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Chapter Seven— The Social Construction of Economic and Political Reality
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Chapter Seven—
The Social Construction of Economic and Political Reality

Financial institutions are the hub of capital flow relations. They provide or deny massive loans to corporations and states, own or control substantial blocks of stock in enormous pension and trust funds, and sit on so many nonfinancial firms' boards of directors that they overwhelmingly dominate interlocking corporate directorates. Their central position gives banks unique control over a vital resource: finance capital.

In and of itself the control of finance capital by many independent banks does not produce power. Industry, commerce, and governments could easily exploit competition between banks in search of the most favorable capital arrangement. The key to the power of the banking community lies in its structural unification—in large lending consortia, in the strong similarities of trust and pension fund portfolios, and in joint ventures. This structural unification produces bank hegemony. Together with control over capital flows, bank hegemony often empowers the banking community to impose its perception of economic and political reality and its interests over those of all other groups (stockholders, workers, the state, and so on).

What do banks do with this potential power? The case studies in this book illustrate some of the mechanisms banks use to socially construct economic and political reality. W. T. Grant Company plunged into involuntary bankruptcy when the banking community declared it bankrupt and refused to provide further loans.


Chrysler Corporation was saved from bankruptcy when the banks, threatening to deny further loans to the automaker, elicited loan guarantees from the federal government that bailed out the banks' investments. Similar processes led to the rescue of Mexico in 1982 and forced Mexico's political economy to shift from state participation to a free-market orientation. Cleveland was forced into default in 1978 when the banks refused to renegotiate the city's debt as a means to force the sale of the municipal utility to Cleveland Electric Illuminating Company. Finally, a healthy Leasco Corporation quickly fell to disaster in a stock-dumping exercise by banks angered at the firm's attempts to acquire Chemical Bank.

Together these cases shed light on the processes of bank hegemony, the functioning of corporate board interlocks, the relative autonomy of the state, and the social construction of crisis as an economic and political reality.

Bank Hegemony

Under ordinary circumstances, the hegemonic structures that bind otherwise competitive financial institutions do not affect corporations and the state. Financial institutions activate hegemonic processes only when common interests are threatened. The economic and/or political threats the banks perceive need not be real. Yet if banks define the situation as a crisis and act on that definition, the consequences are very real. Then the banks set competition aside and pull together to protect the interests that bind them. For example, when Leasco threatened to alter traditional relations between banks and nonfinancials, the banking community used the considerable resources at its disposal to reinforce and defend its domination. Cleveland's default similarly illustrates the banks' ability to act collectively on their common interests when Kucinich's populist politics threatened to disrupt business and banking's domination of city politics and capital accumulation.

The cases examined here exhibit bank hegemony in several forms. The bankruptcy of W. T. Grant demonstrated the ability of the banking community to coalesce in a consortium of 143 banks against the firm's other creditors, managers, workers, and stockholders. The Chrysler bailout showed how easily the banking community could form a unified position in a struggle with the federal government. Here, as in the case of W. T. Grant, coalescence was


structurally produced by the firm's lending consortium of over 325 banks and the reliance of the small banks on lending consortia to access corporate business. Similarly, 1,600 banks fused interests in Mexico's lending consortium.

Consortia do not have to be large to be effective. Although only six banks were involved in Cleveland's default, they were strong enough to push the city around. The six banks were cemented together not only by their common presence in Cleveland's lending consortium, but also by their presence in the lending consortium for Cleveland Electric Illuminating Company, their stockholdings in CEI, and their presence on the CEI board.

Finally, in the struggles with Leasco and Cleveland the banks were capable of deliberate, concerted action because of their collective control of vast capital resources and the strong similarities of investment portfolios for their trust and pension funds.[1]

Coalescence within the banking community is clearly the product of structural arrangements rather than conspiracy or the workings of the "invisible hand." Banks' structural relations (namely, joint investments, common membership in lending consortia, similar stock portfolios managed for pension and trust funds, and so on) cause them to join forces and unify because (1) they know they have to work together in future lending consortia and (2) they have formed long-term relations based on these consortia. This structural unity gives the banking community great power over nonfinancial corporations and the state. Although nonfinancials often have symbiotic relations with one another, these alliances are not necessarily long term and can be replaced by other alliances or alternative resources. In contrast, there is no alternative to finance capital. It alone is the means of purchasing all other resources. And because finance capital is also a social relation, cooperative relations between banks are not easily abridged and are necessarily long term.

The concept of bank hegemony illuminates the subtle but critical difference between power and influence. Power is the ability to fix or change entire sets of alternative actions for other partici-


pants in a given relation. In contrast, influence is the ability of actors to determine the actions of other participants within the confines of the existing set of action alternatives (Mokken and Stokman 1976). Whereas managers, board members, and political leaders can exercise a great deal of influence on corporations and the state, power belongs to those who command capital flows. Managers and board members in all three cases of corporate crisis were able to exercise a degree of discretion in corporate decision-making processes. Mexican political leaders exercised relative autonomy in some of their domestic policy decisions. Mayor Kucinich exercised some discretion in determining how to respond to the city's fiscal crisis. But all were limited by the power of the banking community to define their situations (Mintz and Schwartz 1983; Glasberg and Schwartz 1983).

The reputation for power achieved through bank hegemony preempts corporate and government leaders' consideration of many alternative decisions that might antagonize the banks. For example, W. T. Grant closed more than 50 percent of its stores at the insistence of the banks. At the same time, the banks' reputation for power restricted the alternatives Grant considered and in fact led Grant's management to seek the banks' approval before making decisions. Similarly, the overt conflict between Chrysler and its banks forced the automaker to squeeze unprecedented concessions from its UAW workers. The banking community's reputation for power, based on its unified control of lending capital, forced the federal government to bail out the banks' investment in Chrysler and in Mexico because Congress feared economic disaster if the banks did not get their way. Leasco's struggles with the banking community forced the firm to discontinue its efforts to acquire Chemical Bank. Since that infamous struggle no other nonfinancial has tried to acquire a commercial bank. Finally, Mayor Kucinich's struggles with the banking community set the pattern for future mayors in their attempts to resolve fiscal difficulties.

The Social Construction of Economic Crisis

Institutional theories of organization argue that organizations (such as corporations) "are influenced by normative pressures, sometimes arising from external sources such as the state, other


times arising from within the organization itself" (Zucker 1987, 443). These pressures might cause the organization to conform to the expectations they define. The limitation of this theory, however, is that the external source of influence can be other organizations. Institutional analyses often do not emphasize this point strongly enough. In particular, the cases presented here demonstrate that an organized banking community can pressure nonfinancial firms to conform to the banks' definition of normative behavior. Moreover, the banking community can pressure the state itself to conform to the banks' definition. The major source of influence and pressure is not state laws and regulations (as institutional theory suggests), but rather organized financial institutions' collective control of capital flows. Hence a modified version of resource dependence theory is a more appropriate model for analysis.

Bank hegemony and the control of capital flows empower the banking community to generate economic reality. Banks may advance needed loans to corporations and governments or support a firm with major stock purchases for the pension and trust funds that banks administer. Or they may deny loans to corporations and governments or pull the rug out from under a corporation by dumping its stocks from those pension and trust funds. Thus the banks have the power to define any situation as a crisis, setting in motion all the responses and consequences of a crisis and thereby creating an actual crisis. The banks' definition affects a firm's business trajectory and a state's political trajectory.

The power to make such definitions lies not only in the unified control of capital flows, but also in the increasing reliance of corporations and governments on external sources of finance capital. When W. T. Grant began to experience serious cash flow difficulties, the banking community initially refrained from defining the firm's situation as a crisis and participated at several junctures in restructuring the firm. Ironically, precisely when Grant appeared able to restructure itself into a smaller but more profitable firm, the banking community defined the situation as a crisis. The evidence suggests that the banks timed their definitional process, which permanently damaged the firm's business trajectory and destroyed the firm, to better position themselves to recover their investments. Similarly, Chrysler Corporation experienced severe cash flow shortages and appealed to the federal government for a


bailout when the banking community refused to advance further loans. The ensuing struggle revealed the power of the banking community to choose the outcome of the definitional process. The banks repeatedly threatened to force the automaker into bankruptcy unless the federal government bailed out their loans. Once the banks got the loan guarantees and forced labor to shoulder the largest burden of those guarantees, they refrained from defining Chrysler's situation as a crisis, thus saving the firm from bankruptcy. Chrysler is once again a relatively healthy firm. When the Mexican economy experienced serious cash flow shortages, the banks elicited a U.S.-supported bailout through increased participation in the IMF and the Export-Import Bank as a prerequisite for further bank support. They repeatedly threatened the collapse of the international financial markets. Once those bailout supports were in place the banking community resumed loans to Mexico, thus staving off the crisis definition. In fact, Wood (1986, 284) notes that banks sometimes deliberately withhold new loans "in order to force debtor countries . . . to restructure existing debt on terms more attractive to the banks." Finally, when Leasco Corporation, a healthy firm, was defined as crisis-ridden, the ensuing stock dumping generated a real crisis. Of all the participants in each case, only the banks could collectively define the situation and impose their view of corporate and state reality.

Emerson's (1981) analysis of institutionals' last-resort remedies to troublesome situations implies that banks take extreme measures such as stock dumping and loan denials after less extreme measures fail to rectify the situation. Although this analysis makes sense, it is inappropriate here. For example, W. T. Grant was well on its way to restructuring and rehabilitating under a Chapter XI reorganization program when the banks withdrew their support. In other words, a less extreme measure than liquidation was apparently working when the banks chose to institute the measure of last resort. Leasco was a healthy corporation when the banks dumped its stock. Other, less extreme, approaches could have stopped this nonfinancial from taking over a major commercial bank, but the banks did not seriously consider them.

In Cleveland's case, municipal default became a remedy of last resort when the campaign to recall Kucinich and the legal and political efforts to force the sale of MUNY failed. But here the prob-


lem the banks perceived was political rather than economic: a populist mayor who stubbornly opposed the interests of the business and banking communities.

In the cases of Chrysler and Mexico, the banking community invoked the power to define crises that they had helped produce. In Chrysler's case, the banks had lent money to the firm for more than thirty years while giving tacit consent to a long series of problematic managerial decisions. They should have required changes in corporate policy far earlier than 1979. In Mexico's case, the banks had aggressively pursued the placement of loans in Latin America, demanding highly lucrative up-front renegotiation fees and applying nonconcessional interest rates. A more appropriate action would have been more prudent lending, minimal up-front renegotiation fees, and concessional interest rates (none of which would have destroyed the banks' profits). In neither case did the banks' threats to produce crises represent remedies of the last resort. Rather, they were extreme approaches to rectify the banks' previous inappropriate actions.

Interlocking Directorates: Sources of Power or Traces of Power?

Although banks predominate in networks of interlocking corporate directorates (Mintz 1978; Mintz and Schwartz 1978; Kotz 1978), and although bank representation on nonfinancial boards may correlate with bank loans and/or major institutional stockholdings, such interlocks are merely traces of power (Mokken and Stokman 1978). The ultimate source of bank power is the hegemonic control of capital flows. As the case studies of W. T. Grant, Chrysler, and Leasco revealed, financial institutions' control of lending capital and pension and trust fund assets can constrain the autonomy of the board.

Sometimes interlocking directorates function as one of several mechanisms that fuse the interests of the banking and business communities. In Cleveland, for example, the strong presence of banks on the board of CEI and in the Greater Cleveland Growth Association made them natural allies. But only the capital flow relations, represented in the banks' stockholdings in CEI and their common presence in lending consortia for both CEI and the city,


empowered the banks to determine Cleveland's economic reality. The most important determinant was the lending relations between the city and its creditors.

Corporate board interlocks sometimes facilitate the flow of information between firms—often a one-way flow from the nonfinancial corporation to the banks (Scott 1978). Such information was essential, for example, in the banks' formation of effective strategies against Leasco, as when Continental Illinois informed Chemical Bank about Steinberg's intentions. The presence of bank representatives on nonfinancial corporate boards also gives banks the opportunity to vote on operational decisions. Interlocking corporate directorates are thus symptomatic of capital flow relations between banks and nonfinancial firms.

The Social Construction of Political Reality and the Relative Autonomy of the State

The role of the state in the capitalist political economy has remained an important focus of inquiry for more than a century.[2] But much of this debate has never fully specified the factors affecting the state's relative autonomy (particularly the organized or hegemonic control of capital flows), focusing instead on the internal structure of individual national political economies as if each existed in a vacuum (Rubinson 1977). The relative autonomy of the state in the political economy of internationally organized relations has remained unexplored.

The cases of Mexico's foreign debt crisis, Chrysler's bailout, and Cleveland's default fail to support the pluralist assertion that the state acts as a politically neutral arbiter balancing competing demands. In none of these cases did the state give equal weight to the competing demands of labor, corporations, banks, and the state itself. Indeed, the legitimacy of the demands was not the most important factor in determining the state's actions. For example, although Congress recognized the legitimacy of labor's interests (as well as its own) in the Chrysler and Mexico cases, it reluctantly


acquiesced to the interests of the banks because of economic and political constraints. The relative power of the claimants, not the legitimacy of their claims, was the critical factor in determining congressional decision making. Furthermore, although Kucinich recognized the legitimacy of the interests of labor and the state, he could not completely negate the power of Cleveland's organized banking community.

These cases also illustrate the inadequacies of the capture theory of the state, promoted by instrumentalists such as Domhoff (1967, 1970), Miliband (1969), Mills (1956), and Weinstein (1968). The representatives of the banking community never needed to occupy positions in the state apparatus to have their interests served. Rather, their structurally hegemonic control of capital flows (facilitated by large bank consortia and the imposition of bank discipline) gave the banking community oligopolistic control over financial capital resources that are less accessible to the state without the mediation of the banks. For example, the banks' common presence in Chrysler's lending consortium empowered them to threaten to push the United States closer to economic depression and an almost certain political legitimacy crisis for the Carter administration in an election year. Although the state can generate revenues through taxation, those revenues are rarely sufficient to meet state expenditures, especially under inflationary conditions and during extensive military buildups. State deficit spending increases the debt burden and state dependence on the international financial community.

The cases of Mexico and Chrysler partially support Poulantzas's (1968, 1973) notion of the relative autonomy of the state—that is, the state's autonomy from the control of individual capitalists or sectors of the capitalist class. But although the state may not be controlled by individual capitalists, state autonomy may still be compromised by a sector of the capitalist class, namely, organized finance capitalists.

The organized control of finance capital also enables the banks to intrude in the process of class struggle to accomplish for the capitalist class those goals that the state must set aside to preserve its political legitimacy. Although the banks are not always completely successful, they usually tip the balance of the class struggle in favor of capitalist interests. For example, in Cleveland the banks


fought a populist mayor over a working-class cause, with mixed results. Pushing Cleveland into default failed to win the sale of the municipal utility to its private competitor, but the crisis toppled the mayor. With a new mayor sympathetic to business and banking interests in place, the banks quickly renegotiated the city's debt. The banks' collective intransigence also forced a crisis of political legitimacy in Mexico for the somewhat radical President López Portillo. His successor, Miguel de la Madrid, was more sympathetic to banking and business interests; during his tenure the IMF-imposed austerity plan rolled back years of state support for labor in the class struggle.

Mexico's debt crisis highlights a problem with the analytical focus of theories of the state, which implicitly examine the relative autonomy of the state in relation to the internal structure of individual nation-states. Most such research ignores the external factors affecting the state's relative autonomy. The struggle between Mexico, the United States, and the banking community demonstrates that organized international finance capital relations can constrain the relative autonomy of the state—in this case, of both the United States and Mexico. Politically the state-as-debtor is likely to lose control of domestic policy making and may also lose influence in the state's guiding ideology. For example, Mexico's debt crisis undermined the state's ability to maintain nationalized industries, continue social welfare expenditures, and determine the direction of economic growth. Clearly the IMF and the banking community compromised Mexico's domestic policy of state participation in the economy. Indeed, IMF-imposed austerity programs (which typically demand the privatization of nationalized industries) minimize state participation in the economy and promote instead a "free-market" ideology.

Individual cases such as these give insight into the external processes and relations that influence the relative autonomy of the state. Poulantzas's interpretation neglected the dialectical relations between the state and finance capital. With hegemonic control over capital flows, the banking community wields allocative power to constrain the discretionary power of the state. But the banks lack the political legitimacy to enforce these constraints and must rely on the legitimacy of the state and its institutions. For example, the banks could not restrict Mexico's imports, decrease wages, or curtail social welfare expenditures, but they could rely on the legiti-


macy of state institutions, such as the IMF, to impose such measures. Moreover, the banking community relies on the state to reverse the crisis tendencies of debt cycles by guaranteeing banks' investments. Although the international financial community can ill afford the default or economic collapse of a major state borrower, the state is even less equipped to absorb the worldwide reverberations of such a collapse or the domestic political legitimacy crises that would plague the existing state administration.

Mexico's struggles for economic security and Chrysler's struggle for a bailout support Mandel's (1978) analysis that the state facilitates the fusion of the economic and political sectors in its efforts to regulate the deepening inherent crises of the political economy. With the U.S. and world economies in deep recession (which at times gave way to occasionally weak and temporary "recoveries"), the state had to regulate the "free-market" economy by bailing out the banking community's excessive investments in Chrysler and in developing countries. The threat of substantially increased pressures on an already straining U.S. economy (with rising unemployment) forced the state to capitulate to the interests of the banking community. Thus the relative autonomy of the state both locally and globally may hinge on the capital flow relations forged between the state and a structurally hegemonic banking community.


Although the cases discussed in this book involve corporations and governments in crisis, they reveal a great deal about ordinary relations between banks, nonfinancial firms, and states and about the processes of power within them. Many of the details of these relations become public through litigation and congressional hearings, providing insight into those circumstances under which the potential power of banks translates into real and far-reaching consequences for nonfinancial firms and states. Although I cannot prove that the processes and relations uncovered here are typical in non-crisis situations, I have shown that the banks can activate and exercise that power at will. Moreover, the banking community's power to socially construct corporate reality restricts the everyday decision making of nonfinancial firms by delimiting management's choice of alternative actions.

The cases presented here also demonstrate the dialectics of fi-


nance capital relations. Initially loans expand the relative autonomy of the state by removing restrictions imposed by international aid agencies or by compensating for limited tax revenues. Loans also expand the range of discretion of corporate managers (over labor, other corporations, the state, and so on). But in the long run loan relations can restrict the relative autonomy of the state and the range of discretion of corporate managers. The sale of corporate stock forges similar dialectical relations between corporations and financial institutions that manage pension and trust funds holding those stocks. At first the stock purchases increase a corporation's cash flow, thereby broadening its range of discretion in matters such as plant relocation and expansion, merger mania, merger defense, and product development. But again, in the long run large holdings of corporate stock in pension and trust funds can severely constrain managerial autonomy if those holdings are dumped on the market.

Finally, the patterns of bank hegemony and the control of capital flows found in corporate relations also characterize relations between the financial community and governments both domestically and internationally. For example, the collective control of capital flows gave banks the power to declare St. Louis ineligible for mortgage investments, pushing that city into decline (Ratcliff 1980a, 1980b, 1980c); New York City's 1974–1978 brush with bankruptcy and its subsequent struggles with the banking community illustrate similar processes of the social construction of economic reality (Lichten 1986). The experiences of developing countries like Mexico that have tottered on the brink of default demonstrate that huge lending consortia structurally empower banks to construct the political and economic reality of whole countries, sometimes against the interests of U.S. foreign policy (see Girvan 1980; Glasberg 1987). Poland's struggle with the Western banking community in the early 1980s suggests that this power transcends not only national boundaries but ideological differences as well. Indeed, a 1979 article warned that "U.S. Banks Are Making Foreign Policy" by extending loans to foreign governments:

When many of the loans are not repaid as scheduled, these credits . . . will be recognized for what they are—disguised aid to the recipient countries. It will then be clear that foreign policy decisions have been made


by private institutions. . . . Private banks are effectively making United States foreign economic policy without public debate or oversight by elected representatives. (New York Times , 18 Mar. 1979, F14)

Why should we care about what happens when major elements in the business community do battle or when governments struggle with a collective banking community? Our jobs, our pension funds and IRAs, our financial well-being are threatened by these struggles and the power they reveal. For example, when the institutions managing our pensions and IRAs invest heavily in stocks of firms that go bankrupt or whose stock the banks dump, our funds lose a great deal. Consider that Michigan and Illinois teachers lost their entire pension fund investments in W. T. Grant Company. Workers always lose power when firms and the state struggle with a collective banking community. Mexico's workers lost jobs, wages, consumer power, and bargaining power as a result of the state's struggle with the banking community and the IMF. Cleveland's workers lost jobs and wages when Kucinich lost to Voinovich because of struggles with the banks. W. T. Grant's workers lost their jobs, their pensions, and their severance and vacation pay when that firm went bankrupt. Chrysler's workers lost jobs, wages, pension fund contributions, job security, and bargaining power in the automaker's struggle for a bailout.

The struggles and power processes described in this book also have international consequences. Development may never succeed in countries with mounting debt burdens. Struggles to avoid default invoke the imposition of IMF austerity packages that undermine development efforts as large portions of the country's gross national product transfer from development projects to debt servicing. Reductions in social welfare expenditures leave basic needs unmet. And the austerity package requirement of reductions in imports frequently means that the country cannot import spare parts for industrial production. This pattern suggests that debates on development and growth in the Third World must include an analysis of the role of international finance capital. Those of us in developed countries must also take notice, whether our country is the target or not. Cheapened labor in crisis-stricken countries may undermine workers' bargaining power and jobs in countries like the United States because it attracts runaway shops. In addition, devel-


oping countries' reductions in imports could spell trouble for the exports and balances of trade of developed countries, touching off recessions, job losses, and further reductions in labor power. Remember, too, that the United States is now the largest debtor nation in the world. What happens to Third World debtor countries can happen here as well, with the same consequences for labor.

What can we do? The cases described in this book imply a potential source of power and participation for labor. Pension funds represent the single largest source of investment capital in the world (Rifkin and Barber 1978). Right now banks administer this vast pool of workers' deferred wages. Should labor resume control of its own pension funds, it would be able to offer an alternative to banks' hegemonic control of capital flow relations. Consider, for example, how different the resolution of Chrysler's cash flow shortage might have been had the UAW controlled its own pension funds. The ability to offer a competitive source of finance capital would have strengthened labor's bargaining position with Chrysler, the state, and perhaps the banks. The union might have lost far less as a result. Indeed, it might have gained a greater voice in the firm's decision-making processes in exchange for bailing out the firm.

Federal deregulation of the banking industry in the United States has intensified the power of collective purse strings by contributing to the concentration of capital flows, as large commercial banks take over small savings and loan associations and force others out of business. Fewer banks mean less competition and greater hegemonic control of finance capital resources. A return to federal regulation would allow the state to reverse this increasing concentration of capital and power in the banking industry. Regulation and labor control over pension funds could alter capital flow relations and the processes of power, which in turn could alter the consequences of those relations.


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Chapter Seven— The Social Construction of Economic and Political Reality
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