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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

Starving the beast

Posted by WARREN MOSLER on April 25th, 2010

How to fight back against Wall Street

Much like we killed the buffalo to defeat the American Indians, we can work to tame Wall Street by working to reduce its food supply. And a large part of that food supply is the US pension system. Created and sustained by the innocent fraud that savings funds investment in a ‘loans create deposits’ world, the powerful attraction of being able to accumulate ‘savings’ on a pre-tax basis has generated nearly $20 trillion in US pension assets in thousands of scattered plans, from the giant State retirement funds to the small corporate pension funds, to the various smaller individual retirement funds.

Before I get to the way we can eliminate these bloated whales being eaten alive by the sharks, let me first suggest a few ways to whales from becoming shark food. The first is to get back to ‘narrow investing’ and public purpose by creating a list of investments deemed legal for any government supported pension funds. And ‘government supported’ would include any funds that are in any way tax advantaged. Legal investments would be investments that are in line with further public purpose. Not a lot comes to mind. If the public purpose is safety for the investors government securities would be appropriate, as government securities are functionally government guaranteed annuities. New issue equities might make sense if portfolio managers were required to be sufficiently educated and tested to make sure they are up for the responsibility of deciding where new real investment is best directed. But that’s a major and impractical undertaking. And there is no public purpose in simply trading new issues for relatively short term gain with no longer term stake in the merits of the underlying business. Nor is there any public purpose to investing in the secondary equity markets. In fact, with the rules and corporate governance stacked against shareholders, there is public purpose to not investing in those markets. Nor are these my first choice for the institutions I’d want investing in corporate bonds. It makes more sense to utilize the 8,000 regulated and supervised Fed member banks, all of which already specialize in credit analysis. If there is public purpose to buying corporate bonds, better the banks perform that function and not the pension funds.

So it looks like the only investments that make sense are government securities. The problem there, however, is I’m also advocating the government stop issuing securities. So that would mean the only investments for pension funds that make sense from a public purpose point of view are insured, overnight bank deposits. And that would go a long way towards taking away Wall Street’s food supply, thereby greatly reducing the troubling kinds of activities that we’ve been witnessing. This drastic reduction in financial sector activity would make regulation and supervision of what’s left a lot less complex and far more effective, and at the same time work to stabilize the financial aspects of the real economy.

Longer term, with the recognition that we don’t need savings to have money for investment, we can change the tax laws that are fostering these problematic pools of savings, and let them wind down over time.

Racing to the bottom

Government is about public infrastructure for further public purpose. That includes the usual suspects such as the military and the legal system, but Federal public infrastructure also includes regulation to stop what are called ‘races to the bottom,’ which usually involve what are known as ‘fallacies of composition.’ The textbook example is the football game, where if one person stands up he can see better, but if all stand up not only is nothing is gained, and no one gets to sit and watch. Allowing anyone to stand to see better is what creates that race to the bottom, where all become worse off. A ‘no standing’ rule would be a regulation that supports the public purpose of preventing this race to the bottom.

Another example is pollution control. With no Federal regulation, the States find themselves in a race to the bottom where the State that allows the most pollution gets the most business. The need to attract business drives all the States to continuously lower their pollution standards resulting in minimal regulation and unthinkable national pollution. Again, Federal regulation that sets national minimum standards is what it takes to prevent this race to the bottom.

Insurance regulation has been at the State level, which was deemed too lax only after the failure of AIG, which was the end result of a race to the bottom the Federal Government should have addressed long ago. Discussion has now begun regarding national insurance regulatory standards.

11 Responses to “Starving the beast”

  1. ESM Says:

    Some good ideas in this post, but I think that you run into some problems with personal (investing) freedom. Yes, the government should not be using tax policy to encourage saving per se. That creates a distortion in the market (the idea of a long-term capital gains tax rate that is different from a short-term one is particularly bad). But it is inevitable that individuals and institutions will have tens of billions of dollars of “savings” which they wish to manage. Therefore, it is also inevitable that we will have professional money managers. And as, night follows day, they will be overpaid and do a bad job because it is extremely difficult for their customers to monitor their performance.

    But I certainly do not want the federal government dictating to me where and how I should invest. Not only is that a curtailment of individual freedom, but it will lead to worse problems in the long run as the investment process will inevitably become more politicized than it is.

    In the past, I’ve estimated that roughly 25% of Wall Street revenues are “earned,” in the sense that real value is being provided to the world in that amount. The other 75% is just gouging. Still, you’re only talking about $350B in revenues total, so it’s not THAT big a problem. Not as big as the cost imposed by our crazy income tax code, for example, much of which shows up in Wall Street’s revenues.

    Reply

    ESM Reply:

    Sorry, should have written “trillions” instead of “billions” above.

    Reply

    Matt Franko Reply:

    ESM,
    I think Warren is only talking about ERISA balances. Not all non-govt sector “investments”.
    Resp,

    Reply

    ESM Reply:

    I understand. But Warren asserts that it makes no sense to have tax-advantaged investment pools (ERISA regulated pools being the only kind I can think of off the top of my head), and I agree with him. If you eliminate the tax advantage, and hence the implicit government sponsorship, you’re still going to have roughly the same amount of investments that need to be managed. Maybe the stock market will be a little lower, and maybe corporate bond spreads will be a little bit wider, but you’re still going to have tens of trillions of dollars of assets. Wall Street will have a role no matter what.

    Warren wants government sponsored pools to be more regulated so that Wall Street can’t take advantage of them as easily, but that goal is somewhat in conflict with (or at least mooted by) his ultimate goal of eliminating the government sponsorship altogether.

    Reply

  2. anon Says:

    That tax break might come in handy, given we’re going to be earning the “zero natural rate” on pension funds composed of bank deposits.

    Reply

  3. Panayotis Says:

    Good point about “the race to the bottom”. This is competition of private units whose interests try to “capture” and impose a public cost. However, a public standard must be guarded by institutions whose authority and duty is to protect the solidarity among civic units in the community. If institutions are captured by the competition of private units then the solidarity standard is not practiced and collateral damage or externalities are not removed, even if the standard is legislated. In other words, it is not enough to set a regulation standard but our institutions need to enforce it.

    Reply

  4. Jim Baird Says:

    Isn’t it true that savings has the same macro effect as taxation, so that taxing money someone wasn’t planning on spending anyway serves no purpose other than to get him mad?

    Reply

    ESM Reply:

    Well, we have to be careful about our lingo here. Only savings in the form of government IOUs directly removes spending power and reduces aggregate demand (all other things being equal). Investing in a stock or even a corporate bond does not have that effect because the money the investor pays just goes to the seller who then has to decide what to do with it.

    The public rationale for allowing people to invest tax-free in retirement accounts never made any sense. The only practical effect is to create artificial demand for financial assets and thus boost their prices somewhat.

    Of course, there is an interesting argument to be made that investment income shouldn’t be taxed at all.

    Reply

    Oliver Reply:

    I think there is a danger in only focussing on flows and not on stocks. I can see that only spending and not holding can have undesired effects. But isn’t the potential disruption this spending can cause directly proportionate to the total size of holdings and especially the equality of their distribution? Not that it matters whether it is government IOUs or other assets. I just feel that micromanaging the effects (taxing beach front property, as Warren would say) will more often than not be be too little, too late. Taxing potential is a blunter instrument, but also more effective, imo.

    Reply

  5. Tom Hickey Says:

    extension of the egalitarian defense

    Reply

  6. beowulf Says:

    “Much like we killed the buffalo to defeat the American Indians…”

    That’s an interesting analogy, I had never heard that before. Apparently it has the added advantage (as Kissinger would say) of being true.
    http://www.pbs.org/wnet/nature/episodes/american-buffalo-spirit-of-a-nation/introduction/2183/

    Reply

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