Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else (24 page)

Eight days later, George Soros hosted twenty of Wall Street’s most influential investors for lunch at his Southampton estate, on the eastern end of Long Island. It was a warm but overcast Friday afternoon. As the group dined on Long Island striped bass, fruit salad, and cookies, their tone was serious and rather formal. The meal was one of two annual “Benchmark Lunches,” held on successive Fridays in late August and organized by Byron Wien, a Wall Street veteran who had befriended Soros four decades earlier thanks to a shared interest in then obscure Japanese stocks.

James Chanos, the influential short hedge fund manager, was one of the guests. It was a group, Chanos told me, of “pretty heavyweight investors.” Other diners included Julian Robertson, legendary founder of the Tiger Management hedge fund; Donald Marron, the former chief executive of PaineWebber and now boss of Lightyear Capital; and Leon Black, cofounder of the Apollo private equity group.

In a memo about the luncheon discussion he distributed a few weeks later, Wien wrote that the talk focused on one issue: “Were we about to experience a recession?” We all know the answer today. But just over a year before the collapse of Lehman Brothers definitively plunged the world into the most profound financial crisis since the Great Depression, the private consensus among this group of Wall Street savants was that we were not. According to Wien’s memo, “The conclusion was that we were probably in an economic slowdown and a correction in the market, but we were not about to begin a recession or a bear market.”

Only two of the twenty-one participants had dissented from that bullish view. One of the bears was Soros. “George was formulating the idea that the world was coming to an end,” Wien recalled. Far from being won over by his friends, Soros saw their optimism as reinforcing his fears. He left the lunch convinced that the global financial crisis he had been predicting prematurely for years had finally begun.

His conclusion had immediate and practical consequences. Soros had been one of the world’s most successful and most influential investors: for the thirty years from 1969 through 2000, Soros’s Quantum Fund returned investors an average of 31 percent a year. Ten thousand dollars invested with Soros in 1969 would have been worth $43 million by 2000. According to a study by LCH Investments, a fund owned by the Edmond de Rothschild Group, during his professional career Soros has been the world’s most successful investor, earning, as of 2010, a greater total profit than Warren Buffett, the entire Walt Disney Company, or Apple.

But in 2000, following the departure of Stan Druckenmiller, who had been running Quantum, Soros stepped back from active fund management. Instead, he recalled, “I converted my hedge fund into a less aggressively managed vehicle and renamed it an ‘endowment fund’ whose primary task was to manage the assets of my foundations.”

On August 17, 2007, he realized he had to get back in the game. “I did not want to see my accumulated wealth be severely impaired,” Soros told me during a two-hour conversation in December 2008 in his thirty-third-floor conference room in midtown Manhattan, with views overlooking Central Park. “So I came back and set up a macro account within which I counterbalanced what I thought was the exposure of the firm.”

Soros complained that his years of semiretirement meant he didn’t have the kind of “detailed knowledge of particular companies I used to have, so I’m not in a position to pick stocks.” Moreover, “even many of the macro instruments that have been recently invented were unfamiliar to me.” At the moment he made his crisis call, Soros was so disengaged from daily trading that he didn’t even know what credit default swaps—the now notorious derivatives that brought down insurance giant AIG—were. Even so, his intervention was sufficient to deliver a 32 percent return for Quantum in 2007, making the then seventy-seven-year-old the second-highest-paid hedge fund manager in the world, according to Institutional Investor’s
Alpha
magazine. He ended 2008 up almost 10 percent, the same year that saw global destruction of wealth on the most colossal scale since the Second World War, with two out of three hedge funds losing money, and he was ranked the world’s fourth highest-paid hedge fund manager. Druckenmiller, his former first lieutenant and a self-confessed admirer of Soros’s approach to investing, came in at number eight.

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The twenty more bullish guests at the Soros table that August afternoon weren’t outliers. They reflected the consensus view of corporate America’s top economists. When the
Wall Street Journal
reviewed the 2008 predictions of America’s fifty-two leading economic forecasters, it found that only one of them had foreseen a fall in GDP. As Dick Fuld, the once lionized Lehman chief, told a congressional committee in October 2008, a month after his firm’s bankruptcy and more than a year after Soros’s lunch: “No one realized the extent and magnitude of these problems, nor how the deterioration of mortgage-backed assets would infect other types of assets and threaten our entire system.”

Alan Greenspan was so wrong-footed by the crash of 2008 that he admitted intellectual defeat. “I made a mistake,” he told a congressional committee on October 23, 2008. “Something which looked to be a very solid edifice, and indeed a critical pillar to market competition and free markets, did break down. And I think that, as I said, shocked me.”

Hindsight makes all of us Einsteins. With the wisdom it bestows, it is easy to mock and malign the actions and the explanations of the Fulds and the Greenspans. But in 2007 and early 2008, inertia—whether you believe it to have been motivated by avariciousness or incompetence—was the normal response. While the bubbles are easy to identify in retrospect, when we are caught up in them, most of us find it difficult to imagine they will ever burst. And even those of us who are intellectually honest and experienced enough to appreciate that, one day, the boom is bound to end, find it tough to act on that realization.

It is not just financial crashes we have a hard time anticipating. Significant paradigm shifts more generally—revolutions in politics and society, as well as those in business and the markets—are notoriously hard to foresee. The CIA famously failed to predict the collapse of the Soviet Union. Less than a year before Hosni Mubarak was toppled, the IMF published a report lauding his economic reforms and the stability they had created. Mike McFaul, a political scientist who was appointed U.S. ambassador to Russia in 2011, believes that “we always assume regime stability and when it comes to authoritarian regimes we are always wrong.”

Even after the revolution has begun—after the first overleveraged bank freezes withdrawals from its riskiest fund, after the protesters win their first important standoff against the soldiers of the ruling regime—most of us are reluctant to admit that the world has changed. As historian Richard Pipes observed, after the Bolsheviks seized power in 1917, prices on the Petrograd stock exchange remained stable. And once we recognize that the world has changed, most of us are very bad at adapting our behavior to the new reality.

Instead, according to London Business School professor Donald Sull, most companies respond to revolutionary change by doing what they did before, only more energetically. Sull calls this “active inertia” and he believes it is the main reason good companies fail: “When the world changes, organizations trapped in active inertia do more of the same. A little faster perhaps or tweaked at the margin, but basically the same old same old. . . . Organizations trapped in active inertia resemble a car with its back wheels stuck in a rut. Managers step on the gas. Rather than escape the rut, they only dig themselves in deeper.”

Clayton Christensen, the Harvard Business School professor whose book
The Innovator’s Dilemma
is the corporate bible on disruptive change, has found that established companies almost always fail when their industries are confronted with disruptive new technologies or markets. And that is not, he argues, because their managers are dumb or lazy. It is because what works in ordinary times is a recipe for disaster in revolutionary ones. “These failed firms,” he writes, “were as well run as one could expect a firm managed by mortals to be—but there is something about the way decisions get made in successful organizations that sows the seeds of eventual failure.”

The rare ability—like Soros’s—to spot paradigm shifts and to adapt to them is one of the economic forces creating the super-elite. That’s because moments of revolutionary change are also usually moments when it is possible to make an instant fortune. And, thanks to the twin gilded ages, we are living in an era of a lot of revolutionary shifts.

One set of changes is in the emerging markets. The broad secular trend since the late 1980s has been for authoritarian regimes to give way to more democratic ones and for closed, state-controlled economies to become more open. Sometimes the transition happens with a bang, as it did in Eastern Europe in 1989 and North Africa in 2011; sometimes it happens more gradually, as in India, China, and parts of sub-Saharan Africa. But in much of the world, the late eighties and the nineties were a time of privatization, deregulation, and the lowering of trade barriers. The result was economic windfalls for the locals and foreigners with the skills, the smarts, and the psyche to take advantage of them.

A second set of revolutions is in technology. New technologies, especially computers and the Internet, then mobile and wireless, are disrupting existing businesses and opening up the chance to create new ones. Like the industrial revolution, which started with mechanization of the textile industry, then the invention of the steam engine, followed by the combustion engine and electricity, the technology revolution isn’t a single discovery; it is wave after wave of related transformations. In 2012, the hot new areas were big data—our ability to collect and analyze massive amounts of information—and machines talking to machines, creating what W. Brian Arthur, the economist who studies technological change, describes as the second, digital economy—“vast, silent, connected, unseen, and autonomous.”

Finally, these two big revolutions, together with a broader global trend toward more open markets in money, goods, and ideas, combine to reinforce each other and create a faster-paced, more volatile world. Twitter and Facebook are the offspring of the technology revolution, but they turn out to have made political revolutions easier to organize. Before the invention of the personal computer, the securitization of mortgages—which turned out to be part of the kindling for the financial crisis—would not have been possible. Nor would the algorithmic trading revolution, in which machines are replacing centuries-old stock exchanges and a couple of lines of corrupt code can trigger a multibillion-dollar loss of market value in moments, as occurred during the “flash crash” on May 6, 2010.

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Revolution is the new global status quo, but not everyone is good at responding to it. My shorthand for the archetype best equipped to deal with it is “Harvard kids who went to provincial public schools.” They got into Harvard, or, increasingly, its West Coast rival, Stanford, so they are smart, focused, and reasonably privileged. But they went to public schools, often in the hinterlands, so they have an outsider’s ability to spot the weaknesses of the ruling paradigm and don’t have so much vested in the current system that they are afraid of stepping outside it.

Facebook’s Mark Zuckerberg (New York State public school, Harvard), Blackstone cofounder Steve Schwarzman (Pennsylvania public school, Yale undergraduate, Harvard MBA), and Goldman Sachs CEO Lloyd Blankfein (Brooklyn public school, Harvard) are literal examples of this model. Most of the Russian oligarchs—who were clever and driven enough to get degrees from elite Moscow universities before the collapse of the Soviet Union, but were mostly Jewish and therefore not fully part of the Soviet elite—have a similar insider/outsider starting point. Soros, the worldly and well-educated son of a prosperous Budapest lawyer, who was forced by war and revolution to make his own way in London and New York, is another representative of the genre.

The Citigroup analysts who coined the term “plutonomy” go one step further. They argue that responding to revolution is a biological trait, genetically inherited, and that one way to be sure your society is good at it is to open your borders to immigrants, on the theory that moving to a new country is an example of responding to revolution. They write, “Dopamine, a pleasure-inducing brain chemical, is linked with curiosity, adventure, entrepreneurship, and helps drive results in uncertain environments. Populations generally have about 2% of their members with high enough dopamine levels with the curiosity to emigrate. Ergo, immigrant nations like the United States and Canada, and increasingly the UK, have high dopamine-intensity populations.” Responding to revolution—and the economic rewards it brings today—they argue, isn’t just something we can learn by reading the works of business school professors like Christensen or Sull, or the result of an insider/outsider background. It is, they believe, hard-coded in our DNA.

The economic premium on responding to revolution not only helps to create the super-elite, it is one of the forces widening the gap between the super-elite and everyone else. The revolutions that those Harvard public school kids capitalize on create outsize rewards for the winners and, in the medium term, usually make the world a better place for everyone.

But in the short run, they also create a lot of losers: new technologies destroy old jobs and, according to extensive research by MIT’s David Autor, have significantly hollowed out the U.S. middle class; Russia’s market transition created seventeen billionaires in a decade, but also led to a 40 percent drop in GDP; Soros profited from the 2008 crash and it made John Paulson a billionaire, but millions lost their jobs, homes, and retirement savings. For the winners, revolutions can bring a windfall; for the losers, disaster.