This reality was painfully apparent in the oil business. Government intervention affected every aspect of the industry. And the intervention reached its peak as Charles Koch was building his company.
* * *
On November 7, 1973, shortly after the Arab oil embargo, President Richard Nixon proposed a sweeping government response. The government would cut the “allocations” of heating oil for homes and businesses by 15 percent, essentially rationing the vital fuel. Nixon said utility companies would be banned from switching from coal to oil as a fuel source. He would ask Americans to turn down their thermostats by about six degrees. He would ask Congress to pass a bill that would lower the national speed limit to fifty miles per hour, curtail the hours that shopping malls could be open, and impose other rationing measures.
“It will be essential for all of us to live and work in lower temperatures,” Nixon said during a televised speech. “Incidentally, my doctor tells me that in a temperature of sixty-six to sixty-eight degrees, you’re really more healthy than when it’s seventy-five to seventy-eight, if that’s any comfort.”
It might seem odd that a conservative Republican president would impose price controls and energy rationing, but Nixon’s actions reflected the settled beliefs of American political life in the early 1970s. There was a broad consensus in America that could be called “the New Deal Consensus,” tracing back to the 1930s, when Franklin Roosevelt created a new regulatory regime. The New Deal reshaped everything in America’s business world. It replaced unfettered markets with price controls in some cases. It gave unions very strong protections that helped workers organize. And, maybe most important, the New Deal convinced Americans that the federal government should play a large and interventionist role in the economy. It was loathsome to acolytes of Hayek and von Mises.
FDR’s actions were a response to decades of economic stagnation, when the government largely refrained from regulating markets and large corporations; an era that was defined by the laissez-faire, or hands-off, approach to regulation. During that time, the economy was dominated by a new breed of large corporations whose operations crossed state lines and transcended the control of state-based regulators. The federal government, the only entity powerful enough to constrain the companies, declined to do so on the theory that it would harm economic growth. The government was also constrained by a conservative US Supreme Court, which struck down regulatory efforts after a seminal decision known as the Lochner ruling. In 1905, the court ruled against New York state regulators who tried to penalize a bakery owner named Joseph Lochner. The state wanted Lochner’s employees to work no more than ten hours a day. He argued that the regulation violated the Fourteenth Amendment of the US Constitution, which was passed to protect the rights of newly freed slaves. Lochner said that the Fourteenth Amendment also protected his right, and his employees’ right, to enter into whatever kind of labor contract they wanted to. The Lochner ruling hobbled lawmakers and ushered in an era of business-friendly legal decisions. During the Lochner era, the court would strike down minimum-wage laws, federal child labor laws, banking and insurance regulations, and transportation laws. The Lochner era was a time of great prosperity in America, but the prosperity wasn’t widely shared. There was a tremendous concentration of economic power. A handful of robber barons, like John D. Rockefeller and Cornelius Vanderbilt, amassed huge fortunes, while the people who worked to produce those fortunes—the farmers, weavers, oil rig workers, and others—lived in poverty.
When FDR was elected in 1932, in the depths of the Great Depression, the hands-off era came to an end. Roosevelt, and the Democratic-controlled Congress that worked closely with him, created large-scale assistance and work programs to help employees who’d lost their jobs. They created regulatory agencies to oversee the stock market and prohibited banks from speculating with depositors’ money. They established Social Security, or “old age insurance,” the precursor of Medicare. They passed the Wagner Act, which empowered labor unions, passed a minimum-wage law, and established the forty-hour workweek. The role of activist government was cemented in American life and would only deepen over the next thirty years.
Even Republicans like Richard Nixon were compelled to intervene. Nixon signed bills to create the Environmental Protection Agency, founded in 1970, and the Occupational Safety and Health Administration, or OSHA, founded in 1971. He signed the Clean Air Act and the Clean Water Act into law, two pieces of sweeping legislation that would regulate huge portions of the US economy.
Government intervention affected the oil industry as much or more than any other. A complex web of price caps and regulations were put on Koch Industries, and they seemed to confirm every belief that Charles Koch had adopted from Hayek. A new task force in Washington, called the Cost of Living Council, tried to set the price of oil and control markets from a central office. The result was a byzantine mess that hindered companies like Koch Industries and did little to solve the underlying crisis. The Cost of Living Council created an intricate pricing system that split the oil supply into three classes: “old” oil, “new” oil, and “stripper” oil.I The old oil was oil already in production when the price caps hit, and most of it was controlled by oil majors like Exxon. New oil was any oil drilled after the price caps were put into place.
The council put a hard cap on old oil of $5.25 per barrel but let the price of new oil float in an open market, where supply and demand played a role. Predictably, new oil was generally a lot more expensive. This put a major squeeze on independent oil refineries like Koch Industries, which bought oil on the open market rather than drilling it themselves. Big companies like Exxon drilled their own oil and refused to sell it because of the price cap, suffocating markets.
To solve that problem, the Federal Energy Administration passed a law that effectively banned the oil majors from holding on to their old crude. The FEA ordered the sale of fifty-six million barrels of oil. And this was all just one program, meant to control oil prices. Other complex schemes controlled natural gas prices and the pipeline industry.
This incensed Charles Koch. He called the Republican Party “bankrupt” for its unwillingness to challenge the New Deal philosophy and its inability to dismantle its political structures. Koch wrote a fund-raising letter for the tiny Libertarian Party in 1975, saying that Republican efforts to regulate markets caused him to have “abandoned them in disgust.” Republicans were “no better allies in the fight for free enterprise than the Democratic Party,” Koch wrote.
With the Republicans on the sidelines, Charles Koch set out to dismantle the system himself. For years, he had been dabbling in political philosophy. He owned a small bookstore in Wichita that sold conservative literature. He attended and gave money to the Freedom School in Colorado Springs, which taught courses in Austrian economic philosophy. In the 1970s, Charles Koch took his efforts a step further. He unveiled a plan in 1974 that didn’t become widely known for decades, after he had been executing it with remarkable discipline from the CEO’s suite at Koch Industries.
* * *
In April of 1974, Charles Koch gave a speech at a gathering in Dallas held by a conservative think tank that he’d cofounded, called the Institute for Humane Studies. When Charles Koch addressed the group, his tone was belligerent, even caustic.
“Anticapitalist feelings in the United States are probably more virulent today than ever before,” he began. While many CEOs were grumbling about the burden of regulations, Charles Koch chastised his fellow business leaders as being insufficiently loyal to the principles of capitalism. It was a mistake to even characterize America’s economy as capitalistic, he said. Koch chastised the business community for having been seduced by the thinking behind the New Deal.
“To date, business has attempted to defend itself by taking a conciliatory attitude rather than exposing the fallacies in the anti-capitalist arguments. For example, when the oil industry and others are criticized for having ‘excess’ profits, businessmen should argue that in a free market th
ere is no such thing as excess profit—that without high profits there would be no signal to invest more capital in order to increase production to meet the consumer demand that created the profits,” he said.
Koch attacked the entire narrative behind the New Deal, claiming that Roosevelt’s legislation was not, in fact, in response to a lack of federal-level regulation. Koch said that when the New Deal was passed, the economy was already “polluted by massive governmental manipulations of the money supply.”
He said that businesses needed to fight back, and not on the terms that were laid out for them by their opponents. The business community needed to wage a long-term campaign that would change the way Americans thought about the markets and the role of government. Koch said that the campaign should have four elements:
1) Education
2) Media outreach
3) Litigation
4) Political influence
For education, Charles Koch said that business leaders needed to populate public universities with academics who would advocate for free enterprise and do research to support it.
When it came to the media, Koch said that businesses should “appropriately ‘reward’ the media when they promote the free market and withdraw support when they attack it.”
In terms of litigation, Koch suggested that corporations should “announce publicly and vigorously, both as individual companies and through associations, that they will not cooperate with the government beyond the legally compelled minimum in developing or complying with control programs.”
For political action, Koch recommended lobbying and “litigation to affect bureaucratic behavior.” But when it came to influencing Washington, he sounded a note of caution. He said that engaging with the government tends to corrupt businesspeople, tempting them to game the system through lobbying that delivers profit by hijacking public policy. He said this temptation ultimately undercuts businesses by making them look hypocritical—their support for free markets must be pure if it was to be followed. Therefore, lobbying should be a “limited program,” he said.
Charles Koch would remain remarkably true to this basic game plan over the next forty years. The only part that would change significantly would be the “limited” nature of lobbying and campaign contributions. Koch would eventually build one of the largest lobbying and political influence machines in US history. But the rest of the plan was executed almost exactly as he laid it out in 1974.
But as Koch pointed out in his speech, such a plan took time. Its progress would be measured by decades rather than years. And Charles Koch didn’t want to wait decades to see results. There was one arena where he could implement changes; one venue where he had near-total control. There was one institution that he could transform into a laboratory where he could test the theories of von Mises and Hayek. This institution would become Charles Koch’s privately controlled free-market utopia.
The institution was called Koch Industries.
* * *
By 1975, it was clear that Koch Industries was not going to go under. Income from the oil gathering operations and the Pine Bend refinery helped offset losses in the shipping division. Charles and Liz Koch finished construction on their house and began to raise a family there.
After the crisis passed, Charles Koch focused on cementing the gains he had made during his first eight years as CEO. While most companies paid dividends to shareholders, Charles Koch insisted on plowing profits back into the company to fund its expansion. He also worked hard to cement Koch Industries’ growth strategy in the minds of his managers and employees. Every year, Charles Koch held an award ceremony in Wichita to recognize employees who had done an outstanding job. One year, he singled out Bernard Paulson.
Standing before the gathering of his brain trust, Charles Koch recited a long list of Paulson’s accomplishments: the expansions, the market analysis, the new investments that steadily won Koch more market share. Paulson later said that it was embarrassing to be lauded before his peers, but there was clearly some part of him that enjoyed it.
Charles Koch seemed to be praising Paulson to convey one lesson: Paulson had treated the Pine Bend refinery like it was his own company. Paulson didn’t act like an employee; he acted like a small-business owner. Paulson thought for himself, and he treated Koch Industries’ money as if it were his own. And Paulson shared in the glory once it was realized.
“He pointed out, ‘This is entrepreneurial,’ ” Paulson recalled. “He said that’s what he wanted the entire company to do. To be entrepreneurs.”
To a remarkable extent, this lesson was successfully pushed out into the furthest branches of a rapidly expanding Koch Industries, from senior managers like Lynn Markel in finance, to Bernard Paulson, to the lower-level employees like oil gaugers and refinery workers. Employees at all levels of Koch were made to feel like small-business owners. They never owned actual shares of stock in Koch Industries—ownership was reserved for the Koch family and a few small shareholders. But employees felt like they owned a piece of Koch Industries. Charles Koch gave them performance-based bonuses and issued them “shadow stock” contracts that paid out as the company’s value increased, but that didn’t confer actual ownership. The real shares of Koch Industires were tighly held by Charles and David Koch, and a small group of relatives and associates.
The vast majority of employees embraced this culture. They were inspired by Charles Koch’s vision.
But there was one exception. And that exception was arguably the most consequential employee that was ever hired under Charles Koch.
The exception was Charles’s younger brother, Bill.
* * *
I. “Stripper” oil is drawn from a well nearing the end of its productive life.
CHAPTER 5
* * *
The War for Koch Industries
(1980–1983)
Bill Koch became a full-time Koch Industries employee in 1975, at the age of thirty-five. He spent his early years in one of the company’s murkiest but most important divisions: Bill Koch came up through the trading business.
Koch’s trading division was enmeshed in an industry that managed to touch virtually every American while managing to remain almost entirely invisible. The operations had their roots in Koch’s shipping and oil gathering business, where the company became a broker and middleman for crude oil and gasoline products. During the 1970s, Koch expanded its operations, buying and selling oil as a go-between for companies like Exxon and Chevron. These were specialized markets where only a few companies could operate; a trader needed lots of cash, expertise, and access to oil tankers and pipelines. As Koch’s traders developed expertise, they branched out and traded commodities that were never priced on an open exchange. A single transaction might yield $1 million or more in profits without ever being recorded with a paper contract. One of these markets was for industrial chemicals that most people couldn’t pronounce but that they used every day. Polyvinyl chloride, for example, is used in food packaging and bottles. But the markets to buy PVC were just as confusing and opaque as its chemical formula. The deals were too specialized for open exchanges, and they were often done one-on-one, confidentially, over the phone. Bill Koch was largely responsible for getting Koch Industries into the chemical trading business. It was a business that would become an integral part of the company.
Bill came across chemical trading shortly after he graduated from MIT. He was living in Boston and looking for new companies that Koch Industries could buy with the massive amounts of cash the company was generating. In his search for new investments, Bill Koch stumbled across a chemical trader named Herbert Roskind, who ran what was basically a one-man chemical trading firm called Monocel.
As a trader, Roskind was one of the few middlemen in the global market for industrial chemicals. He sold barges full of sulfur made in Louisiana to factories in Asia that needed it as an ingredient in their manufacturing plants. Roskind spent much of his day in an office in suburban Boston, working the phones to ca
ll contacts in Europe or Singapore or Houston, finding people who wanted to buy and sell giant quantities of things like chlorine, caustic soda, polyethylene, and polyvinyl chloride.
Roskind’s business was a murky one, built on a network of personal relationships and deep knowledge that only he held. People like Herbert Roskind were vital to the market: rather than having a transparent market exchange, the buyers and sellers had Roskind’s brain. He knew who was in the market at any given time; he knew what the demand was for polyvinyl chloride; and he knew what a fair price would be. (Of course, whether a trader like Roskind actually quoted the fair price to a customer depended on just how informed that customer happened to be about the market himself.) He had a Rolodex that spanned the globe and a body of knowledge that was integral to success in trading. He knew the habits of customs agents in different countries and knew which shippers could be trusted and which couldn’t. He had an almost encyclopedic knowledge of global shipping rates. He knew the negotiation customs of different cultures and different nations, and he was adept at navigating dark markets—where prices were never posted publicly, where prices always came down to one-on-one negotiations.
Bill Koch was fascinated with the possibilities offered by the chemical trading business. Its prospects seemed a lot better than the oil business during the 1970s. The oil markets were jumping up and down, but chemical prices were rising steadily as nations like China opened their doors to global trade, causing demand for industrial chemicals to climb dramatically. Bill Koch arranged a meeting with Roskind, and soon he proposed to buy Roskind’s company outright.
Roskind didn’t know what to make of Bill Koch the first time he met him. Bill Koch was dressed like a college kid. He looked, in fact, like he was still attending classes at MIT. Everything about him reflected the MIT style, which might be called Privileged Chic. Koch wore slacks and a button-down shirt, but no jacket or tie. He wore leather loafers with no socks. He drove an old Toyota that had a hole in the floor of the front passenger seat.
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