Show Trials with Capitalist Defendants in Shackles by George Reisman

[Stephane Budge]

New York Times columnist Maureen Dowd has written a column (January
28, 2009) full of withering hatred and contempt for many of today's
most prominent businessmen, first and foremost the heads of the Wall
Street Banks. She singles out Citigroup and Merrill Lynch in
particular, denouncing the first for going ahead with taking delivery
of a $50 million luxury jet at the very time the firm was losing
billions, and the last CEO of the second, John Thain, for spending $1
million to redecorate his office, also in the midst of his firm's
suffering major losses.

Her column leaves the reader with a view of these people and, by
implication, of practically the whole economic class to which they
belong, i.e., virtually all businessmen and capitalists, as having a
mentality that combines the worst features of Marie Antoinette and
Nero. The former, of course, was Queen of France until 1793, when she
was beheaded. She is famous for allegedly having said in response to
being informed of the peasantry's lack of bread, "Let them eat cake."
And Nero was the Roman emperor who is known for having fiddled while
Rome burned, and who died in 68 AD, committing suicide when he learned
that the Roman Senate had ordered that he be flogged to death.

Having led her readers to such an assessment of these people, she
concludes her column with the declaration, "Bring on the shackles. Let
the show trials begin." If they do begin, Dowd will be there, perhaps
with knitting needles, in the role of a modern-day Madame Defarge, the
Dickens character who knitted while watching aristocrats being
guillotined during the French Revolution.

The day after Dowd's column appeared, a news story in The Times
reported that, "Despite crippling losses, multibillion-dollar bailouts
and the passing of some of the most prominent names in the business,
employees at financial companies in New York, the now-diminished world
capital of capital, collected an estimated $18.4 billion in bonuses
for the year. That was the sixth-largest haul on record, according to
a report released Wednesday by the New York State comptroller."

The day after that, President Obama called the bonuses "shameful."

The Fate of Capitalism
It is very easy to interpret the kind of facts that have been
described, as an indictment of the capitalist system, which is exactly
how they are being interpreted. Millions of people have lost their
jobs; millions more fear that they will lose theirs. These millions
cannot avoid the further fear that they and their families will be
utterly impoverished. And they are being led to blame their losses on
capitalism, in large part by being led to blame it on the persons of
individual businessmen or capitalists whom they perceive as hateful.

What is present and being inflamed is the psychology of an angry mob.
Its sympathies are with innocent victims who have suffered a great
wrong. It's sure it knows who is responsible and how. The next step
will be for someone to yell, "Get a rope!"

Already, businessmen and capitalists are starting to cower in fear.
Corporations are racing to get rid of their private jets. Next it will
be their private dining rooms and limousines. Private profit and
personal luxury at any level are in danger before the onslaught of a
collectivist mentality that holds that if many are suffering, all must
suffer, and, further, that those who do not suffer are responsible for
the suffering of those who do. Anyone whose head is above the crowd
will risk being a target.

This is the time for everyone to recall whatever instances in his life
that he remembers when angry mobs turned out to be wrong. Perhaps it's
only a scene from a movie or book, in which someone is able to present
a few facts that the mob doesn't know and that begin to place things
in a different, calmer light. Let me be that someone now and begin
with one very important and fundamental relevant fact.

Today's Economic System Is A "Mixed Economy," Not Laissez-Faire
Capitalism
And that is that even if all of the facts as presented were absolutely
true, it would not imply any reason whatever to condemn capitalism.
Capitalism is a system in which absurd, self-destructive behavior
severely punishes whoever is guilty of it. Such people suffer losses,
go bankrupt, and lose their ability to have significant further
economic influence. Their example then serves as a lesson to others to
avoid such behavior.

However, we are very far from having capitalism today, certainly not
capitalism in its logically consistent form of laissez-faire
capitalism. What we have today is a "mixed economy," that is, a
severely hampered, distorted form of capitalism. In such a system,
such behavior can continue, thanks to government subsidies, grants of
monopoly privilege and suppression of competition, and now by means of
government "bailouts."

A mixed economy is an economy which remains capitalistic in its basic
structure, but in which the government extensively intervenes with the
initiation of physical force to compel actions that are against the
interest of individuals and/or to prohibit actions that are in the
interest of individuals. For example, today it compels people to pay
an income tax, which is against their interest but which they pay in
order to stay out of jail. It also prohibits them from engaging in
various business mergers or paying wages below a certain amount,
things which it would be to their interest to do but now do not,
because they wish to avoid being fined or imprisoned. (In my recent
article "The Myth that Laissez Faire Is Responsible for Our Financial
Crisis," I present an extensive description of the extent of
government intervention.)

A mixed economy lacks the fundamental moral-political principles that
are needed to determine what is proper or improper for a government to
do. Its only principle, if one can call it that, is that the
government can do anything that enough people believe will accomplish
what they think is "good," according to an undefined standard. Our
mixed economy rests on the effective discarding of the United States
Constitution, which placed severe limits on government power and thus
stood as a bulwark in defense of an economic system that was almost
one of laissez-faire. The Constitutional protections were discarded by
a process of pretending that the Constitution could somehow "grow" or
"evolve," which actually meant nothing other than choosing to ignore
it.

In a mixed economy, every significant-sized business must fear what
the government can do to it. It needs protection, in the form of
political connections. It secures these through appointing former
government officials to its board of directors, paying such officials
lavish consulting fees, and giving lavish campaign contributions to
candidates for public office. In these ways it buys the protection it
needs.

But soon businesses learn that their protectors can also be used to
gain lucrative government contracts, government subsidies, and
monopolistic privileges ranging from tariffs and licensing laws to
antitrust suits against competitors. Thus, it is not long before the
upper echelons of large firms become populated not only with men who
cower before the government but also with those who seek to manipulate
the government to their advantage, which is where we are today.

Certainly not all big businessmen are this way, and probably only a
few of those that are, are so through and through. For the most part,
they still have real jobs to do in running their companies, and to the
extent they simply do those jobs, they are productive. But probably
most big businessmen are morally compromised if only because they must
live in fear of the government and are helpless to do anything about
it.

Responsibility for the Financial Crisis
There is a sense in which an important sub-group of businessmen does
have genuine responsibility for the present economic crisis and for
all previous crises of financial contraction and deflation. This is
the sub-group of commercial bankers.

Ironically, the way in which they have been responsible is by means of
doing something that almost everyone very much wants them to do, above
all, the government, and even when the crisis comes, still wants them
to do or to get back to doing as soon as possible. This something is
the practice of credit expansion. Credit expansion is the lending out
of new and additional money that is created out of thin air, with the
encouragement and support of the government. Governments value and
encourage credit expansion both in the mistaken belief that it is a
source of prosperity and in the knowledge that it is a ready source of
money to finance government spending.


Credit expansion is what creates a delusion of prosperity while it
lasts and economic depression when it ends. It is all that needs to be
stopped to end the boom-bust cycle. (In this brief article, I must ask
the reader who wants understand the process, and how to stop it, to be
content merely with references to further reading, namely, Chapters XX
and XXXI of Ludwig von Mises's Human Action and Chapters 12 and 19 of
my own Capitalism: A Treatise on Economics. Concerning the role of
credit expansion in our present crisis in particular, please see my
articles "The Myth that Laissez Faire Is Responsible for Our Financial
Crisis," "Our Financial House of Cards and How to Start Replacing It
With Solid Gold," and "The Housing Bubble and the Credit Crunch.")

I want now to deal with the subjects of bonuses and corporate jets.

Bonuses
Granting bonuses to employees and buying jet planes are perfectly
legitimate for private business firms. In today's context, this means
firms that have not received government bailout money.

Giving bonuses and buying jet planes are purely business decisions.
It's only a question of whether the bonuses motivate the employees who
receive them to bring in profits to the firm that are greater than the
bonuses paid, or not. If the answer is yes, then it makes sense to pay
the bonuses.

To the chief executive of a privately owned, non-taxpayer supported
Wall Street firm, the payment of bonuses even in a year of calamitous
losses may appear as still making economic sense, at least if the firm
expects to stay in business. This is because the bonuses are not paid
to people who have incurred the firm's losses. Those losses are in the
assets the firm owns. They are not in its day-to-day trading
operations, which may continue to be profitable.

The situation is analogous to that of a retail chain which has had
massive losses because of such things as fire or hurricane damage to
its warehouses, but whose stores are still making money. The Wall
Street firm is still executing customers' orders in buying and selling
securities, it is still trading in currencies and in the futures
markets, and still arranging mergers and acquisitions, and
divestitures and breakups. All of these aspects of its business may
well still be profitable.

The brokers and traders, the mortgage and acquisition specialists et
al., and their various assistants and supporting staffs, have
contributed very substantially to these operating profits. The same is
true of many of the economic and financial researchers and analysts
that the firm employs in connection with its still profitable
operations. Money is set aside out of the year-end totals to pay
bonuses to the members of such groups, based on their respective
individual profitability. The bonuses are accumulated employee
compensation, similar in nature to the commissions paid to retail
sales clerks. If the firm expects to be in business in the following
year, and wants to retain the services of these employees, who,
despite the firm's massive losses in its accumulated assets, have
performed well, it probably needs to pay them their bonuses.

John Thain, the then president of Merrill Lynch tried to explain this
fact to an interviewer, when he said, "If you don't pay your best
people, you will destroy your franchise" and they'll go elsewhere, he
said.

Ms. Dowd apparently does not know the difference between an operating
profit and a balance-sheet loss. She apparently does not know the
difference between the due of a successful salesman in a retail-store
and the due of someone whose actions have served to burn down the
store's warehouse. But she does know how to be furious. She responded
to this explanation by exclaiming:

Hello? They destroyed the franchise. Let's call their bluff. Let's see
what a great job market it is for the geniuses of capitalism who lost
$15 billion in three months and helped usher in socialism.
Despite her ignorance and her collectivism-inspired refusal to draw
distinctions between individuals and their respective individual
performances and responsibilities, Ms. Dowd does have something of a
point. Namely, if because of the bankruptcy and closing of many Wall
Street firms, there should be a glut of brokers and traders et al.,
then the remaining Wall Street firms would be in a position to reduce
their compensation. But that would be something they would typically
announce before the fact, not after the fact of an agreed-upon
compensation having been earned.

My discussion of bonuses was in the context of the operations of a
privately owned business firm, not one that has to be financially
supported by the government and is operated with funds provided by
taxpayers. In awarding bonuses after Merrill Lynch's receipt of
government bailout money, which started in September of 2008, Mr.
Thain did not realize that he was no longer in charge of a private
firm. He did not realize what difference this made to the fundamental
character of his firm. Neither did very many other people at the time.
But more on this later.

Corporate Jets
I turn now to the subject of corporate jets.

If a corporation can afford to buy a jet and having it will enable
extremely high-paid executives to avoid wasting time waiting at
airports and be able to be more efficient in working in the time spent
in flight, then over time its purchase may actually save more money
than it costs. If so, then it will be a good business decision to buy
the plane.

It may even be a good business decision to buy it, if the executives
who fly in it simply prefer it because it's more comfortable and
enjoyable. In such a case, even if the plane saves nothing in costs or
not enough to justify its purchase, it can still make good economic
sense for the firm to buy the plane. This will be the case if it is in
a position to reduce the compensation paid to the executives in
question by as much or more than the amount that it must expend for
their personal benefit.

Thus, for example, if the plane falls short of covering its cost
through increased productivity on the part of the executives by, say,
$1 million per year, the firm will have the benefit of more satisfied
executives at absolutely no net cost to itself, if it gets the
executives to accept $1million less per year in monetary compensation.
In that way, it is the executives who effectively bear the cost of the
plane that is otherwise uncovered. And the firm will have whatever
indirect monetary gains that may result from better satisfied
executives.

Indeed, to the extent that the executives are willing to forgo an
amount of compensation that is greater than what is required to cover
any otherwise uncovered cost of the plane, the firm has a clear saving
in monetary terms. Thus, if the executives can be paid $2 million less
per year, while the otherwise uncovered part of the cost of the plane
is still $1 million, the firm has a monetary saving of $1 million per
year by buying the plane. (Today's tax laws work in this direction.
The replacement of $1 million in monetary compensation with $1 million
in indirect compensation, serves to reduce the executives' after-tax
monetary compensation by perhaps as little as $500 thousand, while
saving the corporation the full $1 million.)

Situations such as this actually occur all the time, throughout
business. Again and again, firms provide fringe benefits that are of
value to their employees but which do not cover their cost through
increased productivity. They are motivated to provide them by being
able to save more in what they would otherwise have to pay the
employees in take-home wages than the cost of the fringe benefits.

For example, imagine the situation of employees having to choose
between two employers. One of them provides air conditioning. The
other does not. In the heat of summer, it is a comparative pleasure to
work for the one, and extremely uncomfortable to work for the other.
If the employees can earn $1,000 per week by working for the employer
who provides air conditioning, and they value that air condition
sufficiently, then in order to be induced to work for the second
employer, they might require a wage of $1,100 per week. If that second
employer can provide air conditioning at a cost to himself of, say,
$10 per worker per week, then he will save $90 per worker per week if
he provides it. Because in that case, he can obtain his workers for a
take-home wage of $1,000 plus an air-conditioning cost of $10, instead
of for a take-home wage of $1,100 plus no cost on account of air
conditioning. Obviously, such conditions compel the employer to
provide air conditioning. It is his recognition of such conditions
that led the first employer to provide air conditioning to begin with,
i.e., simply because employees value having it far more than the
reduction in their take-home wages that is needed to pay for it.

This discussion has application to the $1 million office remodeling
that so offended Ms. Dowd. Please keep in mind that the remodeling was
commissioned in late 2007, when the executive in question started his
position. At that time, Merrill Lynch had not yet received any
government money and was thus still a fully privately owned company.
The executive in question, John Thain, was a man in charge of the use
of hundreds of billions of dollars of capital. And, therefore, if he
was indeed the right man for the job, which is certainly what was
hoped, was easily entitled to compensation at least as far into double-
digit millions as that paid to Hollywood movie stars and leading
athletes.

With this many millions in compensation, the value to him of $1
million more or less, may not have been terribly great. (Hollywood
stars have weddings that cost more.) It may well have been far below
the value he attached to spending his hours of working time in an
office that was made to personally please him in every possible
respect, and which he may have expected to occupy for many years. In
such a case, instead of his firm paying him however many millions it
otherwise would have paid him, it could pay him a million dollars
less, or even more than a million dollars less. In that case, it was
he who bore the cost of the office, out of compensation to which, in
the judgment of the parties concerned, he was entitled.

Alternatively, it's entirely reasonable that providing such an office
and the optimum working environment that it provided, could be
expected to improve his efficiency with respect to deciding the
pattern of investment of his firm's hundreds of billions of dollars of
assets. It would not have taken a great deal of such improvement with
respect to the use of sums so vast to be able to earn an additional
billion or more of profit for his firm. Understanding this, the firm
may well have given him his office in the belief that doing so would
add vastly more to its profits than the cost of the remodeling.

When Ms. Dowd discussed this million-dollar office remodeling, her
reaction was one of incredulity, outrage, and utter contempt. Here's
what she said (referring to an interviewer of the executive):

Bartiromo pressed: What was wrong with the office of his predecessor,
Stanley O'Neal?
'Well — his office was very different — than — the — the general décor
of — Merrill's offices,' Thain replied. 'It really would have been —
very difficult — for — me to use it in the form that it was in.'
Dowd then asked in a triumph akin to that of crushing a cockroach:

Did it have a desk and a phone?
I can't help wondering, if when Dowd may need a surgical operation
someday, she will be satisfied if her surgeon has a table and a knife.

Bailouts
Government bailouts put everything in a different light. They give
everyone in the country the right to second guess every decision of
the firms that have received the bailouts, on the grounds that the
money used by those firms is theirs, the taxpayers.

Understandably, the taxpayers become furious about things like
bonuses, corporate jets, and expensive office remodelings. They see
themselves simply as being made to pay for these things. This is
because, unlike the shareholders of a private company, the taxpayers
will never have any possible financial benefit even if the
expenditures might actually be perfectly reasonable and well made if
they took place in the context of a privately owned company. And
unlike the shareholders of a private company, they were never given a
choice about whether or not they wanted their funds to be turned over
to this or that company. Their funds were simply seized in order that
others might have the means with which to pay bonuses and financially
profit from and/or personally enjoy such things as corporate jets and
expensive offices.

Bailouts represent a collision between two incompatible modes of
operation—between what Mises calls "profit management" and
"bureaucratic management." That is, they represent a collision between
operation according to the principle of striving to make profits and
avoid losses, which characterizes private business, and operation
according to the dictates of rules and regulations, which
characterizes government.

The companies bailed out expected to go on operating as private
businesses, but with government money. That's how the bailouts were
advertised. But that is impossible.

Once government money enters the picture, the firms are effectively
nationalized, even though the outward guise and appearance of private
ownership may remain. This is because their operations are no longer
based on profit-and-loss considerations but on satisfying the
government and whatever sectors of public opinion are loud enough at
the moment to influence the government's decisions.

What precise actions the government will take are unclear at the
moment and appear contradictory. For example, the front-page lead
article of The New York Times of February 5, 2009 carries the headline
"Executive Pay Limits Seek to Alter Corporate Culture," followed by
the subhead, "Obama Announces a $500,000 Cash Cap at Companies Getting
Future Aid."

Nevertheless, a careful reading of the article shows that $500,000 is
a limit only on annual salary. Payment of stock options will still be
possible, but they will not be able to be exercised until all of the
company's debt to the government is repaid. Even the limit on annual
salary appears to be not very firm. In most cases, it can apparently
be waived by means of a "nonbinding shareholder vote."

The article declares,

Even the new rules allow companies some leeway. While giving
shareholders a say in bonuses above the cap and restricting when stock
incentives can be cashed in, the rules do not place limits on the size
of such awards, which have become the biggest part of many
compensation packages. In addition, the toughest new rules apply only
to large companies seeking government assistance to survive…. And
companies that seek aid but do not need exceptional government
assistance can waive the $500,000 pay cap, as long as they submit
their executive pay policies to a nonbinding shareholder vote.
Very significantly, the article notes that

The rules would not prohibit a lower-level executive, like a stock
trader or investment banker, from continuing to receive tens of
millions of dollars in pay. (My italics.)
If this last is true, then one must wonder exactly what the brouhaha
about bonuses was all about in the first place. Because, with this
last provision, they appear to be back in, almost in full force.

The current version of the proposed pay caps is clearly contradictory
and bound to disappoint Wall Street's critics. It reads like a
compromise forged of a competition between whose lobbyists could get
to which politicos with the largest bribes or greatest threats first.
At this point, there is no telling what the final proposal will look
like. The Times's article notes that "Officials also emphasized that
several of the proposals would not be made final until after public
comments had been considered."

What would be required to satisfy the rhetoric of Wall Street's
critics would be the total abolition of bonuses and a maximum limit on
total executive compensation in the nationalized firms to $500,000 for
any one individual. That, of course, would mean the destruction of the
nationalized firms as viable institutions.

With such a level of compensation, further discussion of such things
as corporate jets and expensive office remodelings would disappear, at
least as far as the nationalized firms were concerned. This is because
the low pay ceilings on executive salaries, and thus the kind of low
quality executives likely to be attracted, would eliminate the context
in which an economic calculation could justify the purchase of a jet
or an expensive office remodeling.

Executives whose salaries are limited to $500,000 are not going to be
able to afford to accept the kind of reduction in take-home wages that
would be necessary to cover any significant part of the cost of
providing a jet or an expensive office remodeling. Nor is any enhanced
productivity of such executives likely to be great enough to justify
the cost. The head of a government controlled firm may inherit a
luxurious office but all that he can afford or that can be afforded on
his behalf is not very much more than a desk and a phone—and volumes
of rules and regulations that he can consult and scrupulously follow,
in order to be able to prove that whatever losses may strike his firm
were not his fault.

But the destruction of bailouts is not limited to the crippling of the
firms that are bailed out. It also taints the operations of the firms
that are operating without bailouts. As already pointed out, they too
have given up their jets and are keeping their heads down, despite the
fact that economic rationality implies that they should keep their
jets. They have been cowed by a raging hostility toward capitalism and
wealth.

Symbolism
I quote the words of a prominent New York Times reporter, who sees the
facts of the situation, even describes some that I omitted, and yet
approves of what has happened. He writes:

When you get right down to it, the purchase of a new plane or an
office renovation is pretty meaningless for companies as large as
Citigroup or Bank of America [Merrill Lynch is now part of Bank of
America]. It's not unheard of for executives to spend $1 million or
more on remodeling when they get the corner office. It's pocket
change. And companies can usually make a halfway decent business case
to justify a new airplane. (It goes longer distances than older
planes, can take more executives to meetings, allows the top brass to
be more efficient and productive, etc., etc.) The question of whether
bailout money was used to pay for these perks — as alleged by The New
York Post, which broke the Citi airplane story — is, at best,
ambiguous. Indeed, breaking the airplane contract and sending the jet
back to the manufacturer will probably cost the bank more than keeping
the plane. None of that matters. You could make the same argument
about the auto executives who flew on corporate jets when they came to
Washington to ask Congress for help: surely, it was a better use of
their time to fly rather than drive from Detroit, as they did the
second time around, after being spanked for taking the jets. That
didn't matter either. What matters is the symbolism. At a time when
the country is in such trouble — and executives are asking for
bailouts — anything that smacks of plutocracy is going to arouse
justifiable populist anger. (Joe Nocera, "It's Not the Bonus Money.
It's the Principle," New York Times, January 31, 2009, p. B1. My
italics.)
So here we have it. What the outrage is really all about is the hatred
of great wealth and its possessors. The goal is to attack them in the
name of an alleged duty of the individual to sacrifice his wealth,
pleasure, and enjoyment, and ultimately his life, for the benefit of
others less fortunate. Seen in this light, the furor raised about
corporate jets, office remodelings, and the like is understandable. It
is the kind of symbolism appropriate to a campaign on behalf of self-
sacrifice and against the pursuit of happiness.

In sharpest contrast and opposition to the philosophy of self-
sacrifice and to the role of government as the enforcer of sacrifice,
stand these famous lines:

We hold these truths to be self-evident, that all men are created
equal, that they are endowed by their Creator with certain unalienable
Rights, that among these are Life, Liberty and the pursuit of
Happiness. — That to secure these rights, Governments are instituted
among Men….
These words are from the Declaration of Independence, which is the
founding document of the United States. Their meaning is that the
United States was established for the purpose of securing the right of
the individual to pursue his own happiness, which includes material
prosperity. In the United States, the individual and his rights are
supreme. Government exists only in a subordinate role, that of a
servant dedicated to protecting and securing the individual and his
rights from the aggression of common criminals at home and of despots
abroad.

What symbolism would be appropriate to this conception of the
relationship between the citizens and their government? How would it
differ from the present such symbolism?

The present symbolism depicting the relationship between the
government and the citizen is that the head of the government, the
President of the United States, has at his disposal, with no objection
from anyone, Air Force One, which is a Boeing 747 jet plane that costs
hundreds of millions of dollars and, when configured for commercial
operation, carries more than 450 passengers. At the same time, howls
of anger and fury go up when one of the largest private corporations
in the country dares to order a 12-seat jet plane for $50 million.

The acceptance of this relationship symbolizes the total reversal of
the relationship between government and citizen that the founding of
our country was intended to establish and maintain. The symbolism
appropriate to that relationship would be that while private citizens
are free to fly in 747s, or Lunar Landers for that matter, depending
only on how successful is their individual pursuit of happiness, the
President of the country, who is merely the chief night watchman of
the nation, and is its servant, is consigned to a 12-seater jet.

Of course, this is not to begrudge the President of the United States
the use of a 747 in today's world, in which he may require such a
plane merely in order to have necessary means of communication at his
disposal. But it is to remind all those seeking to deify the
government and raise it above the citizens, that they are encouraging
a servant to forget his place and to become the master of those whom
it is his duty to serve.