Incentivize constructive equity instead of hazardous debt

By J. Morton Davis

When purchasing a business, real estate or shares of stock, buyers often invest little of their own funds and borrow as much as they can to maximize returns. If the investment is successful, they multiply the amount they earn on the appreciated asset, as they are rewarded not only on the minimal equity investments they made, but on the amount they were able to invest as a consequence of the much larger amount they borrowed.
If the investment turns bad, then the investor only loses the small amount he actually invested and the lender is stuck with the loss. This kind of default, when it happens in individual cases, only hurts the limited parties involved. But when there are many incidences, borrowing and leverage can unleash economic breakdown and disaster, as we saw in 2008.
Yet, perversely, government policy provides incentives for borrowing and excessive leverage by treating interest on debt as tax deductible. And the leverage that emanates from such borrowing significantly magnifies risk — or more accurately, debt magnifies the consequences of a decline and increases the defaults.
In the event of any disappointing or unexpected negative occurrence, it makes the eventual triggering of defaults and insolvency to both the borrower and the lender more likely. Debt can adversely affect the stability and health of the economy — as is now clearly evident from the bursting of the housing bubble and the overwhelming mortgage defaults that ensued — at a potentially immense cost to taxpayers.
Operating with too much debt and far too little equity, the banks and other financial institutions did immense harm to the country and its economy. As a direct result, the banks themselves became insolvent because their holdings decreased in value to where their entire 5 percent to 8 percent equity and even more was wiped out. If the stimulative TARP program did not rescue them (together with the fact that they were permitted to avoid writing down their holdings to their actual market value), almost all of the “too big to fail” banks and financial institutions would have been history. Astonishingly, Bear Stearns and Lehman Brothers were so leveraged it’s questionable that they even held 2 percent of their own equity relative to their enormous holdings. In other words, they were borrowing almost 100 percent.
In an effort to prevent the recurrence of such dangerous economic practices, the Dodd-Frank financial reform law would require that these” too big to fail” financial institutions maintain capital ratios of 13 percent or more. Had these financial institutions had such minimum capital (and I believe that amount is still hardly anywhere near enough), the debacle that unfolded could have been avoided.
Shockingly, these very same institutions are aggressively lobbying against the introduction of any safety measures because, it appears, they would like to continue operating on a capital shoestring so they can maximize the return on their invested equity. They insist it’s not a good time to hamper the economy.
Greedily, these institutions prefer to continue to enhance return on invested equity capital by enjoying the maximum leveraging through debt, while demonstrating indifference to the enormous economic damage this behavior has inflicted already and could do again, if left unchecked. They like it when it is heads they win, and tails the taxpayers lose.
Obviously, in light of the existing tax system, which favors debt over equity, the policy is unwise and encourages practices that expose the economy to collapse. The banks and institutions pushing for the repeal of Dodd-Frank are, after all, the very same activists that successfully pushed for the elimination of the Glass-Steagall Act that worked so beneficially ever since the Great Depression, as it kept traditional banking safer by keeping it separate from far riskier trading and investment activities.
Glass-Steagall’s repeal contributed to the current financial mess. Freed from the regulations and restrictions of Glass-Steagall, banks increased their risk and inflated the bubble, triggering the crash and almost leading to their own demise.
While debt prudently incurred can be useful, it should not get special favors in tax law. It’s hardly worthy of being favorably incentivized by our tax laws.
Wouldn’t it make far more sense, and be far safer and healthier for the financial system, to incentivize equity investments and, to the maximum extent possible, minimize debt? Instead of interest on debt being tax deductible, dividends should receive that preference. The more equity a bank, corporation, private business or individual has put up, the less chance there is of forced insolvency. In fact, if equity constituted the entire capitalization of every investment on every balance sheet, insolvencies — and the overwhelming disastrous fallouts that emanate from such adversities — would all but disappear.
Were that the case, the catastrophic housing bubble could never have come to pass, nor would the banks, nor indeed the entire U.S. financial system, have been placed in jeopardy. There would have been no need for TARP or the other gigantic government expenditures to save the “too big to fail,” or the resultant excruciating crash.

Source:
http://thehill.com/opinion/op-ed/190363-incentivize-constructive-equity-instead-of-hazardous-debt

A tiny fee that could generate billions in deficit reduction

By: J. Morton Davis

Introducing a one-cent fee on every share of stock and every commodity contract traded and a 10-cent fee on each $1,000 bond traded would be a simple and painless way to increase government revenue and reduce our nation’s menacing deficits and debt.
Such miniscule fees would not cause any real investor or trader harm or much inconvenience, but it could generate many billions of dollars. In 2010, these fees would have generated $47.63 billion.

Many traders, banks and investment trading desks would fight this tooth and nail because Wall Street has evolved into a kind of Las Vegas casino where enormous volumes are traded for profits of even a fraction of a penny per trade. The introduction of such fees would undoubtedly cut the volume of trading. But even if it dropped by as much as 50 percent, which is highly unlikely, it would still generate $24 billion annually.
Even a fee of two or three cents a share would hardly be onerous and would double or triple the amount of revenue generated. Historically, the spread between the bid and asked prices for any security was far greater than it is today, and thus generally far more costly than the small fee I am proposing.
For years prior to the elimination of fixed fees in the early 1970s, the stock market functioned smoothly and effectively for investors despite the fact that the fixed commissions were much higher — approximately $1 per share for a $30 stock whether you bought 100 shares or 100,000 shares — and it was charged both at the time of purchase and of sale. So, the miniscule fee I am proposing should not be burdensome.
To those who suggest such trading fees or taxes would be unfairly discriminatory, it should be pointed out that far more burdensome taxes are paid by others, including those at the bottom of the economic ladder, on such everyday essentials as gasoline, restaurant food, shoes, clothing, text books and so on. So it’s unpersuasive, indeed unscrupulous, to say it would be terribly unfair to impose a small fee on financial transactions.
In contrast to the high-frequency instant traders, real investors such as individuals, pension funds, mutual funds and insurance companies would be almost totally unaffected.
And we should not be sidetracked by suggestions that such a fee would stanch liquidity. Hundreds of millions of shares trading every hour does not evidence liquidity — it merely confirms that what was once a real and respected marketplace to facilitate real investments has become instead a financial casino. The bulk of transactions are not by investors but by computers that trade automatically based on algorithmic formulas that can pick up hundreds of millions of dollars by front-running other less mathematically-sophisticated investors.
The nation’s four largest banks made this plain when they announced that they had experienced not a single down day in the first 61 days of trading last year. Not even the most successful genuine trader in history ever achieved such results.
Many experts believe that high-speed computerized trading has spun out of control, is what caused the “flash crash” on May 6, 2010, and frightens and destroys the confidence of the really constructive and critical long-term investors who provide financing for American corporations.
This explosion of high-speed computerized trading does indeed serve to make trading less costly, but that only serves to create frenzied stock market activity that has very little to do with facilitating the raising of the productive investment funds, which is the foremost objective of a well-functioning capitalist securities market.
The most powerful players would strenuously resist the infinitesimal fee I am proposing. But, while it’s useful to do all that we can to strengthen our banks and financial system through enhanced profitability, that’s not a good reason not to introduce this fee. Helping banks play a more productive role in the recovery of the economy is an important goal. But it does not override the need to do what is best for the economy and the country as a whole.
Let’s enact this immensely beneficial fee. It could prove to be one of the most successful, least painful, revenue generators ever implemented.

It’s time to bring the US postal system into the 21st century

By J. Morton Davis

The United States Postal Service, an independent government agency that does not currently receive taxpayer dollars, lost $8.5 billion in fiscal 2010. Based on first-quarter results, it is on track to lose almost $10 billion this year.

USPS proposed almost a year ago changing a requirement, introduced in 2006, that it pay for the health benefits of its retirees in advance, instead of using a pay-as-you-go system. That requirement costs the service about $5.5 billion annually. As mail volume continues to plunge, the Postal Service’s losses are expected to balloon to at least $33 billion over the next decade, if nothing is done to stop the bleeding.

It is nearing its $15 billion borrowing limit, mandated by the U.S. Treasury, and has unfunded pension and retiree health obligations of approximately $90 billion. If dramatic actions are not taken quickly, ever-larger losses are likely, indeed inevitable, and will have to be absorbed by taxpayers.

It is past time to take action and bring the postal system into the 21st century.

A long time ago, when I was a kid, we had a penny postcard, and a stamp for a letter was 3 cents. There was also a rarely used “airmail” stamp that cost 10 cents. Where I lived in Brooklyn, mail was delivered twice a day, and the same was true of Manhattan. In those days mail was the highest priority: There was no email, text messaging or faxes, and hardly any homes had a phone. In a real emergency, someone came running from the corner drugstore to call us to the payphone. In the event of a birth or a death, when really fast communication was needed, one sent a Western Union telegram, which was terribly costly.

Today, besides everyone having a cellphone, we have a multitude of other communication technologies. A letter delivered by the USPS — so-called “snail mail” — rarely requires urgent delivery.

It would not matter much, and would certainly not be an intolerable hardship, if an ordinary letter took up to a week to deliver. For fast hand delivery, FedEx, UPS or the USPS’s own Express Mail serve well. And the Postal Service could introduce a premium payment service to accommodate any need for rapid delivery.

Enormous losses looming over taxpayers could readily be avoided by simply restructuring the Postal Service so that deliveries came only once or at most twice a week. In fact, there is absolutely no reason it couldn’t be turned into a privately held, profit-oriented, public utility-type company with certain specified minimum service obligations. FedEx and UPS are examples of how profitable this kind of consumer service can be.

FedEx’s fast-growing e-commerce Smart Post drove its daily volume up 24 percent and its revenue per package up 8 percent. Amazingly, Smart Post involves shipping packages to the U.S. Postal Service, which in turn delivers them to residences. The USPS provides the critical, costly service, and FedEx realizes the profits.

It’s mind-boggling that the Postal Service is still conducting its operations as it did more than 100 years ago despite all of the almost miraculous communication advances since then and the available, convenient, instantaneous transmission of information in the United States. It’s almost as if those responsible for running the system were unaware of the revolutionary progress taking place around them and were still using Morse code or carrier pigeons. Wake up and, instead of smelling the coffee, join the 21st century.

As Clayton Christensen proclaimed in her classic work, “The Innovators Dilemma”: “Successful companies ignore disruptive technologies at their own peril.” It seems as if no one at the Postal Service ever read that.

As one would expect, there are mailing interests — such as credit card and insurance companies, which send notifications frequently to customers — that howl when reduced delivery is suggested, as though daily service were an inalienable right. Well, when I was a kid, milk, bread and even cake was delivered door to door. It was convenient, and we didn’t like it when it stopped. Business must adapt or die.

Vociferous opponents of change, such as Sen. Susan Collins (R-Maine), and other lawmakers from rural states, oppose ending Saturday delivery (which, by the by, would trim only 2 percent from Postal Service costs). They argue that a cutback would be tough on people in small towns who receive prescriptions and newspapers by mail. But news is available on computers, phones and iPads. Prescriptions delivered once a week should generally be adequate, but if not, faster services are available.

Such considerations are hardly a reasonable basis for continuing an unsustainable service needed by fewer and fewer people. Progress has a price; ask all those buggy-whip tycoons. But, as Joseph Schumpeter, a Harvard professor of economics, noted, “creative destruction” makes technological advance possible.

Change is rarely accepted without complaint. But we get used to it, adjust, and our lives are often improved. In the case of the post office, acceptance is essential because its finances are a threat to taxpayers.

Jobs, Jobs, Jobs! Not Austerity for Now

Do Something Real, Go for the Bullseye!

Why, in the midst of economic crisis, is Washington’s entire focus on the nation’s growing deficits and massive accumulated debt? Why is raising the “debt ceiling,” which has been raised 74 times since 1962, suddenly the most crucial issue, when it could have been painlessly dealt with when the economy was doing well and unemployment was negligible?

Where were our national leaders and Congress as the country’s debts mounted above $14 trillion? Why wasn’t something done as we engaged in two wars that have cost over $1.2 trillion? Instead of paying for these astronomically costly undertakings in annual budgets during the past 10 years, as the deficits and debt soared, they enacted huge tax cuts.

Focusing on the debt ceiling is outrageous when joblessness is officially at 9.2 percent and the underlying rate is really 17.3 percent, which means more than 25 million people out of work! It’s shameful and scandalous. Job creation and robust economic growth, which would actually eliminate the deficits, should be the No. 1 priority of the president and Congress. Austerity now is counterproductive because reducing spending will erode business and consumer demand, and slow or reverse our fragile recovery. Every businessman knows it is demand for his product, not low interest rates or certainty, that inspires him to invest, expand and hire. If he’s operating at 70 percent of capacity, it doesn’t matter how low interest rates are — there is no reason for him to hire. Let demand press his capacity and watch how fast he’ll increase investment and his labor force even in the face of high interest rates. Demand determines his actions. Austerity exacerbates unemployment, raising demand and the cost of government entitlements like food stamps, welfare and unemployment insurance, and reduces tax revenues. The result will be higher deficits, not lower ones.

We need prosperity, not austerity initiatives, to generate jobs and growth on a large scale. Let’s establish a federal National Infrastructure Bank to provide low- or even zero-interest loans to private companies that will build or rebuild America’s roads, bridges, tunnels, airports, seaports, dams and sewer systems, high-speed rail, low-cost housing, a better electric grid and on and on. The American Society of Civil Engineers says the cost of our decaying surface transportation infrastructure will be $3.1 trillion in forgone economic growth by 2020. The toll for investing only at current levels will be 877,000 lost jobs. Tom Donohue, president of the U.S. Chamber of Commerce, says “the U.S. is missing a huge opportunity to ignite economic growth, improve our global competitiveness and create jobs.”

Sen. John Kerry (D-Mass.) sensibly stated, “We can either build and compete, and create jobs for our people, or we can fold up and let everybody else win. I don’t think that’s America.” President Obama has actually proposed a $30 billion infrastructure bank — hardly enough, especially in light of the fact that the Fed provided $3.3 trillion to foreign entities during the economic meltdown.

There is obviously plenty of work to be done, so legislative and administrative action must eliminate all red tape. (If not, we will be outclassed by China building entire supercities before we can even get approval to start a single project.) Such a national program would create the private-sector construction jobs so desperately needed by an economic sector ravaged by the recession.

In addition, we should also consider the establishment of a National Bank for Job Creation to provide very low-cost, or even zero-interest, loans to businesses. These efforts, together or separately, would do far more to create jobs and growth, grow government revenues and reduce deficits and debt than has the $2 trillion spent by the Federal Reserve to keep interest rates at record lows, the 13-month extension of unemployment insurance or the payroll tax cut. The NBJC would get every able-bodied American working again and would maximize productivity.

We have tried just about everything indirect to create jobs and economic growth. We’ve pushed interest rates down to near zero and sent out $600 stimulus checks, paid cash for clunkers and subsidized first-time homebuyers to the tune of $8,000, plus, most recently, cut the payroll tax. All to no avail. Why repeat the same fruitless efforts again and again?

The term “jobless recovery” is an absurd contradiction. When so many average Americans can’t find a job, can’t pay their mortgages and are having their homes foreclosed, suggesting we are in a recovery is clueless and coldhearted. When just about all of the wealth and savings of most Americans was in the collapsed equity of their homes, how can anyone characterize the present situation as a recovery?

Despite gains in productivity, the working class is deriving none of the benefits — neither improved wages nor more jobs. It’s all going to corporate profits. And monetary policy is doing nothing to reduce unemployment. It is job creation, not the failed interest-rate policies of the past, that must now be undertaken.

The availability of “build America” infrastructure jobs should be considered fundamental to the Declaration of Independence’s promise of insuring every American citizen is entitled to the “pursuit of happiness.”

Let’s enact these efficacious initiatives, which will spark economic growth, which is itself the best prescription to subdue and ultimately eliminate federal deficits. A rising tide lifts all ships. Economic growth produces tax-paying jobs in place of costly government entitlements (unemployment insurance payments alone cost more than $75 billion a year). Economic growth would also boost corporate profits, amplifying their tax payments and increasing government revenues. The result would be no more deficits.

At the same time, we would be building magnificent, life-enhancing infrastructure for the benefit of all citizens and for generations to come. As Donald Trump asserted, “One must give China credit for the good sense to use U.S. funds [which they derive from their positive balance of trade payments] to build airports, bridges, schools, electrical grids and so much other invaluable infrastructure.” Then he asked, “When was the last time you saw a bridge being built in the United States? You see them falling down all the time. When was the last time you saw an airport being built? We’re like a Third World country.”

When business spends on capital equipment that will do service for many years, accountants treat the costs as investments, to be written off over many years of the equipment’s useful life. Our nation’s expenditures that enhance life and increase our competitiveness should be treated in the same way. All the airports, seaports, electric grid, highways, etc., should be considered investments, amortized over many years and carried on the country’s books as invaluable assets on the other side of our nation’s balance sheet in contraposition to its debt.

Treated this way, the country’s fiscal accounts would be more accurate, showing its assets against the debt incurred in their creation. By contrast, debts that are incurred to pay unemployment insurance or other entitlements, or to wage war, do not create assets. They produce nothing lasting to balance the debt incurred in their creation.

Launching a job-creating infrastructure program is the ideal solution because it’s good for everybody and, unlike austerity, hurts no one.

Let’s aim directly at the target we actually want to hit, which is job creation. Let’s accept that the indirect methods, such as zero-interest rates, have not worked. Let’s aim at the bull’s-eye with real job-creating growth programs.

We need prosperity, not austerity, now!

It is the best of times, it is the worst of times. Thankfully, American corporations are generating record earnings, the stock market is approaching its all-time high, banks are flush with cash and their executives are again being awarded mega-bonuses. Oil companies and farmers are likewise enjoying record prices and profits, as are those who have invested in gold or just about any other commodity. Things could hardly be better.

But the little guy endures the worst economic suffering since the Great Depression. He can’t get a job, can’t pay the mortgage, is losing his home, and the cost of basic food, gasoline, utilities, tuition and transportation is rising. Things could hardly be worse.

While the upper echelon of society is doing so well, the federal government is running unsustainable budget deficits, and some politicians are advocating we fix it with an aggressive austerity program that will largely destroy the social safety net that has protected the most needy for generations.

Yes, the government must cut spending or go broke. But accumulated deficits mean that even harsh cuts won’t remedy the problem because of interest costs. The government could eventually restructure its debt, hurting creditors, or declare bankruptcy, ruining its credit rating and limiting its ability to borrow in the future.

America is like a family that has borrowed up to the hilt and whose overextended debt jeopardizes its ability to obtain any additional loans and threatens its solvency. The family must put extra members to work to generate extra income to pay down that debt. Family members already working must work overtime or work two jobs or on weekends to increase the family’s gross receipts — its prosperity. As with that family, so with America. Government austerity alone will not suffice. We need only look at the consequences of austerity measures in Europe to see the failure of such an approach.

The answer lies, rather, in economic growth achieved by a stimulus program that will expand government income and bring prosperity and a concomitant reduction of deficit and debt.

We can do this if we respond decisively as we did to the crisis following Lehman Brothers’ bankruptcy in 2008. Then, we averted a far more devastating crash and revitalized part of our economy now enjoying “the best of times.”

Once we decide something is essential, we act without delay or even any consideration of costs, as we did after the Pearl Harbor attack in 1941 and the attack on the World Trade Center in 2001. Cost didn’t cause even momentary hesitation. We knew that we needed to act, and that we would deal with the consequences after we prevailed.

The present economic crisis presents an extraordinary opportunity, for it is in every way equal to or worse than the crisis of 2008, which prompted the Treasury and Fed to rescue financial houses with trillions of dollars in bailouts.

It is Main Street that should be “too big to fail.” The enormous income disparity between ordinary Americans and the top 10 percent could at some point provoke rebellion and the destruction of the greatest economic system in history, and the American way of life. Mass dissatisfaction could trigger — probably not by violence, as it has in the Middle East, but by the election of socialists promising equality and redistribution of wealth.

No group has more at stake than the wealthy in preventing this. Warren Buffett had great foresight when proposing that he and others enjoying the fruits of capitalist prosperity should pay higher taxes. His proposal was not an act of mere sympathy or charity. He is smart enough to envision the disastrous alternative.

We’d all love to pay less in taxes, but that’s not in anyone’s best interest. In the five years before President Clinton raised taxes in 1993, real annual GDP growth averaged 2.5 percent. In the five years after the tax increase, growth averaged 3.5 percent. The five-year growth rate before the Bush tax cut of 2003 was 2.9 percent, then it fell to 2.2 percent in the five years after the tax cuts.

From 1949 to 1963, when the top marginal tax rate was 91 percent and 92 percent, real GDP grew by 4 percent a year. Arguments for lower taxes, regardless of the status of our American economy, are self-serving and not supported by the facts.

We should all be able to agree on the need to simplify the tax code, which grew from 508 pages in 1940 to an incredible 71,684 pages in 2010. My own preference would be to eliminate the income tax and replace it with a sales tax on everything excluding all essential items (food, rent, medical services, prescription drugs and items of clothing priced under $100). This would redirect brilliant legal and accounting minds now toiling in the business of tax avoidance into more creative and productive work. Such a sales tax would be progressive, since the rich spend the most. It would capture revenue on all purchases and expenditures (thus taxing even illegally-gotten income, which currently is not even reported). When the economy booms or when inflation spikes, the rate could be raised to slow consumer spending; conversely, in a slowdown, the sales tax rate could be cut, encouraging consumer spending.

What do you think?

In addition to raising taxes, we need to cut military spending to the point where instead of spending almost as much as all of the rest of the world’s countries combined, we resolve to spend only a little more than that spent by the 10 countries who spend the largest amounts on defense.

But even if we do raise taxes and judiciously cut spending, it would not be enough to dent our astronomic debts. To do that and to revitalize the economy, we need a massive growth program that will produce more jobs and cut spending on unemployment. This will immediately increase consumer purchasing power and demand, boost sales, profits and capital investment, and bring renewed prosperity.

The most effective way to revitalize the economy, cut deficits and resuscitate Main Street would be the major stimulus of a massive government-funded, but private sector-operated, infrastructure construction program similar to the way our government funds defense production by private-sector companies such as Boeing, Lockheed Martin, Northrop Grumman and GE.

This would immediately create jobs, essential to reviving the economy, for those hurt worst by recession — construction industry workers suffering 20 percent unemployment, and the young whose unemployment rate is higher still. Even many college graduates can’t find jobs. All of these people could become productive taxpayers. And by building bridges, tunnels, the electric grid, airports, seaports, dams, sewers and water systems, as well as schools, hospitals, housing and all such invaluable assets, they would improve everyone’s quality of life for generations to come.

Such a program, though it may temporarily increase the federal deficit, would instantly and enormously boost economic growth. This investment would handsomely reward the country and its people. Just a single percentage point of economic growth generates government revenues that would reduce the deficit by $3 trillion over 10 years. An infrastructure jobs program could trigger extra growth of 2-3 percent or even more and, together with the related reduction in entitlement expenditures and the increased revenues from the newly employed and the profits of the infrastructure companies, readily solve our country’s drastic deficit.

So let’s grow and prosper.