This article was orginally published in the Boston Sunday Globe on 12/27/15
By Michael Kranish
NEW YORK — Morris Pearl, a former managing director of the world’s largest investment company, walked out of his three-bedroom Park Avenue co-op on a recent rainy morning and headed to a Beaux Arts-style members-only club. He fit the scene seamlessly, greeted by smartly dressed attendants who knew him well.
Yet, as Pearl settled into a corner table, he was deeply troubled. For the past three decades, he had worked at a Who’s Who of Wall Street firms and made his fortune.
When he started, he believed that the world of high finance he’d joined was part of a virtuous circle, greatly enriching those at the top but also helping those of all incomes by enabling growth, industry, and jobs.
But he has come to have doubts. On this morning, as it happened, a group that he heads called Patriotic Millionaires helped unveil the latest startling report on income inequality. It said the gap had grown even greater, with America’s 20 wealthiest people owning as much as the bottom 152 million.
The report underscored Pearl’s fear that the compact between Main Street and Wall Street, which helped draw him here, had unraveled.
The chasm between the super-rich and the working poor is widely seen as the greatest division in America. Yet there is no consensus on what to do.
Many Wall Streeters, himself included, had become fabulously wealthy, and that didn’t bother him, but he was troubled at how income had stagnated for tens of millions of average Americans.
The question he asked himself this day was fundamental: how responsible for this gap was Wall Street, and the way it has changed during his career? The answer, he feared, was that it played an even greater role than many realized, even if that notion isn’t widely understood or much evident in the economic rhetoric of the presidential campaign.
“I don’t want to live in a country where everybody is on the edge of not being able to get by, and that’s what I’m afraid we’re moving to,” he said. So he began to study what had changed — and what needs to change.
Inequity is the new normal
To watch the business news channels, read financial journals, or listen to government officials, it seems that the economy has turned the corner. The unemployment rate has dropped from the 2009 high of 10 percent to 5 percent today. Inflation is under control. Many upper-income Americans have seen their income spike. The Federal Reserve Board raised interest rates on Dec. 16 after chairwoman Janet Yellen said the economy is on a “solid course.”
Yet for much of the nation, the impact is indiscernible. Indeed, the fact that even this strong data couldn’t make much of a dent in the income gap marked an unintended turning point, underscoring that the divide is the new normal.
Despite President Obama’s pledge to make reducing income inequality a centerpiece of his administration, the gap has widened. A landmark study released earlier this month by the Pew Research Center said a historic tipping point has been reached in the diminishment of the middle class, with the group having suffered a 28 percent drop in their median wealth from 2001 to 2013.
A key reason is that many people’s income has stagnated. The average annual salary of the American male worker is about $50,000, down from $53,000 a generation ago in inflation-adjusted dollars, even as productivity has sharply risen.
The depth and length and strain of this economic divide has deeply scarred the American mind-set. Consider these polling results, among the most revealing of this campaign season: Just 27 percent of those surveyed say the distribution of incomes among the economic classes is fair, and only 35 percent believe that anyone in America can get ahead economically, according to a New York Times/CBS News survey conducted in June.
More than any other factor, this sense that the underpinning of the American Dream has been shaken — the idea that any hard-working person can vault ahead in a system in which all have a fair chance — explains the angry direction taken by the 2016 presidential campaign.
It has led voters across the political spectrum to be drawn to outsider candidates who promise wholesale change, and play to their fears. To Pearl, that means the focus shouldn’t just be on Washington, but also on Wall Street.
Love for computer science
Pearl, bald and bespectacled at 55 years old, grew up in a small town in upstate New York and moved as a teenager to Burlington, Vt., where his family owned Nate’s Clothing on Church Street. Determined to be an accountant, he went to the University of Pennsylvania and happened to take a computer science class, about which he became passionate.
Putting his two interests together, he became expert in the ways certain markets are managed, which made him attractive to Wall Street.
Throughout his career, he did not directly trade stocks, but instead watched from a slightly removed distance, becoming expert in how markets worked. He traveled inside the heady world of many Wall Street firms, worked at Prudential Bache, Salomon Brothers, and Kidder, Peabody & Co., served as head of fixed-income research at PaineWebber and then UBS, and in 2005 became a managing director at BlackRock, the world’s largest investment company.
He marveled when one of his early employers held nightly 5 p.m. parties on the top floor, with free booze flowing, and trimmed back to weekly parties only when the market turned down. He was shocked when an employer entertained traders with scantily clad Brazilian dancers, and was surprised when one of his son’s classmates was feted at a party by the classmate’s exceptionally wealthy parents, who had rented the American Museum of Natural History for the event.
Still, he clung to the belief that, notwithstanding some excesses, the greater work performed on Wall Street was vital.
When his father expanded his business by investing his profits in other clothing stores, he and others within the family benefited from the expansion. In the same way, large companies could raise the capital needed for growth on Wall Street and sell shares to the public, enabling anyone to own a piece of corporate America, and enrich countless stockholders.
In 1950, individuals owned 90 percent of all stock shares, and usually held them for the long term. This was the virtuous circle that had attracted Pearl and many others, as growing companies hired new workers, raised wages, and rewarded shareholders.
But over the years, the market has changed fundamentally. Institutions took over investing and today own 70 percent of stock, and typically hold it as a short-term play, according to research by John Bogle, founder of the Vanguard investment company. The markets are much more about trading at the margins, measuring profits in transactions that take milliseconds.
Today, 99 percent of volume is for trading, and only .6 percent for raising capital, according to Bogle’s research. Much investment capital today is raised by private equity and venture capital firms, including many in Massachusetts.
All of this has led to a narrowed Wall Street focus that has become known as “short termism,” in which managers look more to the next quarter’s results than long-term planning and profits.
“Management comes and goes and they are happy to leave the hole they dig for their successor,” the 86-year-old Bogle said in an interview. “I don’t mean to be cynical, said he, being very cynical.”
‘All this cash sitting there’
Few have watched the changes on Wall Street more closely than Howard Silverblatt, who since 1977 has worked at various positions at S&P Dow Jones Indices and currently is a senior analyst.
He has rarely seen companies making so much money or holding on to so much cash. This year, the nonfinancial companies in the S&P 500 are making record profits and have a near-record cash stockpile of $1.31 trillion, Silverblatt said.
In the past, a large portion of such funds would be used to create new products, build new factories, hire more workers, and raise wages.
“Companies have as much cash to do anything they want,” Silverblatt said. “They have all this cash sitting there.”
There are, of course, many reasons for the wage stagnation, including global low-wage competition, shifting markets, and diminished union power. Much of the economy is driven by small businesses and privately held companies that aren’t subject to the same short-term pressures as publicly held firms.
Still, the role of publicly traded firms, given their size and sway, has an outsized impact. The data on those firms demonstrate that despite record profits and cash stockpiles, a huge amount of money that could be spent on new jobs and wages is on the sidelines.
Many of America’s largest companies give much of their profits to shareholders in the form of stock buybacks and dividends, according to research by University of Massachusetts Lowell professor William Lazonick. That leaves less for long-term fixed investments, such as building or retooling factories. Lazonick has called for banning buybacks, which he blames “for the destruction of the middle class.”
This is expected to be a record year for stock buybacks, a trend that the Globe wrote about in an earlier installment of this series. Many companies use their cash to buy back stock in the hope that it will quickly raise share prices, while critics say the money would be better spent on investments that would boost long-term growth — which in turn can create jobs and raise wages.
Business groups have defended the state of corporate investment. They note the difficulty of making costly new bets in an economy where many people spend frugally, and when cheaper products made by global competitors are a constant threat. Thus, they say, it can be better to use excess cash to reward shareholders, or hold cash offshore while waiting to see if the next president changes tax policy.
Currently, funds brought into the United States are subject to the same 35 percent corporate tax on domestic income, minus whatever tax has already been levied by a foreign government.
Many Republican candidates have proposed a “tax holiday” that would enable companies to bring the cash to the United States at a reduced or zero rate, predicting it would set off an economic boom. Most Democrats have opposed the idea, citing reports that a 2004 tax holiday resulted in few new jobs, and that much of the money was spent on stock buybacks.
But this is not a typical Republican-versus-Democrat divide, or rich-versus- poor. Both Democratic and Republican members of the Securities and Exchanges Commission have said in speeches this year that they are concerned about short-term thinking on Wall Street.
Republican Eric Cantor, the former House majority leader who last year became vice chairman of the investment firm, Moelis & Co., said in an interview that Wall Street has been stymied by the same inability to take long- term action that has caused gridlock in Washington. He said many companies are slow to invest due to uncertainty about tax and monetary policy.
“The partisan divide between the White House and Capitol Hill has now bled over into the mentality in the private sector,” said Cantor, who lost his Virginia seat in the US House in a 2014 primary against a Tea Party supporter. “I am concerned about the lack of willingness to invest long term. . . . I do think there is a general sense of caution, a lack of willingness to take risk across the board.”
Nor is it a divide just between Main and Wall streets. It is a divide within Wall Street itself.
Laurence Fink, the CEO of BlackRock, is perhaps the most vocal critic of short-termism, writing a letter to Fortune 500 executives earlier this year in which he blasted the lack of long-term investing.
Then, in a harshly worded column that appeared on the website of McKinsey & Co., a business consulting firm, Fink castigated fellow Wall Streeters for what he called “a gambling culture in which we tune out everything except the most immediate outcomes.”
Fink, in language that sounds like it could come from someone at Occupy Wall Street — except that his company manages $4.5 trillion in assets — concluded: “We need a call to arms with many more voices speaking up and taking a stand.” Fink declined an interview request.
Fink’s broadsides have been countered by Carl Icahn, who has championed the role of activist investors as a means of getting poorly managed or stagnant companies to act in the interest of shareholders. Icahn on CNBC earlier this year said BlackRock’s activities endanger the economy because it relies significantly on debt issues. Icahn did not respond to a request for comment.
Fink’s attack on fellow Wall Streeters, along with similar criticism from a variety of academics and politicians, ratcheted up the debate about short-term thinking. And it fit squarely into Pearl’s concerns about the changes he had seen on Wall Street.
Social contract is lacking
Pearl looked around him on Wall Street and gradually became convinced that his brethren were at least partly responsible for the country’s stagnation. The short-term outlook, he concluded, “made America much more fragile than they were before. That is what dissolved the social contract between employers and employees.”
“The income of the people became such a minor concern. Henry Ford said he needed to pay workers enough so they could afford to buy his cars. You don’t hear business leaders today say, ‘I need to pay my workers enough that they can afford to shop in my stores to buy my products.’ That’s not even a consideration. It is like, ‘I need to pay my workers whatever I need to pay them to get the job done.’ ”
It is a harsh assessment, one rejected by many of his coworkers and business leaders. It is far from a majority view on Wall Street. But Pearl, an undecided Democrat, believed such concerns needed to be discussed more broadly in Congress and during the presidential campaign.
In 2013, in what Pearl described as a turning point, he was at a meeting on the top floor of a bank building in Athens during a crucial moment of Greece’s financial meltdown. At the time, BlackRock was advising the Bank of Greece. Pearl looked down at a parade of protesters headed toward Parliament, where debates about austerity measures were taking place.
“I started wondering if I was really helping the rest of the people of Greece,” Pearl said. The United States wasn’t facing anything like the Greek crisis, but he worried what might come if public policy wasn’t changed. Within a year, Pearl said, he decided he had more than enough money to live comfortably “forever.” (He declined to give his net worth other than to say it is in “the low eight figures.”) He asked himself why he had become so wealthy compared to others. He decided to quit his job and become an advocate.
“I’ve benefited amazingly,” Pearl said. “Yeah, I’m a smart guy and I have occasionally worked hard at different times in my life. But a lot of it was sort of having the luck, having to take a few computer science classes, taking advantage of public schools. . . . It is not because God told me to be rich; it is not because I worked that much harder than other people.”
He had heard of a new group called Patriotic Millionaires, composed of “high net worth” individuals whose initial focus was on raising taxes on some of the richest Americans.
For example, they criticized a tax break known as “carried interest,” which enabled certain hedge fund managers to pay the equivalent of the capital gains tax rate on their earnings, meaning their rate was lower than clerical workers pay on their regular earned income.
The issue of income inequality has seeped into the presidential campaign in different ways. Senator Elizabeth Warren, a Massachusetts Democrat, said in an interview that she hopes candidates will look at her proposal to clamp down on corporations who are paying little or no income tax, while Republicans have said US corporate tax rates are too high.
Some voters have been drawn to Democrats Bernie Sanders and Hillary Clinton in hopes that they will push measures that spread wealth more evenly, such as raising taxes on the wealthiest people and providing more benefits for lower income. Others have been attracted to candidates such as Donald Trump, who has rallied those who fear their livelihood is threatened by immigrants who are here illegally.
Proposals aimed at changing the short-term mind-set, such as limiting stock buybacks and extending the holding period for capital gains, have received only limited notice on the campaign trail.
As Pearl entered this new world of seeking to influence politics, he found something familiar to his old life. Money matters.
As he scrolled through his smartphone, Pearl found dozens of requests for his money. He responds to many, sending $125,000 to candidates and traditional political committees in this election cycle.
But that only makes him the nation’s 674th biggest contributor, according to the nonpartisan Center for Responsive Politics, underscoring how wealthy individuals play an outsized political role.
Still, it was more than enough to ensure that Pearl and fellow Patriotic Millionaires had special access, and he took advantage of it. On the evening of Nov. 17, there was Pearl with House Minority Leader Nancy Pelosi at Washington’s elegant Jefferson Hotel.
The next morning, there was Pearl, bypassing the long line of tourists visiting the US Capitol, being whisked to meetings with senators and staff members, at which he discussed his proposal to end tax breaks for hedge fund managers and to require companies to disclose all political spending.
Then it was on to the White House, where he met in the Roosevelt Room with members of Obama’s economic team. They expressed sympathy for his proposals, Pearl said, but said the time wasn’t right to push for them.
As Pearl left the White House grounds, he said, he knew that he wasn’t going to make progress quickly. He figured it had been much easier for him to make millions of dollars on Wall Street than it would be to change public policy. Still, he hoped the group’s meetings and press conferences would at least stir discussion in the presidential campaign.
The only way to change the short-term thinking on Wall Street, he said, is to “take a long-term view. This is going to take years.”