A Synopsis of the book: The Trouble With Billionaires
by Linda McQuaig and Neil Brooks (2010)
SOCIETIES IN AND OUT OF BALANCE:
EFFECTIVE SHARING OF WEALTH AND POWER
A careful balance between private and public access to “property” of every kind appears to be essential to social harmony. Not all forms of property are, or should become, private. Moreover, an important and reasonable argument can be made that rather more of current “property” should cease to be exclusively and permanently in private hands. Parts of it deserve to be returned to the Commons from which it came, to be shared by all—now, and throughout generations to come.
Monopolies have long been recognized as being potentially dangerous for economies and for societies. Monopolies invariably open the possibility (if not the virtual certainty) that they will be exploited in selfish and harmful ways. That is why the prevention of monopolistic powers has long been one important role for governments. By extension, governmental controls over excessive degrees of private property, and excessive levels of income inequality, are proving to be important as well.
Of course, depending on the circumstances, any reduction of private property could bring with it its own dangers to society. And yet “expropriation” of some part of your income, or your land, perhaps your patent on a vital drug, or even requiring you to share your expertise, your time, and your labour, can occasionally be seen as necessary. And sometimes, with appropriate compensation, it can also be seen as fair. Yet currently, and not infrequently, all such “expropriations” are claimed to be extremely unfair—even to be a type of theft.
In particular, there are those who claim that higher taxes on higher incomes are a theft of fairly “earned” and well “deserved” riches. Such arguments ignore the fact that those surplus riches might equally and validly be said to have been a form of loan to each of us, i.e. a loan from a society that provided us with most of the tools and knowledge and infrastructure that together were necessary to create so much income.
A particularly clear and forceful exposition of this latter point of view has been presented in the provocatively titled book The Trouble with Billionaires, written by Canadians Linda McQuaig & Neil Brooks. This delightful and informative book documents many of the societal dangers and moral injustices that are associated with marked inequalities of income, of wealth, and political power. McQuaig & Brooks directly challenge the arguments that these marked inequalities are fair because they are the fruits of personal merit and effort, and, that such inequalities are necessary because they alone are what motivate “progress” and lead to better lives for the rest of the world’s inhabitants. [The Trouble With Billionaires was published in 2010 by Viking Canada, a division of Penguin Books Ltd. A paperback edition, with a new introduction, was published in 2011 by Penguin Canada. All page references given below refer to the 2011 Canadian paperback edition.]
The links between wealth and social power, links that facilitate the abilities of the wealthy to determine many of the conditions under which all must live, and, to distort the flow of information and natural resources on which all depend, are a further problem posed by marked inequalities. These links too are addressed in this book, directly, clearly, and at length.
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In 2010, when McQuaig & Brooks published their book, there were 1,000 known billionaires in the world. By March of 2013 Forbes magazine counted at least 1,400 individual billionaires, plus a number of uncounted billionaire families whose wealth is held jointly, plus a number of billionaire royals and dictators whose wealth is nominally held in trust for their nation. If one adds to these billionaires the much greater number of multi-millionaires, people with personal wealth in excess of as “little” as one hundred million dollars, the amount of very highly concentrated wealth in the world has become truly significant.
McQuaig & Brooks start their book by giving readers a concrete feel for just how vast is one billion dollars. [What follows here is a slight variation of the example they use.] Suppose you are hired to work counting $5 bills for six hours each workday, five days each week, every week of the year. Your pay will be all the money that you count. And let’s suppose that over the long run you consistently average a count of about 40 bills every minute, often more than one per second, but with periodic short breaks and moments when you reach for more bills and put what you’ve already counted into nearby containers. No time for any long rests during each six hours of work. But still, by averaging $200 per minute for 360 minutes per workday, you would be earning a very satisfying $72,000 each day.
Seventy two thousand dollars is more money than 75% of all the people in North America currently earn in a whole year. By the end of just your first week you will have received $360,000, already more than 99.5% of all North Americans will earn in a year. And, shortly before the end of your third week of work you will have accumulated your first million dollars. How long, then, will it take you to become a billionaire?
In fact, at this rate, it will take you more than 53 years to become a billionaire, working 30 hours every week of every year. Even just your first $100 million dollars would take you five years and 4 months to achieve, despite the fact that you continue to earn more every single workday than most people earn in a year. One hundred million dollars is a huge amount of money. Yet for every billionaire in this world there are hundreds more people who have at least $100 million in wealth.
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Having given us a better grasp on just how much a billion dollars is, McQuaig & Brooks then use another example to bring home just how much income inequality exists in Canada and in countries like it. The example they use was first suggested by the Dutch statistician Jan Pen, so it has come to be known as a “Pen Parade.” Each such parade (one for each country or group being discussed) lasts exactly one hour. During the parade a fast moving line of persons, all arranged according to height, move quickly by the reviewing stand. Thus one-sixtieth of the population passes you during every minute of the parade, beginning with the shortest person and concluding with the tallest. However, in this parade each person’s height is proportional to his or her yearly income. The people whose incomes are at the population median go by at the average normal height. But a person whose income is half of the median will appear only half that tall, while a person whose income is twice the median will appear twice as tall, etc. [Formally, the “median” is the middle income, such that half the population earns less than this amount, and half earn more than this amount.]
The 1978 Pen parade for personal incomes in Canada documented the existing inequality that year. For the first six minutes in that parade, no one was as yet even one foot tall. At the fifteen-minute mark no one was yet three feet tall. Not until nearly forty minutes had passed were people of average height finally seen. With about ten minutes left to go, very tall people started to pass by, i.e. high-income professionals who began to reach seven and eight feet tall. With six minutes left in the parade there were people seen who were approaching fifteen feet tall. But the real drama in the parade came in the final minute. Twenty-five seconds before the parade finished, the marchers reached thirty feet tall. And in the 1978 parade, the final few participants included one who was 167 feet tall, another at 199 feet tall, and the last one at 224 feet tall.
1978 was one of the last of a long string of years during which middle-class incomes enjoyed a small rise in purchasing power. In the decades that followed, while the economy continued to grow, the bulk of all increases in purchasing power (and wealth) were seen primarily among to top five percent of income earners, and particularly among those in the top tenth of one percent. McQuaig & Brooks contrast the Pen Parade for 1978 with the same Parade for Canada thirty years later. They write:
…For the first fifty minutes, this [2007] parade is strikingly similar to the 1978 one. But with just ten minutes to go it starts to look very different, with the people noticeably taller. …The real giants appear only at the very end, particularly in the last few seconds. …We can recognize some prominent CEOs in the crowd—except that the faces are so high up that it is hard to see them. [pg. 11]
One of these tall people is the CEO of Magna International. He has just enjoyed an income of $13 million, and he is 2,054 feet tall. That is already nine times the height of the tallest person in the 1978 parade. Soon we see the CEO of Power Corp., who received $29 million in 2007. He is more than twice as high, reaching an altitude of 4,582 feet. Soon comes the CEO of Air Canada who stands over a mile high at 6,636 feet tall. (2007 was the same year that Air Canada suffered major revenue losses and let go thousands of its employees.) The last person in this parade is the CEO of Research in Motion. He stands 8,058 feet high. McQuaig & Brooks note: “From the viewing deck at the top of [Toronto’s] CN tower we don’t even come up to his knees.” [pg. 12]
Between 1978 and 2007 the average height and the median income had each changed very little. But the increases and concentration of wealth at the top had grown dramatically. Moreover, in Canada the degree of inequality was much less than in the United States. The American Pen Parade for 2007 included many people taller than the tallest Canadian. It included Tiger Woods who stood 2.9 miles tall, and a television producer who was 4.3 miles tall. The U.S. parade ended with a number of hedge-fund managers, the tallest of whom earned $3.7 billion dollars that year. He stood 110 miles high. McQuaig & Brooks note that “A high-flying airplane is about at his knees. His head juts well into outer space.” [pg. 14]
* * *
Prior to the first World War, and for two or more decades following the second World War, financial inequality was relatively low in North America and in England. In those days significantly higher taxation rates were the norm for progressively greater levels of income and for large transfers of wealth. Even today, inequality remains low and tax rates are significantly higher and more highly “progressive,” in countries like Denmark, Sweden, Norway, and Finland. But in Canada and the United States, following marked reductions in tax rates and in government controls over the economy, inequality has twice reached its highest levels since modern measures of inequality began to be examined. One such peak occurred just before the onset of the Great Depression, in 1929, and the other peak occurred just before the western financial meltdown in 2008.
One of the primary arguments developed throughout The Trouble With Billionaires is that high levels of inequality are clearly dangerous: economically, politically, and in many other aspects of public life. Only governments are in a position to control the degree of inequality. But recently, government policies that might reduce inequality have led to increasingly vocal opposition. “Big” governments, and their vaunted “interference” with “individual freedoms” are now proclaimed to be the enemies of sound economics and prosperity for all.
The argument that governments, with their rules, controls, and taxes, unfairly distort a natural and democratic free-market system, one that would otherwise allocate all wealth and resources in the fairest and most efficient way possible, is an argument full of flaws. McQuaig & Brooks begin examining these flaws in their next chapter, addressing head-on the frequently asserted implications that governments, regulations, and taxes should be all but abolished. The authors point out, as have many others, that governments alone protect the property of the rich from seizure by others. Without government protection, the wealthy could suffer far greater losses than those in the middle-class. Because of governments the wealthy have far better access to legal support, and to protection by the judicial system, than do similarly threatened middle-class citizens. Governments are crucial for maintaining the comfort and security of the wealthy.
Furthermore, McQuaig and Brooks point out that the “free-market” concept is a fiction. All markets can only be arranged and maintained by governments and their policies. Governments decide on when and where and how markets will be allowed to function. Governments punish violations of the market rules and sometimes they modify those rules, or the degree of their enforcement, to suit the wealthy. The examples given in this chapter underscore the extent to which “recent” changes to the market rules in North America have generally been at the direction of, and to the great advantage of, the very wealthy. Increasing economic inequality, plus further increases in the both the power and influence of the wealthy, have been the result. It is disingenuous for the wealthy to complain that governments should stay out of markets and their regulation.
* * *
Having made the point that government regulation of markets is both necessary and fair, McQuaig & Brooks then address the claim of many extremely wealthy CEOs and celebrities that they alone deserve to keep their income, because only their unique skills and talent and intelligence have made their wealth possible. Step by step, McQuaig & Brooks refute such claims.
If it were true that personal talent and effort alone are sufficient to create the products that have brought one great wealth, then it should have been possible to duplicate that feat on a desert island. But using this “Desert Island Test,” McQuaig & Brooks point out that very few if any of the very wealthy could have taken even the first few steps to their wealth without having built upon the legacy, the infrastructure, and the tutelage provided by those who came before. The wealthy could not achieve their goals without special contacts and powerful allies who help to push them ahead of others on the same or similar path to wealth. Wealth that derives from a new advancement in technology would not be possible without many previous advancements made by many others, advancements that have opened up the possibilities for this latest advancement. And if one particular entrepreneur didn’t exploit the new possibilities, there would soon be others that would do so. (In later chapters of their book McQuaig & Brooks return to these themes, illustrating with some detailed examples how billionaires achieved their financial success with help from society and from many other people.)
McQuaig & Brooks then ask: who should receive the wealth generated by “innovations” that have been based on both a massive inheritance from the past and on the commercial infrastructure that society has provided to the innovator for producing and selling his products? They note that under the current market system “the innovator captures an enormously large share of the benefits.” But, they go on to say:
It is our position that society—and by extension, all of us—should be entitled to a much larger share of the benefits. This could be accomplished through a decision to raise taxes at the upper end, thereby adjusting the economic goalposts—a decision no more arbitrary than the decision made to determine the current location of the goalposts. [pg. 28]
* * *
McQuaig & Brooks turn next to consider the argument, often heard, that the presence of extremely wealthy individuals is an important source of inspiration to all, or, at worst, is “harmless fodder for the celebrity gossip tabloids and glossy magazines.” [pg. 30] But McQuaig & Brooks argue quite the contrary is true. Marked inequality in income and wealth has repeatedly been associated with a raft of socially damaging effects, including higher rates of crime, of mental illness, of heart disease, diabetes, infant mortality, higher levels of general stress, and lower levels of both longevity and social mobility.
These other links they elaborate upon toward the end of their book. But the decreasing levels of social mobility and opportunity in the United States, where one of the world’s very highest levels of inequality is to be found, is particularly striking, and it is underscored here. The “American Dream” of a land of opportunity for all was valid in the years following World War II, but not today. The America of today, with the highest proportion of billionaires in the world, has one of the lowest levels of upward mobility. As McQuaig & Brooks note:
A society top-heavy with billionaires may seem like a paradise of upward mobility, but it’s actually closer to being a boneyard of broken dreams for all but a lucky few. Those wanting to give their children a real chance to live the American Dream would be well advised to move to Sweden. [pg. 31]
There is one other casualty of income inequality that McQuaig & Brooks suggest needs to be added to the list above. As previously noted, inequality rose to its highest levels twice in the past century: both times just before a severe market crash and a bursting bubble of speculative investing, coupled with high levels of personal debt. Just before each crash, in both 1928 and in 2007, the top-earning one percent of Americans received a record high twenty-four percent of all the income in the country. We need to ask if one problem with billionaires might well be that their existence destabilizes the economy. McQuaig & Brooks note that: “While poverty is treated as a problem, inequality in itself is rarely considered an issue, or even a subject for public debate.” [pg 33] They suggest that marked inequality in wealth is an equally serious issue, one that must also be considered. They begin their consideration by examining the roles played by billionaires, and by the wealthiest millionaires, in the history of the economic traumas of 1929 and 2008.
* * *
In both events, the roles played by the wealthiest people in the land turned out to be crucial for creating the conditions that led on to the market crashes. Prior to the 1929 market crash, a few bankers and industrial tycoons were paramount in changing the market rules that led to excessive risk-taking and stock market speculation. Beginning with President William Taft in 1909 and particularly during the presidencies of Warren Harding, Calvin Coolidge, and Herbert Hoover, governmental economic policy was essentially dictated by fewer than a dozen of America’s most wealthy and powerful figures. McQuaig & Brooks document the history of J. P. Morgan and John D. Rockefeller and their successes at circumventing the rules that prevented banks from selling stocks and bonds. The authors illustrate the wide, monopolistic financial power and control wielded by these two men and their wealthy allies: how they shut down Congressional attempts to regulate them more closely; how they greatly weakened the powers of organized labour; and how they took control of the Federal Bank and used it to further their own interests.
Beginning in the mid-1920s, the tycoons of the day, particularly through the efforts of the extremely wealthy banker Andrew Mellon, also pushed through congressional legislation that dramatically reduced the taxes paid by the very wealthy. Mellon’s efforts, in his role as the U.S. Secretary of the Treasury, even allowed the wealthy to receive very large payments from the government in the form of “rebates” for taxes the wealthy had previously paid on the large wartime profits they enjoyed during World War I. McQuaig & Brooks write:
Altogether, between the reduced tax rates and the refunds, Mellon’s Treasury Department handed over an astonishing $6 billion to the wealthiest Americans—equivalent to $72 billion today—a massive windfall that was to act like gasoline in fuelling the stock market bubble of the late 1920s. [pg. 43]
In the ten years between 1919 and 1929, as income inequality was rapidly increasing, worker productivity rose by 43 percent, yet wages rose only slightly, by 8 percent. One effect of this trend was that the costs of production were falling and thus corporate profits were increasing. In general, consumers were unable to afford to buy many of the new autos and appliances coming on the market, so corporations were not investing in expanded production or in higher wages. Instead, corporations, just like their the wealthy owners, began investing heavily in Wall Street stocks. Stock prices began to rise dramatically and large profits seemed to be made by many investors. Middle-class investors were lured into thinking they too could get rich with modest investments made on credit. Banks had been freed to deal in stocks and bonds by the Taft administration and they too joined in the buying spree. Banks also sold financial products of their own creation, giving the illusion that the wealth of the banks themselves stood behind these risky products. Moreover, insiders were issued shares of these new products early, at heavily discounted prices, to sell later for personal gain fuelling the illusion that everyone could get rich in the stock market.
Following the devastating crash in October 1929 and the election of Franklin Roosevelt, hearings were held into the behaviour of the Wall Street Banks leading up to the crash. The tale and trail of abuses revealed in these hearings (described in detail by McQuaig & Brooks) led to legislative reforms that Wall Street was no longer able to prevent: Wall Street lost control of the Federal Reserve Bank; organized labour was reinvigorated; banks were again forbidden to sell securities or insurance; and taxes on the wealthy were returned to higher and more progressive levels.
* * *
Thus, by 1936 inequality in America had begun falling rapidly, and it continued to do so during and after World War II when, for a time, wages were controlled (and effectively raised.) In 1928 the top one percent of the U.S. population had received twenty-four percent of all national income, but by 1948 this share was approaching its historic low of ten percent. McQuaig & Brooks describe the next 20 years as:
…an era of restrained banking, reduced incomes for the rich, and a rising middle class. [It] was also a time of extraordinary economic growth and prosperity. …Our point is that the measures that reduced inequality in the early postwar years did not in any way hamper economic prosperity. This is worth highlighting because in recent years conservatives have [asserted] that measures to reduce inequality lead to a decline in prosperity. [pp. 57-58]
McQuaig & Brooks next explore the events that eventually produced the resurgence of marked inequality in America, ending in the Wall Street collapse of 2008. The regulations that had restored North American markets to stability did not exist in some European markets, and North American banks began to enjoy taking more risks and reaping more profits overseas. Banks also began to finance so-called leveraged-buy-outs (LBOs) at home, which permitted them to earn large fees loaning other people’s money while themselves avoiding most of the associated risks. Moreover, McQuaig & Brooks note that:
Meanwhile, …economists and finance professors at the leading universities started developing arcane new financial innovations—using high yield debt, securitization, arbitrage trading, and derivatives—based on highly complex mathematical models that gave a scientific veneer to the old game of gambling. [pg.59]
Wall Street and corporate financial executives became particularly emboldened following the election of Ronald Reagan, their choice for President in 1980. They sensed a new opportunity for dismantling many of FDR’s regulations and controls on their business practices and taxes. They began a strong and effective campaign to achieve these goals with the help of Reagan and his Republican colleagues in Congress. Taxes were dramatically reduced for the very rich, trade unions were severely hampered, and the processes of corporate deregulation were begun in earnest. Almost immediately income inequality again began rising steeply.
McQuaig & Brooks trace the rise of a new financial oligarchy throughout the period that followed Reagan’s presidency. They note an increasing defiance of regulations by the business elite of the time, and the subsequent dismantling of many remaining regulations. Budget cuts were made to weaken agencies and staff that opposed this process. Wall Street soon trained and supplied the great bulk of financial advisors and decision makers for the governments in Washington. Goldman Sachs alone was (and continues to be) a temporary home for almost every Treasury Secretary and chairman of the Federal Reserve that America has had since 1980.
At this point in their review of the history of the 2008 crash McQuaig & Brooks turn to an examination of the Wall Street “culture.” They write:
In both the pre-1929 period and in recent decades, a culture celebrating greed and wealth accumulation dominated, with notions of social responsibility and public spiritedness shunted to the sidelines, even sneered at as a kind of political correctness. Wall Street traders routinely boasted about “ripping the face off” clients…. Such indifference to clients, let alone other members of the public, promoted an ethos in which greed and an obsessive focus on self-interest were considered normal and acceptable, even laudable and beneficial. [pg. 68]
This culture—competitive, selfish, and often ruthless—greatly amplified the forces leading to extremes of inequality in society. Moreover, it greatly amplified the risks of severe financial collapse, a collapse producing a far-reaching cascade of painful effects, from which most of the very wealthy would be largely protected. For McQuaig & Brooks, both the 1929 and the 2008 crashes shared one key aspect that Wall Street and financial historians are not talking about today: the increasingly extreme inequality of wealth and power in the societies that suffered these financial disasters.
Some historians of the 1929 market crash had previously pointed to inequality as one of the main causal ingredients touching off the Great Depression. John Kenneth Galbraith listed five key factors, the first of which was: “The bad distribution of income.” The historian Robert S. McElvaine declared: “…the greatest weight must be assigned to the effects of an income distribution that was bad and getting worse.” McQuaig & Brooks also cite a number of others who lay the cause of the 1929 crash to “huge inequalities in income distribution.” They conclude:
The evidence suggests that a high level of inequality sets up a dynamic that contributes to financial instability. …[An] elite uses its clout to both create a social ethos that condones greed and to directly shape the political agenda to facilitate the amassing of great fortunes. A crucial element in this political agenda is the freeing up of financial markets for lucrative speculative activities. While these speculative activities are clearly orchestrated by the financial elite, segments of the broader public are drawn in, and bear most of the risks and the ultimate costs of a financial collapse. [pp. 71-72]
* * *
With this history now in mind, McQuaig & Brooks turn to a direct discussion of the issue raised in the title of their book: The Trouble With Billionaires. They examine the lives of a number of individual billionaires, but they begin with a chapter on the man who was once the wealthiest person in America: Microsoft’s William Gates.
Bill Gates is someone who often appears to be among the least ruthless or selfish among what today has become a highly competitive group of wealthy corporate executives. So how did Gates achieve so much wealth? McQuaig & Brooks trace in some detail the many unusual advantages that Gates enjoyed while growing up, and the sheer luck he enjoyed that put him in some fortunate places at some opportune times. They document how he persuaded IBM to give him a contract to supply the operating system of its planned personal computer at a time when a much more advanced operating system already existed, one that had been developed by a friend of Gates. IBM was also considering the purchase of this other operating system at the time. That more advanced system had already inspired the creation of yet another operating system, one to which Gates immediately purchased the rights, and which he then modified and sold to IBM. And Gates happened to have one other advantage in these negotiations. His mother was a friend of the new CEO of IBM, with whom she sat as one of the directors of the United Way charity.
McQuaig & Brooks make a compelling case that Bill Gates came into much of his early wealth both from luck and from using the many gifts that his special schools and local public institutions laid at his feet. The operating system he sold to IBM could hardly be said to be his own invention. Without the earlier programs created by others, he would not have been able to come up with any product to satisfy IBM. And the faintly ruthless and highly competitive way that he closed his deal, behind the back of his older friend who had a much superior and existing operating program but who was conveniently on vacation at the height of IBM’s negotiations, further undercuts much of any argument that Gates earned his billions fair and square by dint of his brilliant and unique technical understanding. Those billions were earned legally, certainly. But McQuaig & Brooks draw a sharp distinction between the morality of obeying a loose set of written laws, and the moral question concerning how much income is fair and is deserved by each of us who enjoy the advantages that society and others have given to us.
McQuaig & Brooks leave the Bill Gates story at this point to trace the historic development of computers and software code, demonstrating that technology has always derived from thousands of incremental advancements and improvements and insights, each of which in turn has been dependent on the assistance and contributions of other people. They show that new products and “advances” are often ripe for creation and more than a few individuals are generally ready to bring them to fruition if some particular person does not. At least three other inventors were preparing to patent a telephone when Alexander Graham Bell filed his first patent, and it was later discovered that his first patent would not work (until he modified it) while those of two others would have worked if their patents had been awarded in time. This history is given in support of McQuaig & Brooks’ argument that individual “talent” and reputed “genius” are no satisfactory argument for justifying extreme wealth allocated to a single person.
Moreover, the Bill Gates story doesn’t end where McQuaig & Brooks leave it. The monopolistic efforts of Microsoft Corporation—its history of “unfair competition” and the legal battles spawned over that behviour—betray a whiff of personal ruthlessness and injustice that calls further into question any claim that Gates and the other senior Microsoft executives deserve their extreme wealth because of their unique financial abilities or genius. These executives were hardly alone in giving the world somewhat useful software, yet they alone arranged to garner most of the financial rewards for having done so.
* * *
Another trouble with many billionaires is the trail of havoc they can create for society and for the economy in their pursuit of a monstrous hoard of wealth. McQuaig & Brooks illustrate this problem with a description of the activities of the billionaire hedge fund manager John Paulson during the years just prior to the financial collapse of 2008. Paulson anticipated the collapse of the existing real estate bubble, and he knew that huge numbers of subprime mortgages had created that bubble and could not survive such a collapse. Those mortgages had been recklessly issued, at great short-term profit, but they were given to people who would not be able to sell their homes for the amount of money they would still owe to the mortgage holders after a collapse, nor could these people continue to make their monthly payments if they lost their jobs, or when their interest rates rose as provided for in the terms of these mortgages.
But Paulson also knew that the mortgage holders were no longer the banks that had written the mortgages in the first place, rather they were investors who had bought special stocks called CDOs, or Collateral Debt Obligations. These CDOs were composed of complex and opaque packages that included very many of these risky mortgages—packages that were sold as being quite free of risk when in fact the amount of risk was unknowable because the many mortgages inside each package couldn’t easily be identified and assessed.
However, in those times of lax regulation and creative financial “instruments,” there was a way for holders of CDOs to buy a kind of insurance against the possibility of their CDO loosing its value. For a small premium, if a CDO lost significant value, the firm that issued such insurance would reimburse the purchaser for part of the “value” that was “lost.” This form of “insurance” was called a CDS, or Credit Default Swap. But in the free-wheeling world of modern finance you could even buy a CDS on a CDO that was owned by someone else. In short, you could bet on the failure of a CDO stock that you didn’t even own. The “insurance” was actually just a gamble. But it was not a particularly poor gamble. One hundred million dollars worth of CDOs could be “insured” for a mere one million dollars a year.
This is how John Paulson proposed to make himself and his clients rich. He invested heavily in CDSs for the risky CDOs that he believed must soon fail. But there was more. McQuaig & Brooks describe how there were not enough existing CDOs for Paulson to bet against:
[So he]…approached a number of investment banks with the request that they create more CDOs to sell to [their] clients, so that he could then take out insurance betting these would fail. The arrangement Paulson had in mind was rife with potential conflicts of interest. He clearly wanted to help pick the mortgages that would make up the new CDOs. …Bear Stearns, the giant investment bank where Paulson had once served as managing director, said no to his scheme. But Goldman Sachs agreed to the arrangement…. [pg. 95]
Thus Paulson was eventually able to bet against approximately $5 billion of risky CDOs which indeed did soon become all but worthless. In 2007, Paulson himself received $3.7 billion for his investment efforts.
Many of the CDOs that failed had been insured by the insurance giant AIG, not only to Paulson (and others) but also to Goldman Sachs, the same company that had created and sold the CDOs and then turned around and bet against them. AIG was in no position to pay the billions it now owed, but the US Treasury Department, overseen by a former Goldman Sachs executive, insisted that allowing AIG to go bankrupt would devastate the U.S. economy. So the U.S. government supplied more than $150 billion to AIG, enabling it to pay off the bets it had so recklessly made with Goldman Sachs, with Paulson, and with a select group of others. (It was Paulson who stood tallest in that 2007 U.S. Pen parade with his $3.7 billion income that year.)
McQuaig & Brooks note that Goldman Sachs was subsequently charged with fraud by the U.S. Securities & Exchange Commission, for selling CDOs without disclosing that Paulson had designed them or that they too were betting that these investments would fail. But since Paulson had not personally misrepresented the CDOs to buyers, no charges were laid against him. McQuaig & Brooks go on to point out that terrible pain had been caused to untold millions of people by the subsequent financial meltdown, and the worldwide recession that followed it. This pain resulted from the activities of those who had sold, packaged, and resold subprime mortgages, those who had facilitated betting against them, and those who then profited hugely from both the losses of others and the convenient gift of government bailouts. So McQuaig & Brooks ask: Did John Paulson deserve his billions? What “contribution” did his efforts make to a better world?
McQuaig & Brooks identify a number of other billionaires whose “contributions” to society, whose reckless and selfish actions, have been clearly disruptive and harmful on a large scale. They note that Paulson’s $3.7 billion income was equivalent to the income of 80,000 nurses in that same year. And in the year 2009, the combined pay of the top 25 hedge fund managers was the same as the combined income of 658,000 schoolteachers. Nurses and schoolteachers clearly contribute greatly to society. Equally clearly, the pay of most billionaires cannot be said to be proportional to their “contribution” to society. So what does justify such pay?
* * *
McQuaig and Brooks next consider the philosophical traditions that address this question. In the west at least, the question of what justifies extremes of inequality was not often raised until comparatively recently, for inequality was generally agreed to be due to “God’s will,” to fate, or determined (and excused) as being simply due to chance, and so it became your birthright. With the arrival of the Enlightenment came the need for a more reasoned justification for marked inequality. John Locke offered what has endured as the most popular justification for inequality. But his arguments had their contradictory aspects, and they have been distorted more recently by neo-conservatives to justify a modern form of selfishness and private property.
McQuaig and Brooks examine Locke’s philosophy and its subsequent distortions in some detail. In summary, Locke argues that properties of all kinds deserve to become private as the result of personal effort put into modifying and creating them from raw resources. You clear the land, and it is yours. You build a house, and it is yours. But Locke also said that land and resources are originally given to all, and held in common.
Historically, human societies have tended to use land, water, and similar resources communally. Property rights originally took two forms, communal and individual: i.e. as a right not to be excluded from sharing a property, and/or, as a right to exclude others from sharing a property. But Locke’s position, currently the philosophic basis for the world’s market economy, restricted property rights just to this latter private-ownership type. McQuaig and Brooks quote the political theorist Anatole Anton who wrote:
Private property, from a democratic point of view, amounts to the surrender of democratic control of social resources to private individuals. Surrender might be the right thing to do, but surely some good reasons ought to be given for so doing. [pg. 106]
Locke went further, he argued that if the “property” is created by your servant, working at your direction, then that property too should belong to you. Thus does the billionaire “deserve” his billions. Yet importantly, Locke also had said that these claims on property are valid only provided that there [is] “enough and as good” left over for others. [pg. 107] Exploiting non-renewable resources would likely be excluded by this caveat, as for instance would monopolizing preferred access to food or to health care.
McQuaig and Brooks conclude their examination of the philosophic assumptions that underlie these justifications for extremes of inequality saying:
Since billionaires are now deemed to have made it on their own, they are also said to owe little back to society. Indeed, the whole notion of responsibility to society has been so denigrated that billionaires are considered deserving of their fortunes when they contribute absolutely nothing to society—or even when they directly imperil the public interest. [pg. 111]
* * *
McQuaig and Brooks next examine the argument that marked inequality is important and helpful because it motivates and inspires talented people to do their very best. In 1974 the highest paid baseball player (Hank Aron) earned $200,000. In 2008 the top salary in baseball, (paid to Alex Rodriquez) was $27.7 million. During that time, the skill and accomplishments of baseball players did not become detectably greater, and certainly not by 100-fold. In professional football (both kinds), in basketball and hockey, the same argument can be made: the rise in salary “motivation” has been completely disproportionate to any small increase in skill and accomplishments to be seen on the fields of play.
The same is true for film and entertainment, where top salaries have become hugely inflated today. Yet it would be hard to argue that singing and acting have became noticeably better than they were in the films of 50 years ago, i.e. in the days of Frank Sinatra, Judy Garland or Gregory Peck. And certainly not ten times better.
Among corporate chief executives, in 1950, the highest salary any American received was the equivalent in 2007 dollars of $5 million. It was paid to the CEO of a very profitable General Motors. But in 2007 the CEO of General Motors was paid $15.7 million, and this in a year when GM had shown a loss of $39 billion. Three times more pay for a far worse performance. In 2007 and 2008 the Wall Street firm of Merrill Lynch paid its executives some $30 billion dollars just in bonuses. Yet the firm earned no profit in either of those years. There are hundreds of similar examples. One might easily argue that very high pay and inequality seem to have become an incentive to greed, but it is hard to maintain that they have produced superior job performances.
However, the neo-conservative economic argument also takes the reverse turn, insisting that to tax or to limit huge incomes and bonuses will reduce executive motivation and productivity. McQuaig and Brooks present considerable historic data that are also inconsistent with this assertion. Times of high progressive taxation, such as in the ‘50s and ‘60s, were times of very high growth and productivity. But after tax rates on high earnings had become significantly lower and executive pay had started increasing dramatically, economic growth began to slow and productivity began to decline. The authors stress however:
We’re not trying to make the case that high marginal tax rates encourage economic growth, but simply that the evidence doesn’t support the assertion that they discourage it. [pg. 115]
The evidence is just as suggestive that increasing the tax rate might motivate some people to work longer so as to keep their level of disposable income where they want it to be, or, in the case of those with already high incomes, a person might instead choose to live comfortably on what they still retain after higher taxes. The motives that lead to higher performance and to higher productivity are much more complex than neo-conservative economists portray them to be. McQuaig and Brooks review the psychological evidence concerning economic motivations and conclude:
A vast array of studies show that, once people achieve a basic material standard of living, economic factors greatly decline as important sources of happiness and satisfaction and are superseded in importance by factors such as family, friendship, self-esteem, and a sense of personal intellectual development. [pg. 119]
The psychology ascribed to homo economicus (consumer-man) by neo-conservative economists, is much too simplified and selective. By assuming that income and wealth are the primary and over-riding goals (and rewards) for working hard and well, what may actually be the most important factor of all is quietly denied. That factor is the social status and social rewards that many high-paying jobs bring with them. McQuaig and Brooks discuss a number of studies confirming the importance of self-motivation and social rewards in the workplace. If every senior corporate executive or baseball player or actor or celebrity musician or President could receive no more than $500,000 per year, there would still be rather strong incentives to earn those non-monetary rewards that are provided by the esteem of both one’s colleagues and society in general. There would still be the gratification of doing an important job well. These motivating factors would still keep productivity and competition high, as they did in the 1940s and 50s, even with wage controls and very high taxes on the rich.
But in nations that suffer from high degrees of inequality, there arises another problem that must be added to theories about job psychology and motivation. In particular there are two ways that inequality seems to create personal demands for higher income: (1) high income has become a sign and signal of your degree of social power and status, so it supports a demand for more of the same. And (2) social comparisons with those around you, comparing your “prestige” possessions with theirs, further creates a demand for the money needed to obtain equivalent possessions and comforts (and their corresponding signs of status.) Once basic needs can be met by one’s income, life satisfaction depends more and more on such social comparisons that people make with those they encounter regularly, including of course the people they encounter in advertisements. These social comparisons unquestionably augment the drive for more income, and thus they encourage more effort. The question is whether that effort creates more or fewer social problems.
This leads McQuaig and Brooks back to one of the main arguments given to justify paying extremely generous salaries and bonuses: namely, that these are deserved because they are necessary, and they are necessary because the demand for rare and superior talents is so high while the supply of individuals possessing those talents is so limited. In the case of baseball celebrities, the talents are rare, they are generally clear, and the opportunities for players with exceptional talent to seek higher paying situations are understandably tempting. McQuaig and Brooks have no quarrel with letting competing markets (teams) bid up the salaries for these star players. However, they stress that:
It should be immediately noted that this argument in no way refutes the desirability of imposing high taxes on large incomes. …Teams could pay as much as they wanted to—and the players could still go to the highest bidder. Only after all this is resolved, and everyone is out playing ball, would taxes kick in. …High marginal tax rates would not interfere at all in the [process of acquiring and keeping talent.] …They would only apply after the fact and would apply to all. [pg. 128]
(And, it should be noted, those high tax rates would still have no effect on ranked amounts of after-tax income. Those who earned more would still keep more than those who earned less.)
But one part of this story is rather different when it comes to “corporate talent” and the claimed “need” to reward such talent heavily, so as to acquire it and then to keep it. Here too, progressively increasing taxes on progressively increasing corporate incomes (whatever forms that income were to take) would have no bearing on the question of who should be offered how much and by whom. But the difference is that the “talent” of any CEO is rather harder to demonstrate objectively, particularly when his or her company makes no profits, or suffers declines in revenue, or faces large costs for errors and oversights or from recalls and lawsuits. In fact, McQuaig and Brooks argue that corporate “talent” is almost always only in the eyes of a few close beholders, old friends of the CEO, who sit on the company’s Board of Directors. The majority of these directors usually have what amounts to a conflict of interest in evaluating their CEO insofar as he or she is often able to help them financially and socially (for instance as members of the Board on their own companies). McQuaig and Brooks make clear a number of the ways that managerial “talent” is very subjective to start with, and the “marketplace” for auctioning that “talent” is neither “open” nor “competitive” in the way that it is for talented baseball or hockey players. Any analogy with paying “talented” corporate executives the same huge amounts, and for same reasons as the pay offered to those who clearly possess physical “talents,” is a failed analogy.
* * *
In their next chapter McQuaig and Brooks discuss the many ways that the very wealthy use their influence to receive favourable tax treatment from governments to “protect” their wealth, including frequent and illegal use of tax havens. This additional problem with billionaires and millionaires they summarize as follows:
When people of modest means break the law by stealing—perhaps because they don’t have enough income—the government’s response isn’t to make sure they have more income, but rather to punish them, even to strengthen the penalties so that others will be discouraged from considering such activity. But when the rich break the law by hiding income offshore, the government often responds by lowering tax rates so the rich will have less incentive to engage in such behaviour. [pg. 148]
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In the next chapter of their book McQuaig and Brooks take a more direct look at how marked inequality appears to have deleterious effects on the physical, mental and social well-being of the residents in a nation or province or city. Much of the evidence they present is drawn from research summarized by Richard Wilkinson and Kate Pickett in their comprehensive book on the effects of inequality. This book was titled The Spirit Level and was published in 2009. The research in that book deserves its own close reading by students of inequality and its attendant ills. (In due course The Spirit Level is currently intended to become the subject of a subsequent blog-post here.)
Then finally, McQuaig and Brooks examine the linkage between inequalities for wealth and political power, and thus, inequality’s many deleterious effects on democracy. In this context, after citing many examples of abuses of power, they have occasion to write:
The political muscle of the very rich may be most evident in issues like financial deregulation, taxation, and monetary policy. But it extends well beyond the purely economic sphere. Wealthy interests have been a key stumbling block—indeed the only real stumbling block—in efforts to organize a global campaign to tackle climate change. [pg. 185]
In short, McQuaig and Brooks reconfirm that marked inequality leads to political oligarchy, and it undermines democracy. And that is indeed a problem.
* * *
There are some obvious cures for income inequality, as can be seen both historically and in those nations today that enjoy high levels of equality. However one such cure stands out over all the others: it is the imposition of progressively higher rates of taxation on progressively larger incomes and transfers of wealth. Dealing with hidden incomes, and with loopholes that take the form of favourable legal definitions of what constitutes partially taxable income, will still require their own corrective attention. McQuaig and Brooks end their book with a short list of actions that could help to restore fairness, democracy, and equality in the world today, without causing overall harm to national economies.
Still, in the current political and economic climate, actions to correct extremes of inequality will not be easy. That is part of the trouble with billionaires. And that is why readers should study this book for themselves.
© J. Barnard Gilmore Kaslo, British Columbia July, 2013