Thomas DiLorenzo is a professor of economics at Loyola College in Baltimore, Maryland. This article is based on a presentation prepared for the Ludwig von Mises Institute’s conference, “Austrian Economics and the Financial Markets,” last September in Toronto.
In 1978 Michael Jensen and William Meckling, writing in the Financial Analysts Journal, offered an extraordinarily gloomy prediction for the future of capitalism: “The most spectacular period of economic growth in our history is over,” they wrote, because “government is destroying two vital instruments of that growth—the system of contract rights and the large corporation.”1 Constitutional and electoral constraints on political plunder have proven ineffective, Jensen and Meckling wrote, as the courts, politicians, and regulators have revoked or attenuated property and contract rights and have attacked freedom of association as well, “especially in the civil rights arena.”2
With regard to the stock market, Jensen and Meckling forecast that because of the instability of property rights caused by government intervention, investors have become much less certain that any contract they enter into now will be subject to the same rules and regulations in the future. An early consequence of the erosion of property rights will be a reduction in the capitalized values of corporate securities, with many corporations able to remain in business only so long as they can finance their operations from internally generated cash flow or [government] subsidy.3
As of 1999 the Dow Jones Industrial Average was about 15 times higher than it was in 1978, when Jensen and Meckling issued their dire warnings. But this doesn’t mean that they were wrong about the effects of the American regulatory state on stock prices. The Dow Jones average might be even higher yet were it not for the large degree of governmental control of the means of production that is exercised through regulation. And the stock market is surely much more volatile because of the great uncertainties created by regulation. Overzealous regulators may even cause the market to crash. As discussed below, it was proposed regulation and taxation of corporate takeovers that likely precipitated the 1987 U.S. stock market crash.
Although regulators are usually blamed for the economic and social harm inflicted by regulation, it is politicians who are ultimately responsible. The U.S. Department of Labor may enforce the minimum-wage law, for example, but it is Congress that passed it. Regulation is just another form of pork-barrel politics whereby politicians dispense regulatory favors to special-interest groups, at the expense of the rest of society. Corporations are particularly susceptible to attacks by politicians pandering to special-interest groups because corporate ownership is relatively invisible, widely dispersed, and politically incohesive, as a rule. Moreover, the stock market is so volatile and complex that the owners of corporations (shareholders) would find it difficult, if not impossible, to attribute declines in their asset values to specific government actions. In contrast, special-interest groups are, by definition, more focused and politically well organized.
Politicians are not merely passive bystanders who go on “listening tours” of their constituencies and then faithfully enact the kinds of laws that the public wants. They are “entrepreneurs” who are experts at either creating genuine economic and social crises or the perception of crises, and then offering their “services” in resolving the crises. The most obvious example of this phenomenon is war. War provides politicians with myriad rationales for controlling and regulating economic activity, and few of the controls are abandoned once the war is ended.4
Of course, politicians never admit that they are the source of the problems. They usually blame corporations in particular, or capitalism in general. Hence, we witness a constant recitation of “crises” manufactured by the state and blamed on capitalism. In the agricultural sector, for example, it has been government policy ever since the Hoover administration to simultaneously pay farmers to grow more (with price supports) and less (with acreage allotments), and to subsidize thousands of failing farm businesses with farm welfare in the form of low-interest loans and grants. The agriculture industry is thereby made weaker and more volatile, which of course is reflected in the prices of publicly traded corporations in agriculture and agriculture-related industries. Government intervention is the source of these problems, but the blame is always placed on “agricultural markets.”
The U.S. Department of Commerce publishes fraudulent poverty statistics to make poverty look worse than it actually is and to “justify” such economically destructive policies as increases in the minimum wage or tax increases for the ostensible purpose of redistributing income to the “poor.”
In the environmental arena, countless capitalistic bogeymen have been blamed for everything from cancer to the destruction of the planet. This list of phony environmental scares is so long that any rational, thinking person should routinely assume that everything the organized, political environmental organizations say is a lie.
The federal government has been forecasting an impending energy crisis ever since the dawn of the oil industry—roughly 1866. In that year the U.S. Revenue Commission warned that the nation may run out of oil at any moment. In 1885 the U.S. Geological Survey forecast no chance of oil’s being discovered in California; some ten billion barrels have been pumped from that state since then. By 1914 the U.S. Bureau of Mines was predicting that only 5.7 billion barrels of oil were left; more than 50 billion barrels have been pumped since then. In 1947 the U.S. Department of State warned that “sufficient oil cannot be found in the United States”; in 1948 more than 4 billion barrels were found—the largest discovery in history up to that point and twice the volume of U.S. consumption. In 1951 the U.S. Department of Interior forecast that oil reserves would last only until 1964.5
All of these gloomy (and false) forecasts were (and are) accompanied by proposals for more government control of the energy industry to “assure” a more adequate rate of development.
The fundamental effect of this regulatory-propaganda regime on stock markets is to convince more and more investors that the right of corporate managers to use the assets of corporations in the best interests of stockholders and creditors (that is, to maximize profits) is tenuous, if not abrogated completely. The politicization of corporate decision-making via regulation causes an overall decline in capital values as corporate decisions become more and more designed to pander to the whims of politicians and bureaucrats rather than satisfying consumers and earning income for shareholders.
Government regulation is often a form of legalized extortion. For example, federal regulators routinely show up at corporate headquarters and accuse a corporation of being out of compliance with regulations that no human could possibly be in compliance with. The EPA requires that corporations which handle “hazardous materials”—which even includes Windex, according to the EPA—must keep a written record of where each and every container is located at every moment. Former New York state environmental protection commissioner Thomas Jorling described this practice as “a kind of extortion.”6 EPA regulators will enter a corporate office and impose huge fines on corporations that could not possibly maintain the EPA’s huge paperwork burden even if they wanted to. Threatened criminal indictments assure payment of the fines.
In a 1997 book, Cornell University law professor Fred McChesney argues that blackmail and extortion are inherent features of the modern regulatory process. In short, political “entrepreneurs” threaten legislation and regulation that will either impose price controls or increase costs (both of which would reduce profit margins) unless the targeted companies and industries compensate the politicians with campaign contributions or other kinds of private payoffs (including speaking honoraria, jobs for relatives, and subsidized travel to luxurious vacation resorts).
Politicians call legislation that is intended to extort campaign contributions from a business or industry “milker bills” or “cash cows.” As explained by one California legislator, a politician “in need of campaign contributions, has a bill introduced which excites some constituency to urge [the legislator] to work hard for its defeat (easily achieved), pouring funds into his campaign coffers.”7
Another name politicians have given to such legislation is “juicer bill,” since they are designed to “squeeze” cash out of corporate coffers in return for not harming the corporation with proposed legislation and regulation. So-called “fetcher bills” are also said to be capable of “fetching” gobs of campaign cash.
Examples of Political Extortion
One recent example of a proposed regulation that seems to have been designed purely to fetch perpetual campaign contributions is the battle over reducing the legal blood-alcohol content (BAC) level from .10 to .08. The federal government’s Office of Substance Abuse Prevention has declared that its goal is to eventually have .04 as the legal limit, which can be attained by an adult male who consumes one or two beers. Congress failed to pass such a law in 1998; the law that it did pass, however, creates a slush fund of highway grant money that can be used to bribe states into passing laws that reduce the legal BAC level. The law is to be renewed every year, guaranteeing that the alcoholic beverage industry will be forced to make campaign contributions indefinitely to defeat this neo-prohibitionist legislation.
In 1992 Congress authorized the Federal Communications Commission to impose price controls on cable television. Ever since then, the cable industry has poured millions of dollars of campaign contributions into Washington annually in an apparently fruitless effort to eliminate the controls.
One of the more notorious examples of political blackmail in recent years involved the Clinton administration’s proposals to impose price controls on doctors, hospitals, and the pharmaceutical industry as part of its failed plan for socialized medicine. Once price controls were proposed, reported the New York Times, members of Congress and the president were “receiving vast campaign contributions from the medical industry, an amount apparently unprecedented for a non-election year. While it remains unclear who would benefit and who would suffer under whatever health plan is ultimately adopted, it is apparent that the early winners are members of Congress.”8
Representative Jim Cooper, who proposed legislation that was slightly less onerous than Clinton’s, received nearly $1 million in campaign contributions in the first four months of 1994; overall, campaign contributions in 1993 were about one-third higher than in the previous non-election year of 1991.9 It was also widely reported at the time that the handlers of Hillary Clinton’s not-so-blind trust were selling her pharmaceutical stocks short every time she made a highly publicized speech demonizing the pharmaceutical industry, which she did quite often. During the Clinton health plan fiasco of 1993-94 the value of pharmaceutical stocks dropped by over $40 billion, according to one account.10 After the industry poured millions of dollars into the coffers of Washington politicians the price-control plan was defeated.
In his book In Defense of the Corporation, Robert Hessen documents how Ralph Nader has long engaged in the same practice as the first lady—shorting the stocks of companies that his numerous think tanks and organizations routinely demonize with highly publicized “studies” alleging corporate wrongdoing.11 The “tobacco settlement” reached by the state attorneys general, the federal government, and the companies might well be considered to be the Mother of All Political Shakedowns. In return for being allowed to stay in business, American tobacco companies are being forced to pay almost a quarter of a billion dollars to trial lawyers and federal, state, and local governments. The media have already begun reporting on how the initial installments are being spent on anything and everything by state and local governments, and not only “health-care costs,” as was promised.
Even this record may someday be broken, however, if the government succeeds in destroying the Microsoft Corporation. Just a few years ago the Washington Post was writing sneering articles about how naive Bill Gates was for believing he could focus his energies solely on producing better computer products without being a “player” in Washington, that is, caving in to the Washington establishment’s legalized extortion racket. Since then, Gates has hired dozens of Washington lobbyists and lawyers and has spent the required millions in campaign contributions.
Regulation is perhaps most effectively used as a tool of extortion when it threatens to sharply increase the costs of doing business, which it always does. Again, the game is for politicians to propose regulations that would drastically increase the costs (and subsequently reduce the profits) of successful companies with “deep pockets.” For example, the banking industry spent millions in campaign “contributions” to stop a 1982 requirement that they withhold taxes on interest and dividends—a paperwork nightmare for the banks. In 1983 and 1984 the life insurance industry spent more than $2 million to defeat legislation that would have banned the granting of gender-based rates and benefits.
Perhaps the most egregious example of regulatory blackmail is enforcement of the so-called Community Reinvestment Act (CRA). The CRA was enacted in 1978 under a patently false pretense—that banks made fewer loans to residents of low-income neighborhoods not because there were fewer creditworthy borrowers there, but because of allegedly pervasive “discrimination” against the primarily black residents of those neighborhoods. Banks do—and should—“discriminate” against less creditworthy borrowers, but in doing so they run the risk of regulatory extortion.
An entire industry of sometimes federally funded “community groups” has sprung up, with names like Center for Community Change and Association of Community Organizations for Reform Now (ACORN), which essentially extort money from banks with the following ruse: Whenever a bank proposes a merger, expansion, or building of a new branch, it is subject to regulation by the Federal Reserve, the Comptroller of the Currency, and the Federal Deposit Insurance Corporation. If anyone files a complaint with any of these agencies accusing the bank of making too few CRA loans, the merger or expansion is halted. So-called community groups frequently lodge such complaints and do not withdraw them until the banks give them or other groups they designate large sums of money, sometimes in the tens of millions of dollars. The Neighborhood Assistance Corporation of America (NACA), led by self-described “urban terrorist” Bruce Marks, has “won” loan commitments totaling $3.8 billion from Bank of America Corp., First Union Corp., Fleet Financial Group, and others. That money is lent to borrowers favored by Marks, and his organization usually gets a lump-sum fee or a percentage of each loan.12 NACA plans to operate in all 50 states by 2001, when it expects its annual budget to be in the $80 million range.
Regulation and the Stock Market Crash of 1987
Economists Mark Mitchell and Jeffrey Netter have provided powerful evidence that regulatory sneak attacks precipitated the stock market crash on October 19, 1987, when the Dow Jones Industrial Average fell 508 points (22.6 percent).13 Their thesis is that proposed changes in the tax treatment of corporate takeover transactions, which would have made such transactions much more costly, triggered the crash.
It is important to recognize the importance to the economy of the market for corporate control, or the takeover market. This market is a keystone of any capitalist economy, for it is the very means by which capital is continually reallocated to those who will make the best use of it. A vital and free capital market, Ludwig von Mises wrote, is the keystone of capitalism and the one thing that most distinguishes a capitalist economy from a noncapitalist one. Unfortunately, that is also why politicians are forever proposing more and more regulatory control of it.
Laws and regulations that restrict corporate takeovers are protectionist. In a corporate takeover a group of investors has determined that a particular company is being mismanaged. They seek, through a proxy battle or other means, to take over control of the board of directors and, subsequently, of management. They may fire some or all of the poorly performing managers, replace them with better ones, and make more profit for themselves and the other shareholders.
No one has perfect foresight, so many takeovers do not work out. But nevertheless, the only way to learn who can make the best use of corporate resources is to allow the free market to tell us, including the free market for corporate control.
Laws and regulations that would restrict takeovers or make them prohibitively costly are invariably the result of lobbying efforts by incumbent managers who have bribed politicians into enacting the protectionist provisions, which only benefit the incumbent managers at the expense of their shareholders and customers.
In early October 1987 the Congress waged a full-scale assault on corporate takeovers by passing several important changes in the tax code.14 Mitchell and Netter calculated that these changes would have reduced the value of acquiring a company through a takeover by about 25 percent; that would in turn cause a decline in the stock price of the acquiring company. Typically, the stock price of an acquiring company increases 25 to 35 percent as the result of a takeover. Moreover, such a dramatic anti-takeover bill would have reduced stock prices overall by generally weakening the market for corporate control, a major source of efficiency in capital markets.
The Regulatory Attack on Microsoft
Microsoft’s critics claim to believe that what is bad for Microsoft (an antitrust prosecution) is good for the rest of the computer industry and vice versa because of Microsoft’s allegedly “exclusionary” practices. Microsoft is supposedly “a threat to everybody in the industry,” according to Alan Ashton, president of WordPerfect, which has lost almost all of its market share to Microsoft Word.
In a forthcoming article in the Journal of Financial Economics, Thomas Hazlett and George Bittlingmayer expose this as a myth.15 The authors surveyed all Wall Street Journal articles from 1991 through 1997 announcing the investigations and litigation and gauged the reaction of the stock markets to it. Categorizing all news stories about the regulatory assault on Microsoft as “positive,” “negative,” or “ambiguous,” they found that:
[W]hen Microsoft receives good news, its stockholders experience average market-adjusted returns of 2.4%. But the news is also good for the industry as a whole, which sees average returns of 1.2% over the same dates. (Both returns are significantly greater than zero at standard levels of statistical significance).
During negative events . . . Microsoft stockholders incur average returns of minus 1.2% per event, while the non-Microsoft computer portfolio declines 0.6%.16
The returns of a few companies, such as Netscape, which is leading the lobbying and public-relations attack on Microsoft, enjoy increased stock prices whenever the news is bad for Microsoft, which explains why it is instigating the political assault on its rival. It is merely attempting to achieve through politics what it has failed to achieve in the competitive marketplace.
The regulatory persecution of Microsoft is yet another example of regulatory extortion. The political establishment is busy extracting “protection money” from Microsoft in return for its promise to allow the company to exist.
The Tobaccoization of Industry?
The so-called tobacco industry “settlement” has ominous implications for all industries (and consumers). The model is for a government-funded attack on specific industries, complete with volumes of junk science and taxpayer-funded lobbyists who pressure for advertising bans and other regulations that make it difficult to sell the product, along with higher excise taxes.17 The industry’s management is demonized and portrayed as corporate outlaws. The notion of individual responsibility (for smoking, drinking, reckless driving, firearm use, and so on) is abandoned as “responsibility” is socialized. Once this is done and it is established that no one is responsible for his or her own irresponsible behavior, then it is relatively easy to plunder an industry at will through the vehicle of “taxation by litigation.”
Florida, Vermont, and Maryland actually rewrote the laws to strip the tobacco industry of long-standing common law defenses, guaranteeing that those states would win their lawsuits against the industry. There is no reason to believe that politicians will not do the same to other industries now that the precedent has been set. The state governments cleverly hired private trial lawyers to bring the cases and paid them enormous sums—in the tens of millions of dollars each in some states.
Tort lawyers are now touting plans to use the tobacco litigation/extortion model against the producers of firearms, lead paint, pharmaceuticals, beer, wine and liquor, chemical additives, fatty foods, sports utility vehicles, biotechnology, and myriad other products. These industries will be demonized, more and more severe regulatory restrictions and excise taxes will be imposed on them, and their stocks will tumble. No industry is safe from the greedy hand of regulatory extortion.
- Michael C. Jensen and William H. Meckling, “Can the Corporation Survive?,” Financial Analysts Journal, Jan.-Feb. 1978, p. 31.
- Robert Higgs, Crisis and Leviathan (New York: Oxford University Press, 1987).
- Ibid., pp. 142-43.
- Phillip K. Howard, The Death of Common Sense (New York: Time Warner, 1994), p. 33.
- Fred McChesney, Money for Nothing (Cambridge, Mass.: Harvard University Press, 1997), pp. 29-30.
- Ibid., p. 57.
- “Requiem for Reform,” Wall Street Journal, October 14, 1994, p. A-10.
- Robert Hessen, In Defense of the Corporation (Stanford, Calif.: Hoover Institution Press, 1979).
- John Hechinger, “NACA Helps Low-Income Clients, But its Tough Methods Draw Flak,” Wall Street Journal, September 13, 1999.
- Mark Mitchell and Jeffrey Netter, “Triggering the 1987 Stock Market Crash: Antitakeover Provisions in the Proposed House Ways and Means Tax Bill” Journal of Financial Economics, vol. 24, 1989, pp. 37-68.
- Ibid., p. 39.
- George Bittlingmayer and Thomas Hazlett, “DOS Kapital: Has Antitrust Action Against Microsoft Created Value in the Computer Industry?” Journal of Financial Economics, forthcoming.
- See James T. Bennett and Thomas J. DiLorenzo, Cancer-Scam: Diversion of Federal Cancer Funds to Politics (New Brunswick, N.J.: Transaction Publishers, 1997).