INEQUALITY FOR ALL ... WHY THE RICH SHOULD BE TAXED MORE

Last night at a Bakersfield screening for Robert Reich's documentary "Inequality for All" I was asked to lead a Q&A with the audience after the show. The documentary was full of information that got many in the audience thinking about the reckless direction of our economy and society, and what we need to do to turn things around.

Among the first points made by Reich in the film was how the top 1 percent of America has seen their share of income swing radically upward since the 1970s. Specifically, in a span of 30 years it more than doubled, and reached levels not seen since right before the Great Crash of 1929.

For Reich the swing in income looks very much like a suspension bridge ...

I noted during the Q&A that the top 1 percent of wage earners believe that their income gains are "earned" because - if we are to believe their argument - they are smarter, harder working, and more deserving, among others. Conversely, if your income and financial situation has stagnated or worsened - as is the case with America's middle class - it's because you are not smart enough, hard working enough, and less deserving. Worse, many are viewed as whiners and moochers.

Both assumptions are simply not true.

Let's make this real simple. The rich are getting richer because of legislative favors that include tax gifts, deregulation, state sponsored globalization (Bretton Woods / Treaties), state supported outsourcing (tax inducements), technological advancements that facilitate outsourcing, manipulation of the law, a string of market bailouts, artificially cheap money, and many other developments that have nothing to do with being harder working or smarter than middle-class Americans.

Put another way, as I point out in my book, the state creates the conditions under which wealth is created. The fact that the rich have gotten richer because of favorable legislation, regular bailouts and deregulation tells me that they should pay more to the state that helps their riches grow.

Put more bluntly - and following Reich's cue during the film - one of the things that we need to do is raise taxes on the top 1 percent of wage earners. I made this point during the Q&A.

Towards the end of our Q&A discussion one of the last questions of the evening was about raising taxes on the richest Americans. The person asking the question was curious as to why it's always mentioned that we need to raise taxes on the top 1 percent. I answered by noting that we have bills to pay, and that the real issue is one of fairness. I left it at that since we were at the end of our evening discussion.

I should have said more. This is what I would have added with more time.

I would have made it clear that the richest Americans need to pay more than they do now (15-20 percent on capital gains, and 39.6 percent marginal rate on other income) because they have been enjoying state supported successes that you and I help to subsidize with our taxes. Think about the following:

1. SOCIALIZED LOSSES: Investors enjoy built in tax advantages for making investments. If they sell their stocks at a loss they can deduct it as a capital loss from their next tax bill. You and I pay for this. Nice.
2. SOCIALIZED LOSSES, II: Did you know that if an investors' losses are so big and they can't use them all in one year they can carry them forward so that they can be applied to another year? It's part of the carry forward law. You and I also pay for this.
3. BAILOUT FEVER: One of the lessons of capitalism is that if you make stupid decisions you're supposed to lose your money. Not so under our current system (see #1 and #2 above). Thanks to a series of market bailouts for Wall Street our nation's biggest market players have seen their financial portfolios surge rather than tank. You and I backstopped the bailouts.
4. CHEAP MONEY: Thanks to Alan Greenspan and the Federal Reserve the biggest financial players have been able to access dirt cheap money. Specifically, because of the Greenspan Put every time market players make a mess of things the Fed is there to push cheap money into the market for the nations biggest financial institutions. You and I pay for the gambling and market crashes that occur because of the cheap money.
5. INCOME IS INCOME. Why should income from investments be taxed at a lower rate when the income that I make - after investing years and money into getting my degree - is taxed at two (and perhaps three) times the rate that the richest Americans pay?  

Seriously, apart from being granted favorable legislation and deregulation gifts, where's the fear of losing money in the market if your investments and market bets are backstopped with tax favors, bailouts, and artificially cheap money?

Put more simply, those who have made a lot of cash in this fixed market environment need to help pay the trillion dollar tabs that we've run up while subsidizing their "market" successes.

How simple has it been for America's richest class to make money? Think about this. Things have been rigged in the favor of the top 1 percent to such a degree over the past 30 years that a monkey throwing darts could have made money in the market.

Seriously, click on the link here to learn about monkeys making money in the market.

Do yourself a favor and watch Robert Reich's "Inequality for All." And bring a notebook. There's so much information (and that's a good thing) that you might regret not bringing it (or buy the DVD when it comes out) ...

If you you live in Bakersfield there will be showings at the Maya Theater on Thursday (11/13) and Saturday (11/15).

- Mark 

DONALD TRUMP'S 1995 TAXES MAKE IT CLEAR THAT HE'S THE POSTER CHILD FOR WEALTH EXTRACTION ... NOT WEALTH CREATION

So Donald Trump lost almost a billion dollars 1995. He then used that "bad year" in a complex tax shelter scheme to avoid paying taxes on things like profits, salary, and interest income in subsequent years.

In tax speak what Trump experienced in 1995 was a "capital loss" which - because of our generous tax laws for the rich - he's able to "carry forward" as a tax credit in subsequent years.

In plain speak, Donald Trump was granted something akin to a perpetual "get out of jail free" tax card. He was granted this for no other reason than our tax laws and favorable legislation tolerates and even coddles bad and incompetent behavior in the market place.

So this is what we have. Donald Trump made bad business decisions (Trump acknowledges paying too much for things like "trophy properties" and airplanes before 1995). Favorable legislation and subsequent tax law allowed him to use his losses to avoid paying taxes in the years that followed. So, yeah, a tax code that was written to help businesses survive a bad year or two, with tax credits and write-offs, morphed into something that became Donald Trump's tax hammock in perpetuity (David Cay Johnston explains the process here, in "The Art of the Steal").

The reality is we shouldn't be surprised by any of this. Donald Trump is a con man. His wealth is a product of inheritance and privilege. The inheritance we understand. The privilege is a bit more complex, but in real simple terms it's exemplified by how Trump can swindle small businesses while taking advantage of generous tax laws that are only available for those big enough to get Congress to write special financial legislation for them.

What this means is that Donald Trump is the poster child of an economy where gaming the system through shady tax write-offs, stiffing suppliers, legal shell games, and bailouts are accepted practices. Wealth creation is replaced by wealth extraction. This is not how private markets are supposed to work.

I wrote about how markets are supposed to work and how they actually work 5 years ago. I'm re-posting it below, with a few small edits to account for The Donald. Enjoy.

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We hear it all the time. Don't interfere with the marketplace. Deregulate. Get the government out of the market. Unfettered competition leads to the best possible outcome for everyone because people rationally pursuing profit will enhance both productivity and quality in the marketplace. Like an "invisible hand" the needs of society would be met. In the end consumers get better products. Producers get more money. Workers earn better wages. Everyone wins. 

At least this was the message many believe Adam Smith, the intellectual godfather of capitalism, told us in The Wealth of Nations (1776). It's this belief system that has fed the free market and deregulation push we've seen over the past 35 years. It's what's pushing us today. Unfortunately, much of what Adam Smith wrote was often misrepresented and taken out of context by many of his followers, including Milton Friedman. It's also one of the reasons I wrote The Myth of the Free Market.

To be sure, Adam Smith argued that the state should stay out of the marketplace. But not because he believed market players should be free to do what they wanted. Rather, Smith believed the government should stay out of the market because it usually intervened on behalf of monopoly and privilege. Smith's message was that we shouldn't allow market players run herd over the rest of us. 

Many of today's market players have no clue about any of this. And it shows. In fact, contrary to popular belief, market players like Donald Trump and those on post-bailout Wall Street ignore - or don't recognize - how they have pushed and benefited from the very visible hand of government supports and subsidies, which Adam Smith feared would happen. 

The bailouts, artificially cheap money, and favorable legislation discussed below are just a small peak into the number of supports the state provides "private" market players so they can be successful in the market place.

A SERIES OF MARKET BAILOUTS 
Talk about a lack of accountability. One of the cornerstones of a competitive market system is the idea that there would be retribution for stupid decision making. In a real market economy you're supposed to go bankrupt and/or lose your business if you make dumb decisions (like gambling, or paying too much for a casino and old planes). Guess what? Increasingly, for America's biggest market players, it's simply not happening. 

Anyone who argues otherwise is either clueless or on crack. 

Here's a short list of the bailouts Americans have yawned at or supported since Ronald Reagan's "free market" revolution began in 1980:

* Wall Street / Mexico in 1982.
* Continental Illinois in 1984.
* The Discount Window intervention to save floundering banks in the late 1980s.
* Market support after the October 1987 crash.
* The Savings & Loan debacle of 1989-1992.
* Intervention to save the Bank of New England and Citibank.
* The 1994-1995 Wall Street / Mexico rescue.
* The Asian Currency rescue in the late 1990s.
* The Fed-organized LTCM bailout.

Impressive, isn't it? But know one thing. This list is incomplete. 

In virtually every case above we were told, in one way or another, by the Chicken Little's of the financial world (and Washington) that bailouts and subsidies were necessary, or else "prosperity in our time" could end. Markets would collapse, and middle class Americans would be hurt. So we propped up the stupidity with bailouts, rather than "let the market work." We were saved. 

Then 2008 came along. Oops.

THE GREENSPAN PUT 
The "Greenspan Put" is perhaps the greatest guaranteed money flood in human history. It all began when Alan Greenspan became chair of the Federal Reserve (1987-2006). Instead of letting market players pay for their market stupidity, Greenspan made the decision to push money into Wall Street - the Greenspan Put - every time things looked bleak, or Wall Street created a mess of things. And he did it by making money available at a cheap price (all the while claiming free market principles). 

Coupled with deregulation, this helped to accelerate the markets appetites for bigger and bigger market bets. It didn't matter to Alan Greenspan that the vast majority of trading isn't done by humans buying and selling shares, but by computers and high frequency traders dealing in ever more complex financial instruments). 

With cheap money so readily available accountability on Wall Street took a back seat to the mentality that the The House was backing the markets bets, so why not bet more. The Greenspan Put continued under Ben Bernanke (with QE I and QE II) and, now, under Janet Yellen. 

FAVORABLE LEGISLATION / MARKET INTERVENTIONS 
If markets are logical, and market players are rational, someone needs to explain why market players need the very visible hand of the government for this: 

* You're not smart enough so ... The 401k was created in 1978 by Congress to encourage workers to invest in the market (by allowing employees to defer paying taxes on income they invest). The rules impose strict penalties for early withdrawal (why do we have penalties if market players are rational?). By enticing investors with tax breaks our financial markets have been given an artificial boost, which is good for portfolio and wealth managers who get paid based on fees and volume managed. Don't believe me? Check out what's happened to market activity and volume traded since the 401k and other "invisible hand" of the market tools were invented by Congress ...

- The Helmet Laws for brokers ... NYSE circuit breaks are designed to maintain confidence when markets tank by putting a stop to all trading. Apart from this circuit breaker, market players are also allowed to suspend redemption's - which means not allowing clients to sell their investments - in order to stabilize markets that are in a panic. Both make a travesty of market logic and the code of rationality that we're told dominates the market. It rewards gambling and stupidity by telling brokers "we'll control the panic, even if your incompetence starts it."

- The "socialize the losses" law (deduction) ... If you sell a stock at a loss you can deduct it (as a "capital loss") from your tax bill. Nice.

- The "carry it forward" tax law (deduction) ... Stock losses can be carried forward for tax purposes. Specifically, a banking stock that collapse can be used to offset gains from more successful ventures, or even a portion of your everyday income. 

From propping up the market with the creation of the 401k, to creating market circuit breakers and suspended redemptions, to socializing market losses over a period of years, one thing is certain: market players don't always have to take it on the chin when they make stupid investment decisions. 

There are many more of these legislative and political gifts. The point is it's hard to argue that people like Donald Trump and the millionaire wunderkinds on Wall Street are rugged individualists going it alone in a jungle-like market environment when we look at all the government created, and taxpayer funded, market supports that are out there. 

In fact, in many ways people like Donald Trump and those working on Wall Street have become a walled off, protected, wards of the state. 

Unfortunately, there are plenty of market players like Donald Trump who are delusional and arrogant enough to believe they're actually market giants, slaying market dragons. In reality, monkeys picking stocks randomly could have made money in this state subsidized market environment, as you can read about here. 

In fact, in our state supported market environment Donald Trump would probably be worth more than he claims if he had just put his money into an index fund.  

Whether Donald Trump would be worth more if he simply invested in an index fund is not as important as understanding this: If Trump had invested in an index fund he would have saved many creditors and small businesses (that he stiffed) the trouble of having to deal with his bankruptcies and the legal threats he regularly uses to avoid paying his bills.

At the end of the day, people like Donald Trump (and the financial mandarins on Wall Street) are the beneficiaries of a massive legislative and financial group hug that's been provided by Washington over the past 35 years. 

When market players like Donald Trump say "Get government off my back" know one thing: It's a hollow battle cry made by people who realize how the state creates the conditions under which wealth is created, but hope you never find out. 

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People like Donald Trump don't want the "government off their back" as Ronald Reagan famously cried. After benefiting from generous tax breaks and trillions in bailout cash, it's clear that Donald Trump and others depend on the state for favorable legislation and economic sustenance.

Without favorable legislation and state subsidies, it's difficult to see them as the "successful" businessmen they claim to be. Donald Trump is the poster child for wealth extraction, not wealth creation.

- Mark



UPDATE: "How a simple rule let Donald Trump turn a $916 million loss into a plus" from the NY Times.

HOSTESS AND THE WEALTH EXTRACTION MODEL IN REAL TIME

The demise of Hostess is a long and complex story, as Fortune's "Hostess is bankrupt ... again" makes clear. If you don't have the time to read the entire piece this about sums it up ...

The real story behind the Hostess mess can be summarized with the following:

1) While the Hostess brand is still viable many products are tired and out of step.
2) Bain Capital-style investment and management techniques are now driving this show.
3) Bankruptcy law, tax deduction games, and "capital loss" and "carry forward" tax law make it clear that the hedge funds will win.

The last point here is key. The hedge funds are at the top of the liquidation, bankruptcy, and tax food chain. While the Fortune article doesn't mention it the players behind the hedge funds also know that they have PBGC - corporate America's pension safety net (PBGC is really a corporate dump) - plus years of favorable legislation and favorable tax laws at their back.

This means the hedge funds can make money even if bankruptcy is declared and losses are filed.

People can talk all they want about pensions and unions, but not only have concessions been made (and further concessions promised) but current tax law means the hedge funds can drive pensions into the ground, declare bankruptcy if they don't get additional concessions, and still win financially.

Whatever bankruptcy and restructuring emerges from the Hostess case one thing is clear. This is a classic case of wealth extraction, where years of favorable legislation and the tax code subsidize our market players.

- Mark

P.S. On the lighter side ...

GET GOVERNMENT OFF MY BACK? HARDLY ...

We hear it all the time. Don't interfere with the marketplace. Deregulate. Get the government out of the market. Unfettered competition leads to the best possible outcome for everyone because people rationally pursuing profit will enhance both productivity and quality in the marketplace. Like an "invisible hand" the needs of society would be met. In the end consumers get better products. Producers get more money. Workers earn better wages. Everyone wins.

At least this was the message many believe that Adam Smith, the intellectual godfather of capitalism, told us in The Wealth of Nations (1776). It's this belief system that has fed the free market and deregulation push we've seen over the past 30 years. It's what's pushing us today. Unfortunately, much of what Adam Smith wrote was often misrepresented and taken out of context by many of his followers, including Milton Friedman. It's one of the reasons I wrote The Myth of the Free Market.

To be sure, Adam Smith argued that the state should stay out of the marketplace. But not because market players should be free to do what they wanted. Rather Smith believed that government should stay out of the market because it usually intervened on behalf of monopoly and privilege. Smith's message was that we shouldn't allow market players run herd over the rest of us.

Many of today's market players have no clue about any of this. And it shows. In fact, contrary to popular belief, market players today ignore - or don't recognize - how they have been pushing and benefiting from the very visible hand of government subsidies and supports, which Adam Smith feared would happen. Check it out:


A SERIES OF MARKET BAILOUTS: Talk about a lack of accountability. One of the cornerstones of a competitive market system is the idea that there would be retribution for stupid decision making. You would go bankrupt and/or lose your business. Guess what? Increasingly, for Wall Street's biggest players, it's simply not happening. Anyone who argues otherwise is either clueless or on crack.

Here's a short list of the bailouts Americans have yawned at or supported since Ronald Reagan's "free market" revolution began in 1980:

* Wall Street / Mexico in 1982.
* Continental Illinois in 1984.
* The Discount Window intervention to save floundering banks in the late 1980s.
* Market support after the October 1987 crash.
* The Savings & Loan debacle of 1989-1992.
* Intervention to save the Bank of New England and Citibank.
* The 1994-1995 Wall Street / Mexico rescue.
* The Asian Currency rescue in the late 1990s.
* The Fed-organized LTCM bailout.

Impressive, ain't it? But know one thing. This list is incomplete.

In virtually every case above we were told, in one way or another, by the Chicken Little's of the financial world (and Washington) that bailouts and subsidies were necessary or else "prosperity in our time" could end. Markets would collapse, and middle class Americans would be hurt. So we propped up the stupidity with bailouts, rather than "let the market work." We were saved.

Then 2008 came along. Oops.

THE GREENSPAN PUT:
Perhaps the greatest guaranteed money flood in human history. It all began when Alan Greenspan became chair of the Federal Reserve (1987-2006). Instead of letting market players pay for their market stupidity, Greenspan made the decision to push money into Wall Street - the Greenspan Put - every time they created a mess of things. And he did it by making money available at a cheap price (and he said he wasn't a Keynesian ...).

Coupled with deregulation, this fed market appetites for bigger and bigger market bets (it didn't matter to Greenspan that the vast majority of trading is not done by humans buying and selling a few hundred shares, but by computers and high frequency traders dealing in ever more complex instruments).

Accountability flies out the door when The House backs your bets in Vegas. So it is with Wall Street (though, to be fair, Vegas doesn't do what Washington does). The Greenspan Put has been continued under Ben Bernanke with QE I, QE II, and what we can expect to be QE III (yes, it's coming).

FAVORABLE LEGISLATION / MARKET INTERVENTIONS: If markets are logical, and market players are rational, why do free marketeers need the very visible hand of government for this ...

* You're not smart enough so ... The 401k was created in 1978 by Congress to encourage workers to invest in the market (by allowing employees to defer paying taxes on income they invest). The rules impose strict penalties for early withdrawal (why penalties if market players are rational?). The end result is that by enticing investors with tax breaks our financial markets have been given an artificial boost, which is good for portfolio and wealth managers who get paid based on fees and volume managed. Don't believe me? Check out what's happened to market activity and volume traded since the 401k and other "invisible hand" of the market tools were invented by Congress ...

- The Helmet Laws for brokers ... NYSE circuit breaks, which stop trading, are designed to maintain confidence when markets tank. Then we allow market players to suspend redemption's (not allowing clients to sell their investments) in order to stabilize markets in panic. Both make a travesty of market logic and the code of rationality that we're told dominates the market. It rewards gambling and stupidity by telling brokers "we'll control the panic, even if your incompetence starts it."

- The "socialize the losses" law (deduction) ... If you sell a stock at a loss you can deduct it (as a "capital loss") from your tax bill. Nice.

- The "carry it forward" tax law (deduction) ... Stock losses can be carried forward for tax purposes. Specifically, a banking stock that collapse can be used to offset gains from more successful ventures, or even a portion of your everyday income. So much for taking it on the chin when you make a stupid investment decision.

There are many more of these legislative and political gifts. The point is that it's hard to argue that the millionaire wunderkinds on Wall Street are rugged individualists going it alone in a jungle-like market environment when we look at all the government created, and taxpayer funded, market supports that are out there.

In fact, in many ways Wall Street has become a walled off, protected, ward of the state.

Still, today there are plenty of market players who are dumb and arrogant enough to believe they're actually market gurus, slaying market dragons. In reality, monkeys picking stocks randomly could have made money in this state subsidized market environment (and they have the tests to prove it).

At the end of the day, Wall Street and their financial mandarins are the beneficiaries of a massive legislative and regulatory group hug given by Washington over the past 25-30 years.

Get government off my back? What a joke. Worse, market players don't even know it.

- Mark

UPDATE: Here's an excellent article (9/26/11) explaining ETFs, or exchange-traded funds. It's written by Money Mornings Shah Gilani. ETFs are complex derivative products, which fit into the "complex instruments" noted above.

IT'S DEJA VU TIME ... IN EUROPE

Back in 2004 Wall Street investment giants Bear Stearns, Lehman Bros., Merrill Lynch, Goldman Sachs, and Morgan Stanley were in trouble. Major losses and big debt was on the horizon, as they were on the hook for trillions of dollars in toxic mortgages and securities.

So Wall Street's biggest banks sent then Goldman Sach's CEO Hank Paulson to the Securities and Exchange Commission (SEC) to work out a deal (it wouldn't be his last).

Paulson wanted to get the SEC to allow the biggest investment banks to borrow more money.

Specifically, he wanted to more than double the amount of debt Wall Street's biggest investment banks could carry on the books. Wall Street's strategy was to borrow and bet invest more in the market, so they could grow their way out of trouble.

After their special exemption was granted, the investment industry's debt limit (net capital rule) was lifted from 12:1 and reached more than 30:1 for several firms by 2008 (and more than 40:1 for Merrill Lynch). We all know what happened in 2008. Wall Street's "let's borrow more to get out of debt" plan was a bust because they were borrowing big so they could bet invest big on market garbage.

Fast forward to the present ...

Remember the €110 billion (Euro) package for Greece, and the €750 billion (Euro) “safety net” for all Euro zone members? The amounts were so large because the European Union (EU) wanted to "shock & awe" market players. They wanted to show the world that the EU knew how to deal with Europe's financial problems ... by borrowing more money.

The EU's financial rescue plan is starting to be exposed for what it really is ... a real mess.

Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives has much to say about how Europe plans to fund it's bailout program. Here are some of the highlights (lowlights?):

* In order to finance EU member countries as needed the EU - through the European Financial Stability Facility (EFSF) - needs to issue debt, which will be backed by EU member states. The major rating agencies have already awarded the fund the highest possible credit rating AAA [didn't this happen before? you know, on Wall Street.].

* The measures are not designed to assist Greece or the other troubled countries. In reality, they are designed to support banks that have lent heavily to them [in plain speak this means the plan is more political than economic].

* If an individual nation-state fails to supply its share of funds it's share will be covered by a surplus “cushion” which requires participating EU countries to guarantee an extra 20% beyond their shares.

* A cash reserve will provide additional support (Greece is not included in the EFSF program because no one believes they can cover their commitment).

Got that? Europe is going to cover it's member countries' debt by issuing more debt.

With the amounts we're talking about, isn't this Wall Street deja vu all over again? Seriously. It doesn't matter that the real goal of propping up the banks (instead of individual countries) is to make sure every one's got some skin in the game. The end result is that Europe is borrowing more to prop up a weak system.

And the system is slowly crumbling because no one really wants to confront the world's financial markets - like we failed to do with Wall Street in 2004 - and  make them pay for their greed and stupidity.

Sigh ...

- Mark