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Dean Baker on How We Can Make the 'Free Market' Work for the 99%

The right has been working for years to rig the market to the disadvantage of most of the population. Why can't we rig it in the other direction?

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Remember, this sector exists to allocate capital from savers to those who want to borrow and invest. It seems hard to contend that capital is being better directed to its best uses in 2011 than in 1961. Nor does it seem credible to claim that we are more secure in our savings than was true 40 or 50 years ago. To take the trucking analogy, this would be as though the share of the workforce employed in trucking had quintupled, but goods were not getting from point A to point B any quicker or more reliably. If this were the case, any serious person would be asking what is wrong with our trucking sector. Similarly, we should be asking what is wrong with our financial sector.

There are several obvious steps that should be taken to rein in the sector. One is to break up "too big too fail" banks. These have no economic justification. The logic is that these banks can borrow at lower costs because everyone assumes that the government will come to their rescue if they get into trouble. This encourages excessive risk-taking and in effect is a taxpayer subsidy to the shareholders and top executives of these banks. 

It also make sense to restore the separation between investment banking and commercial banking from Glass-Steagall. The logic here is that the government is insuring the deposits of commercial banks. If a bank wants government insurance, then it should not be taking big risks with the money that is insured. Commercial banks were restricted to a relatively narrow set of loans -- business loans, home mortgages, credit card debt -- in principle these could be easily monitored and the risks controlled.

By contrast, investment banking means underwriting stock and bonds issues and other activities that are inherently risky. Government insured deposits should not be tied up in more risky activities that can be less easily monitored.

The third and perhaps most important mechanism for containing the financial sector is a modest financial speculation tax. The idea is that a modest tax on financial transactions -- sales of stocks, bonds, credit default swaps and other derivatives -- would discourage excessive trading in these assets. In a paper I wrote with my friend Bob Pollin, we suggested a rate of 0.25 percent on each side of a stock trade and 0.005 percent on each side of most derivative trades. This would have almost no impact on people who are buying these assets for productive purposes. However, this tax would make the sort of short-term trading that dominates markets today much more risky, since there would be a much larger cost hurdle to overcome.

This tax could also raise a vast amount of revenue, close to $150 billion a year, or 1.0 percent of GDP. The great aspect to this is that the money would come almost entirely from eliminating the waste in the financial sector. Our tax rates were intended to roughly double the cost of financial transactions. There is a far bit of research on how trading volume responds to changes in the cost and most find that it is fairly responsive, implying that if trading costs double, then the volume of trades will be reduced by roughly 50 percent.

If we assume that this will be the response to our set of financial speculation taxes, the implication would be that people would be paying twice as much for each trade, but they would cut their trading volume in half, so that they would be paying no more in total for their trades than they were before the tax. So the stock portfolio in our 401(k)s may flip over less frequently, but we would be paying no more for the churning of stock then we did before the tax was put in place.

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