Washington Decoded

Greed Is All Right

Den of Thieves
By James B. Stewart
Simon & Schuster. 493 pp. $24.95

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By Max Holland

    If James Stewart's Den of Thieves (Simon & Schuster, 1991) is just half accurate, Wall Street’s mores and culture in the 1980s bore an amazing resemblance to the Mafia’s. As depicted by Stewart, Wall Street was a world unto itself greased by the exchange of favors. Money, power and sex defined status. Providing for one’s family was the ostensible excuse for any behavior, and only suckers played without an edge. Wall Street argot, as in “This company is going down” or “We’ll squeeze the board of directors,” bespoke violence, albeit of an economic kind. The universe outside was viewed with contempt, and Securities and Exchange Commission (SEC) lawyers (the cops on the beat) were fools too stupid to make it on the Street. Whenever the SEC mounted an investigation, Wall Street prized silence and loyalty above telling the truth. In practice, though, betrayal to save one’s own skin was commonplace. Den of Thieves reads like the script from director Martin Scorsese’s Goodfellas, with investment banker Martin Siegel in the role played by Ray Liotta.

    The great strength of this book lies in its use of SEC documents and federal court records, supplemented by interviews, to construct a story valuable, above all, for its coherence. Readers who closely followed newspaper accounts of the criminal misdeeds of Dennis Levine, Martin Siegel, Ivan Boesky and Michael Milken, the four main culprits in Den of Thieves, will still have their eyes opened by Stewart, a Pulitzer Prize-winning journalist with a law degree. Even the outstanding coverage of The Wall Street Journal, where Stewart is front-page editor, is no substitute for a sustained narrative that weaves together new information with half-forgotten facts. In particular, the means by which the government lawyers bring down “the Russian” (Boesky) and then Milken is crucial to understanding the whole sorry mess. Half the book is devoted to that grinding, slow-motion chase, most of which has never been reported, and it is the better half of the book.

    Few characters emerge with their reputations intact, fewer still with their reputations enhanced. Of the latter, the most prominent is Federal Judge Kimba Wood (a Reagan appointee, it must be pointed out), who sentenced Milken to ten years in prison precisely because he committed “only crimes that were unlikely to be detected.” Wood is to this scandal what John Sirica was to Watergate, a judge who restored some faith in the system, although Sirica had to work much harder and longer. Stewart’s other heroes are the SEC and Justice Department attorneys who persevered, finding resolve in the knowledge that they were, as one of them put it, “engaged in the single most important thing we would ever do in our lives.” Admirable characters outside the government are harder to find. Perhaps only Harvey Pitt acquitted himself well. Pitt, a former SEC general counsel who represented, among others, Ivan Boesky, managed to serve the interests of his clients and Justice at the same time.

That Milken emerges as the most malign individual among large cast of unsavory characters 1s no surprise. As late as 1986 Boesky seemed to have that mantle all to himself. In that year he defined the spirit of the eighties with his “greed is all right” commencement speech at Berkeley, not uncoincidentally marking Ronald  Reagan’s ultimate triumph over the campus that launched the Free Speech Movement. But Stewart rightly shows that Boesky, the arbitrageur, paled next to Milken, the junk bond king. It may have been a symbiotic relationship, but it was not equal. Boesky did Milken’s bidding, and so the decade ended with Milken as the embodiment of greed.

    I grew up in Los Angeles at roughly the same time as Milken, and I still find it hard to comprehend what a cheerleader from Birmingham High School (the Valley, no less) wrought. Start with Richard Nixon’s character flaws, add the zealotry and utter shamelessness of Oliver North, and the result might begin to approach Milken, an insecure, charismatic, obsessive accountant’s son who aimed to dominate the whole financial world. At some point Milken apparently decided that no big deal was going to be done without him, requiring him to seem unstoppable if not omnipotent. To this end he cheated his clients, his partners, his subordinates and his firm, Drexel Burnham Lambert. He tried to prevent publication of a book that dared criticize his junk bond empire. Once the SEC began to close in, Milken paid what amounted to hush money to try to keep his staff closemouthed. In all probability he destroyed evidence.

    Finally, in a last-ditch effort to stave off certain indictment, Milken underwrote an enormous public relations campaign calculated to neutralize public opinion, if not turn popular outrage into outright acclaim. Because any Manhattan jury was likely to include black Jurors, special efforts were made to propagandize the black community. Fortunately these did  not work, although Milken managed to enlist Jesse Jackson in this cynical exercise, yet another reminder that Jackson’s ego is larger than his politics.

    Milken’s lawyers were a true extension of their client. Edward Bennett Williams, the attorney hired by Milken immediately after Boesky pleaded guilty, sought to protect his client from indictment by keeping everyone at Drexel “inside the tent pissing out” instead of on each other. At no time did he ever attempt to get the truth from his client, unlike Harvey Pitt. In effect, it seems, Williams connived to obstruct justice.

    The tactics of Milken’s co-counsel, Arthur Liman, were even worse. When he became chief counsel to the Congressional committee investigating the Iran/contra scandal in 1987, Liman said his respect for the rule of law compelled him to put aside his lucrative corporate practice in order to perform a public service. But his defense of Milken suggests he has one set of legal ethics for government officials and another for wealthy private citizens.

  Just as Ollie North and Brendan Sullivan put North’s  interrogators on trial, Liman sought to make Milken’s critics and prosecutors the defendants. It was Liman who ordered that steps be taken to stop publication of Connie Bruck’s The Predators’ Ball “either through contacts” at Simon & Schuster “or in court.” It was Liman who suggested that Milken try his case in public by hiring Linda Robinson, a P.R. flack who proceeded to try to persuade America that Mike Milken was a “national treasure” instead of a national disgrace. After Williams died of cancer, full control of Milken’s defense fell to Liman, who clung to Williams’s scorched-earth tactics and continued to indulge Milken’s fantasies of complete innocence. When Drexel chairman Fred Joseph advocated a settlement with the SEC in a desperate effort to save the Drexel franchise, Liman accused him of “selling out” Milken, as if Drexel were an investment bank in Nazi Germany shedding itself of innocent Jewish partners. “That’s the first step towards concentration camps,” Liman told Joseph.

  Along with his sharply drawn portraits of right- and wrong-doers, Stewart sheds light on a neglected aspect of the frenzied eighties, namely, the care and feeding of the business press and other media by junk bond and takeover artists. But Stewart raises almost as many questions about the media as he answers. Martin Peretz, editor in chief of The New Republic, was a big investor in Boesky’s arbitrage fund. Did that fact have anything to do with the adulatory review of Boesky’s 1985 book, Merger Mania, that appeared in TNR? (One of Boesky’s assertions was that he never made any “undue profits.“) And why is it that none of the major networks, or PBS, ever put together a serious documentary about buyouts and junk bonds, a phenomenon that affected hundreds of thousands of jobs, pensions and benefits? Is it because "60 Minutes" producer Don Hewitt socializes with buyout artists like Henry Kravis, or because Kravis sits on the board of WNET, the PBS affiliate in New York?

    For all its power and value, Den of Thieves falls measurably short of the distinction some reviewers would give it: that it is the definitive book about Wall Street during the eighties. Stewart’s reportorial skills are considerable, but the book is stingy when it comes to going beyond a description of who-did-what to an interpretation of why things happened. The story begs, at many points, for Stewart to stop and paint the big analytic picture before he resumes his admittedly compelling narrative. He does so too infrequently. The underlying reasons for the eighties’ speculative boom are  inadequately discussed in three paragraphs on page eighty-three. The devolution of deal making over the decade is largely missing, along with significant nuances in the battles for corporate control. Even the October stock market crashes of 1987 and 1989 are treated almost as asides rather than events integral to the story. The sickening transformation of Wall Street from a collective means of financing the economy into a free-for-all looting of corporate America is never fully explained.

    A closely related drawback is Stewart’s focus on criminal activity: insider trading, the “parking” of stocks so as to conceal true ownership, and manipulation of share prices. This emphasis is understandable, given Stewart’s reliance on court documents that resulted in criminal convictions. But Wall Street in the eighties was not merely about illegality, though there was plenty of that. It was also about the utter collapse of business ethics, manipulation of the tax code by Wall Street’s best and brightest, who stole shareholders blind and then justified epic displays of avarice by claiming to maximize shareholder value. None of these activities are illegal, but they constitute more than half the depravity that was Wall Street during the Reagan years. Den of Thieves replicates, curiously enough, the self-centered world view of Wall Street. In fact, it seldom leaves the Street (Milken’s office in Beverly Hills notwithstanding). In his prologue, Stewart takes note of the big, consequential context, the corporations fatally crippled by criminal and unethical activity, the thousands of jobs lost to unserviceable debt, forced bankruptcies and depleted pension plans. But those consequences are only asserted, and never shown to be true in the same searing detail Stewart uses to reveal Boesky’s insider trading. The definitive book would show what happened to Rexene, or any one of hundreds of companies subjected to Milken-financed raids or buyouts.

    The exception to this parochialism is Stewart’s occasional reference to Washington, but he still does not tell enough about this aspect. Never mind the do-nothing Treasury Department and the cheer-leading by economists at the SEC, which was firmly in the grip of laissez-faire ideologues for most of the eighties. The non-response of   Congressional Democrats to Wall Street’s speculative orgy should have been an  important component of Den of Thieves. Stewart never mentions the Alliance for Capital Access, a lobbying front that Milken organized in 1985 with one purpose in mind: to beat back any attempt to rescind the tax deduction for interest on corporate debt. From 1985 through 1990 the alliance raised and spent $4.9 million lobbying Congress to protect the one deduction absolutely critical to Milken’s Ponzi scheme. Instead, Stewart merely tantalizes the reader with isolated facts, such as the $23,900 in campaign donations from Drexel that helped turn liberal Senator Timothy Wirth from a critic into a defender of junk bonds.

  All these gaps explain why Stewart concludes by proposing the most limited reforms imaginable, such as a statutory definition of insider trading (according to Stewart’s own book, Martin Siegel always knew when he was illegally sharing privileged information despite the vagueness of current law). The problems are much more fundamental. Basic issues of corporate governance and accountability need to be reopened and resolved if the corporate form of organization is going to benefit society and not just yield unconscionable rewards to a handful of bankers, lawyers and CEOs.

    Now that the eighties bubble has burst and Milken is in jail sans hairpiece until 1993 or thereabouts, it might seem like this story is mostly over. But recently Milken reduced Arthur Liman’s role in favor of that famed lawyer of last resort, Alan Dershowitz. Milken reportedly was inspired by Dershowitz’s success in the Claus von Bulow case, and there is speculation that, far from seeking a mere reduction in Milken’s sentence or defending Milken in $1 billion worth of pending civil suits, Dershowitz may try to withdraw his client’s guilty plea. The lawyer of last resort is using the tactic of last resort. Virtually all the negative characters in the book are Jewish, says Dershowitz, and gratuitously identified as such. To make his point, Dershowitz took out a $40,000 full-page ad in The New York Times attacking both Stewart’s book and the person who reviewed it in that paper (occasional Nation contributor Michael Thomas) as anti-Semitic. Stewart also says a private detective has been asking friend about his private attitude toward Jews. It is true that Stewart neglects the sociology of Wall Street, which would show the outsider status of Jews, not to mention other minorities. Seen in this context, the criminal behavior of Milken et al. was a kind of retributive assault on corporate citadels unfairly closed to them. That is what happens when people of great ability are treated dishonorably by those in power --they break the rules. But this lapse is not proof of any anti-Semitism on the part of Stewart, it’s just a shortcoming of the book.

    It may take a journalist with a novelist’s skills to write the definitive account of Wall Street during the eighties. Until then, read Stewart’s book.

    Postscript: Almost 16 years later, Wall Street is the same. Only the names have changed--and not all of them at that, viz., Henry Kravis.

       This book review first appeared in The Nation, 16 December 1991
                                  © 1991 by Max Holland

How to Kill a Company: Anatomy of a Leveraged Buyout

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By Max Holland

   

    Phil O’Reilly recognized that his company, Houdaille Industries, was taking a gamble when it underwent a leveraged buyout in 1979. A bad year or two could suck the Florida-based conglomerate into a whirlpool of debt. Ultimately, it might have to sell off its most attractive assets to satisfy creditors and buyout investors.

    But if nothing untoward happened, if Houdaille managed to service its debt, then O’Reilly knew that by 1984 a “pot of gold” awaited him and other equity investors. This is the moment when a private, leveraged company, having whittled its debt-to-equity ratio down to acceptable proportions, returns to the stock market. Equity investors then reap a huge reward, as much as 10 or 20 times their original investment.

  A buyout is a Faustian deal because it flouts a cardinal rule of management: Don’t bet the business. Houdaille’s executives did, and lost. Today Houdaille (pronounced WHO-dye) doesn’t exist anymore as an industrial manufacturer.

    The debate over the business wisdom of LBOs cannot be decided by the fate of one company. Buyout artists point out, and rightly so, that there are lots of “bad” deals to go along with the “good” ones. But interestingly, the investment bankers who engineered the Houdaille deal, Kohlberg, Kravis, Roberts & Co., tout it as a success despite the conglomerate’s demise.

    More disinterested observers might consider it an object lesson in what’s wrong with leveraged buyouts.

Senators Beat the Market with Insider Information

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By Max Holland
   

    The United States Senate is often called “the most exclusive club in Washington,” or exalted by its members as the “world’s greatest deliberative body.” But a new appellation may be in order: the world’s best investment club.

    According to a study conducted by four business professors, in any given year between 1993 and 1998, roughly 1/3 of all senators played the stock market, and those who did enjoyed an “abnormal” rate of return, meaning they out-performed the market. Senators consistently anticipated movements in stock prices: they often purchased stocks just before prices took off like a rocket, and revealed an uncanny ability to sell just when a stock was about to flatten out.

    For some perspective, the authors of the study (university professors Alan Ziobrowski from Georgia State; Ping Cheng from Florida Atlantic; James Boyd from Kent State; and Brigitte Ziobrowski from Augusta State) compared the senators’ performance with that of two groups. The first is the investing public: 66,465 randomly selected households in the United States that were studied in 2000. This group underperformed the market by approximately 1.4 percent annually from 1991 to 1996. The authors also compared the senators’ performance with a 2001 study of corporate insiders during the period 1975 to 1996. This group beat the market by about 6 percent annually—lending credence to the old Wall Street adage that you rarely go wrong if you buy and sell when the insiders do.

    Yet being a corporate insider, and presumably trading on the basis of privileged information, apparently pales next to being a senator. The Ziobrowski et al. study found that senators (including their spouses and dependents) outperformed the market by around 10 percent annually. “Nobody gets results like this in the financial world consistently and over the long term,” notes Professor Tom Ferguson, who studies money in politics at the University of Massachusetts-Boston. Any manager of a mutual fund, in fact, who regularly beats the market by as little as two percent annually is considered an investment genius.

    Since it cannot be a statistical fluke, the most plausible explanation for this achievement is that senators, by virtue of their powerful office, are made privy to such privileged information, and that some choose to capitalize on it. It’s unlikely that stock tips are being exchanged during whispered conversations in Capitol Hill cloakrooms, or that senators are the first to realize the economic repercussions of complicated legislation. Rather, senators’ acumen comes from being “embedded in social networks that provide them with access to valuable information,” as the professors put it. Think of it as the Martha Stewart scenario writ large.

    The study found no statistically significant difference between the abnormal returns earned by Democrats versus Republicans over the six-year period. Seniority, however, appeared to be a significant factor. Surprisingly, those with the least seniority (e.g., in their first six-year term) achieved higher abnormal returns than senators who had served at least two terms. This suggests that lucrative investments of other kinds may flow more easily to established senators who wield more power, say, committee chairmen.

    Mark Twain’s observation, first offered more than 100 years ago, seems pertinent. If your congressman comes back to your state to run for re-election and is not coming home a millionaire, noted Twain, “he is a fool and should be turned out of office.”

    To be sure, senators who trade are not doing anything illegal, or even unethical, according to the Senate’s internal standards. Stock trading on the basis of privileged information is not even addressed in the Senate’s Ethics Manual. Senators are prohibited from directly “cashing in” on legislation they work on; yet overall the rules governing their financial conduct are quite liberal. Senators are not required to “strip themselves of worldly goods” upon taking office, nor are they disqualified from voting on issues that generally affect their personal fortunes.

    Interpreting the ethics code is largely up to the members. At one end of the spectrum lies Richard Lugar (R-Indiana), a senator for 28 years, who decided when he entered politics in 1967 that holding individual stocks was incompatible with public service. Lugar invests only in diversified mutual funds, and each year releases a balance sheet of his assets and liabilities that goes well beyond what is legally required. At the other end is Ted Stevens, the senior Republican in the Senate who is also known as Alaska’s “senator for life,” having represented that state since 1969. Stevens invests in dozens of individual stocks, including telecommunications and technology companies that fall directly under the jurisdiction of the Commerce Committee, which he chairs.

    Because of the wide latitude allowed, sunlight is deemed the best disinfectant. Since 1978, senators have been required to disclose all their personal financial holdings (and those of their spouses and dependents) in an annual Financial Disclosure Report (FDR). This yearly exercise is considered the most effective mechanism for deterring gross conflicts of interest or egregious self-enrichment.

    The supposed transparency of the FDRs, however, is not all that it is cracked up to be. And this is the other troubling aspect exposed by the new study. The trading data available in the FDRs presented a host of problems. While some senators simply attached the monthly financial statements from their brokerage firms to the FDR, others provided only handwritten notations or abbreviations that the professors found impossible to decipher.

    More significantly, senators are only required to report their gains within eleven broad bands ($1,001 to $15,000, $15,001 to $50,000, and so forth), and so the exact amount of their profits cannot be measured. In order to perform their analysis, Ziobrowski and his fellow professors had to create imaginary portfolios that mimicked the buy-and-sell transactions the senators engaged in. While this methodology in no way invalidates the study’s key finding, it dulls the political point with respect to specific senators when a dollar amount cannot be attached.

    Indeed, the “banding problem,” as it’s known to money-in-politics cognoscenti, is a serious defect in the FDRs because it obscures almost as much as it reveals. One member of Congress, for instance, listed assets, in bands, that totaled somewhere between $813,000 and $1.7 million in 1996. This same member, nine years later, listed assets totaling somewhere between $2.4 million and $8.1 million. The gap between those numbers suggests two very different portraits: a member who is either simply a prudent investor, or someone who rivals Warren Buffett, albeit by exploiting, in all likelihood, the boundless perks available to elective officeholders. These opportunities encompass everything from getting in on the ground floor of initial public offerings of stock, to sweetheart real-estate deals. Ted Stevens once turned a $50,000 investment with an Anchorage real-estate developer into $1.03 million in seven years.

    Senators’ ability to time the stock market is one reason why at least 60 senators are worth at least $1 million now. As recently as 1994, only 28 senators had a net worth of that amount or more, and their salaries (currently $162,100) have not gone up fast enough in that 11-year period ($28,500) to account for this increased wealth.

    The Senate, of course, has always had its share of members unable to distinguish between their own personal fortunes and the nation’s. The late Robert Kerr (D-Oklahoma), the “uncrowned king of the Senate” in the 1950s, comes to mind. Born in a log cabin, but the wealthiest man in the Senate by far during his years of service, Kerr was infamous for privileging oil and gas interests, including his own company (Kerr-McGee), from his perch on the Finance Committee. Kerr believed doing business in the Senate was no different than doing business on the outside: Everything was predicated on a quid pro quo basis.

    Besides venal members, the Senate has always had its fair share of “empty suits,” senators whose main qualification is that they look or sound like Central Casting’s idea of a senator, as well as more than its share of ambitious politicians who regard the upper house primarily as a steppingstone. But what seems different now, and what makes these charming peccadilloes and real shortcomings harder to swallow, is that so few senators seem capable of, or committed to, fulfilling their responsibilities as public servants. Seldom in its history has the Senate seemed so removed from what the Founding Fathers envisioned: the place where the power of the executive branch and House could be checked, and the forum for “express[ing] sober second thought on national priorities,” as Lewis Gould put it in his recent history of the Senate, The Most Exclusive Club.

    The restraint of executive power has seldom been weaker. During the last decade, under Presidents Clinton and Bush, and without a declaration of war, the U.S. has bombed Serbia’s Slobodan Milosevic into submission; toppled the Taliban in Afghanistan; and instigated a war of choice to overthrow Iraq’s Saddam Hussein. Towards the end of the Vietnam War, the 1973 War Powers Act was put in place to check the commander-in-chief’s ability to commit American lives and treasure; the Senate spearheaded passage of the act. Although largely symbolic, it at least held out the promise of forcing meaningful debate over the issue of war. But nowadays the Senate is likely to give a transportation bill more thoughtful deliberation than a decision to commit American soldiers, as Leslie Gelb and Anne-Marie Slaughter noted in a November article in The Atlantic. Reportedly, only six senators read the classified intelligence estimate on Iraq before voting to authorize the use of force there.

    The weakness of the contemporary Senate is not only reflected in the absence of stirring debate on pivotal issues. It’s evident nearly every working day. It’s the rare senator who can ask extemporaneous questions of a witness before a committee. The impulse for serious investigating, which is time-consuming, hard work, is also all but dormant. Despite the stunning intelligence failure that preceded the war in Iraq, the Intelligence Committee has yet to explore the Bush administration’s misuse of the flawed estimates produced by the intelligence community. More recently, the Senate roused itself, at least temporarily, and blocked renewal of the Patriot Act. But that only occurred because, on the day of the vote, many senators apparently learned from reading The New York Times that President Bush had signed a secret and unprecedented order in 2002 authorizing the National Security Agency (NSA) to conduct warrant less intercepts and wiretaps domestically. Traditionally, the NSA has been highly restricted in its operations inside the United States.

    One has to go back to the Gilded Age to find a time when the Senate seemed of equal inconsequence. At that time, senators were widely criticized for being captive to moneyed interests and bent on self-enrichment. It was thought that these twin evils stemmed from the fact that senators were elected by state legislatures rather than by popular vote.

    Apparently not.

      This article first appeared in The Washington Spectator, 1 January 2006
                                                 © 2006 by Max Holland

Fantasy v. Reality in the Federal Budget

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By Max Holland

   
    In case you missed it—and the Bush administration was certainly hoping that you would—the federal government’s operating deficit for 2005 was $760 billion, or a whopping 138 percent higher than the much more widely reported budget deficit of $319 billion.

    The Bush administration hailed the lesser amount when it was announced last October by the Office of Management and Budget (OMB), largely because at a projected $319 billion, the budget deficit came in significantly lower than most estimates. But there was no fanfare when the Treasury Department reported the negative $760 billion net operating cost to Congress in mid-December—not so much as a press release. The Treasury’s figure, contained in the annual Financial Report of the United States Government, gives the lie to Bush’s contention that his fiscal policies pose no threat to the nation’s economic well-being and security.

    What is the difference between the budget deficit and the net operating figure? They describe virtually the same thing: the difference between what the government spends, and what it takes in, during a given fiscal year. But there is a world of difference in how they are calculated.

    The OMB’s budget deficit is based on simple cash accounting, a method appropriate to a business, oh, say, the size of a corner newsstand. In cash-based accounting, an expense is logged only when it’s actually paid. Under the more accurate system, called accrual-based accounting, expenses are recorded when a business becomes obligated to pay them; that reveals the long-term implications of current spending decisions. The necessity of taking into account future obligations is a major reason why under U.S. law every enterprise with more than $5 million in revenues is required to use accrual-based accounting, and also why David Walker, the U.S. comptroller general, notes that cash accounting paints a “potentially unrealistic and misleading picture of the federal government’s overall performance.”

    The government only began releasing an accrual-based budget figure in 1997, after it was mandated by an act of Congress. Getting the vast federal apparatus to abide by the buzz phrase “generally accepted accounting principles” was an enormous undertaking. It wasn’t until 2000, for example, that reliable figures for Social Security and Medicare could be incorporated into the annual Financial Report.

    When the Bush administration issued its first financial statement in early 2001, it reported a net operating surplus of $46 billion. Since then, there has been a flood tide of red ink. Every year the net operating cost has grown larger, exceeding the more widely known OMB figure by hundreds of billions of dollars. In 2005 alone, as noted, the difference was $441 billion ($319 billion versus $760 billion). Looking at it another way, from 2001 to 2005 Bush’s spending and tax policies resulted in budget deficits totaling $1.1 trillion, according to OMB’s calculations. The Treasury’s accrual-based figure is $2.9 trillion, or 164 percent larger.

    The lion’s share of this difference comes from a sober, accrual-based accounting of the long-term costs of the war in Iraq and the global war on terror. In the 2005 Financial Report, Treasury Secretary John Snow attributed the $441 billion increase over the OMB’s figure “principally to a $198 billion increase in Veterans Affairs’ actuarial costs,” including higher interest rates that will have to be paid because of mounting public indebtedness (from $5.7 trillion on the day Bush took office to more than $8.4 trillion today).

    Accrual accounting also paints a drastically different portrait of whether Bush’s deficits are shrinking or growing ever larger. When the OMB deficit shrank from $413 billion in 2004 to the lower-than-expected $319 billion in 2005, the Bush administration touted the reduction as proof that it was reining in government spending, and that it had been justified in pushing for tax cuts. Slashing taxes reinvigorated the economy, the administration said, resulting in increased revenues. But the accrual-based numbers tell a different story. From 2004 to 2005, the net-operating-cost deficit increased from $616 billion to the aforementioned $760 billion.

    The harsh truth of accrual-based accounting underscores just how reckless the administration is. Lyndon Johnson’s guns-and-butter policy during the Vietnam war looks almost prudent juxtaposed against Bush’s policy of fighting a major war while cutting taxes necessary to pay for it. Bush has deployed the fiscal equivalent of having an all-volunteer armed forces. Just as the absence of a draft diminishes widespread opposition to military adventures, sloughing off the cost of the Iraq war by citing unrealistic OMB budget numbers defers pressure on the administration. Americans aren’t bearing anything close to the economic burden that corresponds to the true cost of the war. Add in budget-busting costs from demographic trends starting in the next decade, and an economic meltdown is on the horizon.

    One of the members of Congress to take notice of this legerdemain has been Representative Allen Boyd, Jr. (D-Florida), a member of the Blue Dog Coalition, a group of 37 moderate-to-conservative Democrats. Boyd warns that “viewing the budget through rose-colored glasses” is “an unhealthy and damaging practice that will affect our economy, our standard of living, and ultimately, our national security.”

      This article first appeared in The Washington Spectator, 1 May 2006
                                              © 2006 by Max Holland

Bashing, Bullying, Blaming Japan, US Deals With a Deficit

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By Max Holland

 

    Journalistic predictions are risky. But here’s a sure thing. On or before May 30, the Bush administration will significantly heighten trade tensions with Japan and a congressionally-mandated report will be the catalyst.   

    By that date, US Trade Representative Carla A. Hills must identify and initiate action against America’s “unfair” trading partners who run up chronic trade surpluses. And Japan, exporting nearly three times what it buys from America, will be presumed the unfairest trader of all.

    Before leaving the Treasury Department for the State Department, James A. Baker debased the “strong” Reagan dollar and improved the US balance of trade in the process. But the export surge has stalled, at a time when America is still sucking in more than $10 billion worth of imports in excess of exports every month. And since Japan accounts for 45% of this imbalance, it will draw a corresponding amount, or more, of America’s ire. Tokyo’s large contribution to the stubborn US deficit is accepted as prima facie proof of unfairness; the surplus exists, in other words, because Japan keeps its own markets closed.

    Several senators, including Democrat Lloyd Bentsen of Texas, plus the AFL-CIO, certain high-tech industries like semiconductors, low-tech industries like soda ash producers and the Commerce Department, among others, are all dead set on seeing Japan make the May 30 list of unfair traders.

    Some cautious voices inside the administration, primarily at the State Department, warn against stigmatizing Japan just yet, especially during a period of uncertainty for the ruling Liberal Democratic Party. They think it wiser to brand more tractable countries, like Korea or Brazil, before taking on America’s creditor. But should that happen, Japan will be put on ostentatious notice that it’s next. So the prediction still holds.

    The May report is merely one in a series mandated by the complex “Super 301” clause of the 1988 Omnibus Trade and Competitiveness Act. In earlier incarnations, Section 301 was an entirely understandable, indeed invaluable, part of US trade law. It authorized the president to impose trade sanctions against any country engaged in an unjustifiable policy that “burdens or restricts United States commerce.” The president could choose from a wide variety of sanctions, everything from an outright embargo to tariffs or quotas on foreign goods. Section 301, in other words, was a necessary legal resource to hit other countries when they failed to live up to their negotiated trade obligations.

    Super 301 is quite another matter. In scope it is almost breathtaking, for it allows the United States to penalize Japan, say, for its convoluted distribution and marketing system. The practice does not have to be illegal under current international trade law. It simply has to be deemed “unreasonable” in America’s unilateral judgment. After the May report is issued, the Bush Administration has 18 months to get a barrier dismantled. If negotiations fail, then the president will be empowered (also pressured) to impose sweeping sanctions against the foreign malefactor.

    For a true sense of just how misguided Super 301 is, consider the clause’s legislative history. Only then does it become apparent that Super 301 is perhaps the worst piece of trade legislation since the Smoot-Hawley Tariff Act of 1930.

    The story begins in May, 1982, when Houdaille Industries, a Florida-based conglomerate, petitioned the Reagan Administration for protection against Japanese machine-tool imports.

    Houdaille has been one of the top 12 US machine tool builders since the mid-1960s but was suffering an unprecedented loss of market share to the Japanese. None of this was due to its own ineptitude, the conglomerate claimed. Rather, in a 714-page petition, Houdaille charged that Japan had instigated and subsidized a machine-tool cartel bent on carving up the United States and decimating US builders.

    Houdaille’s argument was an admixture of fact and fancy that did not support its thesis. Government subsidies and Ministry of International Trade exhortations were not the main reasons behind Japan’s successful penetration of the US market. Success derived from a Japanese willingness to invest heavily in plant and equipment, to market their products aggressively throughout the world, to work doggedly toward long-term goals and pay unusual attention to worker training and motivation. This description is derived almost verbatim from the finding of a study mission sent to Japan by the National Machine Tool Builders’ Association, the US industry’s major trade association.

    By contrast, Houdaille, and many other American builders, failed to invest (somewhat understandably so) during the uncertain economic climate of the 1970s. In addition, Houdaille labor-management relations were poor, and like many other conglomerates it was addicted to managing by the numbers rather than by the product.

    Houdaille, moreover, was the first large industrial corporation to undergo a leveraged buyout, in 1979 (a buyout engineered by Kohlberg, Kravis, Roberts & Co., the same firm that recently leveraged RJR Nabisco for $25 billion). Houdaille’s nearly $400-million LBO played no small part in the decision to manufacture a Washington solution to its debt crunch, blaming the Japanese.

    It’s always easier to prey on American conspiratorial suspicions about Japanese trade and industrial practices than to engage in self-criticism. And so for 13 months, despite its shortcomings, the novel Houdaille petition was the focal point for a titanic, bitter struggle between protectionists (called “Japan-bashers”) and free-traders (called “white hats”) inside the Reagan Administration. The petition was treated as a claim under Section 301 of the 1974 trade law, and it seized the imagination of both Congress and the press.

    When Ronald Reagan turned down Houdaille in April, 1983, the conglomerate’s legion of sympathizers in Congress believed the company got a raw deal. So the lawmakers subsequently sought to reward Houdaille for its extraordinary, Don Quixote-like struggle. They decided the real culprit (aside from the Japanese) was the inadequate, pusillanimous US trade law – in particular, the fact that the White House was not enforcing Section 301 when American manufacturers were victimized by so-called predatory foreign export targeting.

    First in 1984 and then again in 1988, Congress extensively rewrote Section 301. Members were goaded by other beleaguered industries, most notably semiconductor manufacturers and organized labor. The final result was a score of far-reaching changes in Section 301, and its super transformation.

    Bad facts, as usual, made for bad law. Section 301 went from a necessary weapon to a blunt, bullying instrument. Congress’ attitude was if the president wasn’t vigorous in enforcing fair trade, it would force him, via Super 301, to perform that duty. And Congress attempted to accomplish this the only way – aside from purse strings – Congress knows how: by imposing a nightmarish array of reporting requirements, confrontational deadlines, mandatory actions, and other micro-management practices.

    With the worst still to come, Super 301 has already caused a big headache at the agency charged with carrying out most of its provisions. The Office of the US Trade Representative, one of the smallest autonomous units in federal government, has long enjoyed a reputation as a can-do bureaucracy and impartial judge of competing interests. Now it drowns in a sea of reporting requirements and often impossible demands, such as the mandate to quantify the cost of trade barriers to US exports.

    Basic economic theory says that the value of trade barriers can never be measured accurately. The agency already shows signs of becoming paralyzed and demoralized by a paper monster while its important work goes undone.

    To make matters worse, these same reporting requirements are often self-righteous in the extreme and violate long-standing trade goals. Take the report due May 30, identifying countries with unfair trade practices. That's like identifying a drinker at an Alcoholics Anonymous meeting. Every country engages in discriminatory practices. But the proper forum for settling disputes over trade practices, as the United States has heretofore argued, is the General Agreement on Tariffs and Trade (GATT).

    Instead, Super 301 dispenses with the multilateral approach and exchanges it for crude, bilateral bullying as the US government unilaterally declares certain practices unfair. They may well be, but several US trade practices could also be tagged unfair by another country with a Super 301 on its books. Trade experts are calling this approach “procedural protectionism” because eventually it will provide an excuse for erecting new US barriers on the grounds that other countries don’t live up to pure free trade standards.

    Ultimately, however, the worst aspect of Super 301 is focus; it will divert attention from the profound domestic sources of America’s manufacturing crisis. Put aside for a moment any notions of how open or closed the Japanese market is. When American manufacturers cannot compete or don’t exist at home, the root problem is not foreign but domestic. Solving this problem will be a formidable challenge, requiring nothing less than an American brand of perestroika in both foreign and domestic policy. In the meantime, unbecoming and shrill exercises mandated by Super 301 postpone the day of reckoning, assuring that the cure will be all the harder for having been postponed.

    But then it is always easier to find a scapegoat.

This article first appeared in the Los Angeles Times, 7 May 1989
© 1989 by Max Holland

Silence of the Corporate Lambs: Where was Vernon Jordan?

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By Max Holland   

 

    Vernon Jordan is a victim of guilt by corporate association. Because he serves on the boards of Xerox, American Express, RJR Nabisco and eight other corporations, he has been depicted by some as a prima facie threat to the new administration’s tougher ethics. Yet the central issue shouldn’t be where Jordan sits. Rather, it should be what President-elect Clinton’s transition chief actually did at the powerful corporations he served, and the public policy implications of those actions. In this regard, nothing is more worthy of scrutiny than Jordan’s role at RJR Nabisco, once the 19th-largest corporation in America.

    This is not a reprise of the complaints about Jordan’s involvement with a tobacco company. Nor does it discount his work in encouraging corporate America to diversify its workforce and to support worthy causes like the United Negro College Fund. It’s the story of Jordan’s involvement in the leveraged buyout of RJR Nabisco, a deal that in many ways epitomizes the ’80s-style corporate greed and dishonesty that Bill Clinton ran against.

    Like it or not, the corporate form of organization dominates the American economy. It would be surprising, even disturbing, if the Clinton administration excluded men and women who ably serve corporate America. Nevertheless, corporate directors can be pawns or independent voices, and the weight of the evidence shows that Jordan went along to get along while RJR Nabisco was being ill-served, first by its chief executive officer, and then by Wall Street buyout artists doing the mother of all deals.

    At least two of Jordan’s former colleagues on the board of RJR Nabisco now say that the company and the original shareholders would be better off today if there had been no leveraged buyout. One of them, John Macomber, a former chief executive officer of Celanese Corp., says that RJR Nabisco “lost [its] moral compass” in the 1980s. Jordan’s acquiescence in such corporate excesses undermines his claim to represent the social conscience of corporate America.

    Jordan declines to discuss his work as a corporate director, saying that to do so would be akin to breaching lawyer-client privilege. “I do believe directors have a responsibility to keep what goes on in board rooms confidential,” he says. “Directors who comment even on [published] comments do a disservice to the process . . . . I have always abided by this, perhaps to my peril.”

    The tale begins in 1981, when Jordan left the presidency of the Urban League to join the Washington law firm of Akin, Gump, Strauss, Hauer & Feld. In private practice he began adding to an already impressive list of corporate directorships. He became a board member of R.J. Reynolds Industries at the invitation of Paul Sticht, the chief executive officer of the Winston-Salem tobacco company.

    Sticht says he came to rely Jordan’s “good horse sense.” R.J. Reynolds had holdings in South Africa, and Sticht says he particularly prized Jordan’s counsel “in those troubled political waters.” Sticht also invited Jordan to the Bohemian Club’s annual retreat outside San Francisco, a favorite social event of American businessmen and politicians. The gathering offered Jordan an unparalleled opportunity to be a “rainmaker,” drumming up business for Akin, Gump.

    Jordan was only doing what board members routinely do in addition to official duties, namely use their position to network and make deals. But in 1983, an R.J. Reynolds executive named Tylee Wilson became CEO of the company. Wilson’s blunt, no-nonsense style did not appeal to Sticht’s board, according to Barbarians at the Gate, a best-selling account of the leveraged buyout of RJR Nabisco. Wilson thought his job was to make R.J. Reynolds’ operations as profitable as possible -- and that didn’t include handing out goodies to curry the directors’ favor. As reported in Barbarians, Wilson curtly told Jordan to make his requests for a bigger share of R.J. Reynolds’ legal business to the company’s general counsel.

    In 1985, after R.J. Reynolds merged with Nabisco, the board replaced Wilson with a Nabisco executive named Ross Johnson. Wilson knew he was finished after he polled the board members privately. His last call, as reported in Barbarians, was to Jordan, who told him, “You’d better cut yourself a deal and get out.”

    The RJR Nabisco directors soon found themselves in the corporate equivalent of hog heaven. Johnson re-established an international advisory board that held meetings around the world to discuss global issues. A corporate villa sprang up in Colorado, augmented by a compound in Palm Springs and penthouses in Manhattan. All board members received cut-rate auto insurance and were promised annual retirement payments of $ 50,000 for 10 years. There was even talk of lifetime pensions for directors once they retired. “A few million dollars,” Johnson was fond of saying, “are lost in the sands of time.”

    Within a year of Johnson’s ascension, Sticht, now chairman of the board, was complaining about the new CEO’s spend-thrift ways. At the Bohemian Club retreat in 1987, Sticht told Jordan how appalled he was by Johnson’s behavior and suggested it might be time for the board to mount another coup. Sticht’s recollection is that Jordan “didn’t disagree” but did not join Sticht in pressing the issue. John Macomber says that “we were all somewhat culpable over the fact that Ross [Johnson] spent a hell of a lot of money . . . but it’s not the biggest thing in the world.” A few months later, Johnson ousted Sticht as board chairman with nary a word of complaint from the other directors.

    In 1988, Johnson decided to reward himself with the ultimate corporate perk: a management-led leveraged buyout. The idea was to organize a select group of investors to borrow money to buy out all the public shareholders. When the investors captured control of the corporation, they could use all of its cash flow to retire the debt incurred in the buyout (rather than say, paying dividends). Once the debt was whittled down to acceptable levels, the investors could again sell the company’s stock publicly, reaping windfall profits on their relatively small original investment. Within seven years Johnson expected that his personal pot of gold from the buyout would amount to at least $ 100 million.

    Jordan warned Johnson about the danger of putting RJR Nabisco “into play.” “Somebody might come along and buy this company for more than you can pay,” Jordan is quoted as saying in Barbarians. “You might not win.”

    Johnson was not dissuaded. On Oct. 19, 1988, the board, including Jordan, expressed its “strong sense” that Johnson should go ahead with the deal on the grounds that it was their duty to maximize shareholder value. That evening Jordan and Macomber both expressed lingering uneasiness about the decision while meeting informally with other directors. In particular, they were concerned over what a leveraged buyout might mean for their promised $ 500,000 pensions, according to Barbarians.

    As Jordan foresaw, putting RJR Nabisco into play was akin to putting down a pot of honey in front of a hive. Buyout artists, including the Wall Street firm of Kohlberg Kravis Roberts & Co. (KKR), swarmed to the deal. A special board committee was created to select the best bid. John Macomber, who served on the committee, says that he relied informally on Jordan’s “good judgment and uncanny sense of people and ability to size up situations.”

    Macomber, like Sticht, now believes that the buyout was not in the best interests of the stockholders. The buyout was “a good deal,” he says, </