The Bankers' Attack on Free Enterprise

...Their concentrated control of purchased assets results in “economies of scale,” they say, and yields greater innovation and productivity...

...If those enterprising companies are not able to resist the bank-financed raids of acquirers, Microdot’s managers assert, “There will be no way for American stockholders to realize the potential these growth companies represent...

...The stocks of those companies are, then, low in comparison to their earnings...

...This was a nightmare, and it occasioned public outrage which led to passage of reform legislation...

...Those enterprises would then pass along to consumers prices inflated by a closed, noncompetitive market...

...36 A recent Justice Department study noted that “high concentration, huge size and substantial market power are not prerequisites for research and innovation...

...While frowning on the practices of acquisition financiers, it frowns also on the thought of incurring their displeasure...

...The borrower’s purchase of the corporation would be made possible largely with the money waiting for it in the corporate till...

...Its means of payment would be a loan from a consortium of banks headed by Irving Trust...

...The direct cost to the public of conglomerate growth is substantial, since the multi-billion-dollar acquisition financing costs are ultimately paid by consumers...

...discourages new thinking and new ventures...

...Those companies, it found, have experienced declining profitability under the managements which boasted upon takeover that their purpose was to infuse management strength...

...Corporate Cannibalism Microdot futher alleges that from the information gained through its trust relationship, Irving Trust attempted to negotiate a loan to an acquirer on terms very favorable to the bank...

...But now, with corporate profits up sharply again, the rate of mergers is picking up slightly and is likely to accelerate in coming months...

...As seen, the National Bank Act’s prohibition against bank use of depositors’ money to purchase corporate stock was meant to prevent domination of industry by banks...

...Microdot is sorry to lose its independence, it says, but happy and relieved that its acquirer is Northwest instead of General Cable...

...That information was secured only by subpoena (or threat of it), for the performances of acquired companies is the acquirers’ most guarded secret...

...As did J. P. Morgan, the acquiring corporations assert that the expense to the public is justified...

...But although bank lending to finance acquisitions is greater now than then, the Federal Reserve does not reveal the extent...

...Most important, the act meant to prevent a bank from gaining such control over the economy that it could dictate which companies patronize which, and thus in the long run, the prices consumers pay...

...A prime consideration of International Telephone & Telegraph, for example, in plotting its acquisitions during the 1960s was the cash or financial resources which the target company could provide ITT...

...John Winslow, former counsel to the House Committee on the Judiciary, Antitrust Subcommittee, is the author of Conglomerates Unlimited: The Failure of Regulation...

...It called the plot “cannibalism...

...Market manipulation did not always work as well as it had with acquisition loans...

...They might think about protection for the public as well...

...Perhaps, then, efficiency and productivity considerations will figure more in the renewed merger trend...

...How else is the acquirer to repay the banks other than by charging more for the products and services of the combined companies...

...The House investigators found no evidence, however, that the bank or its officers made use of this information...

...It seems only prudent to warn that if another wave like that of the 1960s develops, not even a semblance of a free enterprise system may remain...

...First, the borrower promised to (and later did) transfer to the bank millions of dollars of the business of the purchased companies...

...And with the upturn, a greater role for banks is foreseen...

...Spurred by their success with acquisition financing, many large banks became leaders in other areas of “gogo” financing...

...But the faceless officers of a large bank like Chase Manhattan would make J. P. Morgan himself appear dull-witted for all the opportunities he missed to make money and sow discord...

...The decline in profitability should come as no surprise...

...With the information on Microdot’s rich cash reserves and profitability, the banks could afford to grant the loan even without security...

...Breathing room for noble failures and extravagant successes is lost...

...And General Cable could afford to pay the bank a generous premium for it...

...The second largest bank on the government’s “problem list” (and third largest in the nation), Chase Manhattan, affords a clearer example of the cost of bank-financed takeovers to the public at large...

...More specifically, the Act was intended to prevent a bank from securing the business of a competing bank% customers simply by gaining control of those customers and transferring their banking business to itself...

...As for productivity, “Acquired companies operated less efficiently after acquisition,” according to the House Judiciary Committee staff, which investigated the merger wave of the ’60s...

...But those areas were riskier...

...The study concluded: “The effect of bigness and its vested interest in the status quo is stultifying...

...The target company claimed it was being swallowed by a moribund parasite that sought to disguise dismal performance by robbing an innovative, prosperous concern of its independence and ability to contribute to the economy...

...Third, the House investigators alleged that Gulf & Western plotted its corporate acquisitions to secure sales to appreciative companies which in turn were beholden to the Gulf & Western Syndicate for their sales...

...Then there will be no future IBM, no Xerox, no Polaroid...

...The go-go gimmickery is not working any longer...

...A few years ago the Federal Re financing of corporate takeovers even the nation’s capital resources, especially in a time of tight money and putative capital shortage...

...The Securities and Exchange Commission also possesses that information, in data scattered over thousands of forms, but does not take the trouble to compile it...

...They say they are just in the business of making loans to credit-worthy customers and have no responsibility for how the money is used-so long as it is paid back with the specified interest...

...The Act was a formal recognition of the danger of allowing large banks to dominate the country by using the savings of the public...

...Why Big is Bad As for innovation, overwhelming evidence points to the opposite conclusion...

...The indirect cost of acquistions may be far more important...

...Modem concentrated economic power is certainly less visible...

...Northwest began its acquisition career by purchasing Chicago & Northwestern Railway, stripping it of its multimillion dollar assets and then using those assets-together with bank loans-to purchase other corporations...

...Bankers indignantly deny that their role in the merger upturn means that they are engineering a new shakedown, one which could destroy another quarter of the remaining independent U. S. corporations...

...Gentlemen’s Agreement ” Chase Manhattan achieved all of these prohibited actions during the 1960s through the device of acquisition loans, according to a 1969 and 1970 House Judiciary Committee investigation of conglomerates...

...The National Bank Act, passed in the 193Os, prohibited banks from using deposit funds to purchase corporate securities, on the theory that if The Washington Monthly/June 1976 they were permitted to buy stock, they would soon gain complete control of the nation’s industry...

...Microdot’s reasons for feeling relieved are not altogether clear...

...That is because large investment institutions-whose large purchases of a stock usually cause it to rise-are prone to ignore medium-sized corporations (sales of $100 million to $400 million...

...Instigating a vicious circle, they inflated the market value of their stock by puffing their earnings reports with the profits of corporations recently acquired, and then induced shareholders of the target companies to take overvalued stock in the big acquiring company in exchange for their undervalued shares in the little company being swallowed...

...Things were different in the go-go world of the 1960s...

...In Other People’s Money and HOW the Bankers Use It, published in 1912, Louis Brandeis described the power of J. P. Morgan and other bankers to dictate prices and to extort American industry by withholding vital rail services which their banks controlled...

...Less than half the acquisitions in that decade were financed by cash borrowed from banks...

...But whether they will for long may well depend on rewards to banks, which do stand to benefit from buying-for-itsown sake...

...All parties were enthusiastic except Microdot...

...But in those heady days, the chief executive of one of the most prolific acquirers, Bangor Punta Corporation, predicted that if the trend continued, by the year 2000 only 200 major corporations would exist...

...Now legislators are trying to figure how to protect the overextended “problem list” banks from their managements...

...These deals went by the unlikely name “tender offers...

...They will be choked off and smothered as soon as they start to show their real growth potential .” The reserves of those target companies will not remain in their control for developing competitive production efficiency-the basic long-term counteraction to inflation...

...During the first quarter of 1976, acquisitions of major corporations involved assets of $2 billion-more than double the figure for the first quarter of last year...

...For all the renewed interest in acquisitions,” The Wall Street Journal reported in April, “companies appear far more selective than in the 1960s” and are no longer “buying for its own sake...

...Irving Trust Company, for one, perceived the quick profitability of acquisition financing late last year when it allegedly perused confidential data on its own banking customers and found that a prime customer of 18 years, Microdot, 1nc.-on Fortune’s list of the top five companies in sales and profit growth for 1975-possessed $12.5 million dollars in cash...

...Instead, the acquirers paid mainly with their own stock...

...After acquisition, General Cable would add Microdot’s revenues to its own...

...In 1974 it sternly told bankers that they should lend for more productive purposes (such as for home building) and give lower priority to takeover loans...

...In 1912 Brandeis commented that industrial concentration financed by banks “results in arrest of development more serious even than the direct burden imposed through extortionate prices...

...That amount was almost half the total needed to buy 51 per cent of Microdot’s outstanding stock...

...Lender and borrower were not always protected by Microdot’s cash reserves waiting for the taking...

...And the cash is supplied pre-dominantly by banks...

...Liberals and conservatives were too distracted by other crusades to pay much attention to this internal attack on the free enterprise system...

...The instigators of the new merger wave of the 1970s will be respectable bankers, not sleazy 1960s conglomerators on the order of Robert Vesco or James Ling...

...Second, Gulf & Western informed Chase Manhattan of the companies which it would acquire, or appear to attempt to acquire...

...The bank would have been able to purchase, through its trust department, shares of those companies before their stock predictably rose in value as a result of the real and feigned takeover attempts financed by the bank...

...The Act also tried to prevent a bank from profiteering at the expense of the public...

...Being bargains, they are likely acquisition targets for big companies which can obtain loans to finance tender offers...

...In any event, on December 2, 1975, General Cable Corporation announced its offer to purchase all Microdot stock at a price slightly above the low market price...

...His prediction lost credibility with the onset of recession and a decline in the number of mergers and acquisitions in the early 1970s...

...For it will be the banks, who, by lending money to big corporations for the purpose of acquiring little corporations, will make the acquisitions possible...

...The increasing concentration of products into larger and fewer companies,” Business Week reported last February, has resulted in a “breakdown of U. S. innovation...

...This year bank loans have financed a far greater proportion of acquisitions than during the peak of the acquisition frenzy seven years ago...

...Exactly contrary to their vaunted claim, the largest acquirers take rather than give financial strength...

...Business Week only observes a truism as old as the industrial age...

...The former banks of those companies were left qut in the cold...

...But today, the role of banks in choking free enterprise through finance of mergers-as nightmarish in its way as the exploits of Morganarouses scarcely a whiinper...

...A firm specializing in acquisitions, W. T. Grimm & Co., predicts a new “upturn in merger activity...

...After so many casualties from the last bull market and its inflated growth stocks, the medium of exchange in today’s “tender offers” is cash...

...Committee investigators believed that Chase thwarted the purposes of the National Bank Act by entering into a “gentlemen’s agreement” with Gulf & Western Industries to supply it easy (unsecured) acquisition loans...

...Instead, that capital will be used in part to pay the inflationary acquisition loans...

...Similarly, acquisition financiers assert that the modern consolidators do not use power as blatantly as did the robber barons at the turn of the century...

...Microdot fended off General Cable’s attack only by offering itself in a “friendly” merger to Northwest Industries, which also is borrowing from banks to pay a slightly higher acquisition price...

...Big company bureaucracy...

...The economy, considered in its broadest sense, is diminished by the loss of each viable, independent enterprise...

...The irony of all this is that by lending money to others, the banks are able to foster what they are forbidden by law from doing themselves...

...The lessons of the 1960s have not been lost on the corporations...

...In a suit filed in federal court last January, Microdot alleged that the bank realized that a borrower could obtain control with a bank loan and repay almost half the loan with cash obtained from the company being acquired...

...Microdot’s managers assert that the freedom of a bank to use confidential information secured from profitable customers to plot takeovers will prove so lucrative to banks that the most successful growth companies will eventually become subsidiaries of conglomerate acquirers...

...When a small company dies, the dreams of its employees go with it...

...On the surface, Irving Trust’s willingness to underwrite the takeover of its customer appears to be a threat mainly to the customer’s managers and owners...