When the executives who control big-business investment decisions place a high priority on innovation and job creation, then we all have a chance for a prosperous tomorrow. Unfortunately, over the past few decades, the top executives of our major corporations have turned the productive power of the people into massive and concentrated financial wealth for themselves. Indeed the very emergence of “the 1 percent” is largely the result of this usurpation of corporate power. And executives’ use of this power to benefit themselves often undermines investment in innovation and job creation.

These corporations do not belong to them. They belong to us. We need to confront some powerful myths of corporate governance as part of a movement to make corporations work for the 99 percent. To start, we have to recognize these corporations for what they are not.

• They are not “private enterprise.”

• They should not be run to “maximize shareholder value.”

• The mega-millions in remuneration paid to top corporate executives are not determined by the “market forces” of supply and demand.

Let’s take a closer look at each of these myths.

1. Public corporations are not private enterprise.

Here’s something you’ll rarely hear stated by today’s politicians and pundits: Publicly listed and traded corporations are not private enterprise. As documented by the pre-eminent business historian Alfred D. Chandler, Jr., in a book aptly called “The Visible Hand,” about 100 years ago the managerial revolution in American business placed salaried managers in charge of running the nation’s largest and most productive business corporations.

This was a peaceful revolution in which a generation of owner-entrepreneurs who had founded these companies some decades earlier used initial public offerings on the New York Stock Exchange to sell their ownership stakes to the public, leaving decision-making power in the hands of salaried managers. In effect, these corporate employees, and the boards of directors whom they selected, became trustees of the immense productive power that these corporations had accumulated.

Even when founders of companies that evolve into major public corporations become their CEOs, they generally occupy the top positions as corporate employees, not owners. For example, when the late Steve Jobs returned to Apple Computer in 1997, 11 years after being denied the CEO position of the company he had founded, his ascent to the top position was as a manager, not on owner. When a company founder like Larry Page of Google gives up private ownership by publicly selling shares, he may become CEO of the new corporation, but he is occupying this position as a hired hand, not as a private entrepreneur.

In other words, private owners make choices to transform a private enterprise into a public company that then needs to be regulated as such. There are other choices that could have been made. When the retiring owner of a private company wants to pass on control over a prosperous company to his or her employees, an alternative to the public corporation is to establish an Employee Stock Ownership Plan, or ESOP. There are many successful companies in the U.S. that are not public corporations precisely because they are under the collective ownership of their employees.

It is also possible for some investors to agglomerate sufficient shares to take a public company private (Mitt Romney made his millions doing just that), but that only emphasizes the point: public corporations are not private enterprise. We regulate public corporations far more stringently than private businesses precisely because they are publicly held. And as U.S. citizens, how we regulate public corporations (or even private businesses, for that matter) is up to us.

2. Corporations should be run to benefit everyone who contributes to their success – not just shareholders.

It’s a myth that corporations have a legal duty to maximize profits to shareholders at the expense of everyone else. Historically, the executives and directors of U.S. public corporations understood that they had a responsibility to other constituencies – customers, employees, suppliers, creditors, the communities in which they operate, and the nation.

Today, however, the dominant ideology is that a corporation should “maximize shareholder value.” At the most basic level, the rationale for this ideology is that shareholders own the company’s assets, and therefore have exclusive claim on its profits. A more sophisticated argument is that that among all stakeholders in the business corporation only shareholders bear the risk of getting a positive return from the firm, while all other participants receive guaranteed returns for their productive contributions. If society wants risk-bearing, so the argument goes, firms need to return value to shareholders.

This argument sounds logical – until you question its fundamental assumption. Innovation, defined as the process that generates goods or services that are higher quality and/or lower cost than those previously available, is an inherently uncertain process. Anyone who invests their labor or their capital in the innovation process is taking a risk that the investment may not generate a higher quality, lower cost product. Once you understand the collective and cumulative character of the innovation process, you can easily see that the assumption that shareholders are the only participants in the business enterprise who make investments in productive resources without a guaranteed return is just plain false. In an innovative economy, workers and taxpayers habitually make these risky investments.

How do workers make these risky investments? As is generally recognized by employers who declare that “our most important assets are our human assets”, the key to successful innovation is the extra time and effort, above and beyond the strict requirements of the job, that employees expend interacting with others to confront and solve problems in transforming technologies and accessing markets. Anyone who has spent time in a workplace knows the difference between workers who just punch the clock to collect their pay from day to day and workers who use their paid employment as a platform for the expenditure of creative and collective effort as part of a process of building their careers.

As members of the firm, these forward-looking workers bear the risk that their extra expenditures of time and effort will not yield the gains to innovative enterprise from which they can be rewarded. If, however, the innovation process does generate profits, workers, as risk-bearers, have a claim to a share in the forms of promotions, higher earnings and benefits. Instead, shareholder-value ideology is often used as a rationale for laying off workers whose hard and creative work has contributed to the company’s success. That’s grossly unfair.

Taxpayers also invest in the innovation process without a guaranteed return. Through government agencies, taxpayers fund infrastructural investments that, given their cost and the uncertainty of returns, business enterprises would not have made on their own. It is impossible to explain U.S. leadership in information technology and biotechnology without recognizing the role of government in making investments to develop new knowledge and facilitate its diffusion. As one example, the current annual budget of the National Institutes of Health is about $31 billion, twice in real terms its level in the early 1990s. Without this government expenditure on research, year in and year out, we would not have a medicinal drug industry. Yet shareholder-value ideology is often used to justify low taxes that deny taxpayers a return on these investments.

So shareholder-value ideology provides a flawed rationale for excluding workers and taxpayers from sharing in the gains of innovative enterprise. To turn this ideology on its head, what risk-bearing role do public shareholders play in the innovation process? Do they confront uncertainty by strategically allocating resources to innovative investments? No. As portfolio investors, they diversify their financial holdings across the outstanding shares of existing firms to minimize risk.

They do so, moreover, with limited liability, which means that they are under no legal obligation to make further investments of “good” money to support previous investments that have gone bad. Even for these previous investments, the existence of a highly liquid stock market enables public shareholders to cut their losses instantaneously by selling their shares – what has long been called the “Wall Street walk”.

3. Executive compensation is a rigged game, not the result of the laws of supply and demand.

You often hear that stratospheric executive pay is the result of some inexorable law of supply and demand. If we don’t give top executives their multimillion dollar compensation, they won’t be willing to come to work and do their jobs. They are supposedly the bearers of “scarce talent” that demands a high price in the market place. Even Robert Reich, Secretary of Labor in the Clinton administration and a critic of U.S. income inequality, has justified the explosion in executive pay, arguing that intense competition makes it much more difficult than it used to be to find the talent who can manage a large corporation (“Supercapitalism,” 2008, pp 105-114).

That is not what determines executive pay. Here is how it works: Top executives select other top executives to sit on “their” boards of directors. These directors hire compensation consultants to recommend an executive pay package, which consists of salary, bonus, incentive pay, retirement benefits, and all manner of other perks. The consultants look at what top executives at other major corporations are getting, and say that, well, this executive should get more or less the same. Since the directors are mostly these very same “other executives”, they have no interest in objecting – and if any of them were to do so, they would find that they are no longer being invited to sit on corporate boards.

Meanwhile, given the preponderance of stock-based compensation (especially stock options) in executive pay, whenever there is speculative boom in the stock market, top executives of the companies with most rapidly rising stock prices make out like bandits. The higher compensation levels then create a “new normal” for executive pay that, via the compensation consultants and compliant directors, ratchets up the pay of all the top dogs. And, when the stock market is less speculative, these corporate executives do massive stock buybacks to push stock prices up.

What we have here is not “market forces” at work but an exclusive club that promotes the interests of the 0.1 percent. All too often executives allocate corporate resources to benefit themselves rather than to invest in innovation and job creation. It is time that the 99 percent see through the ideology, break up the club, and get the U.S. economy back on track.

Corporate power for the people!

Business corporations exist as part of the collective and cumulative development of our economy. The investments in innovation and job creation that these corporations make or decline to make are key to our future prosperity. Public shareholders, the supposed owners of these corporations, are in general only willing to hold shares in a company because of the ease with which they can terminate this relation by selling their shares on the stock market. Yet, almost unanimously, corporate executives proclaim that they run their companies for the sake of shareholders. In fact, their personal coffers pumped up with stock-based compensation, our business “leaders” have increasingly run the corporations for themselves.

The real corporate investors are taxpayers and workers. Through government agencies at federal, state, and local levels, taxpayers supply business corporations with educated labor and physical infrastructure. Through their interaction in business organizations, workers expend the time and effort that can generate innovative products. In the name of shareholder value, however, taxpayers and workers have been losing out. It’s time to confront the myths of “private enterprise”, “shareholder value”, and “market-determined executive compensation” with arguments about how the innovation process actually works with sustainable prosperity as the result.

What will it take to build a movement that can make the business corporation work for the 99 percent ?

We have to elect politicians who will take on corporate power rather than shill for corporate power-brokers. We have to support labor leaders who recognize that gaining a voice in corporate governance is the only way to ensure that corporations will invest in workers and create good jobs. We need teachers at all levels of the education system who understand what business corporations are and what they are not. We need the responsible media to escape from the grip of corporate control. And we have to put in place business executives who represent the interests of civil society rather than those of an elite egotistical club.

Getting Involved

- April 25: National Day of Action Against Student Debt

On April 25th, the total amount of student loan debt in the U.S. is due to top 1 trillion dollars. This staggering economic milestone marks a momentous victory for Wall Street and the 1 percent against two generations of students and families. A day of action will target big banks and student lenders, as well as increasingly corporatized universities.

-May 1st: May Day

Recognized worldwide as International Workers’ Day, May 1st marks the Haymarket Massacre of 1886 in Chicago, where workers were fighting for the eight hour workday. Look for rallies and gatherings across the country that will draw attention to the needs and concerns of workers.

-Move Your Money

The Move Your Money campaign was launched in 2010 to take on the power of the megabanks that helped cause the financial crisis and continue to wreak havoc on our economy. Numerous ongoing actions around the country are calling attention to the need for fairness and accountability in the banking industry (read about the latest: “Move Your Money” Goes Nationwide As Cities Pull Their Money”)

-Occupy Wall Street

The leaderless resistance movement continues to take on the greed and corruption of the 1 percent, including a recent day of action for public transit workers. Check the website for gatherings and actions in your community.

Yet the U.S. Chamber of Commerce wants us to think that corporations – preferably unregulated! – are the patriotic job creators in our economy. They want us to think it so much that in 2009, after the financial crash, they launched a $100 million campaign, which, among other things, draped their Washington, DC building with an enormous banner proclaiming “Jobs: Brought to you by the free market system.”

But the truth is that unfettered corporations are just about the worst thing for creating decent jobs. Here’s a look at why, and where the good jobs really come from.

Taming the Wild Horses

Corporations are kind of like wild horses. They can run you down. Or sweep you around in circles till you’re exhausted. And in today’s world, they’ll surely run off and take your jobs to China or someplace else if you don’t learn how to tame them.

Bad things happen when corporations are unconstrained by strong national policies that force players to think long term, behave decentlyand refrain from dumping their short-term costs on the rest of us. They tend to focus single-mindedly on maximizing profits for shareholders at the expense of all else – including jobs. Executives set their sights on a path to short-term boosts in share prices paved with layoffs, wage cuts and jobs moved overseas, while slashing research and development and investing in the skills of their employees.

The U.S. Department of Commerce found that from 2000 to 2009, U.S. transnational corporations, which employ about 20 percent of all American workers, cut their domestic employment by 2.9 million even as they boosted their overseas workforce by 2.4 million. The result was an enormous loss of jobs nationally, as well as a net loss globally.

In the 1990s, these companies added more jobs at home than abroad. What changed? 1) The rise of India and China, with 37 percent of the world’s population, as hotspots for off-shoring; and 2) the availability of tens of millions of workers in these places, many with college degrees, to do the jobs previously done by American workers.

In India, indigenous companies like TCS, Infosys and Wipro along with transnationals like IBM, HP and Accenture, employ hundreds of thousands of college-educated workers to perform IT services, in large part for American firms. In China, the electronics contract manufacturer Foxconn (headquartered in Taiwan) barely existed a decade ago, but now employs about 1.2 million workers, with Apple its single biggest customer.

And yet Big Business still trumpets itself as the American Job Creator Fairy. Apple has released a report claiming to have created half a million domestic jobs – a highly dubious number which takes credit for everything from the app industry to FedEx delivery jobs (never mind that drivers would be hauling someone else’s gadgets if Apple went out of business). It’s true that in the U.S. managers, engineers and other professionals have found good jobs at Apple. But the non-professional employees are just barely scraping by. A study of the iPod value chain in 2006 calculated that among Apple’s domestic employees, professionals earned around $85,000, not counting stock options, but the retail workers in Apple’s stores earned only $26,000. This is troubling because as Apple has grown in size, most of the employees it has hired in the U.S. work in retail. Are these jobs paths to long-term, stable careers? Quite likely they are not.

While a company like Apple whistles “God Bless America,” executives are not going to talk about the job losses induced by off-shoring, nor the horrifically abused foreign workforce that moving jobs to China has produced. And they’re not going to tell us about Apple’s preference for hiring part-time employees who can’t afford to buy health insurance. When such uninsured people have health emergencies, someone has to pay and the burden falls on the taxpayers.

Here is what Apple executives tell us instead: “We don’t have an obligation to solve America’s problems.”

The Real Deal

Corporate executives have lost the sense that they owe anything to the public. They have forgotten that the 99 percent, as taxpayers, have made huge investments in them. They fight to lower taxes as if all the money “belongs” to the companies. They fight regulations as if the public doesn’t have the right to interfere in their business.

All nonsense.

Despite the anti-government rhetoric from conservative leaders, the truth is that the government, elected by the people, plays a critical role in creating the conditions in which companies can succeed and good jobs can flourish. The government is able to invest in human capital through key services like education. What’s the point of a job if you don’t have an educated worker to fill it? The government also creates job-friendly conditions by investing in infrastructure. How can you get to work if your roads and bridges are falling apart? And it boosts job creation through investing in technology. How could Google create its amazing search engine without state investment in the creation of the Internet? When the government invests in the knowledge infrastructure, businesses can then employ and train people who can, in turn, engage in the kind of organizational learning that leads to that wondrous thing called “innovation.”

We learned this once before. After Wall Street financiers ran amok to cause the Great Depression in the 1930s, the government responded by putting in place regulations on banks and corporations, a highly progressive tax system and a robust social safety net. President Franklin D. Roosevelt created the conditions in which good jobs were possible with programs like the Civilian Conservation Corps and other New Deal initiatives. He focused on the development of highways, railways, airports and parks, investing in the future rather than focusing solely on short-term profits. The GI Bill, rather than leaving graduates with big debts, left them well educated and therefore with a chance of to provide a middle-class life for their families and to retire with dignity.

After victory in World War II, America was able to emerge as the world’s most powerful nation because it had a large middle-class and a strong industrial and technological base. The horses of Big Business were tamed, and they could be harnessed to do useful things for society. Then came the Reagan Revolution and Big Business freed itself from the regulations, unions and taxes that had curbed its worst instincts and it began to shred the nation’s economic and social safety net. The gap in income inequality grew, and jobs were eliminated and outsourced. Long-term investment in innovation and human capital slowed down, while fraud and financial speculation took off.

Today, corporate executives ask for more special treatment and freer rein in calling the shots in our economy, and they threaten to pack their bags if we don’t agree. Some politicians and policy makers respond to this blackmail by saying that we have to create a “friendly business climate” to convince them to stay. But what makes a “friendly business climate”–low wages, minimal taxes and so on — creates a very hostile climate for the 99 percent, which is ultimately bad for everyone – business included. The state of Mississippi and Rick Perry’s Texas, where city and state officials bent over backwards to lure Big Business with subsidies and other perks, are hardly bursting with good jobs.

Many researchers have concluded that tax rates are actually not terribly important to where a company locates. Further, a common rule of thumb for business headquarters location is that quality of life for key personnel is decisive. True, vastly different levels of regulation in the U.S. and China is a problem for which there are no easy answers. But there are real costs to ignoring the environment and keeping workers in a state of misery. If you want job growth, you have to have demand growth: profits and consumption go hand in hand.

That’s why the best way to unleash America’s job-creating potential is to support rights and protections for ordinary people. A climate friendly to the 99 percent is not just fair, it makes the best sense for the economy. We need to remember the complementary roles that government and business have to play in creating well-paid, stable employment opportunities and then ensuring that people can access these opportunities over the course of their careers. To get corporations working for the 99 percent on the job front, we have three major challenges:

1) Education: Young people from low-income groups (especially blacks and Hispanics) need schooling and training to move to good career jobs.

2) Incentives: Corporations must have incentives to retain educated and experienced workers instead of laying them off or off-shoring their jobs. (To do so forces valuable workers into low-skill jobs and wastes their human capital, which was expensive to acquire.)

3) Investment: Executives of financialized corporations who want the government to invest in the knowledge base have to make complementary investments in people that can keep the U.S. economy innovative and generate good jobs. That would mean changing the single-minded focus on boosting company stock prices through buybacks and other financial manipulations that serve the 1 percent but no one else.

Exiting: Greg Smith, executive director of Goldman Sachs’ U.S. equity derivatives business in Europe, the Middle East and Africa, who has resigned in protest of the company’s culture of toxic greed and published his reasons in a New York Times op-ed.

This tale of coming and going, and the public reaction, speaks volumes of the power of Goldman Sachs and the public rage over its ethical lapses.

Which will speak louder? The answer will serve as a barometer to how far America has come in challenging a destructive financial system.

The Devil’s Work

Back in 2009, Rolling Stone’s Matt Taibbi launched the key media indictment of the mega bank’s excesses, famously dubbing the firm a “blood-sucking vampire squid.” Taibbi unsparingly detailed the vast economic and political power of Goldman and its history of destructive market manipulation that helped devastate the world economy in the 2008 financial crisis.

Taibbi’s story involved some of the most influential men in recent U.S. history, including Hank Paulson, Robert Rubin, and other members of a privileged fraternity of Goldman-affiliated players whom he called out as political puppeteers working on behalf of a corrupt financial industry. It was a tale of greed triumphing over democracy. Goldman Sachs was the predator, and we the people, our money sucked away in a “giant pump-and-dump scam,” were the broke and bewildered prey.

Taibbi was vilified by many members of the press for his audacity, and it wasn’t just the conservative press that pounced. Tim Fernholtz accused Taibbi of lying and called the piece a “conspiracy theorist’s dream” in the liberal American Prospect.

A few voices came to Taibbi’s defense, including economist Rob Johnson, who published his reaction on a blog I edited at that time. Johnson pointed out that Taibbi’s article would “surely be discounted by some as hysterical or exaggerated, particularly by those whose senses are deadened by the business press or CNBC-style babble.” But Johnson felt that Taibbi’s outrage was more than justified:

“He is screaming in a way that a healthy press would do in a hysterical time. Goldman Sachs’ uncontested success blurring the boundaries between market and state is symbolic of a tremendous malfunction in finance, politics and civil society.”

The Goldman apologists might dismiss Taibbi as hysterical. But it was a little harder to wave away the condemnation that appeared in the New York Times this week from a man who had worked at the firm for 12 years before quitting because he could no longer tolerate what he described as a culture as “toxic and destructive as I have ever seen it.”

Rip-off, Inc.

Greg Smith came to Goldman as a college intern and over the years has helped recruit students to join the firm. But after 12 years, he found himself working for a company that had become so blinded with greed that its clients were no longer there to be served, but to be duped, profited from, and disparaged. Smith wrote:

“It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as ‘muppets,’ sometimes in internal e-mails.”

Regardless of the legality of Goldman’s activities, Smith found the absence of integrity and the single-minded focus on pushing potentially harmful investments on clients to be destructive and repellent: “I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.”

This announcement came on the heels of a report from none other than Matt Taibbi that Goldman Sachs had just hired a man as global head of mortgage trading whose background is as shady as it is outrageous. Jeffrey Verschleiser, a former Bear Stearns executive, was already making the news back in January, when he bought out a popular Aspen hotel and shelled out $500k to $1 million for his daughter’s bat mitzvah party. The community was disgusted, particularly as this same man had been named in a lawsuit against Bear Stearns that claims the company took millions of dollars from clients in the name of profits and bonuses. Teri Buhl, who broke the story for the Atlantic, named Verschleiser as a key figure in a scheme among Bear traders to sell toxic mortgage securities to investors and then sell back the bad loans with early payment defaults to the banks that originated them at a discount. “The traders would pocket the refund, and would not pass it on to the mortgage trust, which was where it should have gone to be distributed to the investors who owned the bonds.” In other words, Verschleiser and his pals were getting paid twice on the same deal, what’s known as “double-dipping.” The Bear traders cynically referred to these crappy bond mortgages as “sack-of-shit” bonds.

Verschleiser was hired by Goldman Sachs. Two days later, Smith released his op-ed in the Times, which pointed to a “toxic leadership culture” as one of the key problems at the bank.

Release the Kraken!

The vampire squid froze for a moment in horror. And then a tsunami of attacks on Smith and defenses of Goldman covered the media. Within 24 hours, the following stories appeared:

Greg Smith Isn’t A Whistleblower, He’s Just A Goldman Sachs Executive Having A Midlife Crisis (Nathan Vardi, Forbes)

“Smith is not the first person who wants to tell his former bosses to shove it. He is also not a whistleblower. He remained happily employed at Goldman after it took a massive taxpayer bailout.”

Read: Traitor!

Greg Smith Doesn’t Like Goldman Sachs, But MBAs Still Do (Kurt Badenhausen, Forbes)

“Smith might think that Goldman is undergoing a ‘decline in the firm’s moral fiber,’ but MBA students are still clamoring to get in the door of the investment bank.”

Read: Who cares about morality when you can make $$?

Yes, Mr. Smith, Goldman Sachs Is All About Making Money (The Editors, Bloomberg)

“If you want to dedicate your life to serving humanity, do not go to work for Goldman Sachs. That’s not its function, and it never will be. Go to work for Goldman Sachs if you wish to work hard and get paid more than you deserve even so.”

Read: Goldman Sachs doesn’t have to serve society. How cool is that?

The ballad of Greg Smith (Felix Salmon, Reuters)

“It’s much easier to see the disgruntled ex-employee here, quitting in a huff, than it is to see someone genuinely trying to do his part to reconstitute the Goldman Sachs of Gus Levy and John Whitehead … The most remunerative skill, at Goldman, is the ability to flatter someone into believing that they’re incredibly important and clever and sophisticated, even as you’re getting that person to do exactly what’s in your own best interest.”

Read: Fiduciary duty is for suckers. Not for blood-sucking vampire squids.

Goldman on Trial

One of the most memorable spectacles of the Occupy movement was a mock trial held in Zuccotti Park in which philosopher Cornel West and journalist Chris Hedges teamed up with people directly impacted by Goldman Sachs’ destructive policies to publicly accuse the firm of crimes against society. “The People v. Goldman Sachs” concluded with a verdict that found the bank guilty of felony fraud and a demand, among other things, of the return of billions looted from the U.S. Treasury.

Now, perhaps, is the moment for a broader public trial.

Paul Volcker has praised the Smith op-ed and denounced the conflicts of interest rampant in the industry. The blogosphere is ablaze with commentary testifying to widespread anger at the firm and all it represents, including Mike Lux’s piece in the Huffington Post, which includes a petition demanding that Mitt Romney lead the charge for Lloyd Blankfein’s resignation. Web satirists are having a field day — a parody popped up on the Daily Mash website in which Darth Vader resigns from the Empire, unable to swallow its unethical behavior.

Most upsetting for Blankfein, I’ll wager, is that money talks. The company’s shares have already taken a steep dive, evaporating $2.15 billion of its market value.

Hard to say where this will all end. The vampire squid has lost a tentacle, but it knows how to grow three more in its place. Unless, of course, it finds that unmitigated greed and corruption don’t pay quite as well as they used to. At water coolers, dinner tables, classrooms and newsrooms across the country, the people will be asking, how have we allowed this predator to exist in our midst? And some very wealthy clients will be asking, why the hell are we giving this thing our money?

There’s also a lot they don’t know. Some things, like your race or marital status, are prohibited by law from being considered in credit scoring. Other things, like your employment history, where you live, or how much you’ve saved, don’t fit into the algorithms FICO uses. Any normal person might suspect they are relevant to assessing the quality of your credit, but they won’t make a difference in your score.

We are all living, breathing human beings, but big businesses and banks have turned us into half-baked statistics in order to grease the wheels of capitalism – wheels that often catch us in their spokes. At best these statistics are inexact; in many cases, they are much worse than that, with disastrous consequences for the humans they purport to describe.

How did this happen and what can we do about it?

A Bit of History

Credit reporting in the U.S. kicked off in the 19th century when retail merchants and other interested parties created loosely organized local exchanges of information. In a big, young and mobile country, lenders understandably wanted to know something about the people doing the borrowing. Given the cultural norms and the lack of reliable data around, creditworthiness was closely connected to popular notions of “character,” like honesty and thriftiness. This emphasis led local retailers to collect intimate details about peoples’ health, drinking habits and sexual behavior from newspapers and gossip. Being Jewish could also earn you a bad credit rating, or being Chinese, or Catholic, or unmarried, all of which were associated with questionable “character.”

As communication technology developed in the 20th century, the loose-knit organizations evolved into credit bureaus that went national – they were actually among the first businesses in the U.S. to do so. They got quite savvy and efficient about zipping information about consumers from coast to coast. FICO was founded in 1956. Two years later it began selling its credit scoring system. It was the first company to develop algorithms for generating credit scores and got paid royalties for their use.

As these systems grew and became more deeply embedded in the nation’s financial system, they increasingly impacted the the lives and opportunities of citizens. The work of advocacy groups defending consumer rights led to new laws that tried to address fairness and accuracy in credit scoring. In 1971, the Fair Credit Reporting Act (FCRA)  gave consumers, among other things, the right to view and dispute reports. The laws continue to be tweaked in an effort to keep up with a rapidly expanding and increasingly influential business. In 2003, an amendment was passed giving consumers the right to view one free credit report a year.

The Federal Reserve inherited consumer rule writing in the 1960s, and for a long time, officials at the Fed took their role seriously and had competent staff. Paul Volcker, Fed chairman from 1979 to 1987, was widely regarded as reasonably tough on consumer affairs and maintained a decent apparatus to regulate industry players and investigate abuses.

Then along came Alan Greenspan. Greenspan’s fanciful free-market economic theories and world view rendered him completely uninterested in consumer affairs matters. Consumer affairs work at the Fed declined sharply in quality and strength. In the past, the Fed had promoted fairness and accuracy in credit scoring as a shield for banks that might face discrimination charges. But in the 1980s and 1990s, bankers turned the shield into a sword. They began holding the scores over consumers’ heads.

Pressures from Wall Street convinced banks to chase consumer fee income, and they began to use credit scores as a device for justifying higher fees. Ever wonder how bank CEO pay started skyrocketing? Socking consumers with above-average interest rates and collecting fees on late payments and other penalties is a big chunk of bank earnings today. If consumers balked or missed a payment, they would be threatened with lowered credit scores. Consumers became hostages.

Today, FICO sells its assessment of your creditworthiness to credit rating bureaus – the three giants are Equifax, Experian and TransUnion, and their reports influence everything from credit cards to mortgages to job offers. A bad score will cost you dearly. For example, a borrower with a bad credit score could end up paying more than $5,000 in extra interest on a $20,000, five-year car loan. Most banks use the scores to set finance charges; the lower the score, the higher the interest rate on a new loan.

Millions of Americans have seen their credit scores plummet since the financial crash. Meanwhile, the credit-scoring business is rife with problems and abuses, ranging from processes that favor speed over accuracy to preferential treatment for the rich and powerful. Unless you are wealthy, you will likely have to borrow money at some point in your life, whether to buy a house or attend college. Here are a few things you need to know about these all-powerful scores that dominate our lives.

Fast, Cheap and Out of Control

Businesses and banks rely on consumer credit bureaus as authoritative sources of accurate information and analysis. But are their calculations up to snuff? Not really, alas.

A credit score is created when an algorithm is applied to the data in your credit file. This system started out with limited pencil-and-paper calculations, and later clunky operations on early computers. Things took off in the 1980s with the development of turbo-computing power and the ability to do massive data mining. A new branch of applied science was born, and by the 1990s, firms were using large databases in order to make predictions about consumer behavior.

Proponents hailed this as a major intellectual breakthrough. What was once a slow and cumbersome process of pouring big data sets into computers and then painstakingly figuring out correlations became a fast, easy operation on mega-computers. Once the firm ponied up the large initial investment in computers, it was home-free. New consumers and more data could be added at very little cost. This system was irresistibly alluring to mathematicians and statisticians – and to profit seekers.

But the new statistical models could best be described by the title of an Errol Morris documentary: “Fast, Cheap, and Out of Control.” The beauty of credit scores for the financial industry is that they’re inexpensive to produce. Profit incentives have led to a sort of cut-and-run, brute force data mining in which the possibility of errors is enormous. Political economist Thomas Ferguson, who uses large data sets to do analysis of voting patterns, political money and stock market phenomena, scoffs at the crudity of systems used in credit scoring. “The results probably would not pass muster in any serious academic journal,” he says. “You almost certainly couldn’t publish the results.”

One problem with credit scoring is related to the so-called “lantern problem” common to scientific inquiries, illustrated in the stock image of a person looking for lost keys where the light is shining rather than where the keys are actually lost. In the case of evaluating credit risk, the statistician will use whatever data is around to plug into the algorithms, rather than ferreting out information that would best determine actual credit worthiness. She may be able to get a certain type of history this way—drawn from your checks, purchases and other typical activity. But she can’t get at the atypical parts, such as whether or not you are out of work, about to come into an inheritance, or have co-signed a note so your children could get a mortgage.

Because credit scoring and reporting firms sell their products to banks, and banks like to assign high interest rates, guess what kind of information about you they don’t like to put in their reports? Positive information. Negative information, like missing a payment on your phone bill, is welcome. Positive information, like your steadily increasingly salary or the fact that you paid down a credit card, is not.

Credit scoring has some predictive accuracy, but not nearly enough to justify its influence. In old-fashioned risk evaluation, a loan officer at a bank would sit down with an individual and study the typical and atypical factors that make up a person’s credit history. Then he or she would make a judgement about credit worthiness that incorporated what wasn’t in the statistical models, as well as what was. Obviously, you can’t rapidly and cheaply assess credit risk on tens of millions of people using personal interviews. And so now we have a fast, cheap, effectively hit-or-miss system that can prevent you from renting an apartment or getting a job. The motivation of the industry is now less about actually finding out if you’re credit worthy, and more about finding out how lenders can make profits off you.

The Oligopoly Game

Competition is not exactly robust when it comes to consumer credit scoring and reporting. The industry, which does $1 billion a year in business, is dominated by four players: FICO controls the vast majority of the credit score market in the U. S. and Canada, and its scores are distributed by only three major companies, Experian, Equifax and Transunion. FICO is at the very top, condensing our credit worthiness into the three-digit FICO score. Experian, Equifax and Transunion use the FICO scoring system to come up with their own credit scores, based on data they collect about you in their systems. They then sell access to those scores to millions of businesses that want to make various decisions and judgments about you.

Around 90 percent of banks use FICO scores, along with the 25 largest credit card issuers. Talk about industry dominance!

When an industry becomes an oligopoly, several things that are bad for consumers tend to happen. Product innovation becomes limited. Players can collude to raise prices, even as the cost of doing credit scoring and reporting goes down. Up until very recently, you could not get a credit report or score without paying for it, a major reason for the 2003 law requiring that consumers be allowed to view one free report per year.

Worse still, there’s not much incentive to get things right when oligopoly conditions exists. The law provides little penalty to these giant firms when they screw up, and it’s not like consumers can vote with their feet when the product is shabby. You can’t remove your information from the bureaus without enormous hassle, and you can’t take your business elsewhere.

Error Explosion

A shockingly high portion of consumer credit reports contain errors. But just as firms are not rewarded for including positive information in your credit report, neither are they rewarded for removing erroneous information.

Horror stories abound. Like the man who was refused a mortgage for money owed on an appendectomy he never had. Chances are high that if you just ask amongst your friends, you’ll find someone who was inconvenienced–or worse–by a credit score or report error. A study released by the U.S. Public Interest Research Group in June 2004 found that 79 percent of the consumer credit reports surveyed contained some kind of error. Of these, a quarter contained mistakes serious enough to result in the denial of credit, such as false delinquencies or accounts that belong to somebody else.

Several years ago when I was looking to buy an apartment, I checked my credit reports and found a listing for a bank account I supposedly opened in Texas, a place I have never lived. I had to go through an irritating and time-consuming process of writing dispute letters in order to get this false information removed.

Typical errors include credit bureaus mixing the files and identities of consumers; attributing a debt to the wrong consumer; incorrectly recording payment histories; and inaccuracies caused by identity theft or compromised data, which the agencies often try to conceal.

Credit reporting agencies have a legal obligation to address errors, but the Federal Trade Commission (FTC) is lax in enforcing the rules. The perfunctory, mechanized system currently used by the industry to deal with error complaints is a travesty. (For more on this, see the 2009 report by the National Consumer Law Center, “Automated Injustice.”) Credit bureaus don’t have much incentive to carry out thorough investigations, and the burden of proof is placed squarely on the consumer. The consumer, after all, is not the primary paying customer, so why should the credit reporting agency spend its dollars and time resolving her disputes?

If you get screwed by this system, you can take your complaint to court. But that can be a slow, costly and frustrating experience. An entire sub-industry, the credit repair business, has arisen to address this consumer nightmare – and to profit from it. The credit repair industry has a symbiotic relationship with the reporting and scoring industry. Companies charge stiff fees, maybe $250 up front plus monthly maintenance, for promising to do things you should, in theory, be able to accomplish yourself, like writing dispute letters. Why do they have better luck? Maybe because they get the V.I.P. treatment. And they aren’t the only ones.

Preferential Treatment for the 1 Percent

The major credit ratings bureaus are known to have a two-tiered system for addressing errors. If you’re rich and powerful, you get special treatment. In May 2011, a report by the New York Times revealed that Equifax, Experian and TransUnion keep a V.I.P. list of celebrities, politicians, judges and other muckety-mucks who will get rapid response to error claims. And for the other 99 percent? Expect to have your complaint funneled into an automated system and farmed out to overseas contractors where a worker will spend an average of two minutes figuring out the problem.

Perhaps this explains why members of Congress are so uninterested in credit scoring issues. They don’t have to worry about them. Time to Occupy the credit bureaus?

Who’s Looking at You?

Credit reports are a goldmine of information on consumers. Landlords, insurance companies, employers and potential employers, child support enforcement agencies, and others can now gain access to your report. According to the New York Times, 40 percent of employers now do credit checks on their employees. This creates a vicious cycle whereby a person may get into financial difficulties, say, from an illness, and then find that getting or maintaining a job is impossible due to a low credit score. Which leads to foreclosures. And broken families. And untold human misery.

Who else gets gets to see your scores? Marketers, for one. Generating and selling lists for use in “pre-approved” credit and insurance offers is allowed by law. TransUnion, Experian and Equifax all engage in selling lists of consumers who meet certain criteria in order to receive an offer of credit or insurance. This is the source of the many pre-approved credit offers that clog your mailbox. In order to opt out you must remove your name from any marketing list compiled by a credit rating bureau, whether the list is for pre-approved credit offers or direct marketing. (Call 888-5-OPTOUT or 888-567-8688, or go online to www.optoutprescreen.com.)

Right from the earliest days of the industry, control of information on consumer credit was a problem. When you want to borrow, you do expect to give up some privacy in return for the privilege. But with high-speed, error-prone, profit-driven transfers of information, plus toothless national laws, the chance of your information ending up in the wrong hands is too high for comfort.

Criminals interested in identity theft are delighted by the easy availability of confidential financial information, coupled with sloppy practices by creditors and credit bureaus, which routinely lose data. This makes it a cakewalk for crooks to do things like open accounts in your name. The credit scoring and reporting agencies will now sell you products and services that are supposed to protect you from identity theft — which is ironic, considering that their activities make much of this identity theft possible in the first place!

Then there are potential national security issues. What if a foreign company, say, a Chinese company, decided to buy up an American credit reporting bureau? Or maybe a Mexican drug cartel? What use would they make of that information? Let’s hope we don’t find out.

A People’s Revolution?

The system of credit scoring and reporting is clearly in dire need of reform. But how are we ever going to get it?

The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed by Congress in 2010, ensures that you are now entitled to a free copy of your credit score if you are denied a loan based on that score, and also if you get a high interest rate on a new loan. This is a positive development. But what is the mantra of nearly every Republican candidate for president? Repeal Dodd-Frank! Meanwhile the Obama administration is less than eager to push on consumer rights — which is why Elizabeth Warren is running for Senate in Massachusetts, instead of heading up the new Consumer Financial Protection Bureau.

Warren conceived CFPB as a watchdog that would oversee credit scoring and reporting practices and serve as a recourse to consumers. The bureau released a helpful preliminary study in July 2011, which looked at how scores purchased by consumers and those shown to lenders can vary, leaving consumers in the dark about their actual credit worthiness. We can be thankful that the bureau is doing these ongoing investigations. But without Warren at the helm, and given CFPB’s placement inside the bank-centric Federal Reserve, its impact will be restricted. The industry, along the politicians it lavishes money upon, will try to stymie even its most modest efforts.

The truth is that fundamental reforms are required if we want to truly take back our lives from these credit scoring juggernauts. Attorney Walker Todd, who spend two decades in the legal departments of the Federal Reserve Banks of New York and Cleveland, assured me that in order to even begin to address the systemic and structural problems of the industry, a full-dress congressional hearing is order, ideally in three parts, as follows:

1) Role of regulators in the industry. Regulators would come in and testify under oath exactly how they conceive of their role. (You get a maximum potential for embarrassment here.)

2) History of the industry. Focus on how the purpose and design of the industry have changed from the pre-1990s to the present. This section would also address structural changes in the banking industry that have made credit reporting a mess.

3) Testimony on misuses. Consumers would get to tell their stories about the misuses of credit scoring and reporting.

The overall purpose of the hearing would be to determine whether current arrangements and systems have improved the availability and condition of credit, degraded it, or left it about the same.

The bad news is that our broken political system makes such a hearing a very difficult proposition. In the House, Rep. Maxine Waters, the ranking Democrat on the Financial Services Committee, may not have the necessary support to lead such a hearing. In the Senate, the chairman of the Committee on Finance, Max Baucus, wouldn’t touch the subject with a 10-foot pole. Senator Richard Shelby, the ranking Democrat on the Committee on Banking, Housing and Urban Affairs, has sometimes exhibited a healthy distrust of bankers. But his colleague, Senator Tim Johnson, the chair, hails from South Dakota, where Citibank reigns supreme.

Which brings us to the White House. It’s critical to have an executive branch agency that can deal with consumer issues. But of course, CFPB is conveniently housed in the Fed, where the very bank-friendly Ben Bernanke will have to go along with regulations and scrutiny. What we need is a president willing to go to bat on an issue that affects the daily lives of so many of his constituents. We probably shouldn’t hold our breath. With bank-loving advisers like Timothy Geithner and former JPMorgan exec Bill Daley roaming the White House, consumers’ interests are an afterthought. Besides, the president is trying to raise a billion dollars for his election campaign, a great deal of which will come from the financial sector.

What’s left then? A people’s revolution may be the only thing that will truly get the ball rolling. The Occupy Wall Street movement has shined a light on the problem of money and politics, which is crucial to address if there is to be any hope of getting our elected officials to act in our interest. Robust reforms like a constitutional amendment regulating money in elections have been floated, and should remain front-and-center in the national dialogue.

Or how about a credit-reporting agency of the people, for the people and by the people? Similar to the Move Your Money campaign, a Move Your Credit Score campaign might be an experiment worth running, if only to keep the topic in the minds of the public. The idea is that we would all volunteer to submit our information to our own agency, which would agree to sell its scoring to banks and other lenders at a lower fee that those currently charged by credit ratings bureaus. The banks would certainly try to squash it, but a national campaign would be a good way to expose the mess and gain the attention of the mainstream press, which has so far largely confined its reporting to “How to Improve Your Credit Score” pieces.

Taking back the control of our financial destinies is something the 99 percent can certainly rally around. Left, right and center, this is an issue none of us can escape.

Conservatives are tasked with coming up with a narrative that makes villains out of these working folks and heroes out of the powerful people who aim to squeeze them for what’s left of their economic security.

This is not easy. And you have to admire their ingenuity. Amity Shlaes, ever the eager revisionist, has whipped up a widely parroted narrative that contains just enough truth to give it the ring of plausibility. It goes like this: Governor Scott Walker is a paragon of virtue who will soon be embraced by the American public, just like his union-crushing predecessors Calvin Coolidge and Ronald Reagan. According to Shlaes’s account, Coolidge, then governor of Massachusetts, stood boldly against badly abused Boston policemen who walked off the job in 1919 and left the city unprotected against looters. After firing the policemen, Coolidge became a national hero and was promptly swept into the Vice President’s office on a wave of popular admiration. When President Warren Harding died, Coolidge took office and it was suddenly Morning in America. As Shlaes tells it:

“‘Boston Police’ remained American code for the principle that union causes do not trump others. The concern that the U.S. might succumb to European-style revolutions lifted. Strikes abated. Wages rose without unions in Motor City. Private-sector union membership declined. Joblessness dropped. Companies poured cash, which they otherwise would have spent on union relations, into innovation.”

Let us fill in some finer detail, shall we?

As Shlaes admits, the Boston police force had been grossly abused with long hours and horrific conditions. And it was true that there was some disorder when they walked off the job, though she somewhat overstates the case. It is also true that Coolidge’s response made his reputation as a Republican politician.

But it was not exactly popular enthusiasm that wafted Coolidge into the White House. Actually, there was a huge orchestrated effort to push Coolidge by powerful financial interests. He ended up on the ticket with Warren Harding not so much because of his overwhelming appeal to the American public – he was known for being taciturn, unsociable, and downright weird (Alice Roosevelt Longworth wondered if he had been “weaned on a pickle”). Rather, it was his overwhelming appeal to American bankers.

They knew a good thing when they saw it.

Young Coolidge, you see, had gone to Amherst College, where he had hardly any friends except Dwight Morrow, who became his bosom buddy. Coolidge went on to become a small town Massachusetts attorney representing banks, while Morrow became a senior partner in House of Morgan. When Morrow saw his pal Coolidge attracting attention in the Boston Police Strike, he wrote to everyone he knew and launched a national campaign to make a legend out of the uncharismatic Coolidge. Morrow and fellow Morgan partner Thomas Cochran lobbied tirelessly for Coolidge at the Chicago Republican Convention in 1920, and their lobbying paid off. Coolidge, first as vice president and then as president in 1923 when Harding died, became a valuable partner for the House of Morgan. Famously declaring that “the business of America is business,” Coolidge stocked his administration with enough Morgan men to fill a banking convention. Historian Murray N. Rothbard notes that

“the year 1924 indeed saw the House of Morgan at the pinnacle of political power in the United States. President Calvin Coolidge, friend and protégé of Morgan partner Dwight Morrow, was deeply admired by J.P. “Jack” Morgan, Jr. Jack Morgan saw the president, perhaps uniquely, as a rare blend of deep thinker and moralist. Morgan wrote a friend: ‘I have never seen any president who gives me just the feeling of confidence in the country and its institutions, and the working out of our problems, that Mr. Coolidge does.’”

Coolidge got to the White House for crushing unions, where he slept ten hours a day and hopped on and off a mechanical horse in his underpants and a cowboy hat.

Here’s what America got: the Great Depression.

Coolidge’s real legacy was a huge upward shift of income during the “roaring twenties” away from ordinary people to the rich and powerful, who got even richer and more powerful thanks to his regulatory and policy inactivity. The best Average Joe could hope for under Coolidge was for his income to hold steady. The profits from that wondrous innovation and growth that send Shlaes into rhapsodies went to fatcats who turned the country into a casino and smashed the economy.

Reagan’s history is better known — or so you would think. His firing of 13,000 striking workers was, as Washington Post columnist Harold Meyerson put it, “an unambiguous signal that employers need feel little or no obligation to their workers.” After Reagan, employers were emboldened to illegally ditch workers who sought to unionize, replace permanent employees who could collect benefits with temps, and ship factories and jobs abroad. Ever-smiling with his friendly cowboy image, Reagan tried to lower the minimum wage for younger workers, weaken child labor, job safety and anti-sweatshop laws, and do away with training programs for the jobless. He also did his best to replace thousands of federal employees with temps without civil service or union protections. Under his watch, the share of the nation’s wealth held by the richest 1 percent of Americans went up 5 percent richer. Guess whose declined?

At the time, Americans were supportive, by slim margins, of Reagan’s stance against the air traffic controllers, who went on strike to win benefit concessions from the federal government. However, the comparison with Wisconsin workers is not exactly apples to apples. These workers have agreed to concessions, and only fight to maintain their right to collective bargaining. Intuiting correctly that the public may not be on their side in this battle, conservatives have relentlessly pushed the deceptive idea that public employees enjoy higher salaries and better benefits than their private-sector counterparts. But this has been widely debunked. Careful research has shown that when you adjust for skill levels, public sector workers are not overpaid relative to private sector pay scales.

After the Great Crash, Coolidge’s bank-friendly, union-bashing policies didn’t seem like such a great gift to America. And just like in the twenties, Reagan’s signal that it was open season on unions energized a much bolder effort to hold down wages by corporate America: Over the next few years, workers by the thousands were let go, found their pay slashed, and turned into poorly paid part time employees. US income inequality reached Himalayan levels as people’s share of the benefits from increased productivity took a sharp nosedive. Today, after the Great Recession, Reagan’s anti-union attitude and enthusiasm for deregulation has also proven to be a dubious legacy.

Governor Walker says he’s fighting for ordinary Americans. So why does he want to require unions to re-certify every year, but we don’t hear a peep about corporations being required to renew their charters every year? Why does he want to control the salaries of public employees, but doesn’t have any interest in controlling the salaries of grossly overcompensated corporate CEOs? Why does he call for sacrifices from hard-working people who have been screwed by the economy through no fault of their own, and none from the financiers who caused the crisis?

Maybe it’s because he has quite a bit in common with Coolidge and Reagan after all. In Reagan’s case, as in Coolidge’s, busting unions led to some of the biggest peacetime income re-distributions in modern history. Democracy got weaker, oligopolies got stronger, the rich got richer, and the rest of us got left behind.

The real lesson from Coolidge and Reagan is this: If Governor Walker and his Republican friends are allowed to crush the public unions, you ain’t seen nothing yet.

Lynn Parramore is Editor of New Deal 2.0, Media Fellow at the Roosevelt Institute, and Co-founder of Recessionwire.