservative money muscle.” And they go further, with a truly grand claim: that “organized money is the gateway to the next progressive era.” This rippling progressive financial brawn would include $1 trillion in ownership stakes in banks, insurance companies, credit unions, private equity firms, impact investors, family offices, community development financial institutions, socially responsible investors, and more.
The global financial crisis should have washed away this religion [of finance], but that’s the thing about religions: faith endures shocks.
Some of these can certainly provide some help to some people in need, for some of the time, under some conditions. But who would supply this trillion dollars, and why? If motivated by profit and value for shareholders, could this be any more “progressive” than Wall Street is today? If not motivated by profit, then it’s hard to see where these progressive investors may come from, or how they will, as the authors put it, “disrupt the global financial system.”
Ideas such as luring investors into “opportunity zones” using capital gains tax breaks, then hemming them in with “public purpose finance guardrails,” shows muddled thinking: financial players are adept at taking the giveaways and escaping the controls. And to elevate private equity firms, say, as potential saviors is like recruiting wolves to guard a flock of sheep against marauding wolves. The strategy carries, shall we say, risks.
The evidence against a necessary supremacy of economists (and financiers) has been steadily mounting for decades, at least for those willing to look for it.
Appelbaum’s book is nuanced, crediting economists with a number of successes, such as influencing the end of the military draft. Oftentimes, he writes, economists have offered good ideas which then went too far. Ultimately, though, he laments their overwhelming influence. Lemann, by some contrast, blames a shift from “an institution-oriented to a transaction-oriented society”—that is, from a world of large corporations corralled by large governments into serving society, to a more recent one where everything gets seen through a more transactional, financial lens, to finance and dealmakers’ benefit. These two different analyses are quite compatible with one another, and both are surely right.
Lemann’s grand solution to the issues at hand is pluralism: a society where interest groups (such as labor unions) fight in their own corner and influence government, and there’s no Big Idea to rule them all. It’s a story leavened with long sections about the residents of Chicago Lawn in Chicago, who fought to better their community by organizing.
Appelbaum’s solutions are varied and include making markets “less efficient” in some cases, along with good old fashioned tactics: leveling the playing field, providing a safety net; considering the impacts of policies on the distribution of wealth and income; or taking markets out of areas where they have no business being (he cites seats that are reserved for the general public to observe congressional hearings: those waiting in line for them are usually just paid to wait in line to save the seat for a lobbyist.) His other big solution, of course, is to tame the unwarranted super-influence of economists.
Economists may have lost some sway in the Trump administration, which has elevated loyalty over cleverness or experience in its selection criteria. But the apparatus of government remains infested with them, in the United States and around the world, despite all that has happened. A word in Appelbaum’s subtitle, “Prophets,” gives a clue as to why.
In his and Lemann’s book, and in any number of other books on finance, I find religious words again and again: “catechism,” “faith,” “belief system,” “true believers” “messianic,” “saint,” or “religion”. As Clayton Christensen of Harvard Business School has explained, society has been in the grip of a “New Church of Finance,” whose members include finance professors at business schools, economists, and partners in hedge funds and private equity funds.
“It has many of the characteristics of a well-catechized belief system. For those committed true believers within this ‘church’ it is inconceivable that the catechism isn’t true.” Jensen may have had his est-driven epiphany, fully sundering the catechism’s hold on him, but few others have.
The global financial crisis should have washed away this religion, but that’s the thing about religions: faith endures shocks. That’s why, after a brief (and fairly successful) economic stimulus program after the crisis, the Obama administration, with Repubican help, turned decisively towards austerity in January 2010, praising families for tightening belts and “making tough decisions,” he said, adding that “the Federal government should do the same.” The old pro-finance consensus fairly rapidly re-asserted itself.
A criticism I could level against all three books is common to many American authors. They are guilty of parochialism, viewing an interconnected world that tends not to stray too far beyond US borders. Both Appelbaum and Lemann do venture overseas at times, but not enough (Lemann does not, for instance, even mention Margaret Thatcher). The deregulation of finance cannot be understand without properly exploring the central role of foreign financial centers, including small tax havens but especially the City of London, in having provided Wall Street with a financial escape route from the New Deal financial regulations, allowing their overseas outposts to become “competitive” battering rams of money that helped smash open the Bretton Woods system that had successfully curbed the excesses of cross-border finance after World War II.
The so-called Eurodollar markets that first emerged in London in the 1950s and then spread around the world were the foundation for the high-speed, largely unfettered global financial markets which hold such power today.
People may feel fatalistic about the ubiquity and power of global finance, but among the great virtues of Transaction Man and Economists’ Hour are the revelations about just how different things used to be—and, by implication, how different they can be again.
Nicholas Shaxson’s The Finance Curse is out now from Grove Press.