A Blog by Jonathan Low


Aug 26, 2019

The Financialization of the American Elite

The financialization of the economy has co-evolved with the careers of its best and brightest - along with plenty of others who may possess fewer talents but no less ambition.

The question is whether this robust exemplar of behavioral economics at work will, in the long term, benefit the society which spawned it. JL

Sam Long reports in American Affairs:

The career choices of today’s HBS graduates demonstrate the effects of four decades of shareholder primacy. In the 1960s, 6% of the school’s graduates pursued careers in finance; (which) generated 3%of the country’s GDP.  Today, 30% of graduates opt for finance. 24% chose management consulting, with its emphasis on financial initiatives like cost cutting and merger diligence. Stanford and Wharton show identical trends. The finan­cial sector’s contribution to GDP is triple what it was in 1950. Over the last 5 years, 61% of  HBS graduates have landed in Boston, New York, and San Francisco (which) contain 6% of America’s population.
On October 1, 2018, the newly christened Klarman Hall opened to much acclaim on the campus of Harvard Business School. The stunning $120 million building houses a conference center as well as a gleaming auditorium built around a 32-million-pixel, 1,250-square-foot video wall and a state-of-the-art, modular design that seats up to a thousand attendees.1 To mark the opening, the school held a daylong series of speeches and lectures, headlined by the building’s namesake and one of the school’s wealthiest living gradu­ates, billion­aire investor Seth Klarman.
Sixty-two-year-old Klarman leads Baupost Group, a hedge fund headquartered high above historic Boston Common. The New York Times has called Klarman “the most successful and influential in­vestor you have probably never heard of,” while the Economist nick­named him the “Oracle of Boston,” a comparison to Warren Buffett.2 Like Buffett, Klarman has a cultlike following within so-called value investing circles. An out-of-print book that he wrote early in his career, Margin of Safety, now commands over $1,500 for a paperback copy on Amazon.3
Although the building has certainly enhanced his reputation on campus, the school has long held up Klarman as a role model for its students. Klarman launched Baupost with several million dollars of his professors’ money immediately after receiving his MBA from Harvard in 1982, brashly bypassing the apprenticeship model that is common for aspiring investors.4 When faculty members introduce Klarman during classroom visits, they emphasize Baupost’s early days as a start-up, and Klarman is presented both as a bold entrepreneur and a stock-picking wizard with a near-superhuman ability to make money.
Although famous in part for his reticence, Klarman has come out of his shell in recent years, accepting more interviews and taking on the “thought leader” persona that wealthy elites occasionally ascribe to their peers who display a concern for politics. Klarman does not attend Aspen or Davos, but many of those who do studiously exam­ine his annual investor letters, which detail his thoughts on value investing, markets, macroeconomic trends, and global politics.5
In recent conversations, Klarman has voiced concerns about the state of Western democracies. After quietly spending decades as one of New England’s largest GOP donors, Klarman loudly threw his support behind moderate Democrats in the 2018 midterm elections, an effort to check what he saw as the cowardice of a Republican Party in full submission to Donald Trump. The switch from Rom­ney Republican to Clinton Democrat has been well received at his alma mater, where the student body is generally economically con­servative and socially progressive. Indeed, with his name on the newest building on campus, Klarman is no longer a mere role model—he has joined the school’s pantheon of business heroes. As Harvard president Lawrence Bacow said during the Klarman Hall dedication, “Seth and Beth Klarman embody what we hope to see in every HBS graduate—active, engaged citizens working to make our world, our community, a better place.”6

A Symposium on Democracy

In an unusual move, Klarman and Harvard opted to bill the dedica­tion event as a “symposium on democracy” and invited politi­cians, pundits, and political scientists to join them. “My great con­cern at this moment is for our democracy,” Klarman said in his opening remarks.7
Later that day, Klarman was joined onstage by Jamie Dimon, another titan of American finance. The two men have developed an easy rapport since graduating from HBS in the same class almost forty years ago. The school’s dean moderated their conversation, which elucidated the day’s main theme: that business leaders must lead the way in fixing the country’s broken politics and shoring up the electorate’s eroding faith in capitalism.
Speaking again that evening, Klarman returned to his disdain for politicians. He used the language of business to highlight how their selfishness offends both Klarman the citizen, concerned with the sustainability of American democracy, and Klarman the value inves­tor, a patient allocator of capital to America’s best companies and managers: “Politicians tend to follow the polls instead of their hearts or brains. They listen more to political consultants than to voters. Our short-term-maximizing politicians fail to tackle longer-term so­cietal challenges such as climate change or unaffordable entitlement programs and the resultant on- and off-balance-sheet liabilities.”8
But it was his rebuke of Wall Street and the nation’s elite business schools, his alma mater included, that would ripple through the American business community in the weeks ahead. These constituencies were also guilty of short-termism and an unhealthy focus on share price performance, he said. He urged his audience to place their customers first, to pay their employees generously, and to lead with integrity and honor.
Klarman closed with a warning of what Washington held in store for them if they did not correct this myopia:
With an overly narrow focus on the near-term maximization of corporate profits and share price, business leaders leave themselves vulnerable to criticism and harsh regulation. When business owners and business schools fail to regularly ask hard questions about capitalism . . . we increase the chance that when these questions are asked, they will be asked by ideologues seeking to point fingers, assign blame, and make reck­less changes to the system. One U.S. senator recently unveiled the Accountable Capitalism Act. . . . This seems both ill-considered and unlikely to work. I doubt this bill will become law. But when capitalism goes unchecked and unexamined . . . the pendulum can quickly swing in directions where capitalism’s benefits are discounted and its flaws exaggerated. . . . While it’s hard to see how this proposed regulation would solve the problems that I’ve raised tonight, it’s exactly the kind of proposal that business will have to contend with when com­plex issues go unexamined, and when character, sound values, restraint, and long-term thinking fail to gain the upper hand.9
At first glance, this is sound—even admirable—advice for aspiring business leaders. But a closer look at Klarman’s remarks, as well as the origins and trajectory of his career, suggests a deeply flawed messenger. Indeed, Klarman’s story provides an interesting window through which to understand much of what afflicts our economy and society today.
A considerable amount has been written about the financialization of the American economy. Less understood is the financialization of America’s business talent. Klarman, his alma mater, and its peer institutions are all part of this story. What we confront today—a business elite dominated by financiers and their squires, presiding over a disordered economy gutted of both its productive energy and the ability to generate mass prosperity—is a direct result of this economic and cultural evolution.

Shareholder Capitalism: A Brief History

Students of business history may be confused by Klarman’s appar­ent antipathy to the idea that corporations should work only to maximize their stock prices. What began as an obscure academic concept—commonly referred to as shareholder primacy theory—is now generally accepted economic law in American’s boardrooms and business schools. And few people in the world have benefited to the extent that Klarman has from this idea’s rapid ascent since the 1970s.
In 1970, renowned economist Milton Friedman published a now-famous essay, brusquely titled “The Social Responsibility of Busi­ness Is to Increase Its Profits,” in the New York Times Magazine. Although it mostly regurgitates some of Friedman’s earlier arguments, this condensed version was more easily digested by corporate managers and business leaders.
Friedman opened the essay with a broadside, the original “greed is good” argument:
In fact they [businessmen who speak about the social responsibilities of business] are—or would be if they or anyone else took them seriously—preaching pure and unadulterated so­cialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.10
Friedman then jettisoned any idea of corporate responsibilities be­yond shareholder profits, providing the pseudo-juridical justification upon which thousands of companies in the ensuing decades saw their less profitable divisions amputated, their balance sheets loaded with debt, and their workforces offshored:
In a free-enterprise, private-property system, a corporate ex­ecutive is an employee of the owners of the business. He has a direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of society. . . .11
Within a decade, this view had made significant inroads at the nation’s top business schools. A 1976 article by Michael Jensen and William Meckling, titled “Theory of a Firm: Managerial Behavior, Agency Costs and Ownership,” cemented its foothold. In what would become one of the most influential pieces of management literature ever written, the authors argued that distributed shareholder bases were a core weakness of American business. This fea­ture, according to the authors, invites professional managers to ne­glect shareholders’ interests in pursuit of their own. The idea that shareholders (and shareholders alone) are the rightful claimants of the fruits of the economy gained traction quickly, eventually sound­ing the death knell for what historians refer to today as “managerial capitalism.” By the mid-1980s, Jensen had relocated to a new post at HBS, and shareholder primacy had replaced managerial capitalism as the primary lens through which aspiring business leaders viewed the economy.
Legal scholar Lynn Stout has argued that shareholder primacy’s rapid advance towards general acceptance is the result of a convenient alignment of interests between disparate interest groups during the 1980s and early 1990s.12 The first group to latch onto the idea was academics—business and law professors as well as economists like Jensen—who saw that “shareholder primacy offered a simple story about corporate structure and purpose that could be easily taught to students who innocently asked the complex question, ‘what are corporations for?’”13 The idea also gained steam among researchers, for it offered a seemingly elegant way to measure the results of business strategies or initiatives: a corporation’s share price either went up or down.
Among financial markets participants, the theory proved espe­cially convenient to the 1980s corporate raiders. Faced with public outrage, activist investors could point to stock appreciation that oc­curred after cost-cutting initiatives, divestitures, and debt recapitalizations, and justify their behavior by explaining that they were merely “unlocking” shareholder value that had hitherto been squan­dered.
Finally, the shareholder primacy movement proved lucrative to a wave of CEOs in the early 1990s whose compensation was tied to stock price. In 1990, Jensen published another landmark article, this time in the Harvard Business Review. Jensen asserted that corporate performance could be improved by using stock options to compensate CEOs and further align their interests with those of shareholders. The result, coupled with a 1993 tax law that increased the cost-effectiveness of compensating management with equity, has been twenty-five years of skyrocketing executive pay.14
If the division of business proceeds is a zero-sum game played among shareholders, management, and labor, then the effect of Jensen’s first article was to formalize shareholders’ advantage in the economy, to the detriment of the other two groups. The effect of his second was to recast senior managers as shareholders, effectively convincing them to lay down their arms and join the other side.
The influence of this view of political economy on the nation’s most talented youth cannot be overstated. As students at the top business schools came to view the shareholder as the central actor of the economy, their career choices began to change. Fewer MBAs sought roles in industry. The most lucrative jobs were no longer in general management—which involved leading people, building or­ganizations, and creating products and services—but instead in professions that acted on behalf of or in service to shareholders, especially fund managers who pooled capital and became large shareholders of major corporations. When MBAs did choose indus­try, it was often in the finance or “corporate development” functions. Within a generation, finance had transformed from a sleepy backwater to a lucrative and exciting destination for the talented young Americans coming out of the nation’s top universities.
The new elite also applied their ample talent and superior educa­tion to devising financial mechanisms and “business strategies” that captured increasing percentages of their companies’ revenues. They discovered financial engineering techniques to boost stock values without growing earnings or investing in productive assets. Bankers and consultants helped shareholders and boards value, measure, and optimize their equity, which often led to decisions to offshore jobs or purposefully reallocate capital away from asset-intensive industries that employed millions of middle-class Americans. This also resulted in subtler changes to the economy, including, for example, the way Americans plan for retirement. Defined benefit pensions—which created long-term liabilities that financiers struggled to value accurately—were discarded in favor of the now ubiquitous 401(k). This change shifted a generation’s worth of macroeconomic risk off of corporate America’s balance sheet and onto millions of American workers and their families.
Klarman arrived at HBS in the fall of 1980 at the outset of this era. His generation of business leaders would navigate their careers with the shareholder as true north. Though they created new busi­ness models, hedge funds among them, nearly all of these “innova­tions” were dependent on the idea that the path to wealth was to align yourself with shareholders, whomever they might be.
Klarman’s HBS class has become one of the most celebrated MBA cohorts in American history. An impressive number of its members have risen to wealth and positions of prominence. Many of them are household names in the business community. In addition to Klarman, there is Dimon, who leads Wall Street’s largest bank, along with billionaire Stephen Mandel, the most successful of the “Tiger Cub” hedge fund managers. Jeffrey Immelt, who would go on to lead General Electric, was also a classmate. Though not a fi­nancier, Immelt’s rise at GE coincides with that firm’s disastrous foray into financial services and the loss of its position among the giants of American industry.

Shareholder Capitalism’s Legacy

The career choices of today’s HBS graduates demonstrate the effects of four decades of shareholder primacy. In the 1960s, just 6 percent of the school’s graduates pursued careers in finance; the sector itself generated only 3 percent of the country’s GDP.15 Professional man­agers thumbed their noses at “back office” jobs and “banker’s hours.”
Today, that cultural dynamic has inverted, with finance becoming the school’s most popular career field. From 2014 to 2018, over 30 percent of graduates opted for jobs in finance.16 Hedge funds, pri­vate equity firms, and investment banks are just the first order play­ers. Another 24 percent chose management consulting, whose rise parallels corporate America’s subservience to shareholder primacy and its emphasis on financial initiatives like cost cutting and merger diligence. This trend is not unique to Harvard, as data from Stanford and Wharton show identical trends. Within the economy, the finan­cial sector’s contribution to GDP now approaches 10 percent, more than triple what it was in 1950.17
The consequences have damaged the long-term health of the American economy and hindered its ability to create prosperity and offer opportunities for social mobility. As a 2019 report by the U.S. Senate Committee on Small Business and Entrepreneurship shows, the private sector in aggregate has become a net lender to the rest of the economy, a stunning reversal of its traditional role as net bor­rower and investor in a capitalist system. The report concludes that the U.S. economy is no longer “so much a model of traditional cap­italism as it is an indiscriminate mass of savings upheld by federal government net borrowing.”18
Related to this shift in sectoral balances is both a shameful level of inequality and historically weak economic performance and produc­tivity growth. The Gini coefficient, a measure of an economy’s equality, has risen in the United States from 34.6 percent in 1979 to 41.5 percent in 2016. For comparison, that is higher than India, Kenya, Russia, and the Philippines—countries not exactly known for mass prosperity. Comparable western democracies such as the United Kingdom, Canada, and Australia have Gini coefficients of 33.2, 34.0, and 35.8 percent, respectively.19 We live in the richest society in the history of mankind, but as the Federal Reserve report­ed earlier this year, 40 percent of Americans would be unable to fund the costs of a $400 emergency from their savings.20
A common refrain from finance apologists is that the sector and its participants have created real value by making our markets more efficient and more liquid. Perhaps, but for whose benefit? A second rejoinder invariably accompanies this argument: that finance’s rise has been good because private equity and hedge fund returns largely accrue to pensioners and college endowments.
This second argument fails for several reasons. First, it has be­come increasingly difficult to see how Main Street benefits from a model where fees are paid irrespective of performance—for years. Second, it ignores the volume of rents extracted in the modern finan­cial economy: as a dollar flows from a pensioner’s pocket into the company that he or she “owns” via a private equity or hedge fund investment, pension administrators, funds-of-funds, fund managers, bankers, and consultants all take a cent or two, regardless of the investment’s performance. In part because of this fee scraping, hedge fund performance has been weak by pretty much any indicator for years, and the data suggest that over longer horizons private equity as an asset class only slightly outperforms the S&P 500. More than one scholar has highlighted that without the benefits of abnormally low interest rates, the excess returns are basically nil.21
Moreover, when you ask these same people about financialization’s negative “externalities,” the response is often a shrug. After all, investors have “fiduciary duties” to the teachers and police offic­ers whose retirement savings they manage, and labor costs less in Vietnam than in the Rust Belt. Here, Klarman’s concern about democracy is worth revisiting: if given the choice, would America’s teachers and policemen elect to forgo a few points of alpha if it meant not seeing their communities gutted or their neighbors’ jobs shipped overseas?
Meanwhile, investors have gorged themselves on profits generated by American businesses. The amount spent by America’s largest companies on share buybacks has reached unprecedented levels in recent years, despite historically expensive equity prices. In fact, over the last five years, many American businesses have sent more cash back to shareholders than they have earned through the course of normal operations. American business, in aggregate, has indebted itself in order to further enrich its shareholders.22 Given that 50 percent of Americans own no stocks, the wealthiest 10 percent own 80 percent of the country’s stocks, and the top 1 percent own almost 40 percent of the country’s equities, the benefits of this financially engineered asset price inflation have flowed almost entirely to the largest capital holders.23
The impact is not merely economic. The cultural and political consequences of shareholder primacy have undermined our social cohesion. If, for the sake of argument, we accept the premise that graduates of the nation’s top business schools are a proxy for the nation’s talent, the data show just how unequally that talent is dis­tributed: over the last five years, 61 percent of U.S.-bound HBS graduates have landed in three cities—Boston, New York, and San Francisco.24 These metropolitan areas certainly have dynamic econo­mies, but they contain only 6 percent of America’s population.25 This clustering in a handful of cities has created “SuperZips” and a new American segregation based on economic class.26
This brain drain has robbed the nation’s heartland of the upper-middle class upon which the civic culture of towns and small cities depends. A generation ago, these were the high-achieving, high-earning business owners and professionals who pulled double duty as PTA presidents and city council members, or who coached youth sports or organized the neighborhood watch. As Charles Murray has convincingly shown, without these citizens, civic engagement in these heartland cities has plummeted.27
Affluent geographic clusters also shield their inhabitants from confronting the societal effects of some of their more unpleasant business decisions. Executing an offshoring initiative or closing a plant is easier when it can be completed from the confines of New York or San Francisco: it will not be your neighbor who loses their job, after all. At some point, this phenomenon has become self-reinforcing: the more that flyover country is deprived of its share of the nation’s talent, the easier it is for those on the coasts to ignore it.

The Class the Dollars Fell Upon

It was not always this way. If the class of ’82 represents the wealth and success achieved by the shareholder primacy generation, another HBS class tells the story of a different era.
In 1974, Fortune published a profile of the HBS class of 1949 on the twenty-fifth anniversary of its graduation. As a cohort, its mem­bers had achieved fantastic financial success: one in five were mil­lionaires in 1974 dollars. Fortune’s editors titled their profile “The Class the Dollars Fell Upon,” and the nickname stuck.28
By 1974 approximately 45 percent of the class held the position of CEO or COO. A member of the class was the Chairman of Xerox, another held the same position at Bloomingdale’s. A 49er was the CEO of Johnson & Johnson, and another was leading Rohm & Haas. Other classmates led utilities, hotel chains, and cosmetics companies. They too tinkered with business models as the economy evolved—a 49er, for example, was the first man to buy a television network.29
While their wealth, professional success, and acclaim drive the comparison to the 82ers, it is the difference in how the two classes made their money that is striking. The young Americans who ma­triculated at HBS in the years after the war found an institution that sought to instill in its graduates a sense of noblesse oblige, despite the fact that few of them had any blue blood to speak of. They had been given an unprecedented opportunity, and much was expected of them.
Donald David, the school’s dean during the late 1940s, articulated these expectations frequently. One such example, a Harvard Busi­ness Review article titled “Business Responsibilities in an Uncertain World,” was published the same month as the class of ’49’s graduation. As David explained, “The faculty of the Harvard Business School, in reviewing and remaking its training and research programs, has been devoting a great deal of thought to the responsibilities to be faced by business.” David concluded that the school’s aim ought to be to produce a business leader who possessed three key attributes:
The first of these is competence in the management of his business activity. The second is the development and application of social skill as to make his business enterprise a “good society.” The third is the willingness to participate constructively in the broader affairs of the community and the nation.30
The MBAs who graduated that month would go on to contribute mightily to the country’s wealth and prosperity. Undoubtedly many of them sought wealth and material gain. But what they were taught at Harvard channeled these pursuits into productive activity—the hiring, building, and investing that are so critical to capitalism’s shared prosperity and progress.

Short-Term Investing, Long-Term Hypocrisy

The activities of today’s business stars tell a different story. Klarman’s investment track record, for example, certainly shows par­ticipation “in the broader affairs of the community and the nation,” but it is doubtful that these undertakings would meet Dean David’s definition of “constructive.”
On the morning of the Klarman Hall dedication ceremony, Bau­post held approximately $850 million of stock in a large Califor­nia-based utility named Pacific Gas and Electric.31 PG&E, as it is known, provides gas and electricity to one in twenty Americans.32 To some observers, the investment was unusual: the utility sector is a low-growth, sleepy corner of the market, and, because of this, the company was an unusual target for a hedge fund investor.
But Baupost was not alone. Across Wall Street, its peers flocked to buy PG&E stock.33 By late September, hedge funds, including notable firms like Viking, Appaloosa, and D. E. Shaw, owned ap­proximately 20 percent of PG&E.34
The bet was simple: for much of 2018, PG&E was the subject of uncertainty regarding liabilities resulting from a series of deadly wildfires that struck northern California in late 2017. The fires, fueled by climate change–induced droughts, killed 44 peo­ple, rendered another 6,000 homeless, and destroyed over 250 mil­lion acres of land.35 State officials suspected that PG&E had cut corners in replacing its aging equipment, which malfunctioned and sparked the blaze.36 As a result, the company’s stock price had fallen by as much as 35 percent since the fires.
An investment in mid-2018 in PG&E amounted to simple spec­ulation around the magnitude of the company’s wildfire liabilities. With rumors of bankruptcy swirling, the company’s reputation for poor management, its tense relationship with state and municipal governments, and a future increasingly clouded by California’s run­ning battle with climate change, few would say that it presented a compelling opportunity for long-term value appreciation—unless the wildfire liabilities proved to be lower than expected.
For a few months, the PG&E bet looked like it might prove to be lucrative. From early July to early October, the stock’s price rose approximately 15 percent, an enviable three-month return. But those gains would be short-lived.
Six weeks after the Klarman Hall dedication, disaster once again struck northern California. At dawn on November 8, 2018, a fire swept into the town of Paradise, killing dozens of its residents and burning the town to the ground. The scale of the Camp Fire, as it came to be called, was unprecedented: with at least eighty-five deaths and $16 billion in damage, it was the deadliest and costliest wildfire in California history.37
As rescue crews combed through the ashes of Paradise, PG&E’s stock price plummeted. Rumors circulated that PG&E’s aging equip­ment might again be the source of the blaze.38 Within two weeks, the company shed $12.5 billion, or 49 percent, of its market value.39 Several of the nation’s most prestigious hedge funds sold shares, booking losses of hundreds of millions of dollars. Bankruptcy, which would produce a massive loss for Baupost, looked like an increasingly probable outcome for the company.
Except that a bankruptcy could also potentially enrich Baupost. In January 2019, journalists reported that in November the firm had purchased $1 billion of insurance subrogation claims against PG&E, in effect creating a complex hedge on its equity investment.40 By purchasing the claims from the insurer, Baupost now owned the rights to sue PG&E for the wildfire damages. As an investment, the claims had massive upside potential, given that Baupost reportedly acquired them for as little as 35 percent of their notional value.41
The claims also classify Baupost as a creditor in what will be a protracted and expensive reorganization process for PG&E. This means that no matter the outcome for the utility, its millions of cus­tomers, its twenty-three thousand employees, and its existing share­holders, Bau­post will stand to benefit, perhaps making a profit, or at least minimizing what would otherwise be significant losses.
Taking positions in multiple parts of a troubled company’s capital structure is an admittedly clever strategy, and a maneuver that is beyond the capability of most investors. It is also nakedly opportunistic. The image of Baupost deploying a billion dollars to speculate on legal liabilities in the midst of widespread suffering—caused by a combination of climate change–induced droughts and California’s dilapidated power infrastructure—is hard to square with Klarman’s condemnation of short-termism, never mind his newfound concerns about civic responsibility and climate change. Despite all his talk about building long-term value at HBS, there is simply no indication that Baupost ever sought to use its capital to improve the company’s operations or financial position, or that it made any effort to improve its management. The PG&E trade, however, is not an isolated case.
In the aftermath of Hurricane Maria, journalists at the Intercept exposed Baupost as one of the largest holders of Puerto Rico’s controversial cofina bond debt. Particularly galling to some ob­servers was Baupost’s use of a series of shell companies designed to hide the firm’s involvement. Klarman insisted that the firm employed this strategy to avoid tipping off copycat funds—a rather doubtful claim as every serious distressed debt investor was well aware of the cofina situation from the beginning. It seems more likely that Klarman understood how Baupost’s position among the “vulture funds” circling Puerto Rico would be viewed. Following the story, student protests occurred on the campuses of some of Baupost’s most significant investors, including the endowments of Yale, Cornell, and Harvard.42 As the situation on the island became increasingly nightmarish, activists and students began to demand that their universities refrain from profiting on the misery. In re­sponse, Klarman coolly emailed his investors, insisting that it was in Puerto Rico’s long-term best interest to meet its obligations.43
This kind of stratagem is a carefully honed skill at Baupost. In October 2008, with global markets in freefall, Iceland’s three major banks collapsed. With their debt trading at less than a tenth of its original value, Baupost pounced, buying an estimated $3 billion of Icelandic bank debt.44 By using an intricate web of shell companies—most with Icelandic names—to parcel out and conceal the debt’s true ownership, Baupost avoided the negative publicity and rage directed at other hedge funds that followed suit. Meanwhile, Icelanders, grappling with their economy’s collapse, voiced their fury at the ballot box, installing a new government. The new admin­istration instituted capital controls in 2012, trapping much of this foreign money in the country. Baupost, however, had by this point covertly sold most or all of its position.45
Of course, Baupost is hardly the only fund that employs these tactics; amorally pursuing returns is what hedge funds do, after all. These issues are structural, and no one should be surprised when facile speeches on social responsibility go unheeded. But the glaring inconsistency between Klarman’s sermonizing and his firm’s behav­ior—and the extent to which it goes unnoticed, seemingly even by Klarman himself—illuminates the depths of American elites’ self-delusion.
Klarman is certainly an outperformer in this category, frequently insisting that Baupost is not even a hedge fund, that it represents something nobler than the rest of the industry. In his 2016 investor letter he wrote, “While we think of ourselves as a value-oriented investment partnership, our primary competitors are hedge funds, a category we sometimes get lumped into.”46 Klarman continued this routine in an interview with the New Yorker earlier this year, stating, “People will say the words ‘Wall Street’ with a derogatory tone. They’re talking about an immoral place, where there’s just disgusting amounts of greed and nothing good happens. . . . I’m not on Wall Street, I’m in Boston, but you’re tarred with that brush.”47 His interviewer, apparently unfamiliar with common hedge fund marketing gimmicks, seemed wholly uninterested in challenging such a risible rhetorical dodge.
Most hedge fund critics tend to direct their ire at activist managers who are conspicuously less concerned about their public image—compare, for example, the New Yorker’s scathing coverage of Carl Icahn or Paul Singer with their flattering treatment of Klarman. The controversy surrounding these “shareholder activists” is not difficult to understand, and often deserved: they typically do pressure com­panies to pursue short-term strategies, usually with little regard for workers or other stakeholders. But at least Icahn and his ilk are honest about who they are and what they do. And, under certain circumstances, activists can serve useful purposes: they have at times enforced discipline on genuinely profligate companies or improved poor management teams.
As his track record shows, Klarman is no more scrupulous in his behavior than any of the others “tarred” with the hedge fund brush. Yet, ironically, he has actually done much less than the hated activ­ists have to bring about the advertised benefits of shareholder pri­macy, such as they are.
Oblivious to these subtleties, the prestige media has echoed Har­vard Business School in promoting Klarman as the respectable face of financialized capitalism. And the formerly reticent Klarman seems more and more willing to step into this role. “Despite my preference to stay out of the media,” he wrote in 2017, “I’ve taken the view that each of us can be bystanders, or we can be upstanders. I choose up­stander.”48 The residents of Puerto Rico might beg to differ.
These same publications, however, have politely overlooked Bau­post’s underwhelming performance over the last several years.49 The Times referred to Klarman as a “quiet giant.” But he is not so quiet anymore, and a cynic might wonder if that is because he no longer seems like such a giant. He would not be the first hedge fund manager who attempted to burnish his personal legacy—especially among politically sensitive college endowments—as his professional reputation began to fade.

Hiding Behind Democracy

Harvard’s president is correct to note that Seth Klarman epitomizes what Harvard Business School has to offer us today. He is wrong to celebrate this fact. Klarman’s prominence conveys that incongruence between words and actions is tolerable, even desired. Holding him up as a role model encourages our best and brightest to pursue value cap­ture, not value creation—no matter the impact on people in the real economy.
Klarman’s message that evening at HBS was not an exhortation to reform a flawed system but a warning to established and aspiring business elites alike that they face further scrutiny in the months and years ahead. His career tells us how he would advise those beginning their careers to navigate these challenges: Loudly criticize political dysfunction, but make no effort to explore its structural causes or remedies. Decry political inertia on climate change, but keep your powder dry because it will present excellent investment opportunities. Say the easy things about prioritizing your employees, but never forget that your shareholders come first. Speak of investing as an activity that requires a long-term view, but never miss an oppor­tunity for short-term arbitrage. Stand up for democratic norms, un­less, of course, electoral outcomes threaten your returns. When that happens, patiently explain how the market works, and if there is still conflict, use your network, education, and checkbook to cut to the front of the line.
At bottom, when many of our country’s wealthy citizens say “democracy,” what they really mean is “our class’s way of life.” If they respected democracy as fervently as they worship the “invisible hand,” they would see that the popular discontent simmering across the world today is the direct result of decades of elite hypocrisy and greed, hidden behind a façade of neoliberal economics. But rather than consider the structural economic reforms that will be required to actually address the causes of populism, they obfuscate with moralistic rhetoric about democratic norms.
It is telling that the villain Klarman identified in his HBS speech was Senator Elizabeth Warren. Though he avoided referencing her by name, his mention of her proposed Accountable Capitalism Act made her identity clear. Evidently she is now the most dangerous of the “ideologues seeking to point fingers, assign blame, and make reckless changes to the system.”50 Yet Warren infuriates financiers not because she is actually reckless but rather because she is a threat to those who benefit from today’s distorted economy. They see risk not just in her policy proposals but also in her refusal to participate in the tony fundraisers and paid Wall Street speeches which form the soft bribery apparatus that binds politicians and financial elites.
When a hedge fund manager’s “symposium on democracy” de­scends into a screed against financial market reform, it is easy to assign cynical motives. But the even darker reality may be that to­day’s elites genuinely believe their self-serving rhetoric. Con­sider the borderline messiah complex of another successful “value inves­tor”—and now presidential candidate—Tom Steyer. It seems that these elites are not content to simply rationalize their self-interest; they also demand veneration as exemplars of moral virtue. The origi­nal “greed is good” mentality of the 1980s at least carried with it a modicum of self-awareness. Greed was still greed, after all. When the infamous insider trader Ivan Boesky donated to Harvard’s School of Public Health, all he (allegedly) wanted was admission to the Har­vard Club of New York.51 Today’s reputation laundering, as the Klarman Hall ceremony shows, is a much more involved affair.

Correcting the Culture in Our Business Schools

Beyond politics, Klarman is also symbolic of a larger tragedy: his career epitomizes a colossal misallocation of human capital. For decades, increasingly large numbers of America’s smartest and hard­est-working businesspeople have toiled in extractive pursuits, and the result is an economy that benefits an increasingly smaller per­centage of its participants.
Many structural reforms are necessary to change this. With regard to education, it is time to reform the top MBA programs. These schools shape our business culture, and, in so doing, exert an outsized influence on the business practices and the career pursuits of some of our most talented young people.
The schools should begin with an explicit renunciation of share­holder capitalism. This will be the easy part. Without shareholder value maximization as an organizing and simplifying concept, stu­dents will have to grapple with difficult questions of purpose, justice, and corporate responsibility, in addition, of course, to man­agement and business strategy. Fortunately the schools can find wor­thier principles in their archives, ready to be dusted off and ap­plied once more, and perfectly consistent with business success. Every student at HBS recently received hedge fund manager Ray Dalio’s book Principles as a holiday gift, but how many of them are familiar with the principles of the class of ’49?
Some will assert that the nation’s top business schools are passive recipients of a highly financialized pool of applicants and thus must serve this customer base. This argument, however, conveniently ignores the influence that these institutions have on the nation’s economy and business culture. Deans who are unwilling to address the lack of geographic and industrial diversity among their graduates are unworthy of leading institutions that exert an outsized impact on the shape of commercial activity.
Another required reform is the elimination of unofficial admissions quotas which guarantee that large percentages of each class are selected from financial services and consulting. These industries exert a level of capture over elite MBA admissions that will make this fiscally unappealing for the schools, but such a move is critical to improving campus cultures. By reorienting the admissions pro­cess away from financial services and consulting, the MBA programs can once again train leaders of industry, rather than serve as McKin­sey finishing schools.
For their part, the faculties should actively encourage the pursuit of careers that create real economic value for society. Students should be equipped to pursue individual wealth creation—it is busi­ness school, after all—but a healthy business culture would frown upon endeavors that create wealth through value extraction and short-term financial speculation. Wealth via accomplishment, not the reverse, should be the goal. Prominence should be given to those graduates that build best-in-class companies, create innovative prod­ucts, and provide opportunities for economic security and personal advancement to the broader labor force.

The Church of Market Primacy

One of the keynote speakers at Klarman’s symposium on democracy was business school professor Michael Porter. The celebrated guru of business competition and author of “Porter’s Five Forces” has also turned his focus towards American politics in recent years, criticizing Washington for burdening American voters with a stag­nant, uncompetitive duopoly. To Porter, nothing could be worse, for duopolies offer their consumers a suboptimal range of choices and outcomes. This is the analogy that Porter and many other elites would doubtless use to explain the 2016 election, for example. The solution, according to Porter, is for business leaders to step in and apply a “market lens” to the problem, and he believes that such an effort might help lead to the creation of a “new, more centrist third party.”52
It is hard to imagine a more perfect window into the Church of Market Primacy, where so many of our elites now worship. Here, markets define everything else. Supply and demand and “creative destruction” are not just economic concepts; they are first principles. Political priorities should be ordered to conform to market incentives, and not the other way around. The “center” is not where the best policy is made, or where public opinion converges; it is a place where political activity is fully dominated by financial elites and thoroughly subordinated to the mar­ket.
These are the same people who have left us with an upside-down economy and a weakened social fabric. Income inequality, financialization, and a socially inefficient distribution of both capital and tal­ent are the legacies of shareholder capitalism. Although these elites now mourn the erosion of the political “center,” they actively par­ticipated in the erosion of the American middle class. To add insult to injury, they insist on telling us elaborate stories about their entrepreneurial spirit and good intentions, and invite us to celebrate their virtue when they give back a tiny share of their captured wealth.
Encouraged by academics like Porter and Jensen, and the univer­sities at which they preach, this elite now purports to know how to fix our politics. Given their track record, we would be foolish to listen.


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