An obvious point about stock market downturns always seems
to get lost right after one of them occurs. Stock market
losses are not losses to society. They are transfers from
one person to another. For instance, at the end of 1999, I
sank a bunch of money into an Internet company called
Exodus Communications. I was a greedy fool to have done it,
but I had been to a Merrill Lynch conference (them again!)
that featured Exodus Communications, and the story Henry
Blodget and a few other people told was so good that I
figured that even if Exodus Communications didn't wind up
being a big success, enough people would believe in the
thing to drive the stock price even higher and allow me to
get out with a quick profit. Everyone else was getting rich
without working; why not me? I should have sensed that the
moment I finally decided Internet stocks were a buy is
precisely when they became a sell. Instead, I jumped into
Exodus Communications at $160 a share and watched it run up
a few points -- and then collapse.
What happened to my money? It didn't simply vanish. It was
pocketed by the person who sold me the shares. The
suspects, in order of likelihood: a) some Exodus employee;
b) a well-connected mutual fund that got in early at the
I.P.O. price ;or c) a day trader who bought it at $150.
About the trillions that have been shaved off the stock
market in the past two and a half years, the more general
question is: from whom did it come and to whom did it go? A
coming book, ''In the Company of Owners,'' written by the
sociologist Joseph Blasi and the economist Douglas Kruse
with the Business Week reporter Aaron Bernstein,
ingeniously answers this second question. The professors
combed through the record of stock-option sales by ordinary
employees of the 100 biggest New Economy-type companies.
And they found that, while the executives of these
companies made off with great wads of cash, the ordinary
employees, as a group, did far better. Through the boom,
investors forked over $78 billion to the regular employees
of 100 start-ups. The grunts of the bankrupt Excite@Home,
for instance, made off with an estimated $660 million
before their company went under.
The astonishing thing, to the authors, was the egalitarian
structure of boom companies. ''No other industry,'' they
write, ''has ever attempted, much less achieved, the depth,
breadth and extent of wealth-sharing found among these
firms.'' Of course, the recriminations of the bust imply
that the ''wealth sharing'' was mainly a giant con game.
But to anyone who thinks about it for even a moment, this
obviously was not true. The people who worked for these
companies, in the main, believed in what they were doing
and proved it by holding on to many outstanding shares
until the bitter end. Employees of Exodus Communications
held some huge numbers of Exodus Communications shares at
its moment of doom.
Back in 1984, an economist named Martin Weitzman wrote what
should have been a world-changing book called ''The Share
Economy.'' In it he described, as a kind of economic
utopia, what would come to be the innovative corporate
structure of the 1990's. Weitzman pointed out that
recessions may be inevitable, but that their most tragic
consequence, unemployment, don't have to be. The layoffs
that came with recessions occurred because wages tended to
be ''sticky,'' i.e., companies couldn't persuade their
workers to accept lower wages in bad times. Unable to trim
payrolls, companies instead laid off workers.
In bad times, in effect, labor overpriced its services. The
solution Weitzman proposed was breathtakingly simple: make
some part of what workers are paid a function of the
company's fortunes. Give them stock instead of cash. In
good times the stock would have more value and be the
equivalent of a raise. In bad times the stock would lose
value and be the equivalent of a pay cut.
For more than a decade Weitzman's idea was hailed as
brilliant by his profession and went ignored by the wider
world. Then, in spectacular fashion, it took hold. Suddenly
a more rational structure -- in which workers had a stake
in their enterprise -- gained popular acceptance. And now,
just as suddenly, it is thought to be discredited. Why?
I don't imagine that stock market trauma is ever, in and of
itself, a good thing for an economy. But this most recent
one was not nearly so bad, economically or even morally, as
advertised. The most forward-looking companies in America
experimented with a corporate structure based on worker
ownership. It made a lot more sense than the old-fashioned
corporate structure. People like me who played craps with
some hot stock received an expensive lesson about playing
craps in the stock market. Our punishment was swift and
just. It was the rewards of the boom that seemed, in
retrospect, wacky and arbitrary.
But were they? Compare the boom, as many amateur historians
now seem to want to do, to the early-17th-century tulip
craze in Holland. If speculators drive up the price of
tulip bulbs to ridiculous heights, a result is a lot of
rotting tulip bulbs. But if speculators drive up the price
of tech stocks to ridiculous heights, a result is vast
numbers of young people with technical training and a lust
for entrepreneurship, a higher social status for the
entrepreneur and, uncoincidentally, many interesting
business ideas that are at the moment ahead of their time
but one day may well be right on it. A result is also, in
this case, hundreds of thousands of miles of surplus
optical fiber, which is a bit wasteful -- we don't need it
yet -- but not a total waste: we will need it one day soon.
Another result, finally, is a lot of formerly sleepy big
companies that had the living hell scared out of them by
upstarts -- and scrambled to make themselves more
efficient. Say what you will about the boom: it kept people
on their toes.
The massive transfer of greenbacks into the engineering
department of American society had some useful side
effects. Or, if you want to argue that it hasn't, you have
some explaining to do. You need to explain, for instance,
the continuing rapid growth of a great many of the
companies created during the boom. ''From the end of 1999
to the end of 2001,'' write the authors of ''In the Company
of Owners,'' employment in the top 100 boom-era companies
climbed 26 percent. That's 177,000 jobs. These companies
have real customers and real sales, which have continued to
grow after the high-tech bust and the demise of the
dot-coms. As of July of this year, just 8 of the 100 have
failed. Only 3 more beyond these experienced falling
revenues. According to the authors, the rest are growing
and have accounted for an increase of $59 billion in
combined sales in the past three full years.
And what is to be made of the robust productivity numbers
that began to roll in 1995 and continue to roll in to this
day? ''Productivity,'' which is the measure of output per
worker hour, is by far the best measure of the health of
the economy. It is the closest that economic statistics
come to capturing the wealth of the nation. A coming paper
written by Prof. William Nordhaus of Yale, to be published
by the Brookings Institution, shows that, beginning in
1995, there was a mysterious surge in worker productivity.
Mysterious because ultimately no one can say precisely
where it or any other surge in productivity comes from, or
why. But ultimately, Nordhaus would argue, ''it comes from
technological change. People find better ways to do the
same things.''
What were the late 1990's all about if not about using new
tools to find new, better ways to do the same things?
Indeed one way of viewing this entire financial period is
as an attempt by the market to pay people for innovation
rather than for profits, on the assumption that innovation,
in the long run, would lead inevitably to greater profits.
The disjuncture between corporate profits and economic
productivity suggests a couple of intriguing questions. The
first is: Are corporate profits overrated? Not long ago
Professor Nordhaus (who is, I should say, more of a New
Economy agnostic than an apologist) asked a similar
question: Do industries with high rates of productivity
growth also enjoy high rates of growth in corporate
profits? No. Just the opposite. That is, the industries of
the future, the fast-growing ones, the ones in which people
are most rapidly becoming more productive, are among the
least profitable. American economic life tends always to
conform to the interests of investors, but that doesn't
mean that it always should. The Internet-Telecom boom is
one of many examples of an extremely useful technology
bursting upon the scene that failed to make corporate
profits. There are huge, immeasurable social and economic
benefits to improving the speed and availability of
information; and yet companies have had, to put it mildly,
some trouble making money by speeding up information or
making it more widely available.
But the same charge might be made against a lot of other
new technologies, starting with, say, the airplane. Warren
Buffett, who got himself badly singed by US Airways stock,
is fond of introducing air travel as an example of a
technology that has regularly failed to make investors a
penny. But what's bad for Warren Buffett isn't bad for
America. We're not better off economically without air
travel. Investors are simply better off steering clear of
companies that sell it. The sad truth, for investors, seems
to be that most of the benefits of new technologies are
passed right through to consumers free of charge.
(Microsoft, thanks to its monopoly powers, is the main
exception.)
For this reason, sane, cautious investors like Warren
Buffett make a point of avoiding high technology
investments. For this reason, too, a sane, rational stock
market channels less than the socially optimal amounts of
capital into innovation. Good new technologies are a bit
like good new roads: their social benefits far exceed what
any one person or company can get paid for creating them.
Even the laissez-faire wing of the economics professions
has long agreed that government might profitably subsidize
innovation by, for instance, financing university
engineering departments. Government has obviously done
this, albeit in a haphazard fashion. Still, there remains a
huge gap between the optimum investment in technical
progress and the amount we usually invest to achieve it. In
this respect, the late 1990's were an exception.
That suggests another interesting question. Not: Were the
late 1990's a great disaster for the U.S. economy? But: As
a social policy, might we try to recreate the late 1990's?
IV. The Old Old Thing Is Back
A few months ago there was
a vivid illustration of the price we pay, not for the boom,
but for the irrational reaction against it. It had to do
with a money manager named Bill Gross. For the past 30
years Gross has run a very conservative bond fund in
Southern California called Pimco; more recently he has also
written a monthly online investment column. The column is
an outlet for Gross's literary ambition. His articles are
nicely written and fun to read. They were also generally
ignored, until recently. That changed when a) Pimco, the
closest place in the financial markets to that space
beneath your mattress, swelled from $230 billion in assets
to $301 billion and replaced Fidelity's Magellan Fund as
the world's biggest mutual fund, and b) Gross decided he
wanted to write about the integrity of American commerce.
Casting about for material for his March column, his eye
fell upon an item in the ''Credit Markets'' column buried
in the back of Section 3 of The Wall Street Journal. A
woman at GE Capital was quoted saying that G.E. had decided
to sell $11 billion in bonds because ''absolute yield
levels are at historic lows . . . so we think now is the
right time to be doing an offering like this.'' That struck
Gross as an outrageous lie.
Now at this point in the story any ordinary person might
wonder, ''He got upset by that?'' Yes, he did. ''Historic
lows?'' Gross thundered in his column. Then he proceeded to
talk bond talk. ''Maybe three months and 100 basis points
ago, but not now, I'm afraid.'' He then went on to explain
to his readers what G.E. was actually doing: shoring up its
balance sheet on the sly. During the boom G.E. had taken
advantage of low short-term interest rates and investor
lassitude to borrow a lot of money short term, and less
money long term. It was like the owner of a house who had
opted for the 30-day floating-rate instead of the 30-year
fixed-rate mortgage: it was exposed to rising interest
rates. At any moment, investors might change their minds
about the company and cease to lend it money; if they
weren't going to do it on their own, Gross was going to
help them. ''GE Capital,'' wrote Gross, ''has been allowed
to accumulate $50 billion of unbacked commercial paper'' --
short-term loans -- ''because of the lack of market
discipline. By issuing $11 billion in debt, G.E. was
sensing its vulnerability.'' Gross concluded by charging
G.E. with dishonesty, and saying that ''Pimco will own no
G.E. commercial paper in the foreseeable future.''
A few hours after Gross hit ''send'' and posted his column,
G.E.'s stock began what would be a quick 10 percent drop,
G.E.'s financial officers were on the phone to Gross making
hysterical sounds and reporters on G.E.-owned CNBC were
accusing Gross of talking down G.E. bonds so that he might
snap them up cheaply for himself. By the time Gross
finished explaining himself in late April, G.E. had lost a
quarter of its market value, and the company was holding
hastily thrown together conference calls to reassure
investors. In the end, G.E. announced that it would
restructure its operations. Gross had written his thousand
words or so to slake his literary vanity and chosen, pretty
much arbitrarily, G.E. for his material. He himself could
not quite believe how much trouble he was able to cause.
''My point was a general one about corporate honesty,'' he
says, more than a little sheepishly, ''and I wound up
hitting G.E. And I really didn't give a darn about G.E.''
It's hard not to take pleasure in the misfortune of others,
especially when those others are rich and powerful. Who
does not squeal with delight when he sees yet another
article about Jack Welch's divorce? But still: this is
absurd. The country's biggest company, sensing its balance
sheet is out of whack, goes and tries to do something about
it and, for its troubles, gets swatted around by a bond guy
in need of material for his column.
At any rate, when a bond guy can terrorize G.E., it isn't
G.E. who suffers. Not really. Raise the cost of capital to
G.E., and G.E. can live with it. G.E. doesn't like it, but
G.E. can live with it. The person who really suffers from
terror in the financial markets is the person who needs
capital and who is on the brink of not getting it. The
capital markets are a game of crack the whip: the gentle
curve experienced by the big guy at the front is felt by
the little guy in the rear as a back-snapping hairpin turn.
When G.E. can be terrorized by a single mutual fund is when
the venture capitalists of Silicon Valley start giving back
the $100 billion of capital to its original owners, rather
than invest it in start-ups.
That's the odd thing about the present moment: it is widely
understood as a populist uprising against business elites.
It's closer to an elitist uprising against popular
capitalism. It's a backlash against the excessive
opportunity afforded the masses. (No more free capital!)
The big issue in capitalism is who gets capital, and on
what terms. And when the little guy does not get capital,
the big guy usually benefits. Look around. Who is winning
the bust? The old guard. Corporate authority of the
ancient, hoary kind, bond traders, leveraged-buyout firms,
regulated utilities. There's no more talk of the need to
break up Microsoft. Instead there's new talk about letting
AT&T get back together again. Even the big Wall Street
firms, beleaguered as they might seem, have probably
actually improved their positions relative to online
brokers.
V. The Virtues of Vice
There's plenty to criticize about American financial life,
but the problems are less with rule-breaking than with the
game itself. Even in the most fastidious of times it is
boorishly single-minded. It elevates the desire to make
money over other, nobler desires. It's more than a little
nuts for a man who has a billion dollars to devote his life
to making another billion, but that's what some of our most
exalted citizens do, over and over again. That's who we
are; that's how we seem to like to spend our time.
Americans are incapable of hating the rich; certainly they
will always prefer them to the poor. The boom and
everything that went with it -- the hype, the hope, the mad
scramble for a piece of the action, the ever escalating
definition of ''rich,'' the grotesque ratcheting up of
executive pay -- is much closer to our hearts than the bust
and everything that goes with it. People who view us from a
distance understand this. That's why when they want to
attack us, they blow up the World Trade Center and not the
Securities and Exchange Commission. Why don't we understand
this about ourselves?
It is deplorable that some executives fiddled their books
and stole from their companies. But their behavior was, in
the grand scheme of things, trivial. Less than trivial:
expected. A boom without crooks is like a dog without
fleas. It doesn't happen. Why is that? Why do periods of
great prosperity always wind up being periods of great
scandal? It's not that it happens occasionally. It happens
every time. The railroad boom makes the Internet boom look
clean. The Wall Street boom of the 1980's, the conglomerate
boom of the 1960's, when they came to an end, had their
evil villains and were followed by regulatory zeal that
appears to have had exactly zero effect the next time the
stock market went up.
Is it possible that scandal is somehow an essential
ingredient in capitalism? That a healthy free-market
economy must tempt a certain number of people to behave
corruptly, and that a certain number of these will do so?
That the crooks are not a sign that something is rotten but
that something is working more or less as it was meant to
work? After all, a market economy is premised on a system
of incentives designed to encourage an ignoble human trait:
self-interest. Is it all that shocking that, when this
system undergoes an exciting positive transformation,
self-interest spins out of control?
Of course, it is good that the crooks are rounded up. We
can all move on feeling as if justice was done, and perhaps
the next time around fewer people will succumb to
temptation. But in the meantime it's worth asking: how did
the crooks get away with it in the first place? Where were
the bold regulators and the fire-breathing journalists five
years ago, when it actually would have been a little brave,
possibly even a little useful, to inveigh against the
excesses of the boom? Where in the stock market of five
years ago was Eliot Spitzer? (Fully invested with Jim
Cramer, who wrote the book about how to use the media to
juice one's own portfolio.) Where was the press? Egging on
the very people they now seek to humiliate. The very people
who are now baying so loudly for blood were in most cases
creating the climate that rewarded corrupt practices.
Around the time the Enron scandal broke last October, there
was a good example of just how effortlessly the celebration
of the 1990's became the retribution of the 2000's. As
gleefully reported by Forbes magazine, Fortune magazine was
about to go to press with a cover article for its Nov. 26
issue about the post-9/11 economy in which ''the smartest
people we know'' were consulted. As it happened, one of
those people was Kenneth Lay, the chairman and chief
executive of Enron Corporation. The issue was laid out,
with Lay's picture right there on the cover when the Enron
scandal broke. You might think that would pose a big
problem for Fortune magazine, but if it did, the magazine
didn't show it. Using a nifty 1990's piece of photo-editing
software, the editors were able to erase Ken Lay. Fortune
published on schedule and, ignoring all the flattery it had
lavished on Enron over the past few years, piled right onto
the scandal. It took only a few months before two of
Fortune's writers had sold their Enron book for $1.4
million.
Good for them, I say. We all have to earn a living. But the
next time some editor, or regulator, or politician seeking
re-election, begins to shriek about the iniquities of the
boom, someone needs to turn to him and ask: where were you
when it was happening? And if the answer happens to be,
''Making the boom work for me,'' the best thing you can do
is forgive him for it. Really, it wasn't such a bad way to
spend your time.
Michael Lewis is a contributing writer for the magazine.
His book about baseball will be published next spring by W.
W. Norton.
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