Sunday, May 16, 2010

Saving the casino: America's economic recovery strategy

A surprising number of America's localities have made themselves increasingly dependent on casino gambling. Las Vegas and practically the whole state of Nevada need no introduction in this regard. There is also, of course, Atlantic City, New Jersey. And, there are the myriad riverboat casinos, Native American-run casinos, and casinos in many states limited to designated cities. The taxes from these gambling enterprises enrich both localities and states.

But there is a much larger casino operating in the United States. It variously goes by the name banking, stock and bond investing, commodities speculation, asset-backed securities, and myriad instruments classified as derivatives which get their value from some underlying security or commodity. So much of this casino-like activity is now embedded in the American economy that the so-called FIRE sector--finance, insurance and real estate--makes up more than 20 percent of the gross domestic product as of 2008 and 31 percent of corporate profits in 2009 excluding real estate.

That means that nearly everyone in the United States directly or indirectly is dependent on the well-being of the FIRE economy whether they work in it or not and whether they have savings and investments or not. It means that governments at all levels have become dependent on tax revenues generated by this part of the economy. Given this, it makes sense that the federal government's economic recovery efforts have focused on financial companies--commercial and investment banks, insurance companies, brokerages, and, most critically, mortgage lenders. The aim has been to levitate both stock and real estate prices with the hope that confidence will be restored and growth will resume.

But as most people now know the FIRE economy depended for its profit on toxic subprime mortgages, dubious commercial real estate deals, heavily leveraged buying and selling of stocks and bonds, questionable and inscrutable derivative instruments, and the issuance of massive amounts of government debt to finance the American living standard in an era of low taxation.

This system has remained essentially unchanged despite belated attempts to rein in risk-taking and prosecute lawbreakers who duped investors. And, it is this system which we are trying to revive through bank bailouts, automobile company bailouts, huge government stimulus spending, and Federal Reserve Bank emergency measures including ground-hugging interest rates and massive purchases of low-quality mortgages.

It is a sign of just how preposterous and counterproductive this strategy will ultimately be that CNBC's Larry Kudlow is apoplectic over the wave of investigations now besetting Wall Street. His concern is that too much scrutiny of Wall Street's machinations will sink the economy which he rightly suggests is dependent on the FIRE sector for its well-being. If the government shouldn't investigate Wall Street and its co-conspirators in the FIRE economy because it might weaken the overall economy, and if maintaining a strong economy is the single most important task of the government, then perhaps Kudlow believes the government should never investigate these people for any reason. It's the equivalent of saying that we shouldn't investigate drug pushers for fear of creating hardship among addicts.

And, therein lies the problem. The whole nation including the government has become overly dependent on this parasitic part of the economy. We are told that it will be dangerous if we even try to make sure that those working in the FIRE economy don't bilk their customers or if we try to put into jail those who already have.

A healthier path would be to wean America off its addiction to the "gambling" revenues and profit generated by the FIRE economy by once again separating investment banks from commercial banks and heavily regulating commercial ones as mere public utilities for facilitating the day-to-day operations of the economy. We should also limit the size of insurance companies and banks, both commercial or investment, so that financial institutions are not in a position to blackmail the government into saving them when their bets turn against them. In other words, it will be possible simply to let them fail.

The incentives in these institutions should be regulated so that the managers do not get their bonuses immediately, but only after a period sufficient to make sure they are not simply pocketing profits now and saddling shareholders and the public with losses later. Taxes on financial transactions should be raised enough to discourage frequent trading. And, taxes should be levied as well on outsized profits so as to discourage the flow of society's precious capital into the nonproductive avenues of finance. And finally, most people should be actively discouraged from investing their money in speculative markets. Instead, society should find some way to have retirement money managed in a very low risk manner on behalf of the vast majority of people who know little or nothing about the risks they are taking in investing.

The first step to curing an addiction is admitting it. Wall Street took the public for a ride, an almost 30-year ride, promising endless prosperity and riches without work! It turned out to be nothing more than a vehicle to enrich the few at the expense of the many. But instead of acknowledging this fact, members of the public are once again being enticed by Wall Street to stick with what is essentially a gambling addiction. The government is abetting the financial industry with the sales pitch that the Congress is going to reform the casino so that it will be a fairer place to gamble. (But, we aren't even going to do that with the current proposed reforms.)

The odds that throwing one's savings at risky stock, bond and commodity markets will again end in tears for the vast majority of average investors is almost 100 percent--just as they are for the losing gambler who goes back into the casino vowing to recoup his or her losses.

Job losses, bailout fuel noisy crowd marching on Wall StreetFix the economy, not Wall Street

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