Benjamin Franklin famously said that only two things in life were certain: death and taxes. If a congressman from Oregon gets his way, our industry would swiftly be handed both.
The bill is H.R. 1068, officially named the “Let Wall Street Pay for Wall Street’s Bailout Act of 2009,” apparently after House profanity rules prevented the congressman from calling it the “Wall Street Go [Expletive] Yourself Act of 2009.”
As its name implies, the act seeks to punish Wall Street fat cats by taxing all securities transactions that occur within the United States at 0.25 percent (25 basis points). Seven other members of the House proudly added their names as co-sponsors.
The text of the bill says that the tax would have “a negligible impact on the average investor.” But “average investors” don’t own securities directly; they hold mutual funds and pension funds, for which transaction fees are a major cost and a major eroder of returns.
Given that a recent study put the average U.S. equities commission at 9 basis points, this tax would represent almost a quadrupling of annual transaction costs, bringing costs to levels that haven’t been seen in 15 years. Take that, you fat-cat pension funds!
The bill says the tax would generate around $150 billion per year, based on an assumption that volume would remain the same. While market volumes are affected by many things in the short term, the long-term tie between transaction costs and volume is clear and unassailable.
It is as certain as death and taxes that if you increase trading costs, people will trade less. In 1992, when commissions last averaged what they would be under the proposed tax, composite volume in NYSE-listed stocks was 184 million shares per day.
Today, the equivalent number is 5.8 billion shares per day, an astounding increase of 31 times. If costs were to spike to early-’90s levels, it is reasonable to assume that volumes may also drop to early-’90s levels.
A giant drop in trading volume would be disastrous for American corporations. Volume is the lifeblood of markets. People never want to enter into anything unless they know in advance that they can get out at little cost.
The fear of getting stuck is always a concern ahead of any transaction-it’s why those vacation time-shares don’t sell, and it’s why at industry presentations people prefer to stand in the back, near the door, instead of taking the empty cushioned seat up front.
And it’s why if equity volume dried up and the markets became illiquid, people simply wouldn’t buy stocks. At a time when debt financing has become difficult, kill the equity markets and you’ve left American companies with no way to raise money.
Fortunately, companies and pension funds and mutual funds don’t truthfully need to fear the U.S. equity market being destroyed by this tax. For in reality, the tax wouldn’t stop equity trading-it would just move it to our neighbors to the north.
Canada already dual-lists many U.S. stocks. Sophisticated broker-dealers already seamlessly route to whichever market has the best price.
If H.R. 1068 were to pass, the likely scenario is that Toronto would cross-list all U.S. equities, broker-dealers would handle the FX trades behind the scenes, and trading would likely continue on as before, with many clients not even realizing their order had crossed the border and been executed in Canada. Wall Street fat cats would likely remain untouched, untaxed and unrepentant, although a few thousand fat-cat jobs would presumably shift to Toronto.
But Toronto should hold off on going on a hiring spree-the good news is that we are told that the gentleman from Oregon is unlikely to successfully push this tax all the way through, that H.R. 1068 is one of many naive bills that will be dismissed. Even so, it is a disturbing prospect that we have gotten to the point where elected U.S. representatives are lining up to get their name on any anti-Wall Street bill, no matter how inane.
And there are many other unfortunate bills in the works that were clearly written to curry favor with the “pitchfork and torches” crowd. Some are just aimed at Troubled Assets Relief Program firms, like the new rule that bans hiring of foreign workers in TARP recipients’ U.S. offices, or the bill seeking to eliminate conferences and holiday parties. More disturbingly, others are aimed at the capital markets themselves, like the trader’s tax, or the proposal to bring back the uptick rule.
Here’s to hoping old Ben Franklin was wrong about the inevitability of death and taxes, and that H.R. 1068 quickly becomes a footnote in history’s dustbin. But with other more likely trading restrictions looming, Mr. Franklin would likely counsel thinking ahead, having also said, “By failing to prepare, you are preparing to fail.”
Institutional investors should think about how they will need to change their business models in an age of legislation-induced lower trading volumes, higher transaction costs and lower average returns for their investors. But at least these new rules will teach Wall Street a lesson. Take that, you fat-cat 401k holders!
Dan Mathisson, a Managing Director and the Head of Advanced Execution Services (AES) at Credit Suisse, is a contributing writer to Traders Magazine. The opinions expressed in this column are his own, and do not necessarily represent the opinions of the Credit Suisse Group.
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