My piece yesterday examined Hillary Clinton’s economic policy and its focus on “Quarterly Capitalism,” the obsession of corporations with current profits at the expense of important and valuable long-term investment. Her policy correctly concludes that this obsession causes important misallocation of economic resources. As a consequence, our economy falls short in providing well-paying jobs to the vast majority of households and fails to make needed investments in infrastructure and sustainability.
As I pointed out yesterday, Clinton’s solution — a longer holding period for stocks and bonds before lower capital gains tax rates on their sale kick in — would lengthen investor horizons and relieve pressure on corporate management to generate quick profits at all cost. But just doing that simply will not get the job done. Among other things, it misses the core cause of Quarterly Capitalism, which is a capital investment allocation system that prioritizes immediate profits over patient investment in sustained growth. The problem lies with Wall Street and its trading culture, not with investors contemplating their tax bills.
Instead, I propose a far-reaching agenda to fix Quarterly Capitalism, equal to the task of shifting traderscorporate America away from an obsession with short-termism and toward creating shared productivity. These proposals are complementary and non-exclusive, but the problem of Quarterly Capitalism and short-termism is so embedded in the economy that a layered approach is needed.
An effective policy must target the trading screen obsession of money managers and institutional investors. Slowing down trading, for example by limiting high-speed, automated trading and instituting a financial transaction tax, would help.
High-speed trading is run by software programs that operate at nanosecond speeds without the intervention of actual humans. It dominates many marketplaces, representing more than 90 percent of futures trading (synthetic stocks, bonds and commodities) and well over half of trades of actual shares of stock and bonds. This trading is so fast that it is imperceptible to actual investors. As a consequence, investors are really not benefited by these excessive speeds, but instead worry more about being tricked or caught flat-footed when the inevitable glitches occur. The massive volumes of high-speed trades fuel a technological “arms race” that benefits no one but speculators.
Meaningful limits on the market for derivatives would also help. Derivatives are futures, swaps and options and are used to lever up both traders and companies that are devoted to playing the market. The derivatives markets dwarf the actual markets for stocks, bonds and commodities. These synthetic investments can be used to fine tune short-term trading performance, but in the long-term they create havoc because of the complex and volatile risks involved. The Dodd-Frank Act that reformed financial regulation mandated a variety of risk mitigants for derivatives, but did not limit their use. I propose strict and comprehensive disclosure rules concerning the risks and rewards of derivatives used by companies, which will deter excessive derivatives trading by operating companies and re-direct attention to the core business.
Another highly targeted policy change would require a new tool to measure the performance of financial advisors to pension funds and managers of retirement accounts. A typical measure of performance compares current returns on a managed portfolio with the overall market over the same period. However, that does not directly measure the consequences to the fund or the account of following the manager’s advice. In fact, it encourages the advisor or manager to advise additional trading designed with an eye to market moves over the period of performance assessment (usually quarterly, by the way) rather than the long term.
A better measure would compare the outcome of actual trades advised by the manager (including transaction costs) over an extended period with the results that would have occurred had the manager’s advice not been followed. In other words, it would answer the question, what if no trades advised by the manager were made? Comparison with markets could also be used as a supplement to assess investment advisors and managers, but an index based on specific consequences would curb the obsession with liquidity and trading.
The most powerful approach would be a complementary policy, called the “FIX,” or Financial Infrastructure Exchange, that would provide incentives directly to investors to put their money into long-term investments while, at the same time, diminishing the corporate short-termism fostered by Wall Street. A major obstacle to investment for the long term is that returns that are received in the more distant future are more difficult to turn into cash today by selling the investment. The investments are said to be “less liquid.” FIX incentives would compensate for the lesser liquidity of investments that have long-term payoffs, easing the decision for institutional investors and money managers to take the long view. Incentives would be concentrated on investments in infrastructure and other public goods, the categories of investment that are most burdened by Quarterly Capitalism.
This investor-targeted approach would require funding, of course. What better source of funding than a tax or fee on high volume trading activity to put a brake on short-termism at the same time that its consequences are redressed! This is the best rationale for a small financial transaction tax since it would shift financial profits from short-term transaction-intense activities to long-term investments that serve the broader public interests. Investors, such as households saving for the future, would not be taxed but would be benefited. Traders engaged in activities that occur at time scales and in esoteric cyber environments that cannot possibly benefit investors in the productive economy will bear the largest cost. Quarterly Capitalism will be discouraged as investors lengthen their time horizons and corporate managers will respond accordingly.
Since investors need the certainty that incentives will be available, it would be best if the funding mechanism pipes incentives directly to investors and outside the budget, perhaps in a trust fund, so that congressional urges to redirect funds can be avoided. Importantly, investors will pick the projects and enterprises to be funded and will bear the risk of loss of both the investment returns and the subsidy if there is a failure. There will need to be criteria for broad value to economic and environmental sustainability at the federal level, but project and enterprise development can remain local. The main point is that infrastructure investment will be stimulated, improving productivity and sustainability while generating solid, dependable and well-paying jobs.
FIX is nothing if not bold, but its boldness is proportionate to the problem to be solved. As with any policy to address a problem as big and serious as short-termism, the challenge to implement it under the current gridlocked government is daunting. Nonetheless, policymakers must not shy away from a clear assessment of what can work. In that sense, FIX is the answer.
Wallace Turbeville is a senior fellow at Demos and a former vice president of Goldman Sachs.