Forget “The Market”

Economic theory can’t tell us much about the single most important economic fact of the past three decades: how the world has become split between an increasingly wealthy elite, and an increasingly impoverished majority.

Paul Tudor Jones after an especially lucrative day of trading commodities, equities, and currencies, circa 1986.

People who study Wall Street with an academic lens often say one or another thing about the idea of the “smart” investor who can pick winning stocks, buy them at key moments, and hold them just long enough to harvest big returns. Half say it’s poppycock. Markets are efficient, information is readily available, trading is liquid, and share prices adjust virtually in real time to any change in expectations. You can’t beat the market, they say. Burton Malkiel summed the view up saying a blindfolded chimpanzee throwing darts at the Wall Street Journal’s tables could pick stocks with the same success rate as any of the professionals. Malkiel and others have trotted out data sets to prove just this point. Over decades-long time frames professional portfolio managers at the big mutual funds and boutique houses have failed to beat the average rate of return. What’s implied in a lot of this, is that markets are also fair. Nobody really has an advantage. Transactions and assets are transparent processes and things, and when someone does make an absolute killing, it’s either through risky strategies that will sooner or later backfire on them, or some sort of insider crime.

Then there’s the economists who think that some crafty investors can beat the market, but not for the most reassuring of reasons. This camp points to evidence that markets aren’t efficient. Instead markets are ruled by irrational forces buried deep in the popular psyche. Stock trading happens between human beings whose expectations are as much emotional and superstitious as they are educated guesses about the future values of assets based on sober facts. Keynes was the big ideas man who first popularized this view of markets and made it into a proper subject for his colleagues to talk about. Subsequent behavioral theories of markets are summed up by the notion of “irrational exuberance,” the famous utterance of Fed Chairman Alan Greenspan to describe the mid-90s stock market bubble in an otherwise boring speech. Yale economist Robert Shiller used the phrase for a book that warned of the dot com bubble which popped in 2000. He recycled the book with some new material to talk about the irrational bear market for housing in the 2000s. Shiller saw these bubbles coming and made a fortune selling timely book-length criticisms of the macro economy’s fantasy ride. Numerous financiers also saw the bubbles and made killings by shorting housing, equities, bonds, and other over-priced securities. Here again a lot of shenanigans are implied, but so is the basic fairness of the market.

John Paulson, head of the Paulson & Co. hedge fund, circa his “big short” position against US subprime housing debt in 2006.

So are markets rife with under and over-priced deals fit for the taking? The market is certainly systemically inefficient because it’s a big messy human drama, but does this at least provide wiggle room for brave, crafty, and patient investors to beat the average rate of return? Maybe that’s the gloss over the warning the behavioralist school of thought is really trying to impart; financial markets are intrinsically unstable and prone to bubbles and deflations that grow from a bi-polar collective consciousness. If that’s true, there are moments when real value can be seized at discounted prices, and over-priced assets can be shorted by the cognoscenti. The herd perishes before the ubermensch hunters who can smell the beastly fear and stay a step ahead. Is this what we should believe about the few elite investors who continually post massive profits while the pack stagnates?

In wondering about “the market” as a totality this debate between the efficient markets school and the behavioralist school misses the trees for the forest. Yes, I turned that phrase backwards. The problem here is big picture thinking. Too many economists start from the wrong level of analysis. Economists are rightfully concerned with the forest —the economy as a whole unit— but they make the mistake of launching straight into theorizing about “the market” as a whole, and the big forces that drive it. They’re looking too much at aggregate sets of data.

The question of whether markets are efficient or not, and how some investors beat the average returns, has too often proceeded from a ten thousand foot level where individuals and firms and governments and laws and historical events disappear into a noise of statistical data, where returns are averaged, and actors are lumped into vast populations and categories, or else they’re lumped into psychological categories, and all the action is reduced to something akin to ravenous locusts or panicking wildebeest. Specific trees disappear, and we’re left with the abstract jungle of either efficient markets allocating capital and rewards in seemingly random ways, no matter an individual’s efforts, or wild-thing markets swung around by animal spirits, devouring the slow herbivores who feed on the buy or sell ratings of analysts.

If you look at the major studies that bolster the efficient market hypothesis and the behavioralist views you’ll notice that they’re short on micro case studies that focus in on particular investors, firms, and business stratagems. These sorts of accounts are ridiculed anyways as “journalism” or the niche sub-field of “economic history,” which is considered more of a member of the field of historical arts than the “science” of economics. This is largely because economics has pretended to be a rigorous science for over 100 years now. In emulating the rex of science, physics, economics has actually fled from reality and built a world around logical models set spinning into equilibrium with mathematical methods.

There are political reasons for this, of course. It’s too much to get into here, but the short of it is that getting away from concrete reality that could be revealed through detailed case studies of economic activity helps mask some politically damaging realities for those who have managed to accumulate big shares of the world’s wealth.

Most economists never got the memo from the other social sciences that detailed ethnographic, comparative, and historical study is just as rigorous, and can often produce much richer theory than abstractions based on big quantitative data sets. Or they saw the memo, but chose to ignore it. After all, economics serves two purposes. One is to attempt to understand how the economy sets prices, meets demand, grows, and allocates capital, whatever all that means. The other is to attempt to legitimate the way the economy actually functions by telling a value-neutral story about a fair and natural system, using fancy equations and hard to envision categories like gross domestic product and marginal income, when what’s actually being discussed is a not so happy tale of power and conflict.

When I read the best of contemporary business journalism what jumps out are the details, not the big sets of data showing market trends, price movements, or average portfolio returns. It’s the people, firms, and the tactics they use to amass fortunes from securities markets that appear in high fidelity and get my mental gears spinning. All the advanced theories of markets and finance add little value to these tales, serving only to wash away the reality.

To be clear, I think both the efficient markets hypothesis and behavioralist theories can offer some useful guidance in understanding part of the big picture. They’re not entirely without some truth to them. It is incredibly rare for someone to best the market by simply picking the best stocks, bonds, and making smart bets in derivatives markets. In this sense the EMH is good at describing the odds a normal person, acting without any special access, information, and with just a modest sum of capital, can beat the market. You can’t really. Additionally, of course the markets are irrationally driven by emotions, and prone to bubbles, recessions, and depressions. People lose their shirts all the time, especially the little investors and the weaker institutions like pension and mutual funds.

What do these theories really help us understand about our lives though? What do they tell us about the truly pressing questions of our era? Not all that much. The infatuation that the economists have had with their own insular debates about markets reveals more about the function of economics in veiling power relations than anything else.

Another big picture, derived from a decidedly ethical concern, is how the world is becoming polarized between a wealthy elite and an increasingly impoverished majority. Today’s elite, the rentiers and creditors who exert disproportionate influence on our political systems and control most of the world’s capital, and thus our collective future, many of these rainmakers obtained and maintain their positions of power precisely by “beating” the markets and surviving periods of irrational exuberance. Somehow, against both the notion that markets are efficient and impossible to beat, and markets are volatile and dangerous, today’s one-percenters used stratagems to squeeze capital from markets that are otherwise impossible to gain much from because of their efficiency, or their volatile irrationality.

So how did the contemporary elite do this? That, I think, is the real question to be asking about markets. It doesn’t invalidate what’s obvious or useful about other theories, but it does allow us to bust free from the limits of “scientific” economics and finance theory, and concern ourselves with a more social and anthropological study of the economy as a system of power relations. I think it requires attention to specific cases of accumulation on detailed levels.

Getting away from the forest views where actors are all just individual data points and the market is a vast plot of variables moving in impossibly complicated ways is a good place to start. Let’s start instead by looking at the so-called masters of the universe who have done quite well for themselves against the market’s efficiency, and against the noise of volatility and random catastrophe.

Hedge funds and private equity firms seem like great places to start.

Private equity fund Kohlberg Kravis and Roberts has been around since 1976 and throws weight at over $40 billion in assets. KKR has been an astoundingly successful firm when it comes to obtaining returns on investments that beat the average market participant. Or take Bain Capital, the most well known private equity fund in the world now thanks to that guy who ran for president in 2012. Bain pounced on the markets when it was founded, and grew at a phenomenal rate, posting profits that year after year showed acumen far above and beyond what other businesses were capable of, including most other PE firms.

Among hedge funds there are plenty of examples of winners who defy the standard economic theories of how markets work. Bridgewater Associates, the world’s reigning zeus of the hedge fund pantheon, was founded in 1975 and has grown rapidly into an overseer of $122 billion in assets. A new hedge fund outfit, the Brevan Howard firm, with $36 billion under management, has repeatedly bested the market, posting huge gains even in macro-economic downturns. In 2008 and 2009 Breven Howard posted gains of 20 percent and 18 percent respectively.

How do firms like these beat the market time after time? Sure, some blow up. Those that do, like Long Term Capital Management, get sliced up by their creditors, and the quants or dealmakers running the show go gently into the night, into semi-retirement in their Gold Coast mansions, but more often into business under another name. What’s amazing is that so many of the top hedge funds and private equity groups have such staying power. If we’re to believe in efficient markets or take on a cynical behavioralist viewpoint, all these firms should be out of business, or at least not growing at double digit rates into entities with wealth surpassing many sovereign nations. How do they survive the irrational explosions of turbulence that roil asset prices every three to five years? Indeed, how do they often post their biggest gains at precisely the moment the efficient markets are efficiently destroying everyone else’s wealth because the crowd psychology tipped from glee to gloom?

Here’s a hint: it’s not due to their super-human intelligence, secret sauce market models, protestant work ethic, or sobriety. It boils down to power. The contemporary financial elites use power through politics, the law, and sometimes even the raw power of the huge pools of capital they control, to make markets move, or else to get around the other efficient and fair mechanisms that most other market participants must abide by.

This will guide a couple future posts here. I’ll explain some of these strategies, but unlike the dismal scientists, I’ll be focusing in on specific cases to reveal how the top dogs accumulate wealth. These will be tales of non-efficient markets where power relations are masked behind prices, information, and access.

The San Francisco Giants of Real Estate, Tech, Finance

Easily the biggest winners of this year’s World Series are the owners of the San Francisco Giants baseball club. The Giants franchise is owned by a limited partnership called San Francisco Baseball Associates, L.P. There are 32 partners invested in the club, but it’s widely understood that most just possess a couple million in share equity, while a few hold the controlling shares. None of the owners are purported to be very active in the team’s management except Lawrence Baer, a minority owner and president and CEO of the club.

Share values in the Giants partnership have grown enormously since roughly two-dozen investors bought the baseball club in 1992 for about $100 million. At last estimate the Giants franchise was valued at $643 million. With their second World Series title in under three years sealed and their fan-base rapidly growing, that price is likely to have shot up. So who exactly is getting rich?

Charles B. Johnson

The largest Giants shareholder is Charles B. Johnson, estimated net worth of around $4-5 billion. That makes Johnson the wealthiest man in baseball. Whatever money Johnson has made off the Giants is small potatoes compared to the fortune he started with.

Johnson’s money comes from Franklin Resources, a mutual fund company his father founded. Johnson is pretty much Bay Area royalty, about as elite in both the social and economic sense as they come. He’s a trustee of Stanford’s conservative Hoover Institution, and has been a member of the corporate policy lobbying group the Bay Area Council.

Johnson lavishes money on conservative, anti-labor causes and political candidates. Just this year Johnson gave $200,000 to Karl Rove’s American Crossroads super PAC, and $50,000 to the pro-Mitt Romney Restore Our Future super PAC, in addition to many other causes. Johnson is also the largest funder of the campaign against California’s Proposition 30 which would raise taxes on the super wealthy to fund education; he gave an anti-30 committee $200,000. Johnson has also contributed $50,000 to Proposition 32, the California ballot initiative that would virtually ban union money in California politics.

Charles B. Johnson’s home, the Carolands Chateau in Hillsbourough, CA.

Earlier this year Johnson held lavish fundraising events for Mitt Romney in his opulent Hillsborough mansion, the Carolands Chateau. In previous years Johnson invited George W. Bush to hold fundraisers at Carolands also.

Charles Johnson’s partner in business at Franklin Resources, a man named Harmon Burns, was until 2006 the largest share owner of the Giants. His death in that year passed his shares on to his wife, who then died in 2009 leaving the stake to be split between their daughters, Tori and Trina. In other words, majority ownership of the Giants rest with three people whose fortunes come from the Franklin Resources, Inc. company.

Peter Magowan, the Giants’ former managing partner who is credited as the catalyst for bringing the current group of owners together to buy the team in 1993, remains a large shareholder. Like his fellow owners, Magowan’s money doesn’t originate in baseball. And like more than a few of his fellow owners Magowan inherited his fortune. Magowan also shares the conservative, anti-labor values of some of his fellow Giants owners.

Peter Magowan (picture from Caterpillar, Inc.’s web site).

His grandfather was the founder of the investment bank behemoth Merrill Lynch (now part of Bank of America) and also a founder of the Safeway Corporation. Magowan’s father ran Safeway, and Magowan himself was elevated to the position of CEO of Safeway in 1979. By then the company had become the supermarket titan it is today.

Like Charles Johnson, Peter Magowan is a reactionary conservative who actively throws money against social justice causes. Magowan has lavished hundreds of thousands of dollars on Republican Party candidates John McCain, Carley Fiorina, and Paul Ryan. Earlier this year Magowan gave Karl Rove’s American Crossroads a $75,000 contribution toward defeating Barack Obama and other Democrats in key states, as well as $25,000 to the Restore Our Future super PAC. Earlier this year Magowan gave Wisconsin governor Scott Walker a $10,000 contribution to fight the recall campaign initiated against him by labor unions after Walker attempted to abolish collective bargaining.

Magowan is known as an anti-union corporate manager from his earlier years running Safeway. When Safeway was taken private in an LBO orchestrated by KKR in 1986, Magowan led an effort to bust up unions inside the company and drive down wages so as to drive up profits for the new private equity owners. “Our intention is to discuss with the unions those divisions that are having profitability problems, in our opinion entirely because of the fact that we pay higher labor costs than our competition in several markets that we operate,” Magowan told the LA Times during the company’s restructuring.

In addition to his current ownership stake in the Giants, Magowan also sits on the boards of Caterpillar, Inc. and DiamlerChrysler. Caterpillar has been widely criticized for selling bulldozers to the Israeli government through U.S. Foreign Military Sales Program. These bulldozers are used to demolish the homes, businesses, and farms of Palestinians.

The Giants owners aren’t just conservative tycoons. Among the minority owners of the Giants are some Democrats also. Giants owner Philip Halperin runs the Silver Giving Foundation, a philanthropy he created with money he amassed while working as a partner in the Weston Presidio private equity firm. Halperin’s official biography on the Stanford Freeman Spogli Institute for International Studies web site (where he sits on the advisory board trustee) says that at Weston he was, “focused on information technology, consumer branding, telecommunications and media,” and that he “previously worked at Lehman Brothers and Montgomery Securities.”

Halperin contributes relatively small amounts to the Democratic Party and candidates in any given year. He also sits on the board of Autonomy Virage, a company that specializes in developing surveillance systems for corporate and military clients.

More than several of the Giants minority owners are real estate tycoons, a fitting source of wealth given that the Giants baseball franchise itself has been a major force in a broader effort by San Francisco’s landlords to further gentrify the entire city and drive up land values. The Giants’ downtown stadium seamless connects the financial district (the product of 1960s and 1970s urban “renewal”) with China Basin and Mission Bay. The latter areas have seen enormous real estate investment in the 1990s and 2000s, including numerous luxury condo and high-rise apartment projects ringing the AT&T Park and the University of California’s brand new medical school campus (around which biotech companies are in a frenzied push to claim land).

Some of the Giants’ current owners have been keen to cash in on this speculative frenzy. An article from a 1997 issue of the San Francisco Business Times describes one case:

“In March, Allan Byer, a minority partner of the San Francisco Giants and owner of the Byer California clothing manufacturing company, beat out three other investors to plunk down $3.15 million for an aging and empty brick warehouse at 128 King St. On paper, the deal makes little sense. According to the San Francisco Tax Assessor’s office, the building is worth just $316,194. Why pay 10 times that much for an old building that hasn’t earned a dime in decades? The answer lies directly across the street, where in the middle of November, the Giants will hold a groundbreaking ceremony to start construction of PacBell Park, the team’s new 42,000-seat stadium. On opening day in April 2000, tens of thousands of people will stream into the stadium for the game, most of them passing directly in front of Byer’s property, which by then likely will house two or more restaurants — tables packed and cash registers humming.”

Other big shot real estate investors who own minority stakes in the Giants include David S. Wolff of the Wolff Companies, and Scott Seligman of the Seligman Group. Wolff controls a huge portfolio of Houston office properties.

Scott Seligman’s company owns the Sterling Bank & Trust, and numerous office properties in California, Nevada, and Michigan. Seligman has been singled out as the ugly face of gentrification in San Francisco by non other than Lawrence Ferlinghetti, the famed poet and owner of City Lights books. Back in 2001 Seligman was in the process of evicting tenants from a building he controlled in the Mid-Market area (the same part of San Francisco now being colonized by Twitter thanks to a big tax break the Board of Supervisors gave the company). In a press release Ferlinghetti lashed out:

“A developer from Michigan, Scott Seligman, who runs Sterling Bank and Seligman Western Enterprises, wants to gentrify the Mid-Market zone. Not to make the City a better place but to make his bank account a little fatter. He wants a better class of tenant. No more photographers or poets or translators or editors or painters. No more small businesses serving the City. No more small nonprofits, like Streetside Stories, which publishes work by 650 middle school kids every year to foster a love of reading and writing.”

Ferlinghetti was trying to draw a line: “It’s long past time for San Francisco—the people who live here and care about the place, the politicians, the small businesses, the kids who will inherit either a theme park or an exciting, urbane City—to stand up and stop the development juggernaut.”

AT&T Park from the air, obviously a jewel in king gentrification’s crown.

Of course the development juggernaut stumbled for a couple years, but then raged on. The Giants new ballpark was a key piece in advancing the juggernaut not only because it linked gentrifying regions of the city, but also because it secured a much desired form of high-priced entertainment for the tech and finance employees quickly populating trendy neighborhoods like Soma and the Mission. These highly paid, college educated urban pioneers have driven out thousands of long-time residents, mostly Black and Latino families whose existence sullies the theme park atmosphere, and who can’t pay the rapidly rising rents making men like Seligman very wealthy.

Meanwhile tickets to a Giants baseball game have shot up in price, making an outing to even the most mundane mid-season match too costly for some San Franciscans. Ball games have become something of a posh affair. The restaurants that ring AT&T Park are pricey, as is the food and drink inside the games.

Nowadays many of Silicon Valley’s big companies —Google, Yahoo, Facebook— send fleets of company buses into San Francisco’s hipster enclaves like Noe Valley, the Mission, Bernal Heights and Soma to pick up their twenty to forty-something year-old engineers and code geeks, shuttling them on these private transit systems directly to work with onboard wi-fi and other so-called perks to keep them satiated. In the 1990s it was no surprise that the young workforce fueling California’s booming technology capital wanted to live in an exciting city and shunned the quiet suburbia of Palo Alto, Cupertino, and Santa Clara. They wanted city lights, “gritty” urban experiences, 2 AM burritos on 24th Street, over-priced coffee along Valencia, art galleries on Natoma, endless music and clubs, and yes, of course they’d want baseball. Most importantly, they’d be willing to shell out hundreds of dollars or more every year for tickets.

The owners of San Francisco Baseball Associates, L.P., and the companies, foundations, and non-profit corporations they control, own, or direct.

So it should be no surprise that filling out the minority owners of the Giants baseball club are mostly technology executives. They had both the money to burn thanks to their IPOs and buyouts, and they had the larger reasons of class interest to make what was seemingly a philanthropic investment in the 1990s when the Giants almost left San Francisco for Florida. The team’s majority owner back then complained he had been losing money after voters thrice rejected his efforts to get public funds to build a new stadium. Many observers thought the new owners were simply sacrificing a few million to keep the team in San Francisco; the Giants were also a pretty mediocre ball club then, and attendance at games, held out at the windy Candlestick Park, wasn’t the greatest. When the new owners took over they ended up getting millions in public subsidies to build the new downtown stadium by the water. Even though they claim to have been the first franchise to “go private” with ballpark financing, the Giants’ owners did in fact receive at least $80 million in infrastructure upgrades paid for by taxpayers. The stadium also sits on public land, leased to the Giants at a very cheap rate.

Of course the new owners weren’t philanthropists. They were operating as sharp business executives. The baseball club was a keen real estate investment, and a very strategic investment toward their larger project of keeping San Francisco hegemonic in the tech economy. This larger vision of urban development has involved rapidly eradicating working class communities and replacing them with yuppified landscapes populated by mostly white college educated newcomers. Surprisingly few in San Francisco have consistently criticized the Giants baseball club for playing a key part in this harsh gentrification campaign executed on a city-wide level.