Thursday, July 8, 2010

Taming the Beast

The stock market is overrun with speculators. And not just people speculators. No, that might be like actual work (not that it would be anyway). Instead they've automated their leeching. Welcome to the world of high-frequency trading in which computers are used to jump ahead of real traders and grab tiny bits of money from them. That's right, your mutual fund and pension are being slowly drained by a computer.

I propose two methods to calm the markets, to make speculating against other people unprofitable. My goal is to encourage investment in companies and long-term profitability, rather than grabbing the next big payout next quarter with accounting tricks and gambling on the fluctuations of the market, fluctuations which their speculation drives.

First, add a one cent tax to every stock transaction. This will have a minor effect on investors, a larger effect on speculators, and will completely wreck the computers. With a one cent tax buyers would only want to buy when they had a good chance of substantial price increases, the kind which can only be assured over the long term with stable companies. Even if a person can pull of 10 cent profits on transactions, this cuts that by 10%, a significant hit which would discourage such trading. The tax could be reduced or waived for sufficiently cheap stocks which might only move small amounts even over years.

Second, add a holding requirement, such as requiring stocks to be held for at least two years and unable to give dividends for a similar amount of time. This encourages long-term investment. Buyers would want stocks which will perform well for years and will not be tied to the short-term outlook. This means companies could focus on the research and development which drive long-term growth and profits (and the economy), rather than short-term gains from accounting tricks, layoffs, and deceptive advertising. It would also become impractical to speculate on the actions of other investors, since projections would have to go out for years, and therefore short-term bubbles and busts would be insignificant.

The goal is these changes is to stabilize the fluctuations in the stock market, fluctuations which are unrelated to the actual state of the economy, and which only harm it. The focus of traders could then shift away from predicting the market itself and towards the actual health of companies. Imagine how much different the dot com bubble would have been if investors had been forced (by their own self-interest) to look at the long-term profitability of tech firms. Maybe there would have been less of a bubble, less of a bust, and a better economy for Bush to inherit. With a genuinely good economy we might not have been so easily drawn to cheap credit and housing speculation. And so on.

These ideas aren't perfect. The tax needs tweaking, maybe a variable scale based on the initial stock price. The holding requirement might need to be longer or shorter. But I think it's a good start.

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