The Original Sin

   Why James Lorie doesn’t get his name in books

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Posted in Contemporary economics, Uncategorized Tagged with: , , , , ,

Reading Transaction Man: The Rise of the Deal and the Decline of the American Dream, by Nicholas Lemann (Farrar, Straus), I experienced a mounting sense that something in the argument was hidden from me, and perhaps from the author himself.

I understood well enough that Lemann chose his title in contradistinction to The Organization Man, William Whyte’s 1956 book that inveighed against the hierarchic ethos that seemed to dominate America in the 1950s: well-roundedness, belongingness, togetherness, and specialization. Whyte was against gray flannel suits, ticky-tacky houses, business schools and giant corporations; against conformity in general. He was in favor of genius and innovation, entrepreneurs and philanthropic foundations “immune to the pressures of immediacy or the importunings of the balance sheet.”

Lemann is enthusiastic about organizations of all sorts, or institutions, as he prefers to call them, and against the forces that have eroded them. Transaction Man (who just as easily could be a woman) is to be found, he says, engaged in private equity, venture capital, hedge funds, strategic consulting, global philanthropy, education reform, “breaking corporations apart and rearranging them in ways that have made it just about impossible for anybody these days to be an Organization Man.”

That much, too, I understood.  Bloomberg Businessweek’s cover story last week proclaimed, “You Live in Private Equity’s World.” But what are these practitioners of “the deal” about? The PE industry didn’t exist thirty years ago; today it has trillions of dollars under management, Bloomberg explained its seemingly irresistible rise this way: “In a world where bonds are paying next to nothing – and some have negative yields – many big investors are desperate for the higher returns PE managers seem to be able to squeeze from the markets.”  I was almost finished with Transaction Man before I came across a passage that clicked, as Lemann explained one last time:

When a challenge presents itself – how to educate our children, how to fight poverty, how to change politics, how to improve the tone of polarized society – any proposed solution that can be characterized as relying on bureaucracies, organizations, government agencies, or established interest groups, is doomed to lose the argument. Only innovation, disruption, destruction and individualizing can possibly work.  In the manner of someone who thinks the cure for a hangover is another drink, the country keeps reacting to troubles produced by the deterioration of its institutional life by embracing further deterioration. In polls, faith in the core institutions of American life, government, business, religions, public schools, news organizations, the legal system – has been falling for decades. In response, we persist in thinking about solutions that would continue to weaken these institutions, to the point that it would become nearly impossible for them to regain our trust.

But what is the nature of these “solutions”? Nobody goes around promising to deliver “innovation, disruption, destruction and individualizing.” Those often are the effect, but they are not the pitch. What Transaction Men promise are market solutions. Underneath the idiosyncratic use of the words “transactions” and “deals,” what Lemann is really writing about are markets.   The word scarcely occurs in the book.  When I turned to the index, what I found was this: “markets, see free-market purism; investment banking; specific financial instruments.”

Lemann, a distinguished journalist, has written eloquently about race relations and social mobility, among other things over a career spanning forty years. But he is a newcomer to business history. I’m willing to bet he never took an economics course in college.  That means he is a stranger to the most fundamental characteristic of markets, captured by the metaphor of an Invisible Hand: the tendency toward equalization of rates of return, enforced by the disposition of investors to shift from low to higher returns. Markets are what the transactions industry – or, better, the restructuring industry – has been all about.

Specifically, Lemann  doesn’t understand oligopolies, heavily concentrated industries with little competition that are able to set prices and pay, at least for a time, generous wages and benefits to their employees. They differ from monopolies in that a handful of companies dominate the relevant market, rather than a single provider. Oligopolies created the world of the Fifties, especially in America, whose industrial base was energized and mostly untouched by the devastation of World War II. Oligopolies prevail in many Silicon Valley industries today.  But their high rates of return inspire competition.  Other companies enter the business, often with the advantage of new and better techniques.  More workers acquire necessary skills, and wages fall. Corporations relocate to cut their costs. What once seemed insuperable advantages get competed away.  Consumers grow richer, but institutions and practices that once governed production erode and change.  The best recent account of this I know – An Extraordinary Time: The End of the Postwar Boom and the Return of the Ordinary Economy, by Marc Levinson (Basic, 2016), received relatively little attention when it appeared.

For someone without an economics background, Lemann does an awfully good job of assembling a scorecard of those whose work played major roles in elucidating and often justifying what has been happening these last fifty years. He does so in those twenty pages on “free market fundamentals” at the University of Chicago in the years after 1960. His discussion of the work of Harry Markowitz, Franco Modigliani, Milton Friedman, Eugene Fama, Merton Miller, Myron Scholes, Robert Merton, Ronald Coase – all of them recognized by an economics Nobel Prize – occurs in a savvy chapter about Michael C. Jensen, one Chicago economist who has not acquired that extra measure of fame.  Yet Jensen’s work , beginning with “The Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” with William Meckling, which appeared in 1976, did more than any other finding to underpin with economic logic the revolution in corporate governance that has  transformed the global business landscape.

But Lemann stops one layer short of uncovering the most fundamental development of all in his story of institutional change.  That occurred on May 1, 1975, when Congress outlawed the cartel that permitted the New York Stock Exchange (NYSE) to fix commissions on its trades. “Mayday” was, as journalist Chris Welles described it not long afterwards, in The Last Days of the Club: (Dutton, 1975), “quite a spectacle,” at least to the little coteries of newsmen who followed Wall Street in those days.

For nearly two hundred years, Welles wrote, Wall Street firms had insulated themselves from competition.  They had operated as a club, apart from all other industries, free to cooperate and monopolize, and therefore able to allocate capital pretty much throughout the American economy.  But, for one reason or another, the Nixon administration had turned against them; the Justice Department of John Mitchell and Richard Kleindienst had led the fight in Federal courts.

In the wake of Watergate, the NYSE found itself powerless to deflect the onrushing legislation. “Once the privileged, protected elite of the nation’s financial system, members of the Club had been reduced –or elevated, depending on one’s point of view – to [the role of] typical businessmen, feverishly scrambling to boost revenues, cut costs, squeeze out earnings, beat competitors, and increase market share.” It was, for instance, the prospect of Mayday that induced the investment banking firm Morgan Stanley to move its headquarters from Wall Street to midtown Manhattan, the better to compete with the nation’s biggest banks – a tremor which would end, twenty-five years later, with the evanescence of the Glass-Steagall Act.

The Treasury Department report that made the case for ending fixed commission was written by James Lorie, a professor of economics and business administration at the Graduate School of Business of the University of Chicago. He had been appointed to the task by William Simon, a former senior partner of Salomon Brothers who became Secretary of the Treasury under President Ford. Simon went on to help found the private equity industry with a series of leveraged buyouts in the Eighties, along with Michael Milken, Carl Icahn, T. Boone Pickens, Irwin Jacobs, and others.

Lorie remained at the University of Chicago, presiding over its Center for Research in Securities Prices, and died in 2005, at the age of 83. He was never, as far as I know, mentioned in connection with a Nobel Prize, because the grounds for abolishing fix commissions had been obvious to market participants. What he did was provide the formal logic, upending a report a year earlier by former Federal Reserve Chairman William McChesney Martin, who had recommended maintaining the old system. But no single action did more than Mayday to promote the restructuring movement – the market turn – to which Lemann complains. None better illustrates the intimate dialogue between practice, theory, and more practice.

As I finished Transaction Man, my eye fell on a review of a new commemorative edition of Abbey Road, the Beatles’ final recording together, which appeared in late 1969. The original title was to have been Everest.  The four had agreed to fly to Nepal to photograph an album cover.   But when the mixing sessions ran long, Paul McCartney proposed photographing the cover in Abbey Road, outside the studio, and so they did. The group met to discuss another album, but a few days later John Lennon returned from playing a solo concert in Toronto with his Plastic Ono Band, and announced that he “wanted a divorce.” And so the most successful band in history, an oligopoly among oligopolies, broke itself up on its own. The book about the wellsprings of the market turn – the fall of the Iron Curtain, Willian Whyte, Milton Friedman, John Lennon, and all the others, has yet to be written.

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The Nobel Prize in Economics will be announced on Monday.  See The Nobel Prize in Economics Turns 50, by Allen Sanderson and John Siegfried, in The American Economist, for interesting lists of Big Ideas, Pedigrees and Might-Have-Beens.  Elsewhere, Mervyn King, former governor of the Bank of England, assesses the significance of the award.

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New on the EP bookshelf:

Under the Influence: Putting Peer Pressure to Work, by Robert H. Frank (Princeton, January 2020)

How Charts Lie: Getting Smarter about Visual Information, by Alberto Cairo (Norton)