Chapter One—
The Importance of Financial Institutions in the Political Economy

[Banks are] . . . in a position where they can exert significant influence . . . on corporate decisions and policies. . . . [L]argely unknown is the extent to which these institutions actually use the power . . . to influence corporate decisions.
—Julius W. Allen, Library of Congress

The international financial system is not separable from our domestic banking and credit system. . . . A shock to one would be a shock to the other. In that very real sense we are not considering esoteric matters of international finance. . . . We are talking about dealing with a threat to the recovery, the jobs, and the prosperity of our own country.
—Paul A. Volcker, Chairman of the Federal Reserve

Observers have long recognized the power of individual banks to advance or deny loans to industrial corporations (Hobson 1905; Hilferding 1910; Lenin 1917; Menshikov 1969; Fitch and Oppenheimer 1970; Kotz 1978). Yet the processes and effects of banks' collective control of capital flows remain murky. What happens when an industrial corporation faces an organized financial community? National and local governments throughout the world

imitate corporations by borrowing to finance various projects. What happens when the state confronts an internationally organized banking community? What is the effect on the state's relative autonomy? Do state capital flow relations look like those in the corporate community? Many observers and theorists have offered intriguing speculations about these issues, but no one has systematically substantiated them. This book explores what happens to corporations and governments when the banking community pulls the collective purse strings. It uses comparative case studies that together provide a broader perspective than would each alone. Although all the cases presented here are well known, they have not previously been drawn together to form a coherent picture of capital flow relations and their consequences.

I argue that the collective control of finance capital flows empowers banks to define crisis and noncrisis situations. When banks define the economic situation as noncrisis, they may support a firm by providing loans and buying stocks with pension and trust funds. Access to cash enables firms to invest in a variety of pursuits, such as research and development, expansion, mergers (or defense against hostile takeover attempts), relocation, and so forth. Similarly, loans enable governments to pay for social welfare and development programs.

But when banks define the situation as a crisis, for economic or political reasons, they may decide to deny loans or sell large blocks of a firm's stock. The banking community may also demand repayment or deny loans to the state (again for both economic and political reasons). In such instances, the process of defining a situation as a crisis sets into motion all the consequences of that definition and can create an actual crisis even where none existed before.

Organization strengthens the banking community's ability to define crisis situations. This organization results from the banks' common presence in lending consortia, similar investment patterns on behalf of the pension and trust funds they administer, and interlocking directorates. The structural unification of banks gives them access to substantial proportions of finance capital resources and large and lucrative corporate, state, and municipal business. Moreover, unification eliminates competition between individual banks, forcing customers to struggle with the organized banks collectively. The power of these collective purse strings is the focus of this book.

In the remainder of Chapter 1 I examine the theoretical debates at stake here by outlining the role of financial institutions in the corporate community and the state, and by specifying the notion of bank hegemony as the process by which collective purse strings evolve. Finally, I describe the role bank hegemony plays in socially constructing crisis.

The Role of Financial Institutions in the Corporate Community

Most research on the power structure of business places financial institutions at the center of intercorporate relations. This central position offers a great potential for bank control and power, as Julius W. Allen testified to the Metcalf Committee in the statement cited above. What remains to be specified are the circumstances under which banks realize that potential and the processes by which banks formulate and exercise that power. We must therefore analyze the effects of lending relations, institutional stockholding, and interlocking boards of directors on the exercise of bank power.

For the purposes of this study I distinguish finance capital from industrial capital and money capital. Industrial capital includes raw materials, labor, land, and the other tangible resources necessary for production and commerce. Finance capital includes relations involving stocks, bonds, loans, and pension funds, that is, the resources needed to purchase all other resources of production, commerce, and the management of the state. Money capital is cash.

The earliest analyses of financial institutions examined the role banks played in the economy at large (Hobson 1905; Hilferding 1910; Lenin 1917). In particular, they focused on the transformation from industrial capitalism (characterized by the domination of capital in general) to finance capitalism (characterized by the domination of money capital specifically). Capital was increasingly concentrated in a diminishing number of financial institutions. This consolidation fundamentally altered the role of banks from simple intermediary to an increasingly "powerful monopoly which controls a major proportion of the available wealth of society" (Mintz 1978, 50). Simultaneously, the industrial sector needed

more and more capital to continue to expand and grow. This increasing need changed the structural relation between the industrial and financial sectors. Less and less capital belonged to the industrialists, who ultimately used it in production. Financial institutions became industrial capitalists. Banks had to invest in industry for that money to remain productive capital (and therefore profit producing). Finance capital became a fusion of industrial and money capital (Lenin 1917), placing banks in an increasingly central position in the political economy. As the process of increasing concentration of capital continues, those who control this capital (the "financial oligarchy") progressively gain power. Their pivotal position enables them to know the precise financial position of industrial capitalists and to "control them, to influence them by restricting or enlarging, facilitating or hindering credits and finally to entirely determine their income, deprive them of capital, or permit them to increase their capital rapidly and to enormous dimensions, etc." (Lenin 1917, 37).

Whereas Lenin defined finance capital as a fusion of industrial and money capital, Hilferding (1910) saw it as the separation of those capitals. For Hilferding, finance capital was money controlled by banks but used by industrial capitalists for production. Lenin criticized Hilferding for omitting the process of increasing concentration of both production and capital, a process Lenin argued leads to monopoly. I argue here that money has remained separate from production in that industrial and commercial capitalists must use it; but the accessibility of money remains under the control of financial institutions. Although commercial banks clearly exert control over money flows, they are by no means the only institutions to do so. Insurance companies, investment companies, and savings and loan associations also control money flows.

Lenin argued that increasing concentration leads to the development of capitalist monopolies. But although we have witnessed a pattern of increasing concentration, we cannot say it has led to capitalist monopolies. The financial community includes thousands of banks, insurance companies, and investment firms (referred to collectively as "banks" in this study). Although structural arrangements frequently bind these firms in their relations to borrowers, they hardly constitute a monopoly. Nor can we say banks

and industries have become fused into monopolies. True, many major U.S. banks grew out of industrial empires and still retain some of those ties or influences. But those ties are neither immutable nor discreet (see Mintz and Schwartz 1985; Mizruchi 1982). As we shall see later, serious rifts often separate those who control money from those who use it in production, commerce, and the management of the state. This separation does not necessarily mean that banks are wholly independent of industrial capital or the state. Financial institutions depend on both corporations and the state for their most lucrative business, because money must be invested in the production of wealth to increase profits. (Although the state does not produce wealth, it absorbs some of that wealth in taxes, which it passes on to banks as interest on state loans.)

Thousands of individual financial institutions participate in various ways in the process of absorbing surplus money and redistributing it throughout the political economy. Of great importance is their ability to organize to collectively influence the fate of the users of that surplus. Many observers consider banks more powerful than nonfinancial corporations because of the banks' control over finance capital. In particular, observers look at control over loan capital (Lenin 1917; Menshikov 1969; Fitch and Oppenheimer 1970), control over trust and pension funds (Rifkin and Barber 1978), stock ownership (Perlo 1957; Knowles 1972; Menshikov 1969; Kotz 1978), and interlocking corporate boards of directors (Rochester 1936; Baum and Stiles 1965; Chevalier 1969; Pelton 1970; Levine 1972; Scott 1978, 1979; Mintz 1978; Mintz and Schwartz 1981a, 1981b, 1983, 1985; Mizruchi 1982). The relative importance of these sources of financial institutions' power is the subject of continuing debate. But what is the effect on financial relations when banks organize to collectively provide capital?

In sum, financial institutions are important to the business community because of their structural positions as controllers of lending capital, institutional stockholders, and central figures in networks of interlocking directorates. Further, they dominate the process of defining crisis. Debate continues over the theoretical implications of finance capital in the relations and structures of the state and over the role of banks in intercorporate relations and the

political economy. We have yet to document the precise processes and significance of capital relations, the role of bank hegemony and the unified control of capital flows, and the relative significance of the various sources of bank power.

Lending Relations

Lending empowers banks in their relations with nonfinancial firms in several ways. First, the ability to advance or deny loans and credit to nonfinancial firms enables banks to elicit major stock options and representation on recipients' boards of directors (Hilferding 1910; Lenin 1917; Menshikov 1969; Fitch and Oppenheimer 1970). More specifically, lending relations in and of themselves represent potential bank power. For example, bonds can be a source of bank power because financial institutions are the major holders and administrators. Bonds differ from stocks in that bonds are typically longer-term loans (over ten or fifteen years). As such, bondholding by banks produces long-standing capital relations between banks and nonfinancial firms. The significance of these relations is that "even large corporations which sell bonds sign agreements stipulating their dependence upon the creditors" (Menshikov 1969, 173). Furthermore, banks usually hold bonds, whereas individuals usually own stocks (Rochester 1936). Unlike stocks, bonds carry no voting rights and therefore do not entitle their holders to participate directly in decisions affecting the internal affairs of the firm. But they still represent a source of power, particularly during periods of corporate crisis. For example, when a firm goes bankrupt, bondholders' claims take precedence over stockholders' claims.

The short-term loan, which matures faster than bonds, is also a source of bank power. Most nonfinancial firms (including the largest corporations) depend on external sources of investment capital to meet their immediate needs. These large borrowing needs require lending consortia composed of several commercial banks and insurance companies, because banking laws restrict a single bank's exposure to one client to 10 percent of the bank's assets. By spreading the risks of large loans over many banks, lending consortia also minimize the competition between individual banks (Menshikov 1969, 175–176).

The popular belief in competition between creditors is greatly exaggerated. Financial institutions acknowledge and respect one another's role as main organizing or lead bank for a particular corporation or group of corporations. For example, "a banker will not begin to negotiate a loan with an industrial corporation if it is known to be the client of another banker without the latter's consent. Attempts to break this rule lead to joint disciplinary measures against the transgressor" (Menshikov 1969, 180). The development of long-standing relations between investment banks and specific firms is a key element in bank power. These relations "magnif[y] the influence that investment banks can exert" (Kotz 1978, 21). Furthermore, common participation in lending consortia reduces the number of nonparticipating competitors and fuses the interests of the participants.

The manager clause, often included as a term-loan stipulation (or condition of the loan), positions banks at the heart of a business. This clause stipulates banks' rights "to demand either the appointment of executives at their discretion or the placing of the firm's controlling block of stock under bank trusteeship" (Menshikov 1969, 176). Thus banks reserve the right to intrude into executive and personnel decisions should the current management displease them.

These lending arrangements produce structural bases of bank power in capital flow relations. Banks have held this powerful structural position for more than fifty years because of nonfinancial corporations' reliance on external sources of financing for investment capital (Lintner 1966; Sweezy and Magdoff 1975; Gogel 1977). Moreover, the largest firms are often the most dependent on outside sources of investment capital, for several reasons. Participation in mergers, acquisitions, and new ventures is increasingly expensive. So are high dividend payout rates, defensive strategies against hostile takeover attempts, and responses to economic and accounting constraints. For example, a reliance on loans contributes to the illusion of huge corporate profits:

In trying to maintain a false image of prosperity, U.S. corporations are literally throwing away money that they sorely need not only to pay current bills but also to bankroll future investment. As a result, they are forced to lean more heavily on external sources of funds. (Business Week , 19 Mar. 1979, 108)

Inflation also stimulates corporate borrowing because borrowers will eventually pay off the debt in depreciated dollars. Further, "many managers contend that debt can be . . . a cheaper source of capital than equity, because of depressed stock prices" (Business Week , 9 Apr. 1979, 108). Similarly, recession forces corporations to rely more on external capital. Cash flows are difficult to maintain during economic downturns because corporate profits decline (Business Week , 31 Dec. 1979, 153–155). But even the bull market of 1987 did not reduce corporations' need for loans because it was fueled partly by "merger mania." This reliance on external investment capital places banks at the center of the business community.

Some observers regard lending as a mutually beneficial and reciprocal relation between banks and nonfinancial corporations. They argue that the constraining influence of banks is counterbalanced by the power of nonfinancials, which have large deposits in the banks (Herman 1973, 1981; Stearns 1982). If banks interfere in the operations of their borrowers, the alienated nonfinancials might withdraw their deposits. The nonfinancials might also refuse to deal with the offending banks in the future. But such an analysis overlooks the way large organized lending consortia tip the balance of power in favor of the banks. When the major lenders take a concerted, aggressive position against a corporate borrower, they severely restrict the target firm's sources of loans. Furthermore, that banks recognize and respect each other's lead bank status prevents nonfinancials from exploiting competition between banks.

Institutional Stockholding

Institutional stockholding as a source of bank power results from a historical transformation of capital sources. The post–World War II boom in pension plans and the resultant growth of bank trust departments created a new source of capital. Pensions rivaled traditional capital-supplier relations as the major source of financial control. Furthermore, the share of outstanding stock held by personal trust funds has grown steadily. This concentration of personal trust funds has increased the power of large trustee banks.

Just nine New York City banks handled four-fifths of the city's personal trust business in 1954, and hence perhaps two-fifths of the national total.

These New York banks appear again and again among the 20 largest stockholders of record in the country's largest corporations in the prewar TNEC [Temporary National Economic Committee] tabulations. (Perlo 1958, 346)

In the last several decades banking institutions have increased their acquisition of stocks and currently represent almost 50 percent of the value of all shares for public sale (that is, in circulation). According to Menshikov (1969, 161), "This percentage is high enough to ensure complete control over industry by the combined capital of the country" (see also Kotz 1978; Rifkin and Barber 1978; Villarejo 1961).

The increasing concentration of stockholdings in pension funds contributes much to the growth of institutional stockholding, because these funds are controlled not by their beneficiaries but by financial institutions, primarily commercial banks. In 1965 pension funds held only 6.7 percent of total outstanding stock, but they increased their portfolio holdings more than any other type of investor (Chevalier 1969). Moreover, these funds were concentrated in a few major banks, notably, Mellon National Bank, Morgan Guaranty, First National City Bank (Citibank), and Bankers' Trust Company (Chevalier 1969). By 1974, 56.7 percent of the assets of private uninsured pension funds were invested in stocks (Kotz 1978, 68). By 1978 pension funds held at least one-fourth of the shares of firms on the New York and American Stock Exchanges. According to Rifkin and Barber (1978, 114), "the 100 largest banks already control[led] over $145 billion in pension assets, with the top 10 banks controlling nearly $80 billion between them. The banks invest a majority of these funds in the equity and debt financing of America's largest companies."

Pension funds in the 1980s have amounted to approximately $600 billion. At a growth rate of 10–11 percent annually, they could quickly top $1 trillion (Born 1980). Because pension funds have become the major shareholders of corporate stocks, whoever manages and administers them holds the purse strings of the business community. Indeed, institutions buying large blocks of stock in the name of pension and trust funds spurred the 1987 bull market, which collapsed under the computer programs of these same institutions.

The control of pension funds represents substantial clout in the business community. As Rifkin and Barber (1978, 91) note, these

funds are "increasingly being relied on to prop up an economic system that has all but run out of steam." Lane Kirkland, president of the AFL-CIO, acknowledged the power of pension funds when he ridiculed the presence of United Auto Workers' President Douglas Fraser on Chrysler's board of directors: "A far more effective tool for labor unions" in the struggle against corporations, he said, would be for labor to control its own deferred wages (New York Times , 16 Nov. 1981, A1).

Though most people presume that banks invest pension funds prudently, evidence indicates otherwise. Between 1961 and 1971 the return on pension fund investments was 33 percent below the average annual return rate for the 500 index stocks of Standard and Poor's (Rifkin and Barber 1978), and they continue to perform well below the Standard and Poor's averages (Business Week , 13 Aug. 1984, 93). Why would funds managed by "prudent investors" consistently perform so poorly?

Banks often maintain holdings of a customer firm in their pension fund portfolios despite the risk of substantial losses or the opportunity to make more profitable investments elsewhere (Herman 1975). Several cases suggest that this practice is standard. "In each case, the bank either continued to hold on to the securities even after the stock plummeted or only sold them well after they should have" (Rifkin and Barber 1978, 119). The difference between the stocks a bank holds in its own portfolio and the stocks it administers for pension funds is significant. Pension funds represent the deferred wages of workers, that is, other people's money. Their investment therefore does not pose any financial risk for the administering bank. The consistently poor performance of pension funds and the evidence of investment criteria other than prudence underline the notion that "banks are not the instrument serving the fund. Rather, the fund is the instrument serving the banks" (Rifkin and Barber 1978, 117).

Banks use pension funds to control corporations in two ways. First, banks control the voting rights attached to the securities purchased with pension funds, and second, they can dispose of stocks held in the name of pension funds. Indeed, "the easiest way for a bank to make a recalcitrant company toe the line is to sell its stock" (Menshikov 1969, 215). Compounding the impact of institutional stockholding are the strong similarities of pension fund and trust fund portfolio profiles. Large-scale sales of a given firm's

stock typically cause panic "dumping" by other institutions and money managers. This "herd effect" forces the stock value to plunge, and the precipitous drop shatters the firm's credit standing, further obstructing its attempts to eliminate financial problems. The business press widely accepts the power of financial firms as institutional stockholders and administrators of pension and trust funds. Wall Street analysts now assume that sudden sharp declines in stock values are caused by institutional dumping (New York Times , 17 Dec. 1976, D2).

Although we know much about the stock ownership of nonfinancial firms, we know relatively little about that of banks, particularly the largest banks. What we do know is based primarily on the Patman Committee's 1963 findings and the findings of a few researchers (see, e.g., Menshikov 1969). The data indicate that "in most cases the leading shareholders of the biggest U.S. banks are commercial and savings banks, insurance and investment companies. A considerable part of the shares of banks are held in their own trust departments or trust departments of other banks" (Menshikov 1969, 151). We have no evidence to indicate that this trend has declined at all, particularly in the light of continued increases in pension fund assets administered by the banks' trust departments.

This finding suggests two important points. First, the concentration of banks' stocks in trust fund departments reinforces a structural basis of unification among financial institutions. Second, institutional stockholding is not symmetrical within the business community. Although banks maintain and administer large holdings of nonfinancial firms in their trust departments, nonfinancials do not maintain similar holdings of banks' stocks. Hence banks exert greater influence over nonfinancial firms than vice versa.

Interlocking Directorates

Financial institutions in general, and banks in particular, occupy highly central positions in networks of interlocking corporate boards of directors.^[1] Observers disagree over whether banks use

[1] Bearden et al. 1975; Bunting 1976–1977; Bunting and Barbour 1971; Chevalier 1970; Dooley 1969; Gogel 1977; Gogel and Koenig 1981; Koenig 1979; Koenig, Gogel, and Sonquist 1979; Levine 1972; Mariolis 1975, 1978; Mintz 1978; Mintz and Schwartz 1981a, 1981b, 1983, 1985; Mizruchi 1982;Mokken and Stokman 1978; Pennings 1980; Sonquist and Koenig 1975; U.S. Congress, House 1968.

interlocks to exercise power. They also disagree over whether control over capital flows is a more important source of power than a seat on a financial company's board.

For example, many observers argue that corporate board interlocks represent functional, mutually beneficial relations between specific firms with shared goals (Pfeffer and Salancik 1978; Perrucci and Pilisuk 1970; Herman 1973). This analysis suggests that banks are no more powerful than nonfinancial institutions. Therefore banks' representation on corporate boards of directors is not a mechanism of bank power.

Other observers challenge this symbiotic viewpoint (see Palmer 1983; Stearns and Mizruchi 1986), arguing that the vast potential power of banks serves as a mechanism of cohesion and cooperation within the business community. Those banks that control critical resources "develop key positions" in networks of interlocking directorates, becoming the "'pillars of the establishment,' the first among equals" (Koenig, Gogel, and Sonquist 1979, 25).

Patterns of interlocking directorates support the analysis of banks as agents of social control that can steer corporate decision making. Financial institutions, particularly large commercial banks, form the hubs of these interlocking directorates, with insurance companies linking the hubs and their satellites (Mintz 1978; Mintz and Schwartz 1978a, 1978b, 1985). Mintz and Schwartz interpret this configuration as indicative of bank hegemony. Joint investment ventures may produce a common interest overriding competitive tendencies. Strong similarities of investment portfolios and of the ebb and flow patterns of such investments further consolidate mutual interests. Finally, from their position at the hubs of these corporate board interlocks, banks can "mediate intra-class conflict" (Mintz and Schwartz 1981b, 93).

To examine the implications of interlocking directorates and of the power banks derive from them for capital flow relations, we need to trace relations between banks and nonfinancial firms by examining specific cases. And since members of the business community also actively participate in civic and government agencies, they produce another pattern of interlocking similar to that within the corporate community (Domhoff 1978, 1983; Useem 1979,

1984). Futhermore, governments rely a great deal on loans from banks. In the next section we will examine whether the state's capital flow relations are similar to those in the corporate community.

Financial Institutions and the State

The role of the state in capitalist society has increasingly become the focus of debate. Weber (1947) argued that the increasing complexity of the capitalist economy required the development of rational, unbiased bureaucracies to manage society's needs. Therefore he viewed the state as a politically neutral entity that mediated competing interests and demands, producing compromises in the common good. Although he recognized potential problems in state bureaucracies, he attributed them to individual leaders and their styles. He did not consider the dynamics of structural and social contradictions that are the context of bureaucratic processes. And because he also did not include a class analysis of the interests of those individuals who fill leadership positions within the state bureaucracy, he did not address how leaders' class interests and allegiances might affect the neutrality of the state in balancing competing interests.

Pluralists share Weber's premise that the state is a neutral arbiter that enforces politically unbiased laws and rules (see Dahl 1961; Lipset 1960; Rose 1967). According to this argument, the state is able to function as referee for several reasons. First, there is a balance of power within the state between competing agencies and branches. The natural give and take among these groups produces compromise and negotiation, which constrains each group's ability to dominate (Latham 1976; Neustadt 1976). Second, competing branches and agencies offer the various interest groups a variety of state agencies to which they can appeal, thereby ensuring multiple avenues of access to the state (Truman 1951). Third, competition between parties limits domination by any one party (Aron 1950; Presthus 1964), reinforcing the process of negotiation and compromise in the common good.

The pluralist analysis of the state as neutral mediator assumes equal strength and equal resources among all competing interest groups, parties, and government agencies—an assumption that bears examination rather than assertion as fact. Furthermore, pluralists ignore the allegiances and interests of state leaders, arguing

that in the long run competition between the political parties assures that neither party will dominate. This analysis presumes fundamental differences between the interests represented by each party. And it assumes that, once in office, state leaders will eschew their prior allegiances and legislate in the interest of the common good. The definition of "the common good" remains unspecified. Various observers have taken issue with the pluralists' conception of the state as neutral arbiter of competing and equal interests. The key participants in the ensuing debate over the role of the state in capitalist society have been instrumentalists, structuralists, and class dialectic theorists. Instrumentalists (Domhoff 1983, 1984; Kolko 1976; Miliband 1969; Useem 1984; Weinstein 1968) and structuralists (Poulantzas 1973, 1975, 1978; Mandel 1978; Jessop 1982) assume a separation between the economic and political sectors, although they disagree about which sector dominates the other. Class dialectic theorists (e.g., Skocpol 1985; Whitt 1979, 1980, 1982) see some overlap between the two sectors, but they also disagree about which sector dominates.

Instrumentalists argue that the economic sector dominates the state. Capitalists capture key positions within the political structure to attain their goals and further their interests. Mills (1956) specified these relations in his analysis of the circulation of the power elite among the commanding positions of military, corporate, and government institutions.

Both Domhoff (1967, 1978, 1984) and Miliband (1969) present a variant of the instrumental viewpoint. Capitalists need their representatives to capture the state only to maintain the state rule in the interests of capital accumulation. Moreover, capitalists may generate the continuing state support of their interests because they can bring economic power to bear on the state. But this type of analysis (with the notable exception of O'Donnell 1973) does not clearly differentiate between industrial and commercial capitalists, on one hand, and finance capitalists on the other. Therefore it does not weigh the relative significance of the resources each can bring to bear on the state. The case studies of state crises analyzed in this book—Cleveland's 1978 default and Mexico's 1982 foreign debt crisis—help unravel the problem by tracing the various resources the participants used in each case.

Structuralists (Poulantzas 1973, 1975, 1978; Mandel 1978; Jessop 1982) reject the instrumentalists' "capture theory" of the

state. Instead, they argue that the political sector is relatively autonomous from the economic sector. For example, Poulantzas (1973, 1975) argues that the state mediates class struggles. In his view the state's relative autonomy from control by individual capitalists derives from the presumed competition between capitalists. But Poulantzas never specifies the mechanisms by which the state acts as mediator or policy maker in the interest of the capitalist class without being run by that class. Like the instrumentalists, he does not differentiate between industrial and commercial capitalists and finance capitalists. The failure to make this distinction obscures the varying resources, pressures, and tactics each may apply to the state.

Class dialectic theorists view the state as the arbiter of class antagonisms. They argue that the state has more autonomy than instrumentalists or structuralists presume. It is possible, for example, for the state to implement policies that benefit the poor and working class while still preserving the long-run interests of the capitalist class. For example, although unemployment insurance, food stamps, and Aid to Families with Dependent Children are social welfare programs targeted at the poor, these same programs protect capitalist interests by ensuring a minimum level of consumerability in the broader economy. Unlike pluralism, the class dialectic perspective acknowledges power differentials between various interest groups and classes.

Whereas instrumentalists, structuralists, and class dialectic theorists presume the separation of economic and political sectors, critical theorists assert a fusion of these two spheres (see Offe 1972a, 1972b, 1974; O'Connor 1973; Habermas 1975). They argue that the state must regulate and take on the economic functions of the "free market" economy because of the deepening contradictions and crisis tendencies of capitalism. At the same time the state relies on the private corporate giants to provide jobs to the working class. The increasing economic crises produce a political crisis, or legitimacy crisis, for the incumbent administration. State expenditures, such as social welfare programs, may mediate class struggle by cooling off the working class (Piven and Cloward 1978). State regulation of the economy may temporarily postpone fiscal and economic crises. Yet these contradictory expenditures set the stage for deeper state fiscal crises in the long run, including burgeoning budget deficits (see Blain 1985). This critical analysis

implies the possible role of finance capital in influencing the relative autonomy of the state (primarily by financing deficits), although critical theorists have never specified the influencing process. The critical viewpoint also emphasizes the state's ability to make decisions affecting the allocation of resources already at its disposal. But it does not specify how collective capital flows to the state affect the relative autonomy and discretionary powers of the state.

The Role of Finance Capital in the State

Although the state does not sell stocks as a corporation does, its behavior resembles corporate financial relations, particularly lending relations. The same structural contingencies that lead to lending consortia for corporate borrowing also operate in state borrowing. Most municipal and national governments require such huge capital infusions that no individual bank can (or wants to) provide the crucial loans. Moreover, even the wealthiest national governments provide for their capital needs with debt. For example, the U.S. federal government recently acknowledged its status as the largest debtor nation.

Although the state does not technically operate with a board of directors parallel to a corporate board, evidence suggests similar patterns of interlocks, primarily between the capitalist class and the agencies and organizations that influence state policy formation (Domhoff 1978, 1983, 1984; Ratcliff, Gallagher, and Ratcliff 1979; Useem 1979, 1984; Whitt 1979, 1982). For example, Domhoff (1978) identifies strong business community participation in such policy organizations as the Council on Foreign Relations, the Committee for Economic Development, the Conference Board, and the Business Council. Furthermore, businesspeople were the most politically active members of policy- and decision-making organizations (Useem 1979, 1984). Despite important parallels between interlocking corporate directorates and business community involvement in various agencies of the state, the presence of members of the business community does not necessarily mean they control the state. That remains an empirical question. Furthermore, we must specify the actual mechanisms and processes by which capitalist-class participation translates into control of the state. We need to evaluate the relative power of finance

capitalists in these processes. Finally, we must compare the significance of capitalist-class participation with that of capital flow relations. The case studies included in this book respond to these issues by looking at the actual state crises of Cleveland and Mexico.

Finance Capital and the Social Construction of Crisis

The concept of crisis has not been clearly developed sociologically. Conventional usage assumes a medical model that understands crisis as a critical turning point in institutions (O'Connor 1981). Traditional Marxist theory borrows from this medical model, defining economic crisis as "an interruption in the accumulation of capital" (O'Connor 1981, 301; see also Fine 1975, 51). This model views economic crises in capitalism as objective processes or turning points within the structure of the political economy—the product of the system's internal laws, independent of conscious human creation or prevention (although human effort can postpone the inevitable crisis).

O'Connor (1981, 1987) identified three kinds of crises in Marxist writings. Some observers (Haberler 1958; Sherman 1979; Mandel 1978) identify crises as a recurring tendency in the normal business cycle. Others believe they are structurally produced by the long-term tendency for the rate of profit to decline (Mandel 1978; Sweezy 1970) or by the deterioration of one structure of capital accumulation and its replacement with another (Hobsbawm 1976). Still other theorists identify crises as uneven development caused by the tendency for capital to accumulate in some regions or sectors at the expense of others (Bluestone and Harrison 1980).

These three Marxist analyses assume that the capitalist political economy is inherently unstable, with a normal tendency toward crisis. And all three share the premise that capitalism is "crisis-dependent," in that "crises are the mechanisms whereby capitalism regulates itself" (O'Connor 1981, 304). Because traditional Marxist thought conceives of economic crisis as a broad, objective, inherent feature of the capitalist political economy, it overlooks the role humans play in defining, and thereby creating, crisis. Moreover, it fails to analyze crisis as a political economic process rather than a purely objective economic force.

Neo-Marxist theorists (e.g., Habermas 1975) reject the notion of

crisis as an objective economic dynamic and broaden the arena of crisis to include social, political, and cultural spheres. According to Habermas, crisis occurs "when the consensual foundations of normative structures are so much impaired that society becomes anomic. Crisis states assume the form of the disintegration of social institutions" (Habermas 1975, 3). This formulation introduces human experience and interpretation as an element in crises, though retains the traditional Marxist assumption of the inherent instability and crisis tendencies of capitalism. Neither model entertains the notion of crisis as a social construction.

O'Connor's notion of crisis combines the structural tendencies of the capitalist political economy with human experience (O'Connor 1987; 1981, 325). He does not define crisis as anomie and the deterioration of social structures, but rather as a dialectical process of struggle and "social reintegration." This conception allows for the understanding of crisis as a social construction, particularly in its argument that entrenched dominant classes or factions will struggle vehemently against perceived threats to those structures and relations that foster their position.^[2] Thus for O'Connor the inherent contradictions and instabilities of capitalism make possible the social construction of "crises in established institutions and social and economic processes [that] are produced through reconstituted human intervention" (O'Connor 1981, 326). This analysis of crisis still focuses on the broader structural levels of economic, social, and political institutions, but its insights help us analyze corporate and state crises as social constructions manifested in struggles between banks, nonfinancial corporations, labor, local and federal governments, and nation-states.

Because the study of crisis has been confined largely to the discipline of economics, it usually assumes a purely economic definition of the concept. A sociological understanding of crisis improves our grasp of intercorporate and state behavior patterns and the pro-

[2] Berger and Luckmann (1966) developed the term "social construction of reality" in their analysis of the ideological production of knowledge. I use the term here to indicate the sociopolitical processes of the production of economic and political reality. Their guiding question remains appropriate for the analysis of the power of collective purse strings to determine reality for corporations and governments: "How is it possible that subjective meanings BECOME objective facticities?" (Berger and Luckmann 1966, 18; emphasis in original). O'Connor's notion of crisis allows us to analyze the phenomenon as a social construction.

cesses of power they entail. Moreover, approaching crisis as a social and political process helps us articulate the processes of bank power and unification.

In arguing that corporate crises and state fiscal crises do not necessarily begin as objective economic situations, I will examine actual processes and relations to specify how the banks' definition of a situation affects the business community and the state.

Corporate Crisis

Observers typically define corporate crises in vague and narrow terms of managerial discretion (or indiscretion). For example, Ross and Kami (1973, 21) argue that corporations experience crises when managers violate the "Ten Commandments of Management" governing managerial behavior and the internal structure of the firm. This focus implicitly examines the firm in isolation and fails to acknowledge the external constraints on managerial discretion. For example, relations with financial institutions, networks of corporate board interlocks, and joint ventures between firms all serve as constraints, as does the general state of the economy. Economic definitions thus equate crisis with low or declining profitability, overlooking corporate crises that have nothing to do with low profitability. Furthermore, the restricted definition of crisis does not consider possible dynamic or interactive aspects of the phenomenon, treating it instead as a singular event or point in time (see James and Soref 1981).

One perspective that includes some notion of external constraint on managerial discretion is the theory of the "invisible hand" (Smith 1776). According to this view, widely accepted by business analysts, unseen forces of the market act as an external constraint on managerial discretion. But that constraint appears as a neutral mechanism free of conscious or subjective interference. In this sense the invisible hand defines managerial decisions as the cause of corporate difficulties and defines crisis, once again, as a situation of low or declining profitability.

I argue that a corporate crisis is not always a mechanical economic reaction of the invisible hand of the market brought on simply by low profitability. Rather, it is a reflexive definitional process, involving shifting levels of discretion and constraint, that can seriously damage a firm's long-term business trajectory. Because

banks play a central role in capital flow relations, they often control this definitional process. And the structural organization of the banking community enables them to enforce their definition.

According to W.I. Thomas (1928, 572), "If men [sic ] define situations as real, they are real in their consequences." Banks' collective definitional perception and self-fulfilling prophesy determine whether a given corporation's financial position will threaten its business trajectory (Merton 1968, 475–490). Once banks define the situation as a crisis, other persons and institutions will respond as if it is. Consequently, in a reflexive process these responses may actually produce the crisis presumed to exist. As a self-fulfilling prophesy, the crisis is then no longer a subjective political decision but a matter of economic fact. Indeed, sometimes the crisis may escape the control of those whose definition originally precipitated it.

Financial decline and corporate crisis are thus not synonymous. Declining financial health may result from poor managerial decisions, from decisions constrained by economic imperatives that are detrimental to the firm in the long run, or from a poor general national economy. But until a declining performance is defined as a crisis, no real crisis exists. I argue that the financial institutions can exercise this definitional power because of the banking community's collective control of capital flows.

The business press often refers to self-fulfilling prophesy as the "herd effect." Individuals and small institutions assume that large financial institutions act on "inside information." They therefore follow the large institutions' lead for fear of being the last investor to sell their holdings or to call in their loans from a crisis-ridden firm. The more institutions that divest in or deny loans to a given firm, the greater the chance that other investors will follow suit. The herd effect also operates when financial institutions determine that a firm is "healthy": "The more institutions that invest [in a firm], the greater the chance that the others will follow" (Business Week , 28 Jan. 1980, 87). Furthermore, the herd effect is often long-term or permanent. In contrast, singular responses by the banking community to individual instances of low profitability are not necessarily permanent or without alternatives. Other competing banks can define the situation differently. Ongoing and active intervention by the banking community into corporate affairs is unnecessary to perpetuate the banks' definition of the situation.

Some observers argue that banks would only invoke bankruptcy or stock dumping as a last resort to extreme situations. For example, Emerson (1981, 1) claims that "last-resort" sanctions are invoked only when "'normal remedies' . . . are specifically inappropriate or . . . have failed to contain the trouble." Although Emerson focuses on the use of last-resort sanctions in social control institutions (such as mental institutions, correctional institutions, and so on), his thesis suggests that extreme bank behavior such as stock dumping and provoking bankruptcy and default could also be interpreted as actions of the last resort. In the following chapters we will examine case studies to determine whether the banks' decisions to pull their collective purse strings were indeed remedies of the last resort after less extreme approaches had failed.

State Crisis

State crises are as poorly understood as corporate crises. Some observers portray state crises as the result of legitimacy crises produced by despotic, corrupt, or inept governments (Breckenfeld 1977). This is the political version of the invisible-hand theory of the marketplace. Other observers root state crises in economic cycles that inexorably bring the state to recessions, depressions, and budgetary slumps (O'Connor 1973; Habermas 1975). Still others attribute state fiscal crises to the failure of state leaders to keep expenditures in line with revenues (Mollenkopf 1977; Schultze et al. 1977). As with corporate crises, no one has analyzed state crises as definitional processes or examined them as social constructions caused by capital flow relations. And like corporate crises, state crises often reach public forums (such as congressional hearings) that uncover the processes of financial relations that may either avert or precipitate a crisis of the state. The disinvestment and redlining of St. Louis illustrate the social construction of urban decline (Ratcliff 1980a, 1980b, 1980c). In contrast, New York City in the early 1970s is an example of a crisis averted (Lichten 1986). The case study of Mexico's 1982 foreign debt crisis reveals the processes of international crisis formation.

The Process of Bank Hegemony

The theory of bank hegemony and finance capitalism offered here describes the structural bases of unification of the banking commu-

nity. Hegemony occurs because of the dominant actors' privileged access to the major institutions of society. Such access enables these actors to promote values that support and legitimate their position and empowers them to squelch views considered detrimental to their position (Gramsci 1971; Sallach 1974; Williams 1960).

I have broadened the term hegemony here to include a structural component for the analysis of capital flow relations (see Patterson 1975). Cohesion within the business community develops from structural relations that suppress or obliterate conflicts and points of cleavage. These relations include lending consortia, common pension and trust fund investment patterns, and interlocking directorates. Organized capital flow relations condition and suppress friction (particularly between banks) by fusing their specific interests in the short run (Mintz and Schwartz 1985). The state's interest in maintaining a stable economy (at least during the tenure of existing administrations) fuses its interests with those of the business community. There may in fact be a long-term basis for a community of interests in maintaining a stable market economy.

Structural financial domination does not imply control of individual nonfinancial corporations or the state by individual banks. Rather, as a group banks may dominate all firms in the corporate community and the state. The legal and financial inability of individual banks to provide the loans sought by corporations and governments, and the consequent formation of large lending consortia, produces this general dominance. In addition, the similarities of trust and pension fund portfolios further homogenize the banks' interests, minimizing competition among banks (Mintz and Schwartz 1978b, 4; see also Mintz and Schwartz 1985).

Although all financial institutions absorb and reallocate surplus finance capital in general, they do not compete for the sources of that capital. "Commercial banks and property insurance companies mainly accumulate the free money available in the course of reproduction and circulation of capital. Life insurance companies, savings banks, savings and loan associations, and investment companies accumulate chiefly personal savings" (Menshikov 1969, 145). There are several points of cleavage and competition within that community, particularly between large and small banks, regional and money center banks, and commercial banks and savings and loans. One recent indicator of this competition was the

flurry of takeovers of savings and loan associations by large commercial banks, made possible by banking deregulation. Furthermore, although the largest banks in New York may share the common interest of maintaining that city as the financial hub of the country, they are not necessarily united at all times on all issues. Several financial groups in New York have exhibited some competition between them, "sometimes sharp, sometimes muted" (Kotz 1978, 85). These include the Chase group (Chase Manhattan Bank, Chemical Bank, Metropolitan Life Insurance Co., and Equitable Life Assurance Society), the Morgan group (Morgan Guaranty Trust, Bankers Trust, Prudential Life Insurance Co., Morgan Stanley and Co., and Smith Barney and Co.), the Mellon group (Mellon National Bank and Trust and First Boston Corporation), and the Lehman-Goldman Sachs group.

But one must not overstate these indicators of competition within the banking community. Of particular importance here, in addition to the anticompetitive influence of lending consortia, is the process by which large commercial banks can discipline small regional savings and loan firms and investment banks during crises. "Structural hegemony" refers to all the processes that produce coalescence among banks and other financial institutions. I will develop this theme in detail in the case studies in Chapters 2–6.

I do not use the term hegemony to denote monolithic, absolute power. Indeed, as the case studies here will show, banks sometimes fail to attain their ultimate goals (for example, in Cleveland) or lose large sums of money (for example, in W. T. Grant's bankruptcy). Sometimes circumstances or the process of struggle may force banks to accept unwanted compromises (for example, in Chrysler's bailout process). In other instances banks face real threats to their investments, as in the recent informal evolution of a debtor's cartel in Latin America (Business Week, 28 Dec. 1987, 88–89). And there are times when the large banks break ranks and betray one another. (For example, when the Bank of Boston and Citibank performed write-downs of problematic loans to developing countries, they left the Bank of America overextended. The Bank of America faced the choice of either writing down its loans as well or taking the risk without the enhanced power or shared risk of a unified banking community.) But when the struggle is over, financial institutions tend to emerge with more of their goals met than any other participant, because they act collectively to

control capital flows and wield more of the resources needed by both corporations and the state.

Even when clear-cut crises are precipitated by managerial decisions or economic constraints rather than by the actions of financial institutions (as in the case of Penn Central Corporation), banks' capital flow decisions are likely to alter the timing of the crises.

By examining the process of crisis formation, we can follow the alteration of business and state trajectories and trace bank hegemony formation and the development and dispatch of bank power. To elucidate this process, we will examine specific cases of each of the theoretical types of crisis formation. These include crises leading to bankruptcy (W. T. Grant Company), crises averted (Chrysler Corporation and Mexico 1982), and crises caused by political struggles between banks and nonfinancials or the state (Leasco Corp. and Cleveland 1978). Because crises and bailouts precipitate congressional investigations, hearings, and other legal proceedings, publicly accessible records and documents (including transcripts of proceedings, supportive documents, testimony, and so on) reveal the process of crisis formation, the related processes of bank power and bank hegemony formation, and the relative weight of the various postulated sources of bank power. The notion of the social construction of corporate and state crisis is critical to uncovering these processes of bank empowerment.

Organization of the Book

The remainder of this book develops a theory of crisis formation and bank hegemony through a detailed analysis of specific case studies of corporate and state crises and their resolution. Chapters 2–4 focus on three corporate crises: W. T. Grant Company's bankruptcy, Chrysler Corporation's bailout, and Leasco Corporation's struggle with Chemical Bank. Chapters 5 and 6 focus on municipal and international state crises: Cleveland's default in 1978 and Mexico's near default in 1982. Chapter 7 outlines the key evidence revealed in these case studies that supports the notion of bank hegemony. As examples of the techniques used in researching this book, appendixes describe the methodology used and give a sample document outline and interview questionnaire for the W. T. Grant Company case study.