By James Kwak
The June issue of The American Prospect includes a section on financial reform that is already available online. Our contribution is on the way the financial sector has used its time-honored techniques to block and water down meaningful reform over the past year. There are also articles by many of the usual suspects, including Elizabeth Warren, Michael Greenberger, Rob Johnson, and Nomi Prins.
The Baseline Scenario 
Nice piece. The only missing proposal is a transaction tax: Positions held for less than 1 day = 99.9% tax; less than 1 week = 99% tax; less than 1 month = 90% tax; and so on.
Unless someone can explain the social benefit of having computers dodge in and out of positions thousands of times per second.
Glad you are back James
Hey James, It’s not our business why you were away, but we’re glad you’re back. Maybe you decided to evade and sidestep the TV cameras for dear you would get a gigantic ego to rival Paul Krugman’s. But “Baseline” isn’t “Baseline” without Kwak.
I have an inclination you were watching Kevin Garnett throwing punches while have a few swigs of green colored beer with the family (haha). Well, I’ll try to pick up that June issue to “support the team”. I guess just look for it at the bookstores?
for fear, not for dear. Oh my……..
Thanks for a very comprehensive and, as usual, well-written article James.
And thank you and Simon for your tremendous contribution towards educating and rousing the American public to intelligently redress the grievous wrongdoing of the financial oligarchy. Your work is instrumental in rescuing the traditional American values of fairness, honesty, and equality of opportunity and in resurrecting a central mission of American government which is to protect and empower its citizens.
Regarding the battle of ideas, which I agree is really where the long-term battle must be won, I suggest that readers of this blog take a look at the work of cognitive linguist George Lakoff.
Lakoff, in studying political language through the lenses of neuroscience and linguistics, has, to my satisfaction at least, explained how Conservatives have managed to control the political debate for the past 30 years. Even better than that, he provides examples of how average people, as well as people with a wider platform of influence, can reframe the way they speak about issues so as to ignite latent progressive leanings in those people who have both progressive and conservative tendencies. Lakoff estimates that these people number about a third of the American public.
Lakoff’s ideas are briefly outlined in “Don’t Think of an Elephant” and more fully explaned in “The Political Mind” and other works. In addition, there are plenty of his lectures on YouTube.
Conservatives have organized themselves, funded their think tanks, endowed university chairs, lined up their politicians, like ducks, around talking points, and gotten their pundits all over the media mouthing phrases that very smart messaging consultants, like Frank Luntz, have created and that have been adopted as “the way to speak” by the media about many issues.
Democrats repeat the same phrases in rebutting these ideas, which only strengthens their power and further engraves them in the brains of the public. It’s neurocognitive folly!!
James, you sum up your article by saying that we need to shift the conventional wisdom. I think Lakoff’s work sheds invaluable light on how to do just that. I only hope that people with bully pulpits, as well as those of in in the grassroots start, as soon as possible, to check out and apply, his ideas.
Nemo,
I’m sorry to tell you that programmatic / algorithmic trading had nothing to do with the financial crisis and your assertion that such behavior should be taxed exorbitantly does not solve any of the problems faced by the financial markets or the U.S. and Global economies.
I am not going to argue whether or not this activity serves a social benefit, because I don’t think that you leverage taxes on a service or industry simply because it doesn’t serve a social benefit. If you do, then out of fairness it should be done proportionally with regard to all other industries that don’t serve a societal benefit.
For example, I don’t think anyone would contend that McDonalds serves a social benefit, would they? In fact, I would argue that fast-food, although cheap and widely available, is a societal blight and an industry that shows a complete lack of concern for societal health, both physical and economic. In fact, the cost to our healthcare system as a result of childhood obesity and type II diabetes that result from our citizen eating fast food is a much graver threat to future functioning of the U.S.
So if we are supposed to tax the hell out of computer driven trading, then we should also tax the hell out of McDonald & other fast-food chains. Why stop there though, who says that sugar cereals are any better so you should tax the hell out of general mills, and let’s not forget our good old friend the tobacco industry, certainly we should tax them out of existence given their contribution to lung cancer & heart disease.
Finally, I would argue that computers dodging in an out of positions thousands of times per second actually serves to create efficiency in our markets and provide liquidity, in addition to more real-time, better price discovery. Such trading integrates and arbitrages away information asymmettries much more quickly. I suggest studying up on capital markets and the theory of efficient markets before offering a solution to a problem that doesn’t exist.
Ah, yes, the same old hacknied presupposition, that the system is remediable. Johnson and Quack will go their dotage believing such twaddle. To them, the tyrannical hold of the financial interests on our political life isn’t a matter of campaign contributions, its simply a question of intellectual assent. The maggots that populate the Congress aren’t interested in furthering their careers, what moves them are deeply held convictions about economics! And here you were concerned about pedophilia in the Catholic Church.
You would be surprised at what I have studied.
“Efficient markets” are an academic fiction.
“Providing liquidity” is useless at best and harmful at worst. Capital is allocated most usefully by people who actually take some care with their investments. Maybe if investments were less liquid, people would actually need to exercise some care before purchasing, because they might be stuck there. I happen to think this would result in a more effective allocation of capital than the current casino of Nth-order derivatives.
Not only does high-frequency trading produce no social benefit, it also produces several social ills, most notably rewarding people for doing essentially nothing. A society that rewards people for doing nothing encourages everyone to do nothing. This is why gambling is illegal in most places, why it should remain so, and why most of Wall Street’s activity should be treated the same way.
Investors serve a useful purpose. Speculators are pure leeches on society and should be treated as such.
Do you work in the financial sector? If so, may I suggest you consider doing something more useful and less sociopathic with your life?
Simon (and James) writes “In 2004, the Securities and Exchange Commission relaxed capital requirements for major investment banks in exchange for the power to oversee them through the Consolidated Supervised Entity program” and if Simon would just read what “the consolidated Supervised Entity” program was all about, then Simon would find that it explicitly meant being “prepared in a form consistent with the Basel Standards”… and then perhaps Simon could ask himself how come that in the about 1700 pages of Financial Regulatory Reform currently discussed in the US Congress, there is not one single reference to the Basel Committee.
But since Simon should know all that, the more I read Simon Johnson framing the issue in terms of expert and sophisticated well paid bank lobbyists against dumb congressional staffers, the more I get the feeling he has volunteered to draw the attention away from his buddies in the Basel Committee because… if it is discovered how truly naïve and gullible an outright stupid some of these regulators were… that would hurt Simon’s regulate more agenda.
Remember the Alamo “a bad financial regulator is always more dangerous than a bad banker”
Bravo Nemo!
Well done, Nemo.
WILD APPLAUSE NEMO!
“Not only does high-frequency trading produce no social benefit, it also produces several social ills, most notably rewarding people for doing essentially nothing.”
So your argument against HFT, derivatives etc. is a social one. How do you feel about various forms of welfare where in some cases people are also rewarded for doing essentially nothing?
You ask in your article?
“What would it take to curb the political power of the financial sector? ”
The heart of your answer to the question is that “people think that finance is inherently good and big finance is inherently better” and to that end Washington is easily swayed by Wall Street.
Do you have any data that supports that contention?
IMO the reality is that Washington is easily swayed by Wall Street because they are in large part owned by Wall Street: both Democrat and Republican; Senator and Congressperson; the executive branch and yes perhaps even the President himself.
An interesting article on financial reform from another publication:
Yes, It’s a Bailout Bill
http://www.american.com/archive/2010/april/yes-its-a-bailout-bill
Tax them both. We need more revenue.
Are you comparing a few thousand dollars providing year providing bare subsistence to the financial sectors’s 7-, 8-, and 9-figure compensation packages? Seriously?
There is a difference between rewarding people for doing nothing and providing for people unable to do anything. Several orders of magnitude difference, in fact.
As long as welfare does not discourage most people from leading productive lives (and it doesn’t; would you trade your job for a welfare check?), I have no problem with it.
Unlike welfare, the financial sector’s vast compensation packages actively encourage our smartest people to become parasites. They should be spending their days proving theorems and curing cancer and developing fusion reactors, not programming computers to flip financial instruments thousands of times per second. And our modern society has twisted the definitions of “capitalism” and “freedom” to the point where these a**holes actually believe they are earning their money.
On the bright side, doesn’t this mean that if we could structure online poker as a multi-party CDS (perhaps simply by writing the rules of poker as an ISDA schedule) it could be brought back on shore?
April 29 (Bloomberg) — “Nouriel Roubini, the New York University professor who forecast the U.S. recession more than a year before it began, said sovereign debt from the U.S. to Japan and Greece will lead to higher inflation or government defaults.
Eventually, the fiscal problems of the U.S. will also come to the fore,” Roubini said during the panel discussion. “The risk of something serious happening in the U.S. in the next two or three years is going to be significant” because there’s “no willingness in Washington to do anything” unless forced by the bond markets.”
http://tinyurl.com/37x5m7k
The Politics of Financial Reform – Truth or Consequences? Please note: I’m not a fan of Fox News,but they have(business segment page) perhaps “One” of the best financial journalist writer in the world. Her name is Ms. Elizabeth MacDonald – her business blog is second too none,period! I don’t usually recommend off-blog reading, but she’s the greatest – Fox Business News (fnb.com) E’Mac___”Banks Kitchen-Sink Profit Hit Not Over Yet”. Please let me reiterate…I’m not a fan of Fox,but this “Lassie” always hits it out of the park (totally unbiased,I’m surprised she hasn’t been fired). Thanks James,and please “Keep up the Good Digging for America’s Sake”
http://en.wikipedia.org/wiki/Liz_MacDonald
First – Thank You Marin for reading my entire reply to Nemo’s post and understood the basis behind my argument.
Second – To Nemo, et al., I happen to know quite a bit about finance & no I don’t work for GS or a proprietary trading firm, so I’m not here to espouse their propaganda. However, you made an argument against hi-frequency trading (HFT), primarily based whether it serves a social purpose. I gave my argument, based on logic, but was unpersuasive because the argument for you was one of sentiment and personal opinion. So let’s dispense with that, ok.
Finally – To the other point of my earlier argument – specifically, that targeting hi-frequency trading (HFT) as a principal activity germaine to the debate on the underpinnings of the financial crisis or the need for financial reform is patently false. So I just wanted to clarify why that a little bit more:
a.) CDOs & CDS securitizations – which led to the bailout of AIG and are at the heart of ABACUS discussion, are over-the-counter transactions that are done through long-term negotiation and are not remotely related to HFT.
b.) HFT strategies, no matter how well you program a computer to execute them, are not capable of putting trillions of dollars to work. Think of a trading strategy like a water sieve – the finer the buckets of the sieve, the less water each one can hold. Similarly, the finer you slice time, the smaller the amount of money a trading strategy can put to work.
Anyway, long and the short of it – not all finance is detrimental or risky, just because it is termed a “innovation” or because it is not widely understood.
Simon and James, Once again, an excellent piece in Prospect. Keep up the good work. Eventually a critical mass of citizens, and hopefully members of Congress, will comprehend the importance, necessity, and critical need for financial and political change. Your last paragraph contains the most important statement: “We should not think of finance as the pride and joy of our economy but as something like a regulated utility (an industry on which the economy depends but that should be watched over carefully) …”
Not only is there a crisis of finance but of censorship:
http://americaspeaksink.com/2010/04/why-some-people-dislike-tim-tebow/
There is a lot of barking going on, but most of it is up the wrong tree.
So called progressives bark at Wall Street and bank oligarchs… so called conservatives bark at Fannie Mae and Freddy Mac… but too few even know that who they should really be barking at are some naïve gullible and outright stupid financial regulators, many of them sitting over there in the Basel Committee.
well spoken alphaG77,
I think you analysis is well done with regards to the financial industry and utter garbage with regards to the food industry where you have at best a layman’s perspective.
Nemo et el, speak authoritatively about something they barely grasp, and that’s ok. But, at any given slice of historical time, nobody has ever had more than a cursory grasp of even a small fraction of the factors driving our broader collective reality.
The one thing that differentiates relatively successful societies is the devolution of power and authority precisely because it acts as a bulwark against the nonsense of banded individuals.
One Id mirror of modern external bubbles, are the ego inflation bubble present in western man. Witness the comment by Nemo: “Investors serve a useful purpose. Speculators are pure leeches on society and should be treated as such” In an economics blog.
The ego to knowledge ratio is staggering, especially in a forum so rich with counter factual evidence.
nyongesa “The one thing that differentiates relatively successful societies is the devolution of power and authority precisely because it acts as a bulwark against the nonsense of banded individuals.”
On the dot! How can we better control the Basel Committee band and all those financial experts in universities that banded up to keep silence on what the Basel Committee were doing? Many finance PhDs are now saying… “we never studied Basel I or Basel II” and that is a completely nonsensical excuse for anyone teaching finance.