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


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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


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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


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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).


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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)


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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.


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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


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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


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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


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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,


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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.


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