Let me get this straight.

In 2008, funds trying to squeeze out another basis point or two thought they were being conservative  buying insurance on
heavily leveraged portfolios of sub prime loans and other debt. Once
those loans started to default, it created a cascading de-leveraging
event which lead to major financial institutions failing and the
“smartest” minds on Wall Street being forced to dump everything to
raise cash, which in turn lead to a crisis of confidence. And,
de-leveraging that created the worst week in the history of the stock
markets. Did I get this right?

In 1987, funds, trying to squeeze out another basis point or two thought they were being conservative, buying insurance
on leveraged stock portfolios. Once the stock prices on those
portfolios started to drop, their insurance programs pushed them to
dump everything AND sell stock index futures to raise cash, which in
turn lead to a crisis of confidence and deleveraging that created the
worst single day melt down in the history of the stock markets.  Did I
get this right?

Think it wont happen again? Of course it will.

Whatever money the
Fed makes available to stimulate the economy will be used, as
intended,  by entrepreneurs and business people to create and grow
businesses.

Unfortunately, it  will also be used by financial engineers to try
to find a way to make HUGE profits from  highly leveraged, risk-laden
financial packaging. Why wouldn’t they ?

If you can borrow cheap money, invest in some asset that can be
marked to an increasing market, borrow  against the gain and buy
something else and do it as many times as possible, wouldn’t you ? It’s
exactly how homeowners In a bull market drove up real estate prices
with a few making huge money.

If you could do the same thing, but instead of with houses, with
stocks or asset backed securities, and instead of with thousands, do it
with billions so you could profit in the 10’s of millions or more,
wouldn’t you?

Hell yes you would. You certainly aren’t going to tell yourself that
you could be creating the next big bubble that could rival 1929, or for
future generations, would rival 2008, so don’t do it. You would go for
the money.

Which is the genesis of our problem in the U.S. 

It’s not
wrong to run with bull markets and leverage to the hilt. That can be a
very good thing. But we have to make the upside based on investments,
rather than financial engineering. Which is exactly why we have to
change our tax code. We want to encourage investment, not financial
engineering.

The financial  markets  were originally defined as markets that created capital for businesses to start and grow.

Today, that is rarely the case. Sure companies do come to the
markets for cash to grow. That should be encouraged.  But those
examples are a tiny percentage of the market.  When a stock turns over
its float multiple times in a day, those are not investors buying and
selling the stock. Those are traders or financial engineers.

The ONLY WAY WE ARE GOING TO END THIS BOOM AND BUST CYCLE IS IF WE DIFFERENTIATE BETWEEN INVESTORS AND EVERYONE ELSE.

Investors should be rewarded for actually owning companies and
gaining returns on their investments. Financial engineers should have
to pay a premium for the risk they introduce to the entire financial
system. It was not investors that brought on the last two crashes. It was
the financial engineers.

The beautiful thing about this country is that we like to
work hard, and we like to take chances. Unfortunately, over the last 15
years, the incentives have been to take chances as a financial engineer
rather than as an entrepreneur. We give far more money to people who
play games with financial instruments than we give to people who come
up with ideas for the next big thing.  That needs to change if we want
to remain a leader in this world.

Here is what I would do to change things:

I would change to zero the taxes on any gains from the sale of stock
or bonds purchased during an IPO and held for five or more  years. All
dividends/interest paid by that stock/bond would be tax free. If you
sell it prior to the 5 years, you are taxed at your personal regular
income tax rate.

In addition, I would not allow the stock to be borrowed against in
any way. If it was, it would be considered an effective sale. Which
means you couldn’t borrow on it tax free until you have held it five
years. Bottom line, if you hold the stock/bond, like a real investor
would, you are rewarded for it.

For purchases post IPO, in the open market, the same rules apply,
except I would tax a personal income rates the dividends/interest for
the first five years of ownership.

For all other transactions, whether they are options, derivatives,
stocks, bonds, whatever, all gains and losses would be taxed at
personal income rates.

If you are a great financial engineer and make tons of money at what
you are doing, more power to you. If you are good at what you do, you
pay more to Uncle Sam, but you still make a boatload of money.

I would keep taxes on private transactions, just where they are.
Private transactions are less liquid and harder to value, which in turn
makes them harder to borrow against. Which reduces leverage in the
system and encourages investment. It’s hard to financial engineer a
private company.

I would tax gains and losses in private companies at
capital gains levels, but I would extend to three years the marker to not
be considered a short-term investment. I would keep the active vs
passive rules.

Next there is the issue of leveraging. No one ever complains when
cheap cost of funds creates leverage and drives a market up.  And no
one ever will. So we have to set strict leverage limits. We set
margin/leverage limits on day traders as the tech bubble burst. The
only difference between the day traders of the tech bubble and the
Investment Banks and AIGs of the world that cratered in this bubble is
that the big guys started with more chips at the table. And they picked
their own credit lines and there was no pit boss to watch over them. I
would limit to 2x the leverage available on any asset that is insured
by the government or is offered by any organization that is eligible for
government insurance  or tax incentives of any kind.

Of course, I would still levy a fee of anywhere from 1c to 10c on
every transaction of stocks or bonds which would go into a general
fund, that I will call the “Oh Shit We Missed It Fund”. It will be
there to fund the inevitable situation where someone figures out how to
work around whatever regulations and tax code that is created.

As an entrepreneur, I can tell you that this would not change how I
ever started or invested in any business. As someone who trades stocks,
it would impact my investment decisions. I would only trade out of
necessity. I would be willing to take lower yields on my investments,
making it cheaper for companies to raise funding.

I also recognize that it would mean that the chances of the Dow ever
hitting 14,000 in 2008 dollars is about as likely as my catching my elbow
on the rim playing basketball. I dont think that’s a bad thing.

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