The Soul of Capitalism

The Soul of Capitalism

A transformation of Wall Street’s core values is possible, using financial tools.


If capitalism were someday found to have a soul, it would probably be located in the mystic qualities of capital itself. The substance begins simply enough as personal savings and business profits, then flows like oxygen through labyrinthine channels into the heart and muscle of economic life. Once set in motion, the surplus wealth (Marx provocatively called it “stored labor”) becomes one of capitalism’s three classic factors of production, alongside human labor and nature (the land and resources consumed to make things). Capital puts up the money to build the factory, buys the machines and pays the company’s bills until its goods are produced and sold, thus yielding the new returns that pay back the lenders and investors with an expected increase. It is not simple, but that is the essence.

Given the vast wealth of the country, the financial system forms a rather narrow funnel through which tens of trillions of dollars are continuously poured. Yes, the transactions are dizzyingly diverse and complex, involving thousands of large and small financial firms, but the work itself is actually done by a fairly small number of people. On Wall Street (an emblem of the system now dispersed nationwide) fewer than 1 million Americans manage the money. And only a relative handful of those people make the big decisions. Collectively, they are very, very powerful. Nobody elected them, but their exalted position in American life is reflected in their incomes.

My central complaint is with the narrowness of their value system rather than the financial mechanisms. With a few important exceptions, the agents of capital operate with dedicated blindness to capital’s collateral consequences, an indifference to the future of society even as they search for the future’s returns. The capital system does not authorize financial agents to think about such things and may well penalize them if they do. Yet finance capital shapes and polices the “social contract” in America far more effectively than the government, which has largely retreated from that role.

The great contradiction–and the reason reform is possible–is that Wall Street works with other people’s money, mainly the retirement savings of ordinary Americans whose values it ignores, whose common interests are often trampled. In fact, the huge fiduciary institutions holding this wealth own 60 percent of America’s 1,000 largest corporations and yet are utterly passive as investors–meekly following the advice of banks and brokerages rather than asserting the true self-interests of the “beneficial owners.” That is a central element of all that must be changed.

A transformation of Wall Street’s core values is not only possible but eventually likely to occur, I predict. My optimism may seem incautious, but it starts from an appreciation of how dynamic capitalism evolves continuously from its own restless energies. Within the monolith of finance, some adventurous players are always experimenting with new methods and theories, trying to take profit from what the larger herd doesn’t yet see or understand.

Organized labor is widely disparaged as a weak and anachronistic force in American life, but, in one important matter, the labor movement is the vanguard: determined to reposition the capital that effectively belongs to working Americans to serve the true interests of those workers and, therefore, society’s long-term interests too. Labor may be greatly weakened from its heyday, but one thing it possesses is capital assets–the power of the $400 billion in union-managed pension funds and the trillions in public-employee pension funds, where labor unions can exercise real influence over the patterns of investment.

“It’s very much a capitalist project; it’s not socialist or revolutionary,” says Ron Blackwell, head of the AFL-CIO’s corporate affairs department. “It’s a project to improve capitalism through direct intervention.” Institutional investors, especially the pension funds, “are well designed to provide this important social value that we need–patient capital for long-term wealth creation,” he says. “Instead, they are driving things down the low road, following the same destructive practices the capital markets favor. Our vision is to change that. Since it’s our money, we would like to realign the private purpose of business, which is making money, with its broader social purpose, which is wealth creation, and to convince pension funds to recognize that real security for retirees requires wealth creation, not short-term gains.” Wealth creation, as Keynes explained, means an economy that provides the material basis to support civilization–not the other way around.

The collapse of Enron and accompanying scandals became a great teaching opportunity, and the AFL-CIO organized the facts for reform, pushing politicians to think bigger about corporate governance, the disloyalty of money managers to their customers, the blindness of pension funds to what exactly they are investing in. Labor (ironically, given its reputation) reintroduced the language of prudential and trustworthy financial performance.

Most of its efforts are outside politics, however. It helps organize the shareholder proxy fights and lawsuits stirred up by shareholder activists from churches and issue groups, but the AFL also gets up close and personal with the money managers. State Street Global Advisers in Boston manages a lot of union pension money, but meanwhile, the firm made itself a leading advocate for privatizing Social Security. After CalPERS (the California Public Employees’ Retirement System) and some other major funds indicated they were reviewing this apparent contradiction, State Street announced it was withdrawing from President Bush’s Social Security coalition.

The AFL’s Office of Investment won a pivotal victory for all mutual-fund investors in early 2003 when it persuaded the Securities and Exchange Commission to require that mutual funds must disclose how they vote the proxies in corporate-governance shareholder fights. Fidelity and Vanguard, the two largest mutual funds, led the industry in opposing the measure, and for good reason. These investment firms regularly vote against the interests of their own rank-and-file investors in order to curry favor with corporate managements. Why? Because the corporations hire them to manage corporate-run pension funds and 401(k) plans. If Fidelity and Vanguard vote against the corporate boards, they will lose lucrative contracts. If their votes against the investors are revealed, they will lose lots of them. Disclosure thus opens up a new front for leveraging corporate behavior and enforcing the fiduciary obligations in finance.

Morgan Stanley, the “all-service” financial house, provided one of the most blatant examples of how Wall Street firms betray their clients from organized labor. Three Morgan Stanley analysts issued an advisory on investment strategy in November 2002 urging investors: “Look for the union label…and run the other way.” Labor officials were not amused. Scores of union pension funds hire Morgan Stanley for investment advice and park huge sums in the firm’s various investment funds. As the labor clients raised protests, Morgan Stanley changed its tune, drafting a pro-union declaration for the AFL’s approval.

The primary target for education and informed pressure, however, are the pension fund trustees, starting with the Taft-Hartley pension funds that are directly supervised by labor and management representatives. Until quite recently, most labor trustees have been as passive and conventional as their corporate counterparts. “The culture of the financial industry is intimidating,” Blackwell explains. “The trustees are spirited off to conferences in Hawaii or wherever there’s a golf course, and the fear of God is put into them on their fiduciary responsibility. On top of that, these trustees are workers. They don’t have the time to become experts, or the technical and legal support to question the investing decisions. So we are providing that.”

The Center for Working Capital, a research institute started by the AFL, now publishes its own data for pension trustees, much like the advisory materials from Wall Street firms, only it asks different questions. The “Investment Product Review” examines the Wall Street funds that claim to be “worker-friendly” and tells pension trustees which ones are authentic. Its “Key Vote Survey” rates the money managers on how they vote their fund’s shareholder proxies on key corporate-governance issues. “If the money managers end up with a low rating, the money doesn’t go there,” Blackwell says. Eventually, he envisions, labor trustees will be putting some of their investment capital into the localized capital funds that are springing up–guided by the rank-and-file union members on the ground who know the community’s problems and what makes sense, what doesn’t. “The capital that belongs to working people should serve their purposes and values; right now it doesn’t,” Blackwell says.

If all this seems too visionary to be plausible, the startling fact is that some of these ideas are already at work in practical and tough-minded situations. Aggressive pioneers in the labor movement have connected with a few kindred spirits in finance capital, investment bankers who understand the destructive side of how the present system functions and recognize that there are profitable opportunities for real “wealth creation” if the employees, union and nonunion alike, are brought into the deal. The first successful model for labor’s direct investing was fashioned by its most conservative sector: the building trades, which overcame years of traditional legal obstacles and won the right to invest their pension money directly in housing and development projects that create jobs for union members.

More ambitiously, some capitalists and workers, not many but a few, are together now carrying out “labor friendly” corporate takeovers–the direct-equity investment deals that used to be the exclusive domain of the wealthy and powerful. The returns are very strong, typical of direct-equity investing. It is the operating values that are different. And the “deal flow,” as investment bankers call the essential task of spotting new investing opportunities, often originates with local union leaders, people intimately familiar with both the failures and the unrealized potential in business enterprises. Leo Gerard, now president of the United Steelworkers of America, became an early apostle for mobilizing labor’s capital as he saw small manufacturers in the industrial Midwest decimated either by financial maneuvers or their inability to raise capital. Gerard, who is Canadian, helped engineer Canada’s largest worker takeover of a company, Algoma Steel, as well as many smaller rescues in the United States. He created the Heartland Labor Capital Network, which promotes the goal of replicating Canada’s successful labor-sponsored investment funds (Quebec’s Solidarity Fund, by attracting small investors with tax incentives, has become the largest source of venture capital in the province). “American politics, as regressive as it is at the national level, makes it extremely difficult to do this here,” Gerard says. Congress did create new tax subsidies for local venture-capital funds, but the tax breaks go only to large investors, banks and businesses.

Gerard envisions a growing galaxy of like-minded investment firms that do “control investing” for corporate rehabilitations, with union pension funds putting up some of the capital. In return, the takeover insiders would have to agree at a minimum to honor employees and their rights: to remain neutral on union organizing and guarantee speedy recognition of new locals through card-check registration by a majority of workers rather than laborious fights over elections by the National Labor Relations Board. More substantially, workers should be given a role in decision-making processes and, sometimes, an ownership stake with seats on the board. Writing such collateral conditions into direct-investment deals–special terms demanded by major investors–is standard practice. In the language of finance, these are commonly known as “covenants,” a biblical term that nicely expresses the social function of shared commitments. “If you can create these alternative forms, then you can show that capitalism doesn’t have to do the brutal stuff it does,” Gerard says. “Then you have a meaningful, articulate voice that can show a different way of doing things–call it social capitalism, as opposed to Darwinian capitalism.”

Oddly enough, David Stockman, the tenaciously bright young conservative who was Ronald Reagan’s controversial budget director in the 1980s, is leading one of the “labor-friendly” firms–the $1.4 billion Heartland Industrial Partners (evidently, he borrowed the name from Gerard). Stockman’s venture may startle those who remember his combative style in Washington politics, but he impressed labor people with some of the deals he did for the Blackstone Group of Wall Street. Stockman managed large and successful industrial turnarounds by working with the employees and unions instead of rolling over them. Since he launched his own firm in 1999, his “buy and build” strategies have focused entirely on restoring midsized manufacturing companies to good health and profitability: auto parts, home furnishings, aerospace components and other sectors. In all, Heartland manages around $10 billion in industrial companies, probably the largest fund of its kind. The Canadian Pension Plan and Michigan’s state employees’ fund, as well as the steelworkers’, are investors, alongside major private players like J.P. Morgan Chase and AIG, the insurance giant.

“David is buying controlling ownership of these companies, and he’s actually turning them around, and he’s not doing it by beating the shit out of the workers,” Gerard says. “David made his presentation to the trustees of the pension fund, labor and management, and asked for $10 million. When he left the room, the board voted to give him $25 million.” Even the mighty Carlyle Group, run by celebrated conservative Republicans like James Baker, has stuck a toe in the same pond by launching a $750 million “worker-friendly” investment fund, perhaps designed to attract capital from the same labor investors.

In social terms, however, the KPS Special Situations Fund is a far more aggressive pioneer: It takes control of failed or abandoned capital assets and attempts to re-create an American corporation with a very different operating ethos. “We invest in a constructive way,” says Mike Psaros, one of the KPS partners. “Instead of going in and slashing and burning and screwing people, we go in and work constructively with the employee groups to figure out what’s wrong and fix it.”

The “K” in KPS is Eugene Keilen, a former Lazard Frères partner who pioneered the first major employee-ownership buyout–Weirton Steel, in 1980. Psaros was a teenager in Weirton, West Virginia, when Keilen’s plan saved the mill and 10,000 jobs. “My father worked at the mill,” he says. “I watched this guy come in from New York City who quite literally saved our way of life, our town. I said to myself, One day I want to do that–this kid from Weirton who’d never heard of an investment banker.” Psaros studied at Georgetown University, majored in finance and went to Wall Street, where he teamed up with his investment-banker hero.

Blue Ridge Paper Products in western North Carolina is one result: a major US producer of milk and juice cartons and paper cups, with more than 2,000 employees at six processing plants and the main pulp mill in Canton, North Carolina. KPS created this company out of capital assets that Champion Paper was abandoning after a Wall Street auction to sell them failed to find any buyers. KPS bought them for $200 million, alerted by an urgent plea from Bob Smith, a vice president of PACE, the Papermakers, Atomic, and Chemical Employees union.

The KPS fund, with GE Capital as co-investor, put up $35 million in equity capital and borrowed $200 million to acquire 55 percent control–while the employees, union and nonunion, own the other 45 percent through an employee-ownership trust. To finance their stake, the employees agreed to take a painful 15 percent reduction in overall compensation. Workers have four elected directors sitting on the eleven-member board. They are embarked on the promising but very difficult process of changing industrial culture. “It’s going to take a lot of time,” Psaros says, “but we are transforming what I would call a Stalinist, reactionary, stifling, autocratic, oppressive culture that has existed in those plants for more than seventy years. We are creating a participative, communicative, twenty-first-century culture where the company relies on people’s brains more than it does on their backs.”

Bob Smith, the union vice president, spoke in the same terms. “For many, many years, American management of labor has been totally authoritarian,” Smith says. “You come in and go to work and you check your brain at the door and just do what you’re told. Instead, he says, “the culture needs to be, Hey, I’m part owner, I’ve got part of the responsibility for making this operation survive. The quality of the product is no longer the company as such. The company is now partly me.”

Blue Ridge Paper became a more effective and profitable company rather quickly. During its first two and a half years, more than $100 million of expanded cash flow was reinvested back into modernizing the company, buying new machinery and acquiring another packaging company, which expands Blue Ridge’s market share. It now makes every Minute Maid carton and has picked up the Florida Natural account. If things go well, KPS might be expected to “exit” its ownership in four or five years and sell its 55 percent stake to the stock market or other investors, including the employees. Blue Ridge’s 2,000-plus worker-owners could decide to cash in too, collecting an equivalent reward of around $100 million. Or the employees might exercise the covenant that gives them first option to buy out KPS’s stake, and they would own 100 percent of the company–which is what Smith is hoping for.

The essential meaning of Blue Ridge, however, is not about how to save a paper mill or how one can get wealthier by taking risks. The larger meaning is about finance capital’s power to advance society’s values. Blue Ridge Paper Products is a relatively simple example in which targeted investing has been employed to support “a different view of life,” as Mike Psaros put it. In this regard, the techniques of direct-equity investing represent largely unexplored territory, since, outside labor’s ranks, very few social reformers have tried to use capital in a tightly directed manner to gain social leverage within capitalism. The techniques are neutral in themselves. Their purposes depend upon who takes charge, on what they expect in the way of returns–financial and nonfinancial–and what they demand as covenants.

One can imagine many variations on the social theme, as people and groups learn how to mobilize and focus their capital for unconventional objectives. Rescuing industrial assets and manufacturing jobs, important as it is, represents only a small corner of investment activity, and the task of reaching into successful corporations with social covenants demanded by the investors is obviously far more difficult. So is the challenge of financing innovative startup firms that are willing to accept more ambitious social commitments in exchange for patient capital. Given the extraordinary variety of hybridized financial instruments that Wall Street devises, the potential for elaborating specialized interventions is vast but largely unknown. Conceivably, for instance, environmentalists could organize targeted capital investments in major corporations to provide financing for the technological changes in production systems needed to protect nature–the ecological reforms business and finance have been reluctant to make. The returns on targeted eco-capital would be based upon the improved efficiencies these technologies bring to the company. Society’s return would be a less destructive industrial system.

So long as the risks are pursued with tough-minded self-discipline, there is nothing in the operating rules of capitalism to prevent any of these departures from the status quo, whether they involve community-loyal investment funds or the pressuring of pension-fund trustees to alter their investment priorities, or punishing the disloyal Wall Street firms or taking control of corporations by making direct-equity investments. Indeed, these are routine practices within the system, employed every day on behalf of narrower objectives and self-interested values. The financial power of society awaits the rise of tough-minded social inventors, investing risk-takers with the courage to take control of their own money.

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Katrina vanden Heuvel
Editorial Director and Publisher, The Nation

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