Anger at Wall Street Hides Dire Far-Reaching Consequences

Playing on the anger at Wall Street, a class war being fanned by President Obama and efforts to reduce the national debt, Democrats in Congress are seeking to reincarnate a discredited tax that was tried and abandoned 30 years ago.

Introduced Nov. 2 as the Wall Street Trading and Speculators Act, it levies a small tax of three basis points (three cents on $100) on financial transactions, including stocks and bonds along with derivative contracts, options, puts, forward contracts, swaps and other complex instruments at their actual cost.

The tax is small enough ($3 on $10,000 of trading) that long-term investors would barely notice it. Its sting would be felt by traders who move in and out of positions and by those with high-speed robot computers that generate thousands of trades in the blink of an eye.

Proponents say the tax would raise $353 billion over the next nine years. That's nearly a third (29%) of the $1.2 trillion the congressional "super committee" is supposed find for debt reduction.

Backers also contend the tax would reduce the volume of speculation, which they blame for the high volatility of recent years.

So what's not to like?

For one thing, there was such a tax in New York State for nearly 50 years before it was repealed in 1981. Research on the period the tax was in effect showed no consistent relation between tax changes and changes in stock volatility. When there was change, it was an increase in volatility even though trading volume declined.

More recent research has shown that the proposed levy, albeit small, would have far-reaching consequences of considerable magnitude.

Research by Professors Yakov Amihu of the NYU Stern School of Business and Haim Mendelson of the Stanford Business School shows clearly that higher trading costs depress the prices of stocks and bonds. For The Wall Street Journal, they wrote:

"A transaction tax will end up punishing Main Street, hurting the economy and reducing U.S. Treasury revenues in the next few years. It will thus exacerbate the effects of the financial crisis."

They go on to explain that a "tax on stocks will lower their average price by about 10%." The effect will vary, but will be "more depressive for large-cap stocks, like those in the Dow Jones Industrial Average. These highly-liquid stocks trade very frequently with a bid-ask spread of a penny."

The researchers pointed to a report that showed the tax proposal would increase the total transaction cost on U.S. large-cap stocks by 80% and other stocks by nearly 50%.

"The drop in stock prices means that companies would have to earn more on stock-financed investments to make them worthwhile," the professors wrote. "Similarly, a transaction tax on corporate bonds will make their price fall for any given coupon rate they offer, meaning that the borrowing cost for companies will rise."

Amihu and Mendelson wrote: "In essence, a transaction tax on securities is tantamount to a rise in interest rates, which inhibits investment and economic growth."

As for reducing the government deficit, the researchers said: "Not in the first few years (because) the immediate decline in securities prices will reduce tax collection on capital gains."

Another consequence of the tax will be a migration to trading centers not subject to the tax, like foreign exchanges.

"Over time, the loss of trading will threaten U.S. leadership in financial services and reduce employment in the broker/dealer and affiliated industries," the researchers said.

Finally, "a tax on Wall Street hurts Main Street by reducing employment and investment. The waning investors' wealth will reduce consumption and hinder economic recovery. . .

" A far cry from what the tax advocates hope to achieve."

SEC Plays Hardball
The Securities and Exchange Commission (SEC) filed 30% more enforcement actions against investment advisors in the fiscal year ending Sept. 30 than in 2009-10.

The 146 actions taken against advisors were among the record 735 resulting from the most significant reorganization of the agency's enforcement division since it was established in the early 70s.

The increase in actions against broker-dealers was 60% -- double that for investment advisors.

The Corzine Waiver
This is the kind of stuff that enrages folks of all political persuasions: bending a law or regulation to favor the rich and famous or, in this case, the infamous.

A FINRA regulation clearly states that financial professionals who have been out of the business for more than two years must retake the Series 7 and 24 exams before they can get back in.

But alas, this didn't apply to New Jersey's former governor and senator Jon Corzine before he took over MF Global and presided over its collapse. The governor was away from the industry 11 years, but certainly someone who rose to become CEO of Goldman Sachs, the financial world's crown jewel, shouldn't have to sit for an exam designed to test the competency of beginners. So Gov. Corzine was granted a waiver.

True, such waivers are common in the industry. They're granted for experience, educational achievement and regulatory experience. At first glance, it would appear that the governor qualified.

But there's one big hitch. His experience in government did not expose him to the rapidly changing regulatory environment in the investment industry.

And these days, that's what it's all about.