Winning Progressive

(By Mark Bridger, cross-posted at That Mans Scope)

Below I have reproduced a blog I wrote two years ago — Nov 20, 2010. With all the talk about generating revenue and shifting the tax burden from the middle class to the wealthy, no one talks about the inequity of sales taxes on everyday items that the middle class purchases such as school supplies and diapers, but no similar tax on financial speculation. This is a little publicized but important example of the class warfare already declared on the 98% by the top 2%.

When I learned about economics in high school, we were told how the stock market works and why it is good. Inventors and entrepreneurs who had good ideas about new and useful products could form companies and issue stock. Investors who thought these ideas or products were promising could take a risk and invest in the stock, thus becoming part “owners” of the company. The money they paid would be used by the company to grow and develop its products. If all went well, the company would thrive and the investors would be rewarded for the risk they took. Sounds wonderful. Like so much of capitalist theory.

But that’s not quite the way it works, especially these days. There are still people who buy stocks based on the “fundamentals” of the companies: the management, ideas, and products. These are the true investors. However, most of the trading of securities these days is based on speculation. This is not speculation about the fundamentals of the company, but speculation about how the market and other investors will behave. Probably most stocks (and bonds) are not kept for months and years, but are traded monthly, weekly, daily, and even by the minute and second (see the insider newsletter Zero Hedge for some estimates). Sophisticated computer programs can use statistics and mathematical modeling to estimate small-scale fluctuations in segments of the market and relate that to the second-by-second behavior of particular stocks. Lightning fast buying and selling programs can trade thousands of stocks a second based on these analyses. All this computer power is available to trading companies and their best and wealthiest customers. Often a trading company (Goldman Sachs is a notorious example: see this blog) will pit their best customers against their less-favored customers.

There are tens of thousands of individual “day-traders” who do similar things on their own or are the favored customers of the big brokerage houses.

Make no mistake about it:

These People And Brokers Are Social Parasites.

They serve no useful purpose and do what they do solely out of greed. They are responsible for a lot of the volatility of the market. The tiniest bit of news or financial gossip can set off flurries or cascades of day-trading and computer sales that account for big fluctuations in the daily indices. No wealth or products or innovation or anything of social value is produced. The stock market is already very liquid (i.e. it’s easy to pair buyers and sellers), so what these parasites do is create “churning” or “hyperliquidity”: meaningless buying and selling that enriches only speculators. Responsible investors such as pension funds, hospitals and schools end up, more often than not, as victims of these irrational market swings.

Now add in derivatives: side bets on the performance of bundles of stocks and bonds; even bets on the financial indices themselves. Sometimes these bundles are only theoretical, as is the case of synthetic CDOs (Collateralized Debt Obligations) which may not actually contain anything more than a list of securities that one bets on. Or consider the trading of Credit Default Swaps, which are like “insurance policies” on securities. The whole setup has absolutely nothing to do with the fundamentals of capitalism, and everything to do with wild speculation and gambling.

It is universally acknowledged now that this gambling culture on Wall Street is responsible for the recent economic collapse and resulting unemployment. Unlike other ruined gamblers, however, the big players here — investment banks (Citi e.g.) and insurance companies (AIG e.g.) were bailed out because their excesses threatened our entire economic system. Not only are many of the villains in this debacle now taking home huge annual bonuses — often more than the average family’s life savings — but the Republicans and the woefully ignorant Tea Screamers think that we need fewer regulations of Wall Street.

(Gambling behavior by banks was forbidden after the Great Depression by the Glass-Steagall Act. This worked to prevent a major market crash for more than 60 years. It was repealed by a Republican Congress helped by then President Bill Clinton. For more, see my blog about it.)

The time has come to make Wall Street start paying. One effective way to do this is to enact recently proposed legislation to tax stock and bond sales. This has just been done in Europe and, in fact, there was such a tax in the U.S. from 1914 to 1966.

Yes, Virginia, it’s true that we all pay sales taxes on purchases, except the gunslingers on Wall Street.

They can trade a hundred million shares in a day and not pay a dime in sales tax, while you and I fork over 5% or 6% or even more on back-to-school supplies and lawnmowers.

The idea of a Speculation Tax is simple and fair and necessary. Each time a stock is traded, the buyer and seller each pay a small tax — about 1/4% in some plans. This is a tiny amount: $25 on $100,000 worth of stock, or about what you‘d pay in sales tax on a $500 stove. It is absolutely no burden whatever on a long-term investor or conservative pension fund, or hospital or university. It does amount to a burden — and rightfully so — on people who make massive and frequent computer trades to take advantage of tiny point fluctuations in securities. It could also be called a Parasite Tax. Conservative estimates say it would bring in at least $100 billion a year in tax revenue (e.g. see Robert Kuttner’s article). This revenue could be used constructively to undo some of the bad things that Wall Street has done to us.

Here is a fairly extensive article on the Parasite Tax (a.k.a. the Financial Services Tax or Tobin Tax) from SourceWatch and some other articles from the AFL-CIO and The Hill. Google it yourself to find out more.

Another important thing we can do is to make stock and bond traders’ profits subject to regular income tax, not just the capital gains tax. But that will be the subject of another blog.

The important thing is: Make Wall Street Pay.

Winning Progressive adds:

If you want to help make Wall Street pay, contact your congressional representatives and write to your local newspapers urging that we establish a Speculation Tax on Wall Street financiers, rather than cutting spending that helps the middle class, working class, and poor.

(By NCrissie B)

I’ve been considering Yves Smith’s 2010 book ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism. In my first post, I looked at the economic theory that enabled the Great Recession. In the next post I examined how blind faith in that theory led to deregulation, looting, and the shadow banking system collapse. Today I conclude with Smith’s proposed remedies and our ideas for talking with median voters like our archetypal Fred.

Yves Smith is the founder of Naked Capitalism and has over 25 years experience in finance. A graduate of Harvard College and Harvard Business School, she has worked in corporate finance for Goldman Sachs, was the head of mergers and acquisitions for Sumitomo Bank, and currently heads Aurora Advisors in New York City. She has written for The New York Times, The Christian Science Monitor, and several other print and online publications.

The Story of Shady Eddie

Shady Eddie’s business card says he’s an electrician, and he is, sort of. Most electricians’ make a tough living, but Eddie and his bosses are raking in the dough. What’s their secret?

For starters, he uses complex, ‘innovative’ wiring schemes that use fewer and cheaper materials. Eddie’s bosses don’t understand his wiring schemes, but they’re making money so they don’t look too hard. City code enforcers don’t understand Eddie’s work either, but his company’s fees pay their salaries so they sign off on the permits. He also gets do to the rewiring when customer have problems, because no one else knows how to fix his work.

But even cutting corners on materials and getting the rewiring jobs aren’t Eddie’s real business secret. He knows that, sooner or later, at least some of the buildings he’s wired will have electrical fires. So he buys fire insurance. He makes a nice profit on the initial installations, gets paid again on the rewiring jobs, and gets yet another payday when the insurance check comes in.

Of course, Shady Eddie is only an electrician, so once the city catches on to him he’ll be charged with insurance fraud, at the very least. If only he’d become an investment banker instead….

Why They’re Not In Jail

Yves Smith explains that credit default swaps – the highly-leveraged bets that exploded the global economy in 2008 – are basically insurance policies against the failure of an underlying derivative. Many traders who set up those credit default swaps on mortgage-based derivatives knew the housing bubble would burst soon. In fact, many were structured so the trader stood to profit most when homeowners defaulted and the credit default swaps paid off. Like Eddie’s ‘creative’ wiring schemes, the mortgages were set up to fail, providing refinancing fees for mortgage brokers and bonuses for traders packaging those mortgages into derivatives. And as with Eddie’s scam, the traders convinced companies like AIG to guarantee credit default swaps if the mortgages failed.

But unlike Eddie, those credit default swaps were not regulated as insurance policies, so the traders weren’t committing insurance fraud … at least not under the law.

Shining a Light on Shadow Banking

Changing the law to regulate credit default swaps as insurance policies – not reinstating Glass-Steagall or breaking up ‘too big to fail’ banks – is Smith’s most compelling reform proposal. She concedes that credit default swaps are now so central to the ‘market-based credit’ model that the swaps cannot be shut down. But they can and must be regulated, including rules that require those who buy or sell swaps to have an insurable interest in the derivative on which the swap is based.

Smith acknowledges that regulating credit default swaps as insurance policies would increase the cost of the swaps, thus increasing the cost of the derivative bonds being insured, thus requiring the bonds to pay and the lenders to charge higher interest rates. In plain language, regulating the swaps as insurance would make credit more expensive.

And that, Smith argues, would improve the stability of the global economy. Cheap credit allows too many investors to leverage too much speculation – and creates too many profits for too many bankers – based on too little real productivity. “Finance should be the handmaiden of business,” she writes, “and not its master.”

While Smith does suggest reinstating Glass-Steagall, her reasons are not the reasons you’ll hear in the progressive media. Small commercial banks can be as profitable as larger competitors, because the services they offer do not benefit much by economies of scale. But investment banks benefit greatly by economies of scale. To remain competitive in an international market, investment banks must be ‘too big to fail’ and backed by implicit government guarantees.

A new Glass-Steagall, Smith argues, would both encourage small commercial banks to thrive again and also allow the federal government to treat huge investment banks as public utilities, with what she calls “strict and intrusive” regulations on their risk-taking, accounting, and compensation practices. If investment banks require government support during market crises – and they will – then government must be able to limit the risks being underwritten by We the People.

Alas, Smith acknowledges that enacting these reforms will require both business and political leaders to abandon the myth of Marketopia. She does not believe that will happen until the ‘free market’ dogma has failed so completely that its manifest flaws can no longer be excused away. And on that point I disagree.

President Obama and several other Democrats like Elizabeth Warren are using their 2012 election campaigns to make a case for shared responsibility and regulated markets that allow capitalism to flourish. If we activists do our part to help – including telling archetypal Fred the story of Shady Eddie – polls show that President Obama, Ms. Warren, and other Democrats can win on that case and change our economic dialogue.

Realworldia is not as tidy as the precise formulas of Marketopia. But we live in Realworldia, and our political and economic systems must admit that.

(Crossposted from Blogistan Polytechnic Institute (BPICampus.com))

(By NCrissie B)

This week I’m examining the curious conservative belief that the solution to many problems is more of the same problem. In a previous post I looked at their view on mass shootings. Today I examine the Wall Street crisis and financial regulation.  In the final post, I’ll conclude with deficits and tax cuts.

Once Upon a Time …

… in the lush Garden of Enterprise, people were free to do as they wished. Guided by the invisible hand of the free market, each acting in rational self-interest to maximize his or her individual utility, sharing complete information and with zero transaction costs, the people combined to build the Pareto Bridge to an optimal utopia. There every buyer found a seller and every seller a buyer, every employer found workers and every worker found employers, wages and prices were stable, investment and hard work were rewarded, goods and services were distributed efficiently, and neither fraud nor sloth could exist. From high atop the Pareto Bridge, Adam Smith looked down and saw that it was good.

The people would have lived happily ever after, but government slithered into the garden and tempted them with promises of equality and offers of social welfare. Then darkness swept across the land and the people became lazy and selfish. And Adam Smith looked down and wept….

The conservative economic myth isn’t quite that poetic, but it’s close.

Regulations caused the Wall Street collapse?

Consider this article by John Maalouf in CEO Quarterly:

The ill conceived and poorly executed regulations imposed upon the financial services industry over the past eight decades are the direct and proximate cause of the current turmoil taking place on Wall Street.

Although regulations that are specifically tailored to curtail certain types of malfeasance on the part of a small number of companies is beneficial to the economy at large, the ‘shot-gun’ approach favored by legislators over the years has caused far more harm to Wall Street and to the global economy than good.

Maalouf goes on to argue that the Glass-Steagall Act “had the effect of weakening the entire U.S. banking sector by putting it at a substantial competitive disadvantage when compared to banks in the rest of the world which were still able to offer ‘Universal Banking’ services to their customers” … without mentioning the decades without a banking crisis.

The Wall Street Journal‘s Peter Wallison told a similar myth:

Beginning in 1992, the government required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities. The original legislative quota was 30%. But the Department of Housing and Urban Development was given authority to adjust it, and through the Bill Clinton and George W. Bush administrations HUD raised the quota to 50% by 2000 and 55% by 2007.
[...]
As housing bubbles grow, rising prices suppress delinquencies and defaults. People who could not meet their mortgage obligations could refinance or sell, because their houses were now worth more.

Accordingly, by the mid-2000s, investors had begun to notice that securities based on subprime mortgages were producing the high yields, but not showing the large number of defaults, that are usually associated with subprime loans. This triggered strong investor demand for these securities, causing the growth of the first significant private market for MBS based on subprime and other risky mortgages.

The problem wasn’t financial alchemists devising derivatives so complex that only the alchemists themselves could understand them, then pushing the ratings agencies for investment-grade AAA marks, the same ratings agencies that relied on the alchemists for their incomes, the same alchemists who then took out insurance bets against the very derivatives they sold to pension fund managers, municipal governments, and others in search of safe, reliable investments. Only the “gullible Occupiers” – and perhaps “the college kids, the baby sitters, and the nails ladies” – would believe such a silly tale.

The problem was that working families refinanced their mortgages – leaving investors without efficient market signals that housing prices were in a bubble – rather than defaulting and losing their homes. “You people” can be so thoughtless….

The power of myth

No conservative believes the Garden of Enterprise ever existed. But most conservatives believe that optimal utopia could exist, and would, if only government would get out of the way. As we’ll discuss in depth next week, that utopia is predicted by neoclassical economic theory. Indeed it can be proved with mathematics …

… if you assume those rational economic individuals – neoclassical theory ignores corporations and cartels leveraging economies of scale to distort markets to their advantage – each acting in self-interest to maximize his or her individual utility, sharing complete information and with zero transaction costs. You also must assume that every good or service of a given type is indistinguishable from other goods and services of that type, and that every individual will settle for an equal portion of every type of good and service.

If you assume all of those non-facts, then the mathematics prove the Garden of Enterprise would produce the optimal distribution of goods and services, with no need for government.

Thus, conservatives say government should help turn those assumptions into actual facts, by getting out of the way and letting the free market work. Any economic problem, then, can be traced to the actions of government … and the solution to an economic collapse made possible by deregulation is … more deregulation.

More, more, more….

(Crossposted from Blogistan Polytechnic Institute (BPICampus.com))

Wall Street reform is a complex topic, but the issue can be summed up as follows: Conservative deregulatory zeal allowed a financial market meltdown to occur, costing our economy eight million jobs.  Republicans and Democrats voted to save the financial industry through the TARP bailout.  Only one party – the Democrats – has worked to address the causes of the meltdown by seeking to avoid future bailouts, creating a consumer financial protection bureau, and regulating derivatives.

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While many contributing factors to the Bush Recession, which led to the loss of eight million jobs and the elimination of trillions of dollars in household wealth, have been identified, the overriding cause was the complete meltdown of our financial system in 2008.  And it is widely acknowledged that this meltdown was triggered by a deregulatory ethos that overtook our political system over the past twenty years, leading to a situation where more and more risky and speculative financial products were created with little to no oversight by the government.  Even Alan Greenspan, who was identified by the Washington Post’s business columnist Steve Pearlstein as “The Laissez-Fairest of Them All”, admitted in testimony to Congress that his deregulatory zeal was a flawed theory that allowed the financial meltdown to occur.

Unfortunately, members of both major political parties were complicit in allowing the conditions that led to the financial meltdown.  While the failed deregulatory approach is a core principle of the conservative movement that finds its home in the Republican Party, too many Democrats fell for the allure of the snake-oil that the deregulatory zealots were selling.

But important, substantive differences between the parties have been revealed by their responses after the meltdown occurred.  First, only one party – the Democrats – worked to make sure that the Troubled Asset Relief Program (“TARP”) funds were properly spent.  President Bush proposed, and Congress approved by a bi-partisan vote, TARP, which authorized the government to use up to $700 billion purchasing troubled financial products in order to save the financial industry.  After serious concerns were raised about the effectiveness of the distribution of the first $350 billion in TARP funds by the Bush Administrations, House Democrats passed the TARP Reform and Accountability Act, which would have dedicated $100 billion in TARP funds towards helping homeowners facing foreclosures, forced banks to report how they were using TARP funds, and limited executive compensation at firms accepting TARP funds.  Unfortunately, this legislation was one of 372 bills passed by the House that have so far died in the U.S. Senate, largely due to Republican obstructionism.  So, while both parties supported efforts to save the financial system, only one – the Democrats – had a significant block of members who wanted to increase government oversight to make sure that taxpayer money was being used in a transparent and effective way.

The second prong of the government response to the financial meltdown is to put in place policies that would reduce the chances of another meltdown in the future.  On this front, Democrats have had to act virtually alone, as Republicans have almost uniformly opposed and worked to weaken such efforts.  In July of this year, the U.S. Senate passed an historic financial reform bill by a 60-39 vote, after three Senate Republicans finally acted to break a long-running Republican filibuster.    The House had previously passed financial reform by a 232-202 vote, with every Republican member voting against it.

The financial reform legislation focused on filling a number of regulatory gaps that had developed because conservative anti-regulatory zeal had prevented our regulatory structures to keep up with changes in the financial system.  Three important provisions are especially worth highlighting:

• Avoiding Future Bailouts: Since the 1930s, the Federal Deposit Insurance Corporation (“FDIC”) has had the authority to step in and liquidate a bank that was in financial trouble in order to prevent failure of that bank from having negative repercussions on the rest of the economy.   Unfortunately, that authority did not extend to other financial institutions, such as investment houses like AIG and Bear Stearns, which had become “too-big-to-fail.”  Because their failure would have taken down the entire economy, folks in D.C. felt that they had to bail those financial institutions out through TARP.  The financial reform legislation seeks to avoid this situation in the future by taking steps to prevent financial institutions from becoming too-big-to-fail, granting the FDIC the authority to liquidate financial institutions that are in trouble, and ensuring that the costs of such liquidations are borne by shareholders and creditors, not taxpayers.

• Protecting Consumers: A second contributing factor to the Bush Recession was the growth of questionable consumers lending practices by subprime mortgage lenders, payday loan stores, and credit card companies.  Those practices led to an increasing wave of defaults on loans and foreclosures that undermined the real estate market and consumer spending.  Because the real estate mortgages had been securitized by the financial industry, the collapse of the real estate market had reverberations throughout the industry and economy as a whole.  The financial reform legislation creates a Consumer Financial Protection Bureau, housed within the Federal Reserve, which will be run by a Presidential appointee and have an independent budget.  The Bureau will be charged with enforcing a wide array of consumer protections, including the new credit card industry reforms signed by President Obama, and will consolidate enforcement of consumer protections that are currently handled by seven different agencies.

• Regulating Derivatives: Another major contributor to the financial meltdown was the growth of over-the-counter derivatives, which are financial instruments whose value are based on the price of a different item.  While traditional derivatives, like trades in pork or corn futures, are done in the open and relatively safe, over-the-counter derivatives, which are often based on bets about the value of a particular currency or interest rate trends in a specific country, were almost entirely un-regulated before financial reform passed.   The reform legislation brings over-the-counter derivatives out of the dark, but subjecting them to regulation by the Security Exchanges Commission and Commodities Future Trade Commission.

The financial reform legislation, of course, does not solve all of the problems in the financial system, and some unfortunate compromises were made to get the legislation passed.  But, as I’ve discussed previously, progressive change involves a long, ongoing struggle in which today’s progress is built on with future successes.  In addition, the need for more reform is further evidence of why we need to return Democratic majorities, rather than letting Republicans who would turn the clock back on financial reform take Congress over.

The Democrats’ financial reform legislation makes a good start on addressing key causes and impacts of the financial meltdown of 2008 by avoiding future bailouts, protecting consumers, and regulating risky derivatives.   And, as our friends over at The People’s View recently pointed out, these reforms, combined with international financial reforms recently achieved by the Obama Administration, are already leading financial institutions to shift their investments into more safe and secure transactions.  By contrast Republicans, after voting to bailout the financial institutions that caused the Bush Recession, have largely sought to obstruct any effort to make sure that future financial meltdowns do not occur.

Are you glad that President Obama and the Democrats in Congress succeeded in passing financial reform that will end some of the worst abuses on Wall Street, avoid future bailouts, and protect consumers from subprime and payday lenders?  If so, volunteer for a local Democratic candidate, write a letter to your local newspaper editor, and make sure your friends, family, and neighbors know who you are going to vote for.