Are the .01% Capitalists?

Dec 22, 2011Bruce Judson

money-question-150The super-rich might not be so outraged by accusations that they haven't earned their money fairly if they didn't know it was true.

Thanks to the Occupy movement, the extreme inequality in America has become a focus of the national dialogue. Recently, several of the super-rich have stepped forward to defend their place in society. Leon Cooperman, the billionaire founder of  Omega Advisors, a hedge fund sponsor and previously a senior official at Goldman Sachs, wrote a much publicized letter to President Obama, while Bloomberg News reported that Jamie Dimon, the CEO of JPMorgan Chase & Co, used a question at an investor conference as an opportunity to say that "Acting like everyone who's been successful is bad and because you're rich you're bad, I don't understand it."

For me, the question is not why there seems to be an outpouring of criticism and anger at the rich but whether it's justified. My answer is straightforward: Many of today's super-rich, particularly in the financial sector, have achieved their wealth in ways that are fundamentally anti-capitalist. As a consequence, people are justifiably wondering whether we have an economy that operates on the principles of capitalism or of oligarchy.

A central tenet of capitalism is that those who create the greatest wealth for society should receive the highest compensation. This is the ideal that has for generations motivated Americans and led to the admiration, indeed often veneration, of the rich. These wealthiest members of our society are seen as the people that have helped make us all somewhat better off.  As a result, they deserve their rewards.

What the Occupy movement and others are questioning is whether making us all better off is, in fact, what has made people "rich" and "successful" (Mr. Dimon's words) in the current era. Are the rich and successful the creators of wealth and jobs for all of us, or are they the predators and moochers (Ayn Rand's term in Atlas Shrugged), the reverse Robin Hoods who succeed by finding ways to redistribute wealth upwards?

To me, it's also notable that the most virulent complaints of the 1% seem to come from those in the financial sector. As I talk with wealthy Internet titans, I hear almost universal praise for our societal focus on income inequality. In essence, the complaints emanating from our financial titans have the ring of Shakespeare's famous phrase in Hamlet, "the lady doth protest too much, methinks."

Let's examine the ways in which many of today's highest income Americans, originating in the financial sector, are reverse Robin Hoods rather than wealth creators:

First, as I have written in earlier articles, the financial sector now operates outside all of the disciplines that are inherent in capitalism, from accountability for terrible business decisions to the enforcement of fair bargains to retribution for malfeasance. On the contrary, Bloomberg News recently disclosed massive secret Federal Reserve support for failing banks. This has led to an emerging consensus that the financial sector is socially useless or acutally destroys our overall societal wealth. Nobel Laureate Paul Krugman wrote in his New York Times column that:

[A]fter the debacle of the past two years, there's broad agreement -- I'm tempted to say, agreement on the part of almost everyone not on the financial industry's payroll -- with Mr. Turner's assertion that a lot of what Wall Street and the City [London's stock exchange] do is "socially useless."

In addition, it seems almost undeniable that, in the absence of the excessive anti-capitalist activities of the financial sector over the past decade, our entire society would now be wealthier. I wonder whether many of the "rich" and "successful" who have emerged in this arena would have achieved this wealth if they had been forced to compete on a level, fair playing field governed by the disciplines and rules of actual capitalism.

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Second, finance is an intermediary good. It is not an end in itself, but a means of greasing the wheels to make the economy run better. In a capitalist system the purpose of finance is to help limit risk (for example, by allowing a farmer to hedge against price drops in grain) or efficiently allocate investment capital in support of the long-term growth of new enterprises. According to AR Magazine, the top 25 hedge fund executives earned $22 billion in 2010. In addition, a recent report indicated that, despite the recession, Wall Street was on track for a record year in bonuses, while the financial sector now accounts for 29 percent of all U.S. corporate profits. Since the Census Bureau just reported one in every two Americans is poor or low income, this suggests some kind of massive disconnect between the operating purpose of the financial services sector and the wealth it is accumulating for itself versus the benefits is it creating for our larger economy.

Third, in a capitalist economy, all zero-sum activities which have a winner and loser with no growth in societal value,  are, at best worthless. Yet the majority of hedge funds, Wall Street traders, quants (the people who created sophisticated trading models), and issuers of so-called naked Credit Default Swaps all make money largely through zero-sum activities or high-speed trading (which now accounts for an estimated 75 percent of all equity trading in the U.S.), none of which are oriented toward creating value for society. This suggests, as David Cay Johnston pointed out in a recent column, that the entire business associated with so-called naked Credit Default Swaps is zero-sum gambling and should be illegal. At minimum, it has no value in a capitalist economy.

Moreover, the marginal societal benefits of hedge fund activities, if they exist, are almost certainly offset by the other costs they impose on our society. They create the potential for systematic risk to the overall economy, while hedge funds and other high-paying Wall Street activities also lead to the terrible allocation of talent in our nation. An important share of the nation's top talent is now gravitating to high-paying finance activities, engaged in determining new arbitrage strategies rather than creating the businesses that will create the next generation of jobs and real wealth the country so desperately needs.

In short, I would deem the billions of dollars in bonuses and earnings from hedge fund activity, several large lines of business, and high-speed trading on Wall Street to be antithetical to the capitalism that has helped to make America great. I recognize that I am undoubtedly painting with too broad a brush, but the fundamental point remains.

Finally, many of the rich are not playing by the same rules as the rest of Americans, and in our democracy people resent this basic unfairness. Hedge funds and private equity firms have used their political influence to ensure that the carried interest rule -- which allows a large portion of their earnings to be taxed at 15 percent as opposed to ordinary income rates -- remains in place.

So this brings me back to my original question: Are there a sizable number of the "rich" and "successful," particularly among the most notable members in the financial services sector, who don't meet even the most basic definitions of practicing capitalists?

If so, then perhaps the emerging dialogue over wealth in America is justified and represents an important examination of whether the country's economy has strayed from a core value in the capitalist ideal. Is the vitriol we are now hearing really fear that soon crony capitalism, socialism for the rich, and corporatism will no longer guide national policy?

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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