We Can End Federal Taxation as We Know It

By Barry Elias | Friday, 18 Dec 2015 06:56 AM


The way we tax is obsolete.

More than a century has passed since the inception of the federal income tax. It’s safe to say, this system has completely broken down. The complex, voluminous tax code — included in the 70,000-plus page CCH Standard Federal Tax Reporter — needs a revolutionary overhaul.

The current system doesn’t raise nearly enough money, social security is nearing insolvency, the administrative cost is exorbitant, and economic growth is actually impeded.

We need tax reform that will increase investment, productivity, employment, income, purchasing power, and economic growth, while keeping inflation and tax compliance costs low. I believe my tax plan will achieve all of these objectives.

The purpose of the federal tax is to collect enough revenues to pay for the government’s annual expenditures. We spent nearly $3.7 trillion in this fiscal year 2015, but only collected about $3.2 trillion, leaving a shortfall of nearly $500 billion, which must be borrowed, and we pay interest on this debt.

Furthermore, we forgo tax revenue due to deductions, exclusions and other preferential tax treatments. Last year alone, that amounted to roughly $1.2 trillion. New types of transactions have spawned an underground economy that is valued at close to $2 trillion per annum, which goes completely unreported. Included in this figure are transactions that occur on eBay and Airbnb; Bitcoin trading; illegal drug trafficking and distribution; domestic assistance; babysitter services; and lemonade stand revenue: The list is endless.

Due to the underground economy, the U. S. Treasury loses nearly $400 billion of tax revenue every year. In addition, social security taxes are only collected on the first $118,500 of earned income. The professional athlete earning $10 million, for example, pays no social security tax on nearly 99% of his pay.

To make matters worse, complying with the current arcane system – one that looms large as a nuisance on our calendars in the months leading up to April 15 – has a hidden cost totaling hundreds of billions of dollars each year. This expense includes tax preparation professionals, financial advisers, estate planners, attorneys, lobbyists, Internal Revenue

Service agents, and the time spent by all parties involved. Nearly 6 billion hours are invested in this activity each year.

Tax compliance actually impedes economic growth. We can use the savings and 6 billion hours of time more productively to grow the economy. Our focus should shift towards making value-added goods and services at more competitive prices, rather than complying with an ineffective and inefficient tax code. The environment has also been harmed as we destroy forests to accommodate the massive printing of forms, manuals and instruction booklets.

Lost revenue and the cost to comply with the current federal tax system probably exceed $2 trillion. This is an extraordinary problem that yearns for a substantial solution.

Huge issues have been tackled at other times in our history. At the dawn of the 20th century, when the NY Central Railroad was forced to convert from steam locomotive to electric trains, the $70 million cost nearly matched their $80 million of annual revenues.

Nevertheless, management figured out a way to lay new tracks underground, while the railroad continued to operate. Incidentally, this investment created a huge, unexpected economic boom. As it turned out, Park Avenue was built over the tracks, permitting air rights to be leased to developers.

Herculean problems call for out-of-the-box measures.

My solution to the current tax conundrum is streamlined and elegant. Instead of taxing monetary inflows, such as income, I propose assessing what is done with the money: it is either saved or spent, and we can derive revenue from both to balance our annual budget.

This plan will minimize tax rates and administrative costs, while maximizing the tax base and transparency. It will also increase investment, productivity, employment, income, purchasing power, and economic growth over the long term for the general population, while keeping a lid on inflation.

My proposal will eliminate all current forms of federal taxation. These taxes include the following: income, social security, Medicare, disability, interest, dividends, capital gains, gifts, inheritances, and corporate profits.

They would be replaced by a tax on savings and consumption. Savings will be assessed at a lower rate than consumption, since a dollar saved generates significantly more jobs and income for society than a dollar spent.

The savings that are assessed would include only liquid financial assets, such as stocks, bonds and cash. These products typically involve the trading of existing assets or the restructuring or retirement of existing debt, instead of the creation of new assets. Too often, financial assets are a method for transferring wealth rather than creating value.

Hence, these savings need to be subject to tax, albeit at a much lower rate than that for consumption.

Excluded from these savings would be direct capital investment, since this activity generates strong employment and income gains. Physical land and buildings would also be excluded due to strong productivity potential, and a low level of liquidity, which might cause extreme market volatility in the event of strong selling pressure to meet tax obligations.

This proposal would balance the federal budget at current spending levels, preserving key social programs like social security, Medicare, disability, Medicaid, food stamps, other welfare programs, and the earned income tax credit, while maintaining a strong defense and homeland security apparatus.

Savings in the form of equities, bonds and cash for individuals, corporations and tax-exempt organizations total nearly $189 trillion, according to the Federal Reserve.

From this amount, the following liquid financial assets would be excluded from taxation:

  • wages and salaries, or $7.9 trillion;
  • $100,000 for a family of three, or $10 trillion;
  • retirement funds, or $25.7 trillion;
  • education IRAs and 529 plans, or $250 billion;
  • direct investment for capital expenditures, or $3.6 trillion (20 percent of GDP);
  • and tax-exempt organizations, or $4 trillion, for a total $50 trillion.

The net taxable amount after exclusions would approach $139 trillion. A savings tax rate of 2 percent on this figure would raise approximately $2.8 trillion.

Instead of reporting dividends, interest and capital gains, financial institutions would report an average daily balance of liquid financial assets on hand over the course of the year — to minimize or eliminate tax arbitrage opportunities — and send the tax directly to the federal government, another cost saver for the American people. I assume most people will not stash much cash under a mattress, since they would forgo a return on their money, and it’s not a safe methodology.

Americans consume about $12.4 trillion annually in goods and services, according to the Bureau of Economic Analysis. Taxing consumption at 10 percent would raise about $1.2 trillion. An annual tax refund of $3,000 would be provided to each family of three to offset the first $30,000 of essential consumption expenditures, costing $300 billion each year.

Therefore, the total revenue raised would be around $4 trillion: $2.8 trillion from savings and $1.2 trillion from consumption. These revenues would offset the current $3.7 trillion annual budget plus the $300 billion yearly consumption refund.

To generate these tax rates, we divide the tax revenue by the pre-tax amounts for both savings and consumption. That is, a 10 percent consumption tax on a $1 (pre-tax) retail item would generate 10 cents of tax revenue, resulting in a post-tax amount of $1.10 ($1 plus 10 cents).

The Fair Tax proposal, which was presented to Congress in the late 1990s, would divide the 10 cent tax revenue by the post-tax amount of $1.10, to arrive at a consumption tax rate of 9.1 percent. By using the post-tax amounts, as used in the Fair Tax model, the tax rates for my plan would be less than what I have stated: 1.96 percent for savings (instead 2 percent) and 9.1 percent for consumption (instead of 10 percent).

The fair tax proposal would subject consumption to a pre-tax rate of 30 percent (10 percent in my plan) and a post-tax rate of 23 percent (9.1 percent in my plan). The Fair Tax plan does not include a savings tax, but does eliminate all existing federal taxes.

In my view, the Fair Tax plan is far too regressive. It hits the poor and middle class hardest, since they consume a much greater percentage of their income and wealth, as compared with those in the upper economic strata.

I believe my plan is fairer in this regard, and will have mass appeal.

The poorest would no longer pay 15 percent for social security and Medicare as they do today; they would likely pay no other federal taxes; and they would still have access to Medicaid, food stamps, other welfare programs, and the earned income tax credit.

The wealthy would no longer pay any of the current federal taxes, including those on income, payroll, interest, dividends, capital gains, gifts, and inheritance. Expenditures on estate planning would be negligible, and wealth will be preserved, since the average annual return on investment will most likely exceed 2 percent.

The middle class would benefit from all of these proposals, including the participation in the earned income tax credit program and a reduction in tax compliance expenditures.

These benefits and savings can then be directed toward the consumption of essential goods and services, such as food, housing, clothing, healthcare, and education.

Corporations will experience tax-free profits and dividends; lower costs of production, including tax-free labor and capital; and severely reduced tax compliance expenditures. As a result, there would be downward pressure on the price of goods and services produced, which would increase purchasing power for the masses.

On the government side, the strategy would virtually balance the federal budget at current spending levels and make social security and Medicare more solvent.

This simple method would assess the most money at the lowest rate with the least cost and most visibility. This transparency would ensure that virtually all individuals would feel the impact of any tax rate increase immediately, resulting in a call for justification or reform. This check and balance would likely keep the rates low and stable over the long term.

Today, special interest tax benefits are visible to a very select few, resulting in higher tax rates and tax bases for others to offset the lost revenue to the government. This system would also allow us to focus more on the creation of value-added products and services instead of on minimizing the tax liability.

By excluding labor and capital from taxation, employment, investment and productivity will rise, generating greater income, stronger purchasing power, and more robust and sustainable economic growth, while keeping inflation in check.

Low tax rates will likely increase net capital inflows from overseas, including some of the more than $22 trillion of U.S. financial assets that reside abroad, as well as new foreign assets. If these net inflows materialize, tax rates can be lowered while maintaining a balanced federal budget. Moreover, reductions in government spending would allow rates to fall further.

My tax proposal is seen as fair, effective and elegant in its simplicity by a large swath of the political spectrum, including liberals and conservatives. The time has come to end federal taxation as we know it.

My wife, Billie Elias, contributed significantly to this article.

Barry Elias is an economic policy analyst. To read more from him, CLICK HERE NOW.

© 2015 Newsmax Finance. All rights reserved.

Cruz Champions Sound Money

By Barry Elias | Thursday, 03 Dec 2015 11:05 PM

The primary function of the Federal Reserve should be to stabilize the U.S. Dollar.

This view has been voiced recently by former Federal Reserve Chairman Paul Volcker and 2016 republican presidential candidate Senator Ted Cruz from Texas.

By stabilizing the dollar, real income for the masses will once again increase tremendously, thereby reversing a 40-year trend of income stagnation for the bottom 90 percent (the striving majority), according to Put Growth First, an organization that advocates for pro-growth monetary stability and supply side tax reform, and has provided advice to the several 2016 republican presidential candidates, including Senator Ted Cruz of Texas.

(Disclosure: I am an economic advisor to Put Growth First.)

Annual inflation-adjusted GDP growth from 1790 to 1971 averaged nearly 4 percent.

However, since 1971 – the advent of the floating paper dollar backed only by empty political promises, but no real intrinsic value – yearly growth slid to 2.8 percent, and since 2000, it fell further to 1.7 percent per annum.

Moreover, the future prospects are dismal: the Congressional Budget Office and Social Security Trustees now project real economic growth of slightly more than 2 percent.

From 1948 through 1971, the bottom 90 percent experienced a cumulative rise in real income of 85 percent according to the 2012 World Income Database.

Why was this happening?

During this time, the value of the dollar was stable and the Fed did not employ a single labor market variable on its dashboard of indicators. It was up to business to invest so productivity kept pace with wage growth.

A stable dollar permitted more stable material costs for businesses and less demand for expensive financial hedging.

This allowed capital to flow toward more productive investments that generated employment and income for the many – instead of exotic financial products that tend to rely on arbitrage and speculation that extract equity rather than enhance wealth.

The result was faster economic growth. And, despite strong income growth for the striving majority, business profits relative to GDP remained strong and steady.

The situation changed drastically in 1971 when the U.S. dollar lost its intrinsic value anchor and began floating. Since then, real income for the bottom 90 percent (the striving majority) stagnated while that for the top 10 percent grew an additional 140 percent.

Lost economic activity due to the lower growth rate since 1971 totals $104 trillion: $75 trillion since 2000 and nearly $9.2 trillion in 2013 alone. The total inflation-adjusted cost of all U.S. military wars is $7.7 trillion, according to the Congressional Research Service and Stephen Daggett, a specialist in Defense Policy and Budgets. In other words, stagnation has caused more destruction than all wars combined.

Had the 1948-1971 trend for real income of the striving majority continued, the bottom 90 percent would be earning 2½ times more than they do now. If income for the striving majority was 2½ times greater today, how many of our current problems would still be problems?

What happened?

Since the dollar was no longer stable, the Fed surreptitiously began targeting wage growth as an indicator of inflation that needed to be curtailed.

This is because inflation was redefined to mean an increase in a price index rather than a decline in the value of the dollar. To keep the index from going up, they have raised interest rates every time we’ve had decent wage growth in the last 30 years. This squelched the growth along with wages and employment opportunities, causing volatile business cycles and stagnation.

This theory was promoted in the 1970’s, which suggested there was a tradeoff between unemployment and money wage inflation as depicted in the Phillips Curve.

However, empirical evidence has contradicted this model over several decades and it has become more apparent that inflation is a function of the supply and velocity of money relative to the total quantity of goods and services provided in the general economy.

Also, the Fed was given a dual mandate by Congress in the late 1970s, to minimize and stabilize unemployment in addition to inflation. Unfortunately, the Fed lacks proper tools to deal with unemployment, since it involves fiscal policy to a large degree.

In essence, the Fed was acting in a reactionary manner, since inflation and unemployment are lagging indicators, have subjective measurements and are constantly revised.

Moreover, the policy intervention has lag built into it; by the time it became operational, the underlying conditions that were being addressed may have changed. Therefore, too often we were treating the wrong problem with the wrong solution at the wrong time, causing severe business cycle volatility.

During Senate testimony, Janet Yellen (now Federal Reserve Chairwoman) said, “A key lesson of the 1970s is the critical importance of maintaining well-anchored inflation expectations so that a wage-price spiral like we saw back then does not break out again.”

There have been numerous times that Yellen has referenced strong labor market conditions as a potential source of inflation, which the Fed needs to keep in check – primarily via increased interest rates.

However, the goal of the Fed should be to maintain the stability of the dollar as a unit of measure, and not guided by fiscal parameters, such as wage levels, that the Federal Reserve Bank has little control over.

Partially backing credit and currency formation with the production of real assets, such as gold, silver and virtual currencies using market-driven pricing, would couple money supply growth with the productive use of resources, including land, labor, and capital, and lead to more productive investment of that credit. In addition, business borrowing will be predicated on well-developed ideas that have greater likelihood of being executed effectively.

As a result, the increase in money supply will be absorbed by money demand in a more timely and complete manner, thereby maintaining a stable and predictable value of the U.S. Dollar – a requisite frame of reference, since all economic activity is based on its value.

Real time, market based prices of commodities, foreign currencies and future investment opportunities (bond yields) provide better signals for altering the money supply. The market would set interest rates and determine the money supply, which would require much less monetary intervention by the Federal Reserve.

In fact, it is advantageous for wages to rise so long as they are met with commensurate gains in productivity.

This will ensure cost-effective unit production and strong purchasing power, where unit wage increases tend to be small, stable and roughly equivalent to unit commodity price increases over similar time frames.

Predicating credit creation on the production of real assets will help ensure strong productivity gains in the future, thereby creating an environment ripe for employment, economic growth, moderate and stable inflation, and strong and stable purchasing power.

Direct domestic investment has been weak over the past few decades as a result of this misguided monetary policy. This is the worst economic recovery precisely because this is the worst recovery in business investment.

A volatile dollar inhibits business investment. Business investment acts as the fuel for the train engine that drives economic growth. Consumption is the caboose that follows: it does not push the train. One only consumes what has already been produced.

Currently, Put Growth First is actively working with members of Congress, including the House Freedom Caucus led by Rep. Jim Jordan, R-Ohio, and will soon launch a Growth Task Force with input from caucus members such as Rep. David Schweikert, R – Arizona.

Put Growth First has also been involved in helping to advance House of Representatives bill 1176 in the previous 113th Congress, sponsored by Rep. Kevin Brady, R.-Texas, that would establish a Centennial Monetary Commission to examine United States monetary policy, evaluate alternative monetary regimes, and recommend a course of monetary policy going forward. It was reintroduced to the House of Representatives on June 25, 2015, as H.R. 2912: Centennial Monetary Commission Act of 2015.

Senator Cruz is right to promote a stable U.S. Dollar, which is backed by real assets that are produced with an efficient use of limited resources.

It will increase business investment, productivity, income and purchasing power over the long term for the masses.

It is important to couple this sound monetary policy with a pro-growth tax reform plan to ensure optimal results.  I will elaborate on my tax proposal in the following column.

© 2015 Newsmax Finance. All rights reserved.

Barclays Bankers Bilk Their Clients

By Barry Elias | Thursday, 19 Nov 2015 10:45 PM

“Obfuscate and stonewall.”

That was a June 2011 directive from a Barclays managing director and head of automated electronic foreign exchange (FX) trading. It was the recommended response to inquiries from clients, the sales department, or virtually anyone else regarding bank transactions related to its BATS Last Look functionality, according to the New York State Department of Financial Services (DFS).

The managing director further stressed in the email that one should “avoid mentioning the existence of the whole system.”

Barclays’ “Last Look” functionality enabled traders to cancel the execution of client foreign exchange orders if they were deemed unprofitable to the bank, even if they would be profitable to the client.

Milliseconds became the difference as to whether a trade was executed profitably. Since it could take this amount of time to transmit an order across the globe, the bankers were at a disadvantage relative to the high frequency traders, who can execute within nanoseconds. Instead of quoting greater buy/sell spreads to accommodate potential price movements, which would disenfranchise the algorithmic traders, Barclays opted to possess the right of first refusal for the trade on behalf of its client.

Clients and others were not told the trade terminations were the result of this business policy decision. Senior employees instructed traders and information technology employees not to inform the sales staff of Last Look and the underlying policy. Instead, the information conveyed was vague, misleading, or inaccurate – and sometimes they were not given any explanation. Blaming the malfunction on technical latency issues was a recommended strategy from management.

This case was unleashed during the forex rigging probe, for which Barclays agreed to pay about $2.4 billion to the DFS, the U.S. Justice Department, and other agencies, which included $485 million for its manipulation of forex spot trading. This settlement was part of the more than $5.6 billion agreement by six banks for manipulating the $5.3 trillion daily foreign exchange market. The other five banks include Bank of America, Chase, Citigroup, JPMorgan, Royal Bank of Scotland, and UBS.

Barclays recently agreed to pay $150 million to resolve the “Last Look” allegations of abuse in the foreign exchange market through its electronic trading platform: a very serious charge, since it intentionally sought unfair advantages over clients and counterparties through this venue. The DFS also required the bank to fire its global head of electronic fixed income, currencies and commodities automated flow trading. Barclays has not named the dismissed individual and has admitted to wrongdoing in this case.

This settlement will bring the total litigation provisions for Barclays Bank to about $13 billion since the beginning of the financial crisis. Litigation costs for all financial institutions since 2008 have reached nearly $219 billion, most of it borne by U.S. banks, led by Bank of America with about $70 billion, according to Moody’s, a rating agency. They expect more to come, especially from Deutsche Bank’s exposure to foreign exchange litigation and the Royal Bank of Scotland’s exposure to U.S. mortgage litigation.

Barclays is still not off the hook: It is being investigated for other potential misconduct, including possible manipulation of precious metals markets and payments to Qatari investors in its 2008 rights issue.

Even after the crisis, Barclays continued down the road not to be traveled.

© 2015 Newsmax Finance. All rights reserved.

Derivative Debacle Persists

By Barry Elias | Friday, 13 Nov 2015 06:53 AM

Taxpayers remain the backstop for risky swap derivative investments held by financial institutions.

In December 2014, the Congress rolled back provisions of the Dodd-Frank legislation as part of a must-pass government spending bill to prevent a total government shutdown. The original Dodd-Frank rules were designed to prevent future taxpayer bailouts of banks that arise from improper management of derivative contracts, including inadequate capital requirements for swaps.

The Federal Deposit Insurance Corporation (FDIC) recently estimated approximately $9.7 trillion of swap derivatives remain on the balance sheets of 15 banks that are registered as swap dealers. This represents roughly 4.4 percent of the total outstanding derivative contracts at these institutions and is comprised of $6.1 trillion in credit derivatives, $2.6 trillion in equities derivatives. and $1 trillion in commodity derivatives.

If the taxpayers did not insure these swap products, counterparties would require banks to hold more collateral to offset potential losses, and this would undermine bank profit margins. Swap trades enable financial institutions to exchange payment streams, typically to lower interest rates or currency risks.

Sheila Bair, the former chair of the FDIC, has stated the swaps repeal represented a “classic backroom deal.” “There’s no way this would have passed muster if people had openly debated it, so [the banks] had to sneak it on to a must-pass funding bill. For an industry that purports to want to regain public trust, it was an extraordinary thing to do,” said Bair.

The net worth of the financial industry has been negative for most of the past 20 years, reaching a nadir of negative $1.46 trillion in April 2007 prior to the financial crisis. Following an injection of approximately $29 trillion in credit by the federal government in the form of asset purchases, guarantees, and loans during the crisis, the financial industry reached a peak net worth of $1.93 trillion in March 2009, only to see it plummet with the end of quantitative easing: It stood at negative $809 billion in June 2015.

The financial industry has been greatly subsidized by the taxpayers for many decades. It’s time we implement the bank bail-in rather than the bank bail-out.

© 2015 Newsmax Finance. All rights reserved.

Bank Bail-In Rather Than Bail-Out

By Barry Elias | Friday, 06 Nov 2015 07:02 AM

The Federal Reserve plans to rein in the extraordinary bank mismanagement that lead to the financial and economic collapse in 2008.

In a recent 5-0 ruling, the Fed will require 30 of the largest banks worldwide –global systemically important banks (GSIBs) – to maintain significantly more capital on their balance sheets to weather potential losses. The Fed recommends total loss absorbing capital, or TLAC, be set at or near 20 percent of assets, with half coming from equity and the other half from long-term debt provided by investors, which can then be converted to equity.

GSIBs are considered so large and interconnected that each could seriously threaten the solvency of the global financial system if it were to fail.

The thinking here: If some assets, such as loans, turn sour, and if equity capital is insufficient to cover the losses, the investor class will absorb the differential instead of the taxpayers-at-large: hence, a “bail-in” rather than a “bail-out.” As compensation for this added risk, the investors will command a higher rate of interest for lending funds to these financial institutions.

The GSIBs include U.S. subsidiaries of the largest global banks and eight U.S. banks: Bank of America, Bank of New York Mellon Corp., Citigroup, Goldman Sachs, J.P. Morgan, Morgan Stanley, State Street Corp., and Wells Fargo. The Fed estimates these banks will need to issue an additional $120 billion in long-term debt to meet the new requirement. An analysis by Barclays Bank suggests Goldman Sachs and Morgan Stanley have already meet this standard, while Wells Fargo may need to issue as much as $86 billion in bonds to conform.

The ruling also requires banks to post collateral to cover losses for derivative trading that are conducted outside exchanges or clearinghouses. Many policymakers blame the $600 trillion global derivative market, which was deregulated by President Clinton in 2000, for hastening the financial implosion due to inadequate margin requirements and a high degree of speculation.

The proposed rule would also apply to the U.S. operations of foreign GSIBs. In this case, the U.S. entity would issue new long-term debt to (or borrow from) the foreign parent rather than selling bonds to external investors. Should a bank fail, the holding company would be seized by the federal authorities, but the subsidiaries would be permitted to continue operations.

If formally adopted, most of the requirements would take effect in 2019, with the remainder in 2022.

This new ruling comes on the heels of rules adopted by the Fed in July for the eight banks to increase their financial assets by about $200 billion in additional capital. This is also above and beyond the 2014 rules directing all large banks to hold adequate quantities of high-quality assets to survive a severe market fall. The banks are also required to pass “financial stress tests” and provide a “living will” that demonstrates how they could declare and proceed through a potential bankruptcy without taxpayer assistance.

The previous rulings have been characterized as the “belt” holding up the pants of the bank, while the new ruling represents the “suspenders” in the event the belt fails.

This policy is a prudent approach that should be implemented immediately.

© 2015 Newsmax Finance. All rights reserved.

Barclays Gets Washed Up in Dark Pools and High Frequency Trading

By Barry Elias | Friday, 30 Oct 2015 07:02 AM

Barclays Bank seems like it is next in line to settle with the authorities regarding its dark pool operations.

In recent years, the Securities and Exchange Commission (SEC) and the New York State Attorney General (NYSAG) have focused on the disruptive nature of dark pools and high frequency trading: especially when used in tandem, as the authorities allege to be the case with Barclays Bank. The SEC and NYSAG claim Barclays misled its clients into believing high frequency traders would be less active in their LX dark pool trading venue.

Dark pools are essentially private, anonymous, off-exchange and opaque venues that permit the trading of exchange-listed securities. This structure helps camouflage the trading strategies of large financial institutions, such as mutual funds, pension funds, hedge funds, and insurance funds to afford them optimal profits or minimal losses. These venues are lightly regulated, require less public disclosure, do not carry the same protective margin requirements as the public exchange marketplaces, and allow banks to forego paying fees to exchanges for trade execution.

Dark pool trading as a percentage of total trading volume more than tripled from 4 percent in early 2008 to nearly 14 percent by the end of 2011, according to Rosenblatt Securities. Haoxiang Zhu, a financial economist at the MIT Sloan School of Management and the author of a new paper in the Review of Financial Studies, cites a study in which 71 percent of financial professionals believe dark pools are “somewhat” or “very” problematic in establishing stock prices.

Despite denying any wrongdoing and fighting this case, Barclays is in serious discussions to pay a fine of $65 million.

Thus far, two firms have agreed to pay fines related to this activity: $14 million by UBS Group and $20.3 million by Investment Technology Group, which has admitted to wrongdoing in its case. A third, Credit Suisse, has a planned agreement to pay an $85 million fine.

To evade recent proposals that would regulate and undermine dark pool trading, some U.S. banks are conducting their derivative trades through non-U.S. subsidiaries that do not have explicit guarantees from the U.S. parent.

The SEC and other regulatory bodies need to keep the playing field level for all, and where possible, prosecute individuals as a more effect deterrent.

© 2015 Newsmax Finance. All rights reserved.

Why Economists Fail


By Barry Elias | Friday, 23 Oct 2015 07:24 AM

I attended a presentation this past week at Cooper Union College in Manhattan by an economist promoting his new book.

I was rather aghast to hear him say: “No one” predicted the global economic crisis and experts did not foresee how slow the recovery would be.

Following the collapse of Bear Stearns on March 17, 2008, I divested most of my family’s investment portfolio from the market when the Dow Jones Industrial Average hovered near 12,000. By September of that year, the Dow reached its nadir – around 6,500.

At that time, I expected the unemployment rate to double from 5 percent to 10 percent, which it did. I also suggested the global recovery may take a decade or two to return to robust growth, since the crisis was the result of financial mismanagement that spanned several decades.

Further, on May 6, 2010, the day of the infamous “Flash Crash,” my article entitled “Why I Divested From the Dow” was published: About six hours later, the Dow had plummeted about 1,000 points.

The Cambridge-educated economist that I alluded to earlier is Adair Turner, the chairman of the Institute for New Economic Thinking; a member of the United Kingdom’s Financial Policy Committee: and the former chairman of the Financial Services Authority (FSA) until its abolition at the end of March 2013.

The FSA was an independent regulatory body for the financial services industry in the United Kingdom (U.K.) between 2001 and 2013. It was appointed by the Treasury and funded entirely by fees charged to financial firms.

Due to the apparent regulatory failure of banks during the financial crisis, the U.K. government abolished and replaced the “failed” FSA on April 1, 2013 with two new agencies: the Financial Conduct Authority (FCA) and the Prudential Regulation Authority of the Bank of England, in an effort to strengthen England’s financial system with a more forward-looking perspective.

While the FSA under Turner’s leadership presided over the near-total collapse of several major financial institutions, including the merger of Lloyds Bank with ailing HBOS in September 2008, Turner claimed in February 2009, as well as today, that other global regulatory authorities also failed to predict the economic collapse. He did not apologize for the actions of the FSA, and believes the intellectual failure was the result of a focus on processes and procedures, in lieu of the larger economic landscape.

Economists ought to take note of that admission and view the world with greater breadth and depth, especially before proposing public policy prescriptions that may have implications for many decades to come.

In his new book, Turner argues most credit formation is not necessary for economic development. He suggests excess credit drives real estate booms and wealth inequality, which then lead to financial crises and depression. Turner believes banks need to increase capital and reduce real estate lending, and debt needs to be taxed as a form of “economic pollution.” I wholeheartedly agree with the premise and prescriptions presented.

Income inequality is self-reinforcing, since wealthier households consume a smaller percentage of their income, and savings tend to be invested in short-term, speculative, and arbitraged financial assets. This dynamic undermines employment and economic growth for the masses as compared with direct investment. Favorable tax rates on investment income, especially for hedge fund managers, perpetuates this viscous cycle.

Since 1970, financial firms expanded credit among themselves and households seeking real estate, because it involved a simple and secure business model: real estate collateral valuations were more predictable as compared with the assessment of an entrepreneurial endeavor. This methodology permitted the excessive refinancing of existing assets, and less on the creation of new ones.

Financial firm credit skyrocketed from 10 percent of GDP in 1970 to 125 percent in 2008, while that for household credit rose from 40 percent to about 90 percent, which included toxic subprime mortgages. (During the same period, federal government debt as a share of GDP increased from 35 percent to 60 percent, and that for non-financial corporate debt rose slightly, from 35 percent to 40 percent.)

The financial firms essentially transferred wealth among themselves and others instead of creating new wealth. This led to less optimal employment and income growth for the masses, since direct investment in business endeavors was on the wane. Instead, financial products that were derived from preexisting assets exploded, and wealth and income inequality grew.

The net worth of the financial sector was negative from 1996 through 2007, reaching a nadir of negative $1.46 trillion in April 2007. Quantitative easing by the Federal Reserve following the financial crisis put the financial industry in positive territory, but it turned negative at the end of 2013, and by of June of 2015 it stood at negative $809 billion.

Why was the financial industry protected so well?

Some suggest a significant number of economists with keen academic and think-credentials regularly accept funding from corporations to provide “objective” analyses that actually promote corporate objectives and defy evidence and logic.

Let’s keep the economists honest and forward-looking, shall we?

© 2015 Newsmax Finance. All rights reserved.

Too Big to Jail Is Being Tested by US LIBOR Trial

Friday, 16 Oct 2015 07:27 AM

Dollar banknotes, handcuffs and judge's gavel isolated on white

Financial behemoths have paid handsome penalties to settle criminal and civil charges related to manipulation of the LIBOR. Now American citizens may be in jeopardy, thereby disrupting the implication that bank employees are “too big to jail.”

In recent years, more than $5 billion have been ponied up by several financial institutions for these transgressions: $2.5 billion from Deutsch Bank, $1.5 billion from UBS, $450 million from Barclays, and $325 million from Rabobank. Other perpetrators include Citigroup, The Royal Bank of Scotland, JP Morgan, Lloyds, and ICAP.

LIBOR, or the London Interbank Offered Rate, is the interest rate paid by banks to borrow funds from other banks. It represents the average lending rate offered by the 16 participating banks. These offers are submitted daily to the British Bankers’ Association for five currencies and 7 borrowing periods, spanning overnight to one year loans. Other lenders, including financial institutions, mortgage banks, and credit card companies set their rates relative to these. It is estimated that $350 trillion of derivatives and other financial products are based on the LIBOR.

The Justice Department issued a memo last month that prioritizes the investigation of employees for financial malfeasance before seeking settlement with corporations. In an important test for U.S. prosecutors, two Rabobank employees are now being tried in a Manhattan federal court for manipulating LIBOR in order to benefit other Rabobank traders’ trading positions that were tied to the LIBOR. The traders on trial are Anthony Conti, a senior U.S. dollar trader, and Anthony Allen, a former global head of liquidity and finance, and supervisor of Rabobank’s Libor submitters, including Mr. Conti. They are alleged to have conspired to rig the rate on or about May 2006 through early 2011.

Thirteen individuals have been charged thus far in the U.S. in relation to the LIBOR investigation. While several defendants have pleaded guilty, including three other former Rabobank traders, none have gone to trial yet. Six former brokers accused of rigging LIBOR are currently on trial in the U.K. This comes on the heels of Tom Hayes’ conviction in London several months ago. He was a former UBS and Citigroup trader sentenced to 14 years for LIBOR manipulation.

Former Federal Reserve Chairman Ben Bernanke believes some Wall Street executives deserve jail time for their roles in the financial crisis, since individuals, not abstract firms, committed these crimes. He lays the blame with the Department of Justice and others who are responsible for enforcing the laws of our country.

Wide swaths of the political spectrum are extremely dismayed with the way the financial industry operates. In the recent debate, democratic presidential candidate Bernie Sanders claimed the banking business model is one predicated on “fraud.” And republican presidential candidate Donald Trump believes too many in the financial industry do not pay their fair share of taxes.

The maximum tax rate for capital gains on financial products is 23.8 percent, while that for ordinary income is 39.6 percent. Further, unlike ordinary income, capital gains are not subjected to social security taxes of 12.4 percent, which is shared equally by the employee and employer.

The only effective deterrent to financial misdeeds is the possibility of personal punishment.

© 2015 Newsmax Finance. All rights reserved.

Bankers Battle Banks

By Barry Elias | Friday, 09 Oct 2015 07:27 AM

Bank profit margins are expected to decline at an accelerating pace over the next five years as bankers team up with technology firms to provide more cost-effective products and services.

Technological competition is expected to reduce profits from non-mortgage retail lending, such as car loans and credit cards, by 60 percent and revenues by 40 percent over the next ten years. Profits and revenues for mortgages, wealth management, small and medium-sized lending, and payments processing are also slated to fall between 35 and 10 percent, and earnings on some financial products may decline by nearly two-thirds, according to McKinsey & Company, a global management consulting firm.

Technology firms are focusing on the most lucrative segments of bank portfolios, especially those that involve customer relations. This will return banks to their roots as a utility: one that manages balance sheet assets and liabilities. McKinsey says banks generated $1.75 trillion of revenues in 2014 from origination and sales activities, earning a 22 percent return on equity, compared with $2.1 trillion of revenue and only a 6 percent return on equity for managing balance sheet net interest.

McKinsey calculates banks earned a record $1 trillion last year with a 9.5 percent return on equity. Nearly two-thirds of banks in developed markets and a third of those in emerging markets earned a return on equity below the cost of equity, causing their equity prices to fall below book value.

McKinsey expects this rate of return to plummet rapidly as bankers continue to enter technological finance as advisors, investors, board members, and company executives, such as former JP Morgan executive Blythe Masters, who is the current Chief Executive Officer of Digital Asset Holdings, a start-up that provides ledger and settlement services for digital and mainstream assets.

Thirteen more banks are now collaborating with R3CEV, a New York based start-up to develop a private, distributed ledger system for financial institutions, bringing the total to twenty-two financial institutions. In contrast, the bitcoin blockchain platform permits access to all and is secured by a digital token.

These 13 banks are: Citigroup, Bank of America, Morgan Stanley, HSBC, Bank of New York Mellon, Deutsche Bank, Mitsubishi UFJ Financial Group, Commerzbank, National Australia Bank, Royal Bank of Canada, SEB, Société Générale and Toronto-Dominion Bank.

Nasdaq is also using the blockchain to set up a private share trading platform with Chain, a start-up that has received funding from Nasdaq, Citi Ventures and Visa.

The bitcoin blockchain methodology ensures more timely, efficient, cost-effective and secure asset ownership transfer. This will be especially useful for the syndicated loan market, where settlement can take 20 or more days to finalize.

The New York State Department of Financial Services recently approved two firms to operate Bitcoin exchanges: Gemini, founded by Cameron and Tyler Winkelvoss, and ItBit. The Wicklevoss brothers are also working on a bitcoin-backed exchange-traded fund, which is expected to trade on the Nasdaq exchange and awaits regulatory approval.

Banks are beginning to brace for the coming seismic shifts of the financial terrain.

© 2015 Newsmax Finance. All rights reserved.

Treasury Market-Rigging Further Disrupts the Middle Class


By Barry Elias | Friday, 02 Oct 2015 06:48 AM

The U.S. Department of Justice and the New York State Department of Financial Services are looking into possible manipulation of the U.S. Treasury market by banks and brokers that serve as primary dealers to underwrite government debt.

To date, 23 lawsuits have been filed, with 2 more coming soon, that allege collusion by these institutions to enhance their profits at the expense of their investor clients. More than half of the cases brought forth thus far have been on behalf of pension funds, which predominantly serve the middle class.

The allegations claim the dealers inflated the price of newly issued Treasury securities that they sold to investors and lowered the price for securities they purchased from the U.S. Treasury. If accurate, this raises the cost of issuing Treasury security debt to taxpayers.

These cases include a comparable price analysis that was used in the market manipulation trials over the Libor — the London Interbank Offered Rate and the benchmark interest rate for lending between banks — and the currency markets, which resulted in more than $5.6 billion in penalties from six banks.

Gregory Asciolla, a partner at the law firm Labaton Sucharow, which is the lead counsel in two cases that involve the State-Boston Retirement System and Arkansas Teacher Retirement System, claims the auction and pre-auction market — also known as “when issued” — are “rigged.”

The Cleveland Bakers and Teamsters Pension Fund alleges the price was reduced in 69 percent of the auctions for securities in the secondary market — or those already in circulation. This analysis included data between 2007 and 2015.

Declining comment are the U.S. Treasury, The Federal Reserve Bank, and primary dealers contacted by The Financial Times.

Once again, high powered financial institutions continue to prosper at the expense of the middle class.

© 2015 Newsmax Finance. All rights reserved.