Free Minds & Free Markets

Gekko Echo

A closer look at the "Decade of Greed"

One of the most memorable scenes in Oliver Stone’s 1986 movie Wall Street takes place at a shareholders’ meeting of Teldar Paper Corp. Gordon Gekko, the oily financier, is defending his bid to take over the company. "The point is, ladies and gentlemen, that greed, for lack of a better word, is good. Greed is right. Greed works....And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."

Long before they ended, the 1980s were tagged as the decade of greed. That epithet has been repeated in dozens of books and movies, in hundreds of articles, editorials, and sound bites—repeated so often that it no longer seems controversial. In a single phrase, it represents that tumultuous decade as a melodrama peopled by greedy financiers obsessed with short-term profits, yuppies engaged in an escalating spiral of conspicuous consumption, and the long-suffering working and middle classes, who played by the rules but had to pay for the party. The plot runs as follows:

In the early ’80s, the Reagan administration lowers income taxes on the wealthy, cuts social spending for the poor, and rescinds regulations on business. Money pours into financial markets, setting off a speculative frenzy reminiscent of the Roaring ’20s. A wave of mergers, acquisitions, and leveraged buyouts changes the face of corporate America. Obscene sums of money are made by corporate raiders like T. Boone Pickens, Carl Icahn, and Ronald Perelman; by LBO firms like Kohlberg Kravis Roberts; and by rogue investment banking firms like Drexel Burnham Lambert.

Great American companies are dismantled, swallowed up, or saddled with crushing debt loads which they have to service by firing employees, slashing wages, and cutting back investments in research and capital improvements. The vast increase in debt is made possible by "junk bonds": high-risk, high-yield securities pioneered by Michael Milken at Drexel Burnham. Milken is the evil genius of the piece, a financial pusher who gets American business hooked on leverage.

In Act II of the drama, retribution comes to Wall Street. Ivan Boesky, the notorious arbitrageur, admits to trading takeover stocks on the basis of inside information, which he paid for with cash by the briefcase. With Boesky’s help, federal prosecutors set off on a white-collar manhunt that eventually snares Michael Milken, who is sentenced to 10 years in prison.

By curtain’s close at the end of the decade, most of the gains from a booming economy have been captured by the wealthiest 1 percent of the population. There has been a huge increase in the inequality of wealth and income. Meanwhile, the junk-bond market has collapsed and taken with it the savings and loan associations, imposing huge costs on the taxpayers. As penance for the orgy of greed, the economy plunges into a long recession.

This melodrama is very nearly pure fiction.

There’s no denying that crimes were committed—though not on the scale suggested by such fevered accounts as James Stewart’s best-selling book Den of Thieves. Leaving aside the guilty pleas by Boesky, Milken, and others, most of the convictions the government obtained have been overturned on appeal. And Milken pleaded guilty only to six technical violations of the law; the government was never able to make a case against him on the more serious charges of insider trading, stock manipulation, or bribery. Outside the courtroom, it is true that there was greed on the Street. Greed has always existed and always will. Though no one has yet found a way to measure these things, it may be that the flame of avarice burned brighter in the ‘80s than at other times. There was easy money to be made for a while, and easy money always draws people of easy virtue. But in every fundamental respect, the story being sold under the title "Decade of Greed" is the exact opposite of the truth.

In the ’80s, capitalism won its long political conflict with socialism. Nations in the former Soviet bloc abandoned their commitment to command economies, as the rest of the world rushed to embrace private property, free markets, and limited government. Meanwhile, an unprecedented wave of innovation swept over the capitalist West.

Those who watched the collapse of the Berlin Wall may have taped it (on an ’80s VCR) as it was broadcast live on CNN (the ’80s news network). Or they could have called the airlines (on an ’80s cordless phone) or faxed a travel agent (on an ’80s facsimile machine) and reserved a flight to Germany (on an ’80s computerized reservation system, at ’80s prices for international flights). On the flight back, they could call their friends (from ’80s airplane phones), leaving a message if necessary (on ’80s voicemail). Then they could put their chunk of the wall next to their PCs and laser printers.

Accompanying these innovations in consumer products and services—and making them possible—was an equally profound wave of innovation in financial markets. The financial innovations were intangible, but they were just as real—and just as valuable—as the new consumer products

Prior to the ’80s, financial services were extremely segmented. Commercial banks made business loans, savings and loan institutions made mortgages, investment banks handled mergers and acquisitions, and so on. Like the meat in a crab, these niches were walled off from each other—not by the market but by law. Government regulations kept banks and S&Ls from owning stocks, imposed controls on interest rates, and subsidized banks by means of federal deposit insurance. Within their domains, financial firms specialized in serving a more or less fixed base of clients; a local bank, for example, would originate, service, and hold as assets the loans it made to local businesses. To protect these relations from disturbance through changes in prices and flows of credit, foreign competitors were excluded. Protection was the glue that held in balance the relationships among clients, financial firms, and government regulators.

During the last two decades, the postwar financial world came unglued as a result of broad economic and technological changes. Cheap computing power, vast improvements in communications, and the growth of foreign economies created a global financial market, symbolized by 24-hour trading in securities. Some $900 billion now changes hands every day in currency trading.

The volume of security trading between Americans and foreigners has skyrocketed: In 1980, the dollar total was equivalent to 9 percent of GNP; by 1990, it was equivalent to 93 percent of GNP.

Protectionism became impossible. So did the domestic regulations that limited the interest banks could offer depositors. Inflation in the late ’70s made deregulation necessary if banks were to compete with the new money-market funds.

Other innovations in capital markets broke down the traditional segmentation among firms. Large creditworthy borrowers could go directly to the market to issue commercial paper; they no longer needed the banks as intermediaries. In the mortgage market, the rationale for savings-and-loan institutions was disappearing. Mortgage bankers and other sorts of finance companies could originate loans, credit agencies could guarantee them, and mutual funds could hold them by buying mortgage-backed securities, a product pioneered by Salomon Brothers in the early ’80s. It turned out that these functions do not need to be bundled together in a single firm; unbundling them allowed more competition and lower mortgage costs for consumers. In addition, new techniques for balancing debt/equity ratios. selecting market portfolios, and pricing undervalued assets; revolutionized corporate finance and securities trading.

These innovations made a great deal of money for those who invented, developed, and took advantage of them, with the greatest profits typically going to those with the vision and courage to get in early. The profits were a fair return for the creation of value: The innovations lowered costs, improved efficiency, saved time.

The same is true for the two most controversial innovations of the ’80s: leveraged buyouts and junk bonds. There is now an extensive body of academic research on both phenomena, and the conclusions are diametrically opposed to the popular impression.

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