Not sure new taxes is enough...

We need some much more honest talk about how money works within our economy soon if we're going to turn around some of the political idiocy we see from both parties.

We need to rethink the whole way we organize ourselves around material gain. If you look at the components of wealth and measure the interactions, it’s pretty apparent that we can figure out better, fairer, and simpler (maybe) ways to organize our approach. All that’s required is that the small minority that has most of the stuff give up a significant chunk of said stuff. Sadly, the list of volunteers for the role of “giver-upper”, while growing, is small, and the amount of energy (and money, of course) used in efforts to reverse that karmic flow is substantial.

This is made more complex when, every couple of generations, the group of people that believes most strongly that the group of people who control the majority of a society’s assets deserve to do so (and those making the rationalization are closely aligned to the wealthy in terms of membership), that group pushes conditions of wealth inequality past sustainable levels - and the system collapses. As we’ve gotten more efficient at implementing markets, we appear to have a bevy of government/regulator/market-related professionals who have deluded themselves for years with concepts such as “equilibrium’ who cannot help but think it must have been something, anything else that explains what happened.

What happened really isn’t in denial. Repeat after the me:

The Banking System in the US and the EU, plus the UK and some of the Scandinavian countries, crashed. Strictly by letting the industry run according to the best tenets of the prevailing economic wisdom of the time:

o The Rich got Richer and fewer.

o The Poor got Poorer … and so did everyone else in the middle.
And then,

BOOM

The world's economic structures crashed. Nothing worked as it was supposed to.
And we still don't talk about how it happened. Some do, to be fair. But they're kept off to the side while the Players try to control their information. It's a really strange place we live in.

* * *

Every time I think I am amazed at the state of political dialogue in this country, something else happens that reinforces my previously held analysis and its resulting mix of disgust, chagrin, and wonder at how the old barriers to information managed to wash out on a wave of technology and leave a lot of people on the beach who had apparently been swimming sans trunks for quite some time.

Read My Lips: We Need Taxes!

It feels like we've been having this conversation for a long time. Politicians love to tell their constituents that they will lower their taxes. It makes for good politics. But when the cold, hard truth comes out - We need taxes to make the country run - for some reason, this seems to come out of left field for the country. Pity President George H.W. Bush for his punishment for failing to deliver on his promise of "Read My Lips: No New Taxes." But the fact of the matter was that in the aftermath of the crash of 1987 and the negative reverberation in the markets in 1989, he didn't have any choice but to make up for the losses in the markets (and incomes) by raising taxes.

And the truth hasn't changed. We need taxes to run the country. Today we have trillion dollar wars ongoing (happily, one of them being ramped down), we have a country in the midst of its worst recession since the 1930s, and an increasingly stratified country in terms of the "haves" and the "have-nots." We have a ballooning deficit and an unemployment rate that is making most of us uncomfortable, if not shaking some long held beliefs about our economy and the American dream.

Here's a concept - the richest people in the country should pay more taxes than the people that make very little money. The rich folks would have you think this makes no sense at all (in a related story see "Why Wall Street is Deserting Obama") - but from my perspective, it is the only way we can run this country of ours. The people who make very little money spend it - they have to. They need to pay for housing and food and clothes. The people who make too much to spend it all, save it. They don't need to worry about food and housing and clothes. I know from tracking my own expenses - food only makes up about 2% of what I spend each month. We can tax the spenders, but that leaves them little to spend. And they don't have much in the first place.

The widening disparity between the socio-economic classes is well documented. A recent study found that the gap between the rich and the poor is now at the same level it was just before the crash in 1929. In a recently published book by David Schweikart ("After Capitalism"), the author describes the disparity:

If we divided the income of the US into thirds, we find that the top ten percent of the population gets a third, the next thirty percent gets another third, and the bottom sixty percent get the last third. If we divide the wealth of the US into thirds, we find that the top one percent own a third, the next nine percent own another third, and the bottom ninety percent claim the rest. (Actually, these percentages, true a decade ago, are now out of date. The top one percent are now estimated to own between forty and fifty percent of the nation's wealth, more than the combined wealth of the bottom 95%.)

As blogger David Chandler shows on his website, www.lcurve.org, the L curve - not a bell curve - illustrates the income distribution in the US:

The bottom 99% of the population measure their incomes in inches. The top 1% measure their incomes as stacks of $100 bills feet or even miles high! The total wealth of the few people in the vertical spike equals the total wealth of the rest of the population combined. [Chandler shows this as a graph looking like a football field; most people are on the field, the top 1% are on the endline - the vertical spikes off the page.]

What does that income disparity result in? Most of the country trying to get by - going to work, raising their kids, going to movies, paying mortgages and watching TV and Netflix. But as for the other 1%:

People on the vertical spike can use their influence single-mindedly and very effectively. A single billionaire can get the undivided attention of any politician he wants, any time he wants. If he doesn't get what he wants he can, in fact, "fight city hall," the statehouse, and even the federal government. People on the horizontal spike must pool their limited individual power and organize to have any effect at all. This is a very difficult thing to manage, in practice.

This widely skewed allocation (can't even call it distributed) of wealth and income is repeated in many different studies (see http://sociology.ucsc.edu/whorulesamerica/power/wealth.html, http://www.businesspundit.com/wealth-distribution-in-the-united-states/, http://www.levyinstitute.org/pubs/wp_502.pdf). It's a fact of life in the US today.

So is it not better to tax the savers, since they have alot of money? OK, even I find this argument a little difficult - I save money (and don't spend it) because I make enough to do so. Why should I let the government take that money from me?

Here's why.

The government should tax my savings because I don't need all of it. And there's a good to come out of it. Admittedly, I am biased, because I worked for the government once, for four years, and had a salary because of the taxes collected from my fellow Americans. But I also know that as a result of my taxes I have roads and bridges, schools and libraries, art museums and repertory theaters, national parks and golf courses, an armed militia and a sizable government that takes care of things like courts for overseeing litigation, making sure that our environment is protected, monitoring consumer products and providing services for our returning veterans. I think all that stuff is pretty darn good. And I'm willing to pay for it.

Postscript to last post

While there's still lots of jumping up and down and angst about the May 6th market crash/recovery, I think Christopher Whalen has pretty much nailed it -- the markets worked fine.  Did exactly what they were supposed to do.  It's a question of whether or not we want to let them act this way -- which is a question of values, not one of economics.

Perfect trading QUARTERS -- 4 of them!

The NY Times reported today that Goldman Sachs, Citigroup, JP Morgan Chase, and Bank of America all achieved perfect trading quarters in the first 3 months of the year.  In other words -- every day in the quarter, they toted up their winnings and losings after the markets closed (note -- this never actually happens, the markets don't close for global traders, they just follow the sun around the planet), and discovered they had made money.

Every single day.

From what I can tell, this is the first time this have ever happened for even one firm, much less four.
This struck me as being pretty unlikely, to say the least.  So I started to think about how to calculate the odds.  Turns out, someone else had beaten me to the punch -- see "More On Goldman's "Perfect Record".
According to his calculations, the odds on this happening for one firm are 8.67 x 10^-19.  That's not very good odds, to say the least.  8.67 times in 10,000,000,000,000,000,000, compared to a rough chance of 1 in 500,000 of getting hit by lightning walking down the street.  That's a million times less likely than a one-in-a-trillion chance.  If you take the odds on this happening, again for one firm, and spread them out over the approximately 936 possible quarters since the founding of the US, you end up with something like close to 100,000 times less likely than a 1-in-a-trillion chance.

Not what I would call gambling odds.

But the whole point is that it didn't happen for one firm.  It happened for four. At this point we're way past my willingness to count zeroes ...but I don't think the odds are better.

Seems to me that the banks could give the casino boys in Vegas some lessons about how to set up the house odds.

And it seems that we still can't figure out why the markets did their plummet/climb last week (other than all the buyers ran away at the first sign of trouble).

Gotta love "free" markets ...

The Drop

We'll have a much better picture in the next few days, but for 90 minutes today on Wall Street, there was quite a bit of anxiety as we watched the Dow plunge almost 1000 points. There was talk of the Greek crisis, and the ECB and rates, but it was the specter of that graph on CNBC with the steep ski slope that really made us gasp. Could it be?

Could it be that the contagion that is Greece had just made the US markets go into free fall? Had we not learned anything about systemic risk in 2008? Was there anything to keep us from going into a free fall? Of course not - there's been no legislation to make any changes. The legislation that would have gone into effect (but did not today) was the circuit breaker rule (for when the market drops 10%) that would have given the markets a breather and allowed them to assess what was going on in the event of a rapid drop. That was enacted after the Market Crash of 1987.

But no, it was not in free fall. We watched with open mouths as the Dow, again, spectacularly, shot right back up 500 points in several minutes. Anyone that had been around in 1987 knew what this was too - program trading. No one person can trade in that volume - only machines can. There was talk later of a possible person involved in making a mistake with an order, and maybe that will turn out to be true (person error - an operational risk - not necessarily systemic risk!), but the sweep of the trading wave was awesome to watch.

What will we learn from May 6, 2010? Time will tell.

Game Change

It's been over 18 months since the Crisis hit us full force in September 2008. At that point, when the government had to step in and prevent a crisis by injecting liquidity into the major financial institutions in the US (which is not the way the financial institutions would recount the story, by the way), many of us said this is surely going to change things. How could it not? Secretary Paulson and his Treasury staff went to inordinate lengths to prevent a complete meltdown of the markets, which looked imminent in that first week of September, and indeed, not many days later, the credit markets completely locked up. Money was not flowing from anywhere except the Treasury. Trust in our markets had been shaken to its roots, and not only here at home, but around the world. It was pretty scary, even to those who had spent their lives in the financial world.

Discussions I had with my friends around that time and several months thereafter focused on thoughts of how things were going to change: "Wall Street will have to change the way it's been doing business" and "this will force people to take another look at the way they live their lives - pursuing the almighty dollar." Many of us were hopeful that finally the Naked Emperor that was Wall Street would be seen for what it was - simply a source of money, not a producer of goods. Why should the financial markets be nearly half of our economy - it didn't make sense. What, as Paul Volker has argued, had financial firms done to help the economy since creating the ATM?

After reading and learning about exotic derivative instruments that helped bring down the markets, I and many others (including Warren Buffet) questioned that these instruments did anything for anyone other than make money for the investment banks that created and sold them (and made money more than one way in the same transaction). The investors (as has been painfully evident) did not benefit (at least in the same way) most of the time.

But it seems apparent that Wall Street hasn't gotten it, and is vehemently opposed to change. At least that's what you'd have to take from the hordes of lobbyists on Capitol Hill at the moment, trying to subvert the financial reform legislation that is trying to make its way through Congress. I've heard people say, You can't rush this kind of thing through. Look at what we did after Enron! They are referring, of course, to Sarbanes-Oxley, the financial reform legislation that, heaven forbid, made chief financial officers of public companies annually review their internal controls and attest to the effectiveness of the internal control structure and procedures of their company for financial reporting. That's the kind of legislation I am in favor of.

One could argue that SOX, as it's commonly known, created an annuity for accounting firms, but I would argue, accounting firms already had an annuity in that public companies needed to have audited opinions to be listed and traded on an exchange. As an investor and long-term shareholder, I think SOX made things better. And I refuse to listen to the complaints of how much SOX cost and continues to cost companies - I am very happy to have my company spend a few million making sure that their internal controls work, and that people are being held responsible for the financial health of the company.

But I digress. To counter the critics: The financial reform legislation now in Congress arrived TWO YEARS AFTER the Crisis. That's not really rushing something through. The National Institute of Finance group of volunteers who developed an idea for an Office of Financial Research, to help try and identify systemic risk issues ahead of the next crisis, spent a good year working on their proposal before it was included in the Dodd legislation now before Congress. There is some criticism that the reform legislation is trying to fix something for which the cause of the problem is not known. I think that's fair criticism, but on the other hand, as my co-blogger and I have written, there is some pretty decent evidence that the shadow banking market was largely to blame for the regulators having no idea of what was going on from a transactional point of view in the financial world in the lead up to the meltdown. But wouldn't you know, it is the legislation that tries to bring transparency to that shadow market of over-the-counter derivatives, that is the piece of legislation that is getting the most attention from lobbyists, who are all trying to create loopholes in that particular legislation for their clients.

Is there any hope to change the game of Wall Street? I like to be optimistic, but at the moment, I'm finding it hard to find the sun shining anywhere on Capitol Hill.

More Goldman Sachs discussions

Blooming all over the web, they are ....

Though a bit strongly worded, this one is good, and inadvertently makes the point that if the Tea Party folks want to be upset about something, they're pointing in the wrong direction at the moment.  Chris Whalen, as usual, has some cogent thoughts on his Institutional Risk Analytics site.

And Paul Krugmans's column in today's NY Times has the quote "For the fact is that much of the financial industry has become a racket — a game in which a handful of people are lavishly paid to mislead and exploit consumers and investors."

And, from Crazy Eddie's old CFO, we have this really interesting assessment.