Surprisingly little to do with real investment

Excerpt from Doug Henwood's book Wall Street p.3-4 

In a soundbite, the U.S. financial system performs dismally at its advertised

task, that of efficiently directing society’s savings towards their optimal

investment pursuits. The system is stupefyingly expensive, gives

terrible signals for the allocation of capital, and has surprisingly little to do

with real investment. Most money managers can barely match market averages

— and there’s evidence that active trading reduces performance

rather than improving it — yet they still haul in big fees, and their brokers,

big commissions (Lakonishok, Shleifer, and Vishny 1992). Over the long

haul, almost all corporate capital expenditures are internally financed,

through profits and depreciation allowances. And instead of promoting

investment, the U.S. financial system seems to do quite the opposite; U.S.

investment levels rank towards the bottom of the First World (OECD) countries,

and are below what even quite orthodox economists — like Darrel

Cohen, Kevin Hassett, and Jim Kennedy (1995) of the Federal Reserve —

term “optimal” levels. Real investment, not buying shares in a mutual fund.

Take, for example, the stock market, which is probably the centerpiece

of the whole enterprise.1 What does it do? Both civilians and professional

apologists would probably answer by saying that it raises capital for investment.

In fact it doesn’t. Between 1981 and 1997, U.S. nonfinancial

corporations retired $813 billion more in stock than they issued, thanks to

takeovers and buybacks. Of course, some individual firms did issue stock

to raise money, but surprisingly little of that went to investment either. A

Wall Street Journal

article on 1996’s dizzying pace of stock issuance

(McGeehan 1996) named overseas privatizations (some of which, like

Deutsche Telekom, spilled into U.S. markets) “and the continuing restructuring

of U.S. corporations” as the driving forces behind the torrent of

new paper. In other words, even the new-issues market has more to do

with the arrangement and rearrangement of ownership patterns than it

WALL STREET

4

does with raising fresh capital — a point I’ll return to throughout this book.

But most of the trading in the stock market is of existing shares, not

newly issued ones. New issues in 1997 totaled $100 billion, a record —

but that’s about a week’s trading volume on the New York Stock Exchange.

2

One thing the financial markets do very well, however, is concentrate

wealth. Government debt, for example, can be thought of as a means for

upward redistribution of income, from ordinary taxpayers to rich bondholders.

Instead of taxing rich people, governments borrow from them,

and pay them interest for the privilege. Consumer credit also enriches the

rich; people suffering stagnant wages who use the VISA card to make

ends meet only fatten the wallets of their creditors with each monthly

payment. Nonfinancial corporations pay their stockholders billions in annual

dividends rather than reinvesting them in the business. It’s no wonder,

then, that wealth has congealed so spectacularly at the top. Chapter 2

offers detailed numbers; for the purposes of this introduction, however, a

couple of gee-whiz factoids will do. Leaving aside the principal residence,

the richest

1/2% of the U.S. population claims a larger share of national

wealth than the bottom 90%, and the richest 10% account for over threequarters

of the total. And with that wealth comes extraordinary social power

— the power to buy politicians, pundits, and professors, and to dictate

both public and corporate policy.

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