Reform Agenda
 

          Washington “reforms”   will extend some regulation to previously unregulated shadow banking and will reduce borrowing leverage from an average of 30:1 to about 10:1 but the enormous lobby power of Wall Street will resist real reform and these fundamental reforms of capitalism will be missing:
 

• Fire Wall Street and move pension savings into job producing investments

• Prevent asset inflation in stocks and real estate and end recessions

• Use corporate surplus for growth and dividends, not stock buy backs and deals

• Change measurement of corporate performance to long-term

Fire Wall Street and move pension savings into job producing investments

Wall Street failed  in handling the wage earners’ pension savings. It did not move them into investment in job producing economic growth, it wasted them on speculative adventures that cost jobs, it destroyed much of their value, it charged ten times index funds for similar performance, it took interest rates so low that  bond income was negligible, it wasted over a trillion dollars in stock buy backs and deals instead of returning this money to the economy in dividends, and it lobbied to allow high-risk investment of pension money that then tanked. The damage to wage earners’ savings is visible and depressing but the damage to their bond income is equally depressing.[1]

  At the same time, hedge fund managers benefited from this low cost money. The top 25 averaged $1 billion in 2009 borrowing taxpayer insured money while paying 15% capital gains taxes, not ordinary income. (top dog made $ 4 billion) For this kind of performance Wall Street should have been fired long ago. While these hedge fund managers enjoyed their additional riches there was 30% unemployment of urban males who could not get a job or a good education. 15 million Americans are out of work and those employed had their average earnings of $18.90 an hour reduced by 2 cents during March 2010.[2]

 How do the wage earners fire Wall Street? By finding other ways to invest their pension savings including direct investment in companies, purchase of bonds for infrastructure needs, and by decentralizing banking to local and smaller banks. The solution to the “too big to fail” bank problem is to take the 401(k) money away and let them shrink. There is an enormous opportunity for citizens to cooperate and write the rules. There is over $2 trillion in infrastructure repair badly needed in our deteriorating country, including broken water mains, grid locked streets, crumbling dams and levees, and delayed flights.   But there is $2.3 trillion in 401 (k) savings seeking long-term low risk investment. Can’t our country create a new tax-free bond, move the savings into infrastructure jobs, and pay the bond interest with the taxes of the newly employed millions? An opportunity to rebuild long-term retirement savings with such bonds would attract a large part of the savings now being recycled on Wall Street as well as the new pension savings looking for investment every year

Pension savings mandated by ERISA in 1974 was the greatest savings-investment opportunity in the history of capitalism because of the trillions of dollars involved and because of the potential to democratize capitalism. This money was used instead to pressure companies to sacrifice future growth and jobs for short-term improvement in earnings, stock price, and values of options. The shocking paradox is that the wage earners’ patient capital was perverted into a job-cutting weapon that then caused the economic disaster that destroyed a large part of their savings. The abandonment by Wall Street of the function of moving savings into job-growth investment was demonstrated in 2006 when, incredibly, $585 billion more was taken out of the market in stock buy backs and deals than was added in new stock to fund growth.[3]

Unless America shifts back to long-term building it will become a second rate economic power with declining living standards. This is a shocking thought for many who still believe that Americans have a nearly automatic opportunity to pass on a better world to the next generation.  A more sustainable economy will have to be more export-oriented, powered by cleaner fuels, bolstered by innovation that comes from a renewed focus on research and development, and committed to delivering a better-educated, more highly skilled work force, all products of the superior economic system that builds more wealth and distributes it broadly.

The question now is the same one that Congress failed to address in 1974. The supply of savings is clear but where are the best places for this patient and risk-adverse capital to be invested for the benefit of the wage earner and the economy?  The normal relationship in capitalism is investment-seeking capital, which insures careful competitive analysis. When, instead, capital is seeking investment the tendency is to move to speculative high-risk adventures that have a presumed better short-term return.

Excessive liquidity was a product of ERISA and made worse by keeping it on Wall Street and not moving it into growth investment. The ideologues of the liberation of capital markets then pulled a big trick on American wage earners by applying the equilibrium theory of free markets to finance capitalism. There is nothing in the dynamic of costs, prices, and volume that applies to finance capitalism. On the contrary they actually use the high prices of their competitors to rationalize their own high prices. These deregulation ideologues had apparently not read Adam Smith’s warnings to beware of the speculators with borrowed money, the prodigals and projectors as he called them. By ignoring this clear warning Wall Street proceeded to lobby ever higher levels of leverage and ever higher levels of risk.

Direct investment of pension savings is gaining momentum. The Ontario Teachers Pension Plan beat out a hedge fund to buy the UK Lottery operator Camelot Group. The Wall Street Journal reported:

Pension funds such as Ontario Teachers are bypassing funds to make direct investments. Their offer of longer-term ownership and higher prices could give them an edge. Over half of its $34.9 billion equity investments are made directly. Other funds are following suit. CALPERS will this year invest directly up to a third of the $1.3billion earmarked for infrastructure.[4] 

     Ontario teachers reported better returns from its direct investment than from  money managers. 

Pension savings have been very passive, that is, there is no agency that speaks for how it is invested or how much money managers charge. The deferred to retirement tax feature of the 401 (k), originally designed for executives, encourages this passive attitude. There should be a building anger that supports reform but observers look at record exploitation of the wage earners’ passive capital and ask: “Where is the outrage?”  Capitalism has been criticized since the beginning of the Industrial Revolution for exploiting the wage earners’ labor. Now in the 21^st century finance capitalism has learned how to exploit the wage earners’ capital.

Part of the pension portfolio can be invested in high-dividend index funds costing .15% (that’s point 15) annual cost compared to ten times as much for Wall Street money managers. With the usual benefit of compounding, from this dramatically lower cost of handling there will be substantial improvement of the money available on retirement in 20, 30, or 40 years. This index investment, however, should be limited to companies whose governance structure gives explicit priority to use of surplus for growth or dividends, not stock buy backs or non-strategic acquisitions. Jack Bogle, the founder of Vanguard has proclaimed the benefits of index funds in articles and books at the same time calling attention to the enormous shift of wealth from the new owners of capital, the wage earners, to the handlers of that money.

     During 1997-2002 alone, the total revenues paid by investors to investment banking and brokerage firms exceeded $1 trillion and payments of mutual funds exceeded $275 billion.”[5] 

     Most wage earner capitalists have no idea of how much of their potential annual return is instead compensating the people handling their money. A small percentage of investment money is in index funds the rest is recycled every year making the handlers wealthy.

     Moving pension savings out of Wall Street is not just a penalty for poor performance but also recognition that future returns on the wage earners’ retirement money can be best made by those whose mission is to benefit the wage earner not support the compensation feeding-frenzy on Wall Street.

    The solution is not vague anger but a fundamental change in pension savings capital and the stock price of public companies away from those with a mission of personal wealth and towards those with a mission to maximize return for the the wage earner. John Maynard Keynes summarized the problem in the 1930s as follows:

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism-which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object.[6]

     Keynes thus emphasized a theme here that affects reform: align the financial incentive with the goal. Lord Bacon warned us several centuries ago that the course could not be run well unless the goal had been properly set. One of the features of the domination by finance capitalism has been perverse incentives that motivate Wall Street’s individuals in ways that damage their client, the wage earner.

Mandated pension funding made trillions of new savings available for investment. It was used instead to fund the Wall Street speculative craze that climaxed and crashed into the present tragic recession, tragic because millions of families have been severely damaged, and tragic because it was so unnecessary. Hedge funds were part of this redirection and perversion of job growth investment capital and nothing could be more obscene than the report that the 25 highest paid hedge fund managers “earned” an average of $1 billion in 2009. Enough of the ugly history however, now citizens must direct their political representatives and money managers to do what they neglected to do in 1974, that is, determine where these savings can be best invested for the benefit of the wage earner and the economy such as infrastructure repair and index funds.

Prevention of asset inflation and future recessions

Government fights price inflation based on the Consumer Price Index (CPI) but does not fight asset inflation in stocks and real estate. A stable value of currency is desirable but the main reason that the Fed fights price inflation is that a shrinking value of the dollar shrinks the asset value of the wealthy. The lobby power of Wall Street pushes government to put people out of work by raising the interest rate and slowing the economy with the mission of protecting their wealth from erosion.

Government, however, has never fought asset inflation despite the fact that it has caused repetitive recessions with devastating effect on millions of Americans. Asset inflation causes the business cycle to overheat and eventually causes recessions. Although it is more damaging to more Americans than price inflation, finance capitalists make money in the up part of the business cycle and do not want government to prevent it.

The financial oligarchy successfully lobbies government policy two ways the common denominator of which is putting people out of work. They actually use the number of people without jobs as the trigger point to slow the economy. Originally it was the Phillips curve where unemployment under 6% was considered the danger point for price inflation. Later this was replaced by the more sophisticated NAIRU (Non-Accelerating Inflation Rate of Unemployment) used for the same purpose. In both, the ugly goal is to identify when too many people have jobs and then slow the economy to put more out of work. It took the Washington price inflation fighters years to understand that the innovation and productivity of the Information Age took the unemployment level from 6% to about 4 % without inflation.

Asset inflation is caused by speculation in stocks and real estate that cause the business cycle and must be controlled by a coordinated use of all tools by government, responding to the cohesive voting power of citizens. In 2010 the damage is severe, wide spread, and will be long-lasting. This time citizens will have to sustain their anger, do their homework, and get enlightened politicians to finally democratize capitalism.

The way will begin with recognition that currency and credit must be in fact controlled for the general welfare and not for the speculators. This will be followed by recognition that distinguishing between money and credit for growth or speculation will not be done by a Committee but rather by one agency with one leader. This person could be the Comptroller of the Currency as that is presumably their responsibility now. The tools to be used carefully and slowly include various taxes, risk-related reserves, interest rates, and supply of currency and credit.

Economist Robert Shiller, one of the authors of the Case-Shiller Home Price Index commented on this question of a single responsible agency:

Senator Dodd’s ( D.Conn) original plan to consolidate regulatory authorities would have been important because part of the problem that led to this crisis was that the regulatory authorities were too scattered, but he backed off on that.”[7]

     Dodd undoubtedly responded to the lobby power or Wall Street but where were the voices and votes of citizens opposing this crucial compromise?

The economic disaster demonstrated that a proliferation of agencies each with a piece of the regulatory responsibility cannot do this job. While existing regulation was faulty and deregulation a bad move there was still enough regulation to have prevented much of the damage. In a grid locked government, however, the complex and delicate use of tools to contain the business cycle cannot be done by multiple agencies one of which, the Fed, even told Congress that it was impossible.

Once the mission is accepted and the structure in place to distinguish between credit for economic growth and speculation, then the bankers and all sources of credit can add a risk premium and build reserves for money and credit for speculation. The present recession should be dramatic evidence of the level of risk that demands such a premium.

This proposal will be violently resisted by Wall Street but if evidence is needed in support of a single agency to prevent the type of damage now affecting American families and the world one need to go no further than an examination of the original pension funding bill that send trillions of wage earners’ money to be wasted on Wall Street. In the ten years it took to design ERISA Congress apparently never asked where the money would go and how much would it cost to get there.

The original intent of the bill, ironically, was to protect pensioners because they were left with an empty bag after Studebaker went broke. The money that was intended to protect pensions was, however, hi-jacked by Wall Street and used to double everyone’s  pay many tens of millions annually, and at the same time increase Wall Street profits from 4% of total corporate to 40%.

     Adam Smith first wrote about the human instinct for social cooperation,  he  then wrote the Wealth of Nations in 1776 that presented economic freedom that could eliminate material scarcity. He did, however, condition its success on control of the speculators with borrowed money; he called them “prodigals and projectors” and warned that they would deflect capital away from the job growth economy-how right he was!      

     Alexander Hamilton made clear in a speech at the 1787 Constitutional Convention that he did not trust the will and wisdom of the people. A few years later as the first Secretary of Treasury he gave privileges to the wealthy and powerful in exchange for their financial support of the new government. The speculators had already used borrowed money to buy up most of the Revolutionary soldiers’ script for 20 cents on the dollar knowing that Hamilton would redeem at full value.

     Thomas Jefferson thought the banks were invented “to enrich swindlers at the expense of the honest and industrious” and vowed to get the “powerful enemy under perfect subordination”[8] when he became President in 1800, but like many since he did not know how to do it.

     The government’s disinterest in asset inflation in stocks and real estate became apparent in the post-war boom of 1812. Speculation with borrowed money did its usual damage and by 1818 thousands were out of work and hundreds in jail because they could not pay $20 debts.

     Four presidents later, populist Andrew Jackson vetoed the National Bank and in his Farewell Address warned of “consuming corruption which is spreading stock jobbing, land jobbing, and every species of speculation.”[9] Jackson did not know how to control currency and credit for the general welfare either and his favored state banks gave easy credit to the speculators and caused the Panic of 1837. 

Economic freedom is so powerful that it spread its benefits to many during the next century and a half despite functioning at a fraction of potential. Positive economic momentum was, however, regularly set back by lack of control of the business cycle in which the rich got richer in the up direction and the poor got poorer in the down.

In the past quarter century the domination of the economy by the financial oligarchy grew to unprecedented extremes fueled by trillions of dollars of pension money that stopped at Wall Street to help fund the misadventures instead of going into job-producing investments. Many Wall Street abuses contributed to the domination by finance capitalism including percentage of the deal pricing instead of advisory fees, and partnerships going public motivated then by the short-term stock price instead of long-term trusting relationships. Trading for their own accounts instead of their clients changed Wall Street all for the bad as sensitivity to the public good by firms such as Goldman Sachs became anachronistic concepts. Economic cannibalism was demonstrated on Wall Street when the big banks stopped lending overnight funds to Bear Stearns and Lehman Bros, demanded more collateral, and then make sucker bets for hundreds of millions of dollars that the Bear and Lehman stock would go down.

During this time the government, in the person of Alan Greenspan Chairman of the Fed, not only did not try to prevent asset inflation he even testified to Congress that he did not have the tools to do it and it was better to wait for the bubble to burst and then go to work on damage control.

Greenspan and Robert Rubin as Secretary of Treasury in the Clinton administration were the leading ideologues of the liberation of capital markets and did enormous damage in America and other countries such as Indonesia by incorrectly applying the equilibrium theory of Smith’s free markets to finance capitalism. The interaction of costs, prices, and volume in this free market theory that brings capitalism back into equilibrium has nothing to do with the dynamics of finance capitalism and for this reason it needs regulation not deregulation.

 Rubin, and the American dominated IMF, used the economic problems in Indonesia to provoke another regime change and got rid of Suharto who had been the architect of an amazing improvement in the lives of the people in the world’s largest Muslim nation. These ideologues talked emerging nations into taking down all cross border capital controls to let “free capital find its most efficient application.” Hot money instead rushed in with the click of a computer mouse and went primarily to stock markets and high-risk  projects.  Nobel Prize winner and former Chief economist of the World Bank Joseph Stiglitz commented:

The countries in East Asia had no need for additional capital, given their high savings rate, but still capital liberalization was pushed on these countries. I believe that capital account liberalization was the single most important factor leading to the crisis.[10]

After the economy was devastated by US led hot money and currency speculation that drove the Indonesian currency down 70%, another regime change was promoted by America while also promoting Wall Street firms.  The Indonesian economy was further damaged by the bankers’ knee-jerk reaction to cut expenses and limit lending. Regime change had been a feature of American foreign policy during and after the Cold War as America assumed responsibility to run the world. The fundamental error was to confuse economic freedom and democratic elections. The former feeds, clothes, shelters, educates, and provides health care while the latter does none of this and frequently upsets the economy. This destructive policy began with the dumping of democratically elected Mossadegh in Iran in 1953 the beginning of American mistakes in the middle-east. Young Iranians develop their attitude toward America by studying this question: How can the country that proclaims the benefits of democracy and free elections bribe enough rioters to get rid of a democratically elected leader? American students never hear about this. 

The Case-Schiller Home Price Index, can be used to identify the increase in house prices beyond economic growth. The P/E (price/earnings) ratio that has averaged about 16 for 60 years can be used to monitor stock prices. If it departs significantly from growth consistent with the economy then restraints should be gradually applied. Brokers’ margin accounts, for example, can be increased in 5% increments from its present level of 50%.

Bubbles take several years to do their damage and if gradual application does not slow the cycle then more tools or stronger application is in order. Perhaps the most powerful tool will be recognition by speculators that easy credit and easy profits in the up direction of the business cycle are a matter of history and that they had better limit their bets.

The following are specific ways to limit speculation and asset inflation:

           Capital gains taxes:  Gains under one year are now taxed at ordinary income rates while longer term are taxed at 15%. Speculation will be controlled with a capital gains tax beginning at 50% under three months going down in a linear fashion to 10% in five years.

           Transaction taxes: Originally proposed by Professor Tobin of Yale over 20 years ago the idea can be a win-win. Each transaction in the $2 trillion a day in international currency, for example, has a slight tax that will mute speculation while providing hundreds of billions of dollars for world development, infrastructure, and educational needs. This tax is opposed not only by the speculators but also by all of those who break out in a rash at any mention of world order. Their resistance must be challenged however as the instabilities in international finance are dangerous and eventually a bankrupt America will be relieved of its world currency reserve status to be replaced with a world currency. How Tobin tax money is collected and used obviously needs dialogue with all nations and the U N. This will not happen until America has an epiphany and recognizes its role in the world as strong team player, not cop of the world on borrowed money.

            Income taxes:  The source of easy credit for speculation should being limited and incomes over $5 million should be progressively taxed. A good beginning will be to take away the capital gains tax privilege for the hedge fund managers and charge them ordinary income taxes. Entrepreneurs and small businesses can be encouraged by tax relief and subsidies.

            Bank reserves:  BIS (Bank for International Settlement) the central bankers club in Basel Switzerland has issued Basel II on  “risk related reserves” but it is a very slow process and leaves many loop holes. Rules should be based on participation of all countries with U N involvement. The first risk to be addressed is the use of money for speculation instead of economic growth and reserves should be increased when bubbles appear. New rules should be international reflecting the global nature of commerce and the tendency of Wall Street to resist reform on the thin argument that it will force financial services companies into other countries. European countries seem more determined and more conservative in their regulation.

            Leverage: Most of Wall Street copied Goldman Sachs’s risky trading for their own accounts then increased profits by increasing the leverage with borrowed money.  An infinitesimal profit could be made betting with one’s own money that an anomaly in the relationship of different currencies would return to the long-term relationship.  A huge profit could be made by the same bet if one borrows 30 times one’s capital. Ten times is usually regarded as conservative leverage but failures like LTCM (Long Term Capital Management) in 1998 exposed leverage of 50:1 and higher. Chasing profits by increasing leverage inevitably leads to disaster as the bets go bad for strange reasons, like Russia defaulting on its bonds. Then the losses are enormous and out of proportion to the size and resources of the company. Listen to the advice of an independent investment banker from Little Rock:

One of the primary causes that bought the financial system to the brink of collapse was that investment banks were over leveraged while the balance sheets of commercial banks were undercapitalized. If an investment bank has a leverage ratio of 30 to 1, a drop in asset prices of 3.3% will basically wipe it out. Surely we’ve learned that all asset classes are at risk for a disruption in liquidity, the magnitude of which could far exceed 3.3%.[11]

Recommendations are to impose a 15 to 1 leverage ratio on all investment banks and require a sliding scale on capital requirements with lower requirements for small banks while the very large institutions, the “too big to fail” ones would have a greater equity capital cushion if a crisis did occur. Also suggested was getting rid of the accounting rule that prevents commercial banks from building up their loan loss reserves in the good times          

The FDIC (Federal Deposit Insurance Corporation) insures deposits up to certain levels. The government effectively copied this theory and insured big banks for their losses (except Lehman) an extreme violation of free market disciplines. The government “reforms” will not make companies “small enough to fail” and will instead extend implied government bailout insurance to shadow banking, such as hedge funds and G E capital.

Risk premium on money:  A government trying to control currency and credit for the general welfare should begin by distinguishing between a low interest rate for job growth investment that improves the lives of people and a high interest rate for speculation in which making money on money has no social benefit. If the going rate is 5% for commercial loans then it should be 7% for speculation and higher if a bubble continues.

Condo flipping: Extreme speculation such as buying and selling condos on the computer without ever using or seeing the property should not enjoy credit effectively insured by the taxpayer. The risk premium on the cost of this credit should be high enough to prevent this abuse along with higher capital gains taxes on short-term gains.

Subprime mortgages: Floating rate mortgages for low-income families should be prevented by government policy. Many families were blind-sided by the large increases in monthly mortgage payments when the rate floated up and lost their homes.

CEO responsibility: Most citizens are appalled at the damage that Wall Street and Corporate CEOs have imposed on the economy and on their lives. Some mistakes were admitted but only the outright criminal have suffered penalties. Most wonder how hundreds of highly paid presumably smart bankers and executives could have missed the incorrect values on their balance sheets for long periods of time. Professor Robert Reich, Labor Secretary in the Clinton administration, has a suggestion: don’t look for new solutions just enforce the Sarbanes Oxley Act of 2002. Reich points out that “Sarbox” required CEOs to take personal responsibility for the accuracy of their companies; financial reports.

If they don’t, they’re subject to fines and criminal penalties. If they did not know then they failed the ‘Sarbox’ requirement that they have internal controls in place to assure the integrity of reports. [12]

Transparency:  Bankers used many tricks to move loans off their balance sheets in order to have room for more lucrative loans. Reform coming out of Washington may require transparency on standard derivatives but not on other derivative trading.  During the past decade bankers have presented balance sheets in their annual reports that they either knew were misleading or should have known. Structured finance was the technique used by big banks like Citigroup to move hundreds of billions of dollars off their balance sheet.

Learn from other countries: Canadian banks were relatively unscathed by the economic crash because they had speculation under better control. China disagrees with Alan Greenspan that countries do not have the tools to prick a bubble. They do it regularly with bank reserves. Hong Kong is notable for mortgage delinquency rates staying remarkably low even when real estate prices dropped sharply.  A WSJ article quotes this Hong Kong advice: “Make sure if there is a bubble, the only people who get hurt are the speculators, not the banking system.”[13]

Accurate credit reports:  Credit agencies such as Moody’s and S&P were paid by the users of their credit ratings but that changed to being paid by the issuer of the credit report at the same time the agencies made more money on consulting than credit.  Moody’s net income went up from $159 million in 2000 to $705 million in 2006. According to Fortunes’ Bethany McLean in a large part because of increase in fees from “structured finance” the umbrella under which this mortgage alchemy falls.[14]

Priority use of corporate surplus for growth investment and dividends

     The domination of the economy by finance capitalism is demonstrated by the priority distribution of corporate surplus for stock buy backs that benefit the executives rather than dividends that could provide a “capital wage” for the wage earner capitalists. “The 401 (k) has evolved into America’s largest private-sector employer-sponsored retirement plan, covering some 50 million workers and holding $2,3 trillion in assets, according to the Employee Benefit Research Institute". [15]  These are the shareholders who should determine the distribution of corporate surplus but they are poorly represented both by money managers and their political representatives. Despite becoming the new capitalists they have been limited in the rewards from capitalism. Finance capitalism that exploited their labor during the Industrial Revolution have now learned how to exploit their capital. This incredible contradiction cannot continue as there are too many bright Information Age workers and the damage by Wall Street is too severe and visible.

     Corporate surplus is the cash available at the end of the year compared to profits that are not cash but an accounting calculation. The uses of this surplus include reinvestment in growth, dividends, stock buy backs and deals. The domination of the economy by finance capitalism was demonstrated during the last quarter when about $1 trillion more surplus was used for stock buy backs than returned to the economy in dividends. About a third of corporate profit improvement in the last decade was arithmetically produced by this buying back of shares. If the all-important earnings per share have a lower divisor then the earnings, stock price and stock options go up but no jobs are created.

     Much of the usual need of surplus to grow on was purged by sacrificing programs to hype short-term earnings. Growth, of course should be the priority use of surplus in order to provide citizens with economic opportunity, the first human right.

     Dividends have always represented one-half of the return from capitalism until the last quarter when the domination by finance capitalism resulted in their 6% yield shrinking to 1-2%. Wall Street does not make money on dividends and would prefer the cash be available for a deal or to attract a deal. The strongest argument for large dividends is to review the benefits of the trillion dollars wasted on stock buy backs if it was paid out in dividends to the wage earners. The opportunity to democratize capitalism with pension savings would become real and the vision of matching a capital wage with the labor wage would become a reality. It did not happen that way but now it can.

     Obviously the benefits of large dividends to the wage earner would expand if they were tax-free but there are other benefits. As the pension savings have been diverted to Wall Street games and then losing value, the opportunity for wage earners to be motivated as owners of companies is lost. Among ways to motivate people to produce more wealth and to distribute it broadly a feeling of ownership from pension savings is the most remote. It can, however, be stimulated by large tax-free dividends that steadily build or rebuild retirement accounts. Democratic managers can use this ownership to build an environment of trust and cooperation but such damage has been done that it will take many years.

     Some might object that this return of large dividends would reduce the amount available on retirement now encouraged by the deferred tax feature. Dividends, instead of wasting money on stock buy backs, allows the pensioner to spend half of the money to the benefit of the economy and still have more money in the other half than the puny dividends now paid. This half can be diversified in another patient capital investment. The option is available for those close to retirement to reinvest all of these dividends in their existing account.

     Finally, large tax-free dividends would help spread profit sharing and ownership plans. It would provide the lacking financial incentive to pressure politicians to make them tax-free as well as the pressure on corporations to give dividends priority right after growth reinvestment.

     An argument for stock buy backs is that they prevent dilution from the exercise of stock options. This will become academic when stock options are recognized as a short-term motivator that seduce CEOs into being ripe for deals not long-term planning. Occasionally they trap lower level employees with big loans and stock that is “underwater”, that is, the loan is more than the depressed stock value. Options should be replaced by stock grants that are disciplined by a charge to earnings for the company and a tax obligation for the recipient. The Wall Street short-term priorities that have infected corporate American can be further purged by rules that require all bonuses to be paid in stock and no sales of any stock until after retirement.

Change in measurement of corporate performance to long-term criteria

     Shareholder capitalism that caused the economic crisis measured corporate performance on quarterly earnings per share and the price of the stock. It was not even “shareholder” oriented as it favored Wall Street and money managers who had little stock and hurt the 50  million wage-earner shareholders with their 401 (k) ownership.

This reform agenda proposes that corporations are best measured by a three year running average of sales growth, profits, and cash flow against managements’ predictions. This measurement is more responsive to the longer-term nature of business. This measurement will encourage the democratic work culture and help build the economy.  This measurement can also serve as the basis of executive compensation following these protocols:

·         The Board compares these predictions to a peer group in order to determine bonus opportunities and then pays on performance

·         Base pay will be based on an internal logic determined by wage consultants

·         The same inflation adjustment will apply to all levels

·         All employees including the CEO will participate in the same profit sharing and stock purchase plan.

·         The CEO and other top executives will take all bonuses in stock

·         The CEO and other top executives will not sell any stock until 6 months after retirement

·         This measurement will encourage long-term programs and end the practice of sacrificing long-term     plans for quarterly earnings

·         This measurement will emphasize organic growth and limit deals to those that are truly strategic

·         The long-term emphasis will help move the stock market back to its proper function of providing new capital for growth

·         Stock buy backs are limited to preventing dilution from the stock purchase plan

     When the flow of mandated pension savings hit companies and Wall Street, the CEOs and Directors tried to insulate themselves as much as possible from responsibility for properly investing the workers’ retirement money. Money managers were given the responsibility and those whose quarterly performance rated low on measurements like the Becker Median were replaced. Quarterly predictions of earnings per share and analysis of results elevated the analysts to new heights. Their average compensation went up by a factor of ten. Their comments on company performance were devoured by CEOs and executives and were usually the first order of business at Board meetings. Beating estimate could add substantially to the companies’ market capitalization and not only reward the executives with stock options but also provide a higher P/E that made acquisitions easier. Conversely, a miss of a few cents a share could provoke analyst reports that drove the price of the stock down and made the company more susceptible to take-over.

     Few questioned that the quaqrterly measurement was too short to have anything to do with the dynamics of most businesses. If Warren Buffet was on the Board then there would be no estimates and only annual results were emphasized but most of corporate America accepted the quarterly vise and began to sacrifice long-term programs and do “financial engineering” to meet the estimates. CFOs were celebrated for their ability to find ways to “make the numbers” usually reversing inventory or bad debt reserves as too conservative. Eventually many CFOs ran out of these gray zone opportunities and  crossed the line into forcing the numbers, for example, shipping products to a warehouse but booking it as a sale. Pension funding reserves were another favorite hunting ground and in a rising market estimates on long-term performance crept up from 6% to 12%. This raiding left the pension funds under reserved in the inevitable downturn.  Pension fund reserves were also looked at as low-hanging fruit for the take over artists.  Some companies found a simpler way to handle the problem-just fake the numbers, give Wall Street whatever they wanted.

     This quarterly pressure for a quarter century has shut down many growth programs and cut jobs. Despite this profound effect on the economies’ growth the solution is quite simple-change the measurement to one long enough to represent the real dynamics of the business. Such a measurement should be against managements’ predictions on a three-year average of sales, profits, and cash flow.  A CEO would then propose that sales would grow, for example, an average of  6 % during the next three years but would have the flexibility to estimate that sales would be flat in the first year due to investments that would increase growth in subsequent years. If the average profit estimates were less than 6% then shareholders could properly question why there was no leverage. There have to be good reasons why a company cannot improve the profit growth percentage faster than sales.

     The benefit of the cash flow estimate can be best understood by retroactively applying it to Enron.  This debacle first demonstrated the effects of repealing Glass Steagall. The point of this law passed in 1932 was to recognize the conflict of interest between commercial banks who loaned money and investment banks who participated in deals. The argument was that the commercial bankers would provide easy credit far beyond reasonable limits in order for the investment bankers to come in and get the lucrative deals. The year after the law was repealed this is exactly what happened at Enron. Chairman Lay made Skilling CEO and gave the international market to Rebecca Mark as a consolation prize to Skilling’s Harvard Business School competitor for high position at Enron. Skilling was not only a graduate of HBS but was given the highest honor as a Baker Scholar

     Mark proceeded with deals around the world including a power plant in India most of which failed and drained cash. If Enron had predicted cash flow it would not have expected most of the deals to go bad and the actual build up of more loans against a favorable estimate would have exposed Enron incompetence early. Until near the end Enron was being hailed as one of the best and this reputation kept the funds flowing. A few years of bad misses would have alerted the analysts, shareholders, and pensioners with their net worth tied up in Enron of a chance to bail out. 

     The function of finance capitalism is to support the job growth economy by moving savings into long-term investment.  The function of bankers is to handle this transfer at the lowest cost while assuring the quality of the loans.

     The damage is wide-spread and deep. The pensions that were to be protected by ERISA (# 13) added trillions to the flow of cash to Wall Street but stayed there to hurt the wage earner in these ways:

·         Companies were pressured into short-term “shareholder” capitalism in which the price of the stock was paramount while jobs and growth were sacrificed for short-term earnings.

·         Hedge funds and private equity deals also sacrificed jobs and long-term growth for quick profit

·         Money managers charged ten times index funds for worse performance

·         Over a trillion dollars was wasted on stock buy backs instead of returning the money to the wage earner and the economy in dividends

Specific reform of Wall Street

     The above reform agenda is directed towards the fundamental problems in capitalism as distinguished from reform of finance capitalism that caused the problem. This assumption was based on Congress getting it right this time-an overly optimistic assumption. Consequently reform of capitalism is still dependent on cleaning up the mess on Wall Street with a citizens agenda that will neutralize the damage continuing to be done by their lobbying. The politicians still want their money and there are still 5 lobbyists for every politician walking the halls.

     Wherever possible reforms use economic motivation instead of bureaucratic oversight:

1 Mortgage brokers on salary not commission with a “claw back” provision for the following five years in any bonus system

2 Originators of loans must keep “skin in the game” at least 20% of loan to encourage careful examination of the quality of the loan

3 No floating rate loans for subprime borrowers. It was the sudden increase in the monthly mortgage payment that put many of these financially unsophisticated borrowers in default.

4 Regulate “shadow banking”. All source of credit including hedge funds and corporations who borrow and lend must be subject to the same regulations as banks

5. 8% Capital Reserve as a buffer against the quick withdrawal of short-term money and demands for collateral that triggered the crisis.

6 “Coco” bonds: A bank structure in which “convertible contingent” bonds convert to equity if the bank violates any regulation such as the 8% capital reserve. A representative of these bond holders should be a Board member alert to trends that would endanger their bonds.

7 Small enough to fail:  Free market punishment for failure must not be abrogated and the “too big to fail” banks must be broken up first by again separating the commercial banking from the investment banking and by moving pension money to other investments.

8 Derivative clearing house will provide transparency and a market price to avoid the “mark-to-market” problem of valuing trillions of derivatives in a fire sale market.

9 Double dealing made a criminal act: Prevent the practice of Goldman Sachs and others of shorting, that is betting it would lose value, at the same time the instrument is being offered for sale as a desirable investment. This corruption was even extended to creating new products for sale in order to have a vehicle to satisfy the demand to short sell. 

10 The ideologues of the liberation of capital markets must take a cram course in Adam Smith’s free market theory in order to understand that his theory of seeking equilibrium did not apply to finance capitalism. In fact, he warned against the “prodigals and projectors” who would deflect capital from the job growth economy.

11 No fantasy football. Credit default swaps can be used only by those who own the bonds.

12    No off-balance sheet tricks: If it can be a liability now or any time in the future

show it on the balance sheet. Footnotes not acceptable.

13    No renting of wage earners’ pension stock: the practice of pension funds “renting”

their pension funds to short sellers must stop. It is quite possible that the short seller is attacking the company that pensioners work for.

14    Make the “up-tick” rule official: No short sale for stocks that have declined over

10% unless the price is higher for that day and the following. This rule was passed by the SEC by a 3-2 vote on party lines.[16]

15    No naked shorts: The Seller must have possession of the stock to short, no

renting.

16    Credit agencies only in the rating business: The conflict of interest in selling other services should stop. Government regulators should require credit agencies to explain significant change in the cost of credit default swaps without change in the credit rating. Go back to rating agencies paid by the user not the issuer.

17  International reserve currency: Keynes and Stiglitz recommend that the dollar no longer be the reserve currency. The two trillion a day bet on currency would go away and the waste of country’s assets building up reserves as protection against currency speculation would stop. Use the money for growth and education

18    Tax stock options out of existence: Stock options encourage a short-term

mentality and a proclivity for deal making. Stock grants are disciplined by a tax consequence to the company and to the recipient and should be used instead.

19    Senior executives cannot sell stock until 6 months after retirement. With all

mentality and a proclivity for deal making. Stock grants are disciplined by a tax consequence to the company and to the recipient and should be used instead

20    Limit to 8:1 leverage.  30:1 leveraging and worse must be stopped as a major   

      contributor to the disaster.

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