Fourth in our Shift Dialogs Series — Full Transcript and Video
I first posted about Rana Foroohar back in May, when her timely and well-received book Makers and Takers: The Rise of Finance and the Fall of American Business came out. That interview was one of our most-read pieces back then, but in the last few months, tens of thousands of new readers have come to NewCo Shift, and Rana was kind enough to come into the Nasdaq studios and shoot a fresh interview with us.
This twenty-minute conversation lays out not only the core argument of Rana’s book, but also ties today’s extraordinary social shifts to a long term trend of financialization in our economy. Along the way she has some choice words for Apple and Uber, and some deep insights on today’s political circus (she notes that Trump voters have not had an increase in real income since the 1970s, for example).
Rana’s highly articulate and super smart. The video is well worth your twenty minutes, and if you’re a print person (like me!) the full transcript, edited for clarity, is also below.
Edited Full Transcript:
John Battelle: I read your book a few months before it came out. I found myself thinking that it really framed the NewCo Shift narrative. So let’s say you’re at a cocktail party and someone hears you’ve written a book, and asks — what’s your central argument?
Rana Foroohar: My central argument is that our financial system, which we know has been troubled for the last eight years, is much more troubled than we think, and it’s actually slowing down our economic growth. When you (only) talk about too big to fail banks and the 2008 financial crisis, that’s a pretty siloed conversation. My book explores how the growth of our financial sector over the last 40 years is hurting companies and hurting our economic growth.
If there’s a killer stat in the book, it’s that only 15 percent of all the capital flowing out of US financial institutions right now — including big banks, insurance companies, real estate trusts, anybody that moves money around — of all the cash flowing out of those institutions, only 15 percent of it is being invested in businesses. Where’s the rest of it going?
That’s my question to you. That 85 percent of the money is being used to do what?
Well, my argument is that it’s in a closed financial loop. It’s part of a process that I call financialization, whereby the markets have begun to exist basically to serve themselves.
You have 15 percent of investment going into business. If you think about what Adam Smith envisioned banks as doing, they were supposed to take all of our savings — productive labor — and put it into banks, and then the banks were supposed to lend it out to new businesses that grow jobs and grow the economy. Fifteen percent of it does that.
The rest is being used for trading, for the buying and selling of existing assets — bonds, stocks, real estate. Real estate is highly financialized. One of the reasons that we have the up and down housing bubbles is because those markets have become so financialized. Banks and other financial institutions now spend the majority of their time buying, selling, splicing, and dicing those assets rather than investing in the new, new thing.
Though one of the many goals of the 2008 bailout was to encourage more lending, it doesn’t seem like that actually has happened. When I speak to folks in large financial institutions about that question, many responded “Well, lending to small business is too risky.”
Well, that’s the most ironic answer, because that’s what you’re supposed to be doing. Nobody said it was easy. You can ask any venture capitalist. It is risky. That’s what the capital markets were set up to do.
Nobody ever thought that Wall Street was going to become an end in and of itself, in which trading, buying, and selling has very little social value. This is not just my opinion, but the opinion of many serious economist, some Nobel prize winners like Joe Stiglitz. That has very little social and economic value. The stuff that does have real social and economic value is the productive allocation of capital to new businesses. That’s not happening.
Nobody ever thought that Wall Street was going to become an end in and of itself, in which trading, buying, and selling has very little social value.
By the way, this is barely being talked about in policy circles. It’s not even being modeled. When the Fed comes up with a giant algorithms and it crunches them in the basement in Washington, the financial sector itself doesn’t even get modeled.
There was this mythology that the financial sector and that the markets in general were so efficient that we didn’t need to worry about them. If we learned anything in the last eight years, that that’s not the case.
The Fed had signaled that there may be some interest rate hikes coming. But after Brexit, those signals got mixed. What’s the impact of Brexit on the financialization story?
It’s a big issue. My take on the last eight years is that we haven’t really had a real recovery. The markets are way up — even after Brexit.
The markets have recovered.
The markets have recovered. They are still at near record highs, but Main Street is still on the longest, weakest recovery of the postwar era. You’ve still got stagnant wages, you’ve got barely any inflation, and now you’ve got this headwind and turbulence from abroad in the form of Brexit.
The economic dynamics driving Brexit are very similar to those that I discussed in my book. I think that you have 40 years of financialized globalization, in which the elites and people that own stock, own assets, have really benefited tremendously. People who actually make their money from wages have not. That’s why you’re seeing the populism in the UK and here at home.
To go back to the immediate effects, Janet Yellen, the Chair of the Fed, is very worried. She’s keeping interest rates low. Low interest rates encourage debt. It encourages the corporate debt bubble we’ve seen in the last few years.
Corporate debt is a record level, which also brings up another irony that I cover in my book. Even as there is a bigger than ever corporate debt bubble, corporations also have more cash on the balance sheets than ever before.
We’ll talk about that shortly…but when you say, “There is more corporate debt than ever,” it makes me think, “Oh, then there is a lot of lending going on.” But it’s not lending to the real economy.
No. Basically, corporations are going to the bond markets. They are using this low interest rate environment. I’m not really blaming the Fed for this. The Fed did what they had to do. There was nobody in Washington that was able to push through real fiscal policy of the kind that would have really stimulated the Main Street recovery.
The Fed just came in and tried to put everything together with duct tape. They dumped a lot of money into the economy, and they kept rates low. What that does is create an environment that makes it really, really easy for companies to issue a lot of debt on the public markets. That is why you see record number of share buybacks — companies go out, they issue billions of dollars of debt.
They use that money not to invest in new factories, work or training, or higher wages, but to pay back shareholders. That then increases this Wall Street/Main Street divide because 10 percent of the population in this country owns 80 percent of the assets. When you’re driving up asset prices, you’re really only enriching a tiny sliver of the population.
When you’re driving up asset prices, you’re really only enriching a tiny sliver of the population.
That of course leads to political populism.
It’s a terrible snowball effect.
Let me try to bring this to an example that people here in the Valley really understand, which is Apple. In a way, it’s a company that is doing exactly what it’s being incented to do. In the book, you actually open with an example about Apple.
I got interested in Apple, because I did a big profile of Carl Icahn, a few years ago for Time. At the time, he owned the large chunk of Apple. About every couple of days, he was tweeting manically for them to give more money back to shareholders, do more buybacks. Tim Cook was apparently listening to him.
As you’ve seen, Apple has already done billions of dollars of debt issuances and share buybacks. They now have commitments over the next few years to issue almost as much debt and do as many buybacks as they have money sitting in overseas back accounts. Now, they don’t want to bring the money back, obviously, and pay the higher than average US corporate tax rate.
It’s this great irony that a company like Apple, which actually doesn’t need any capital, is more involved than ever in the capital markets, in a way that’s not actually changing the underlying business story. It’s certainly not helping Main Street.
It’s also creating a really volatile path for Apple itself. As bullish as Carl Icahn was for a number of years , the minute there’s bad news for the company in China — boom, he dumps the stock and it tanks, which just shows you have financialized that growth story is.
So Apple has hundreds of billions of dollars overseas?
$200 billion sitting oversees in bank accounts, and commitments to do almost that much in terms of debt issuance and buybacks.
So Apple is issuing debt, even though they have plenty of cash to buy their own shares back and release dividends to shareholders. They’re not using that money, just to be clear, to figure out what the next iPhone is?
No, they’re not. As a matter of fact, R&D as a percentage of revenue at Apple has been falling as buybacks have been increasing. They’re not alone. That’s by and large true for most S&P 500 companies.
It’s ironic because a lot of technologies that make the iPhone smart were actually developed by the federal government. One might say, “Well, hey, it might be a good idea to bring back that money and pay the US tax rate, whatever it is.”
The point is that this doesn’t change the underlying growth story of the company. It’s not real growth. It’s genetically modified growth.
It’s stock price growth.
Yes, it’s saccharine. It’s market highs. It can go away. Right now, we’re at a tipping point. Actually, if you look at the record number of share buybacks that are being done, it has a less and less effect in terms of bolstering the stocks.
We’re pretty much at the end of that financialized growth. Actually, companies that do more share buybacks than average are starting to have poor performance. We’re going to start to see this correcting.
Maybe that’s a good thing. Share buybacks were actually illegal in the early 1980s. It was considered market manipulation.
It became legal under the Reagan administration. Things really got turbo charged in the 1990s, in part because the Clinton administration passed some rules around how executive comp could be tax deductible if it was paid in share buybacks for performance pay.
The markets have had a true north of “maximization of shareholder value” for more than 30 years. It strikes me that’s really at the center of your book.
I think it is. It’s naive to think that there should be one metric for corporate performance: share price. If you think about what that incentivizes a company and executive to do, it’s to jack up your share price at any cost.
If you look at what the markets reward, one of the examples in my book is back in the mid-2000s, when Microsoft wanted to make a shift to (new) digital technology. It introduced the big new R&D program, and the stock price went down.
A couple of years later under (Steve) Ballmer, they issued a bunch of share buybacks, the stock price goes up. The markets aren’t necessarily a good gauge of what the underlying value of the company is. The markets are about “What can you give me today? What can you give me next quarter?”
Here in the valley, we like to lionize founders with different points of view. Steve Jobs was “Think different.” Google, for example, and Amazon, these are companies with founders who have told the Wall Street to pound sand. At least, that’s the way that we think of them.
That’s fair. Google is actually an interesting contrast to Apple because R&D, as a percentage of revenue, has actually stayed high there. They’ve bucked this financialization trend.
I’m curious when your book came out, what was the response in the finance industry? If I’m making 10, 11 million bucks a year running this financialized engine, I’m probably not going to like this book, am I?
It was funny. I thought it was going to get a lot of pushback from Wall Street. In fact, I’ve gotten a lot of calls from high-level financiers, from hedge funders, from private equity guys, who are actually really interested in the book because they’re interested in the underlying premise that when finance gets too big, growth starts to slow, because they think about that as something that’s eventually going to hit their own portfolios.
There’s lots of research to show that when finance is even half the size that it is, as a percentage of GDP in this country, it starts to be a headwind for growth. People are really thinking a lot about that right now.
It’s already doubled where the headwind starts?
Exactly. The headwind starts at about 3.5 percent, 4 percent. We’re over 7 percent now.
As a percentage of corporate profits, you have a great metric for the financial industry. I want to tease that out of you.
Finance, as an industry, makes only four percent of jobs in this country, but it takes 25 percent of corporate profits.
Yes, this is the “taker” part. Finance, as an industry, makes only four percent of jobs in this country, but it takes 25 percent of corporate profits.
You can even just look at this as a classical economist and say, “That’s a lot of economic oxygen being taken out of the room. That’s a monopoly power right there.”
The other thing that’s really important — that will resonate with people in the Valley — is as finance has gotten bigger, it has not gotten more efficient. Financial fees have doubled as the industry has grown. That again shows me that there’s something funny going on here. This is not an efficient, productive model.
If the smart money is calling you and saying, “All right, maybe we’ve taking this a bit too far,” are there ideas about what to do about it?
Yes, the asset management industry — which is the part of finance that manages everybody’s pension money, 401(k)s — they’re very interested in this because they see a looming crisis coming.
A lot of smart money believes that we are at the tipping point of financialized growth. We’ve had 40 years of this. We’re entering a period for the next 20, 30, 40 years where returns will be lower, significantly lower, maybe half of what they have been in the past. That creates a pension crisis.
You already see California grappling with this. You see Illinois grappling with this. Pension fund managers are panicked. The guys that run that money are thinking, “All right. Well, we have these huge pools of capital. How can we deploy them in ways that actually might help offset this problem?”
I’m hearing sovereign wealth managers, big asset managers like Larry Fink at BlackRock, starting to think about how could we invest in things that would support the real economy, and decrease inequality. Some of it is obvious. For example, when there’s a big health outbreak in Africa, a big problem like the Ebola virus, travel and transport stocks tank. That affects pensions. Well, maybe if you put money into infrastructure and public health in those areas via your asset management pools, that could help.
There’s a lot of deeper thinking going on about that. It’s a big area of potential.
It doesn’t sound exactly the way that I would expect most financial managers to think.
Well, I’m not saying it’s most. There are a couple of guys that are controlling a lot of money, that are starting to think this way. Particularly at sovereign wealth funds, the Norway’s, the Canada’s. It can help create a virtuous cycle. Managers are starting to agitate for better corporate governance, for some changes in the tax code that might actually support people being incentivized in better ways that would support more long-term thinking.
There is not one silver bullet, because it’s taken 40 years to get here. But I think some smart people in powerful positions are starting to think about this.
It begs a question — “What role government?” Should we be thinking about more regulation?
I don’t want to say more regulation. I actually think regulation is very, very tricky to get right. I want to say the right kind of regulation. If we can kind of step way back, one thing we often do is the fight the last war. Whenever there is a financial crisis people come in — and you can see this in the Dodd Frank financial regulation — you try and figure out, “OK, what happened and how can we close all the loopholes?”
Well, for starters, you can’t close all the loopholes, and because the financial lobby is so powerful, they’ve pushed back and really made Dodd Frank into Swiss cheese, and a lot of people on both the right and the left aren’t pleased with the result. But I think what could help is to simply say, “Let’s not think about how to prevent all the bad things finance are doing. Let’s make finance prove us to us what good things it’s doing, and then let’s incentivize that.”
I think one simple question that the financial industry should be asked and should come up with the metric to answer is: “What is the productive, economically and socially useful thing that you are doing for society, for business, for the economy?” That’s a simple question.
What is the productive, economically and socially useful thing that you are doing for society, for business, for the economy?
It strikes me as similar to the intent of Obamacare, the new regulatory framework around health care. It’s outcome based.
Do you feel that there may be a growing consensus about what the outcome should be for the financial services sector?
It’s a really good point and it’s a deep question, because it requires an existential shift in mindset from a “market knows best finance knows best” approach: If we just do what Wall Street tells us do, as companies, as consumers, that we will have good economic outcomes. That has been a very difficult orthodoxy to turn back, and there are powerful people in Washington and on the Street that have that belief system.
But I think the fact that we are eight years on, and still in the slowest, weakest recovery the postwar era, that we are basically reliant on near-zero interest rates to avoid falling back into another recession — that is kind of waking people up.
I think we’re starting to see a conversation — you can hear a little bit of this in some of Hillary Clinton’s speeches — asking for a recovery on Main Street. Wall Street and Main Street are not the same thing. Eventually, in an economy that is 70 percent consumer spending, if people don’t get a raise, the math starts to not work.
Prior to the past 40 years, your pension, your retirement, was part of your working life. You paid into it regularly, and it was a highly regulated environment, but it took care of you. That switched completely. In the ’80s and ’90s, we said, “Well, don’t worry. We’ll just make our pension the market.” Everybody, including my mother, checks their stock balances almost every day and they’re often more than a little concerned.
Right, and as a society we get into this sort of Faustian bargain, where everybody is dependent on the markets going up, up, up, up, for their wealth or their perceived wealth, so you don’t want to look too closely at how the sausage gets made.
That’s why when you raise these issues, people get a little concerned: “Well, what’s that going to do for the market?” We may have a correction at some point, but ultimately we’ll have stronger, more robust, sustainable growth if we switch to a different model.
I want to ask you about another Valley company — Uber. Uber is a Rashomon here in the Valley. It plays the role that Google played 10, 12 years ago, or that Facebook played five years ago. It’s our greatest success. It’s also the thing that makes more people uncomfortable than almost any other company in recent history. What’s your point of view about Uber as an expression of our current Western capitalism? Is it a Maker or a Taker?
Well, I think to the extent that it’s putting a lot of wealth in a very small number of people’s hands, it’s taking. Uber is an interesting company, because I think you’re right, it really touches on people’s anxieties about what the 21st century global economy is going to look like. All of us know, to some extent, that we can be Uberized.
Journalism has been Uberized. Many white-collar professions have been or will be Uberized. What does that breakdown of the traditional social compact, which Uber didn’t start, but is just a really public expression of, what does that look like? Who picks up the slack?
You have a system where you’ve got a company with an incredibly high market value, creating fewer and fewer full-time, good, sustainable jobs and a lot of freelance piecemeal work. How do you make sure that the people that are doing that work are secure and don’t end up sort of getting the dregs of the economy’s cup?
If we’re going to have portable benefits, is government going to step in and do that? What are solutions? I think that it really just touches a lot of anxiety.
Now, you’re part of what we in the West Coast call the East Coast establishment. You look at us and say, all those nutty West Coast technology people…
We would call you the West Coast establishment.
Yes, we have our two establishments. But what I know is that the conversations in the East Coast tend to be about finance and politics, the conversations here tend to be about technology and innovation. Uber is an interesting combination of the two. I’m curious what your East Coast establishment point of view is about the current West Coast obsession with basic income?
This is actually reminding of a conversation I had a few years back with Warren Buffett, when he first came out talking about how he was paying a lower tax rate than his secretary. We were talking about where this whole trend was going and he said, “A lot of people say just more education, more training. Bring those people up and then they’ll be able to compete.”
“But I don’t think we’re going to be able to educate our way out of this problem. I think we’re going to need some wealth redistribution, at least in the short term, while we’re figuring out where all this technological job disruption is going to take us.”
I mean, we know that technology throughout the history of the world has always been a net job creator, but as everybody knows, we’re in this really disruptive period where it’s just not clear what’s going to happen and how the benefits question is going to play out. I think it’s a useful conversation to have.
Personally, I’m more interested in how technology might actually help labor to harness a greater share of the pie. I’m interested in some of the cooperative platform technologies that are springing up. There are some disgruntled Uber drivers that have started their own Ubers online, and there could be more of that.
I think if we adopted some kind of model, rather than just hand out a flat rate to everybody — which I think could become politically very difficult — if we figured out ways to help technology help labor get a bigger share of the capital pie, to me, that’s the way to create a more share recovery.
Isn’t that what unions were supposed to do?
Well, it kind of was, but I mean talking about East Coast establishment, this is one of the things that I’m always amazed about. There is such an opportunity right now for a bigger, broader, deeper labor movement that would incorporate people across all economic strata. But the way in which the labor movement in this country is set up, it’s very difficult to do that.
Frankly, we get the labor movement we deserved. I think that we’ve been so dismissive in this country and so contentious about labor relations that we don’t have what the Germans have, for example, in which corporations are actually glad to have union representatives on their board so they can talk to them and fix problems quickly and help the company be more productive.
If you were to wave a magic wand and the government did one or two things, and the business community did one or two things, what would they be?
Let’s get a new narrative going that makes it clear that we are not here to serve Wall Street, as companies, as consumers, as workers. Wall Street is here to serve us.
Well, I think my first solution would be, let’s flip the paradigm. Let’s get a new narrative going that makes it clear that we are not here to serve Wall Street, as companies, as consumers, as workers. Wall Street is here to serve us. Finance is an intermediary. It’s supposed to support businesses. It’s supposed to support wealth creation.
I think if you can get that message across, then the policy decisions start to become clearer. One immediate technocratic thing that I would suggest is start looking at the tax code, set up a committee to look at the tax code and figure out all the ways in which it subsidizes debt, both at the corporate level and the consumer level. Figure out ways that we are not paying rich people to buy bigger houses.
Figure out ways so that we can stop allowing corporations to lever up and pay much less to go more and more into debt than they would to build up equity, because there is a big body of academic research that shows that debt is always at the route of financial crises, and financial crises wipe out more prosperity for society as a whole.
One of the things that you’ve pointed out is a significant lack of trust between the population at large and that population’s elite. Can you tell me a little bit about that?
I think you see it playing out not only in the Brexit vote in Britain, but here at home in the politics, in our presidential cycle. I’ve been so struck, not only by the success of Donald Trump and to a lesser extent Bernie Sanders, but the fact that Hillary Clinton, even when she comes up with policies that are smart and do address these underlying Main Street growth issues, she can get traction.
Now part of that may be down to her own political persona, but it’s about the fact that for 40 years, elites have been a bit smug about globalization and financialization. I noticed in these East Coast establishment circles, until the last few years, it was just totally forbidden to question any of the stuff. You would be laughed out of rooms for asking dumb questions.
That’s just arrogant. We need to look at how these trends, which increase prosperity at a global level, impact citizens on the ground in every country because they do create winners and losers. We have to make sure that we’re getting the rules right to compensate those who are losing.
Well, it does seem the disconnectedness of the elite is perhaps at a dangerous level.
It’s about the fact that many of us who are invested in the asset markets, who own equity stakes in firms, or at least own property in large stock portfolios, are doing better than ever before, because the returns to assets have been rising and rising and rising, that’s where capital flows. It flows up. It’s the opposite of trickle down.
If you get most of your money from income, you are in trouble. Most people haven’t gotten a raise in real term since the early 1990s. Donald Trump supporters haven’t gotten a raise in real term since 1970s.
If you get most of your money from income, you are in trouble. Most people haven’t gotten a raise in real term since the early 1990s. Donald Trump supporters haven’t gotten a raise in real term since 1970s.
Well, there you have it in a nut shell. Let me end with this question. If through the Friedman school’s edict of “maximize shareholder value and the rest will follow” was the marching orders for business for the past 40 years, what do you think the purpose of business is going forward?
The purpose of business should be to enrich economies at large through a broad number of stakeholders. I don’t want to go too crazy with my pro-German views because the German economy has its own (issues), but I am always struck when I go to the German export companies and look at how they run their businesses. It’s an ecosystem. They have many family owned businesses. Even if they are public, often times the families own large shares. There’s a sense of stewardship.
Founders have that as well, here (in the Valley). (In Germany), you have civic leaders, you have labor, all of which are sitting on boards together discussing problems, coming to resolutions. I mean you saw this play out post-2008. One of the reasons that German companies grabbed a lot of market share from Americans is that instead of laying everybody off in mass, they came up with furlough programs, workers took wage cuts, the government helped subsidize companies, put in money, and so you had workers training and revamping factories while the economy was slow, and then boom. 2010 comes around, China picks back up, the Germans are able to just go in and grab market share. The Americans are struggling to keep up.
It (shouldn’t be) this kind of feast or famine model, this Darwinian model, but a more sustainable, shared, practical model that enriches local ecosystems. It’s one of the reasons that German wages are relatively high, and yet they are so globally competitive.
Well Rana, thank you so much for coming by today.
Thanks for having me.
Join us for the NewCo Shift Forum, where 400 of the best minds in business, technology, and government will come together for two days of focused, action-oriented dialog. Taking place February 6–9 in San Francisco.