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Investor's Business Daily

 

New 'Rules' For Finance Are Politics By Any Name

October 26, 2011

By Nicole Gelinas

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To the “Volcker Rule” and the “Buffett Rule” observers should add the “Obama Rule.” The maxim: Rules named after people are cheap political pandering — and come at the expense of governing.

The Volcker Rule was President's Obama's first attempt to borrow a trusted face to placate voters frustrated at the lack of progress on a complex issue.

Back in January 2010, the White House was upset over Republican Scott Brown's victory in the Massachusetts Senate race. The president decided to reconnect with people by looking tough on banks without being tough on banks.

The Volcker Rule was born, later to become part of the Dodd-Frank law. Named after Paul Volcker, the rule adopted a suggestion made by the former Fed chairman: Banks that benefit from taxpayer guarantees of their deposits should not be in the business of speculative trading. The rule was to be, in the president's words, “a simple and common-sense reform.”

The Volcker Rule sounded nice. But it had nothing to do with the financial crisis.

One cause of the meltdown was that over the two decades leading up to 2007, thanks to the transformation of long-term debt into supposedly instantly tradable securities, speculation had become core credit creation.

A hedge fund that needs mortgage-backed securities for its arcane leveraged bet on interest rates is supplying credit to the economy just as an old-fashioned commercial bank supplies credit to the economy with its approval of a loan that it will keep on its books.

The problem is not where these activities take place, but that they — as well as speculation via complex derivatives — take place without enough of a cushion of non-borrowed money to protect the economy when things go awry.

The answer is consistent capital requirements across the financial system. But that type of rule would really scare the too-big-to-fail financial system. More capital — less borrowed money — would make the economy better able to withstand financial-firm failure.

So Obama has preferred to engage in financial-security theater. Now, the Volcker Rule's implementation is bogged down in thousands of pages of ancillary questions and objections, and has created only confusion.

More than a year after announcing the Volcker Rule, Obama is in a political panic again — so he's pushing the “Buffett Rule.” This rule, in honor of the billionaire Omaha investor, Warren Buffett, would “require the wealthiest Americans to pay a tax rate at least as high as the middle class,” Obama said last month, adding that it's “just common sense.”

Just as the Volcker Rule sounded nice, the idea of taxing all rich people at the same minimum rate as middle-class people sounds nice, too.

But a “Buffett Rule” would be just as difficult to implement as the Volcker rule is proving to be. Buffett — and a relative few others like him — pay lower tax rates because most of their income is made up of gains from investing their capital, not investing their labor.

Generally speaking, lower tax rates on capital are a sound idea. Capital income is what's left over after the corporation generating the income has already paid its taxes. Further, a person takes a risk by investing his capital. He could lose the capital that he started with.

By contrast, when Warren Buffett's secretary shows up, she knows that she will be paid a fixed salary for that work.

Of course, exceptions to this principle exist. When a freelance writer pens an article, she takes a risk that she won't be paid for her sweat: that is, that she won't find a buyer for her work.

Perhaps she should pay the lower capital rate on income from such risky labor.

Overall, though, the Buffett Rule is another diversion from bigger issues, including:

How big should the differential be between taxes on capital vs. labor? Should the tax rate on capital be progressive, as the tax rate on labor is? That is, should it remain at today's 15% rate for wealthier earners, but be scrapped altogether for middle-income earners, an idea that presidential contender Mitt Romney has proposed?

The biggest issue of all, though, ties the Volcker Rule and the Buffett Rule together into one entwined distraction. For a good quarter of a century, the too-big-to-fail financial industry has used its implicit (and sometimes explicit) government guarantees to compete unfairly with other industries, distorting the economy.

This state-sponsored capitalism via too-big-to-fail has thrown off more and more of its government-subsidized profits to the people in the top few percent of the economy, many of whom work or have worked in the financial industry.

The Volcker Rule doesn't fix the first problem. The Buffett Rule doesn't fix the second problem. That's because Obama is dealing with symptoms, not problems, and he's doing so in the world of politics, not governance.

Original Source: http://news.investors.com/Article/589391/201110261648/New-Rules-For-Finance-Are-Politics-By-Any-Name.htm

 

 
 
 

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