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Making the rich richer

| Sunday, Sept. 28, 2008

Today, money is on everyone's mind. The rich think about it and the poor worry about it.

This past week, the gains of the rich were protected while savings of the poor were threatened together with potential tax increases and cuts in living standards.

The situation was so bad that it persuaded Treasury Secretary Henry Paulson that free-market capitalism on Wall Street was no longer up to the task and had to be changed. His proposal was desperate and aimed at buying time for the more orderly unwinding of excessive financial leverage.

How could Wall Street, with modern, sophisticated tools at its disposal, have gotten itself into such a mess that our government found it "politic" to expect American citizens to bail out the investment houses?

A brief look at past years will indicate some developments that led to a fundamental change in Wall Street's attitude toward ethics, reputation and risk-taking.

Until the early 1970s the investment banks were partnerships, owned by the individuals who ran the firms. At Morgan Stanley, for instance, Henry Morgan, son of J.P. Morgan, led 30 partners, most of whom had fought in the U.S. Navy. They learned the vital necessity of professionalism and the value of dedication, honor and integrity.

Morgan aimed to do first-class business in a first-class way and commanded the loyalty of most of the largest governments and corporations in the world.

The capital of the firm was made up of the accumulated retained earnings of individual partners who had resisted taking their share of the years' profits as salary.

When leading a series of large underwritings, the firm needed to borrow in order to finance the securities held for the underwriting periods. Continued success and predominance demanded a core culture of extremely tight risk management and the maintenance of the highest credit rating.

A similar culture pervaded Wall Street.

In the early 1970s, the size of underwritings and trading operations increased dramatically. A series of mega underwritings -- like that of AT&T's $3 billion -- demanded larger teams of bankers to handle them. They also demanded more capital or underwriting capacity.

At the same time, many of Wall Street's senior and richer partners faced retirement. Younger partners found it difficult to replace the outgoing capital.

In response, Wall Street partnerships went public. From that moment and unrecognized by most, the ethics of Wall Street changed fundamentally.

Now, the leaders of Wall Street were no longer partners but managers. They could gamble with other people's money at far higher risks.

Furthermore, they no longer had to leave much of their salaries within their firms and could draw them all. Viewpoints became dominated by short-term returns and bonuses related to performance.

Former Fed Chairman Alan Greenspan, ignoring his crucial "independence," aligned himself with politicians anxious to avoid naturally curative recessions. His federal printing press flooded the world with billions of dollars worth of excessive liquidity.

These dollars were leveraged irresponsibly by Wall Street managers, who made fortunes for their companies in financing three of the largest asset booms in history. Wall Street even created additional concealed, leveraged risk through the securitization of bundled mortgages.

Paid on performance, the managers received huge salaries and even larger bonuses.

Repeal of the Glass-Steagall Act was the final nail in the coffin. It mixed financial institutions of differing character, skill and risk profile. It exerted pressure to increase risk taking to maintain margins in areas of business outside areas of core expertise.

When reality dawned, bad loans appeared on the books of major Wall Street firms. But accounting "standards" allowed most to be overvalued and concealed, many off the balance sheets, from the accounts.

This heralded an era of official and corporate deception, which was magnified by the presidential override of state legislation against predatory lending.

Eventually the truth emerged. Major institutions were required to recognize enormous asset losses.

There was criticism but these financial corporate leaders walked away with their wealth intact and massive severance packages. The outgoing head of Bear Stearns pocketed $65 million; the former head of Merrill Lynch, $110 million; and the head of Lehman three times as much.

There has been no attempt by government to claw back any of these profiteering gains.

The real estate, derivatives and commercial-lending markets indicate a deleveraging cost of many trillions of dollars. So far, Henry Paulson has talked only of $700 billion. Like a teaser mortgage rate, the true figure is likely to be many trillions and will kick in like an adjustable rate mortgagee.

The government bailout of the savings and loans' holdings of junk bonds has cost every American $4,000 in lost living standards. To save Wall Street, Americans will have to pay far more.

Little wonder Americans are becoming distrustful of government and Wall Street antics. They have begun to feel, with some justification, that their decreasing wealth is the price of keeping Wall Street not just alive but rich.

As George Bernard Shaw wrote, in "Major Barbara": "Who made your millions for you• Me and my like. What's kep' us poor• Keepin' you rich."

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