by Guest Author Dan Flemming, a retired Logistician. He has utilized dozens of defense systems to identify bottlenecks, problems, systemic issues, and solutions across agencies within the Department of Defense.
We are all U.S. stakeholders. We all want better behavior with regard to government spending and corporate patronage. Some of us feel disenfranchised and the current economic pressures have resulted in OWS protests. It is disingenuous to ask why people are protesting at Wall Street and other locations. We all have a stake this this country, in our children, and our neighbor’s livelihood. The protesters are saying now is the time for modification of government inefficiencies, corporate shenanigans, systemic risk, fraud, and increased scrutiny of corporate behavior. The protests are saying “no more business as usual.”
Behavioral Economics
Let’s start with the Wikipedia definition:
Behavioral economics and its related area of study, behavioral finance, use social, cognitive and emotional factors in understanding the economic decisions of individuals and institutions performing economic functions, including consumers, borrowers and investors, and their effects on market prices, returns and resource allocation. The fields are primarily concerned with the bounds of rationality of economic agents. Behavioral models typically integrate insights from psychology with neo-classical economic theory.
Behavioral analysts are not only concerned with the effects of market decisions but also with public choice, which describes another source of economic decisions with related biases towards promoting self-interest.
One area of Behavioral Economics could be defined as economics interested in studying how to regulate businesses to prevent corruption and accounting scandals. This would entail the study of how regulations change behavior. If we govern (regulate) with the knowledge that, if unchecked, corruption will occur, then we want to utilize regulations to modify behavior.
Visibility and Metrics for Banking
One of the biggest arguments for working with the tools of behavioral economics is the banking deregulation in the 1980s and 1990s. This appears to have enabled the casino like behavior that developed in banking. In this case the behavior modification/stimulation produced by deregulation created incentives for taking increased risk.
We have a private banking industry that is pretty much unregulated in the most competitive country in the world (the US). There is a great opportunity in fractional reserve policy for US banking and for corporate profit. However, there are rational limits, and we have exceeded many of them. We have ended up with abusive financial derivative securities, risky credit default swaps, and a shadow banking system in the US. We have little visibility and few metrics in banking that is spinning a roulette wheel of CDS, CDO, and other synthetic asset backed securities. These have flooded “markets” around the world and many of the “markets” have been back room deals, the so-called over-the counter market.
Global financial derivatives for CDS in 2008 had a notional value of $62.2T and for all financial derivatives it was $615T in 2009. (Numbers are from Wikipedia.) Wikipedia points out that the net value of all derivatives is far less than the notional value because of multiple off-setting positions. They state:
According to Bank for International Settlements [notional value of derivatives were] “$516 trillion at the end of June 2007”
—
Gross market values, which represent the cost of replacing all open contracts at the prevailing market prices, have increased by 74% since 2004, to $11 trillion at the end of June 2007. (page 28, http://www.bis.org/publ/qtrpdf/r_qt0712.pdf)
The risk was way more than $11 trillion, however, because that value assumes all offsetting counter parties will support their positions. If just a few billion dollars here or there default, the ripples through the financial system can create problems larger than the net gross. This problem exists because of lack of visibility, transparency and metrics.
Without Reins on the Banks Things Can Get Worse
The Occupy Wall Street (OWS) demonstrations should not be ignored. Awareness of the Tea Party social movement may have been one of the factors in the development of OWS. There are actually a number of shared values and concerns. Among these are (1) wasteful government spending, (2) corporate favoritism, and (3) bank bailouts.
Many with ties to government and corporate interests prefer the status quo rather than the protests. But small businesses lost access to loans and have been hurt by the systemic failure of US banks. And many of us will remain concerned that the nature of capitalism, competition, and greed will create new ways to tilt the playing field. Without reins on the banks things can get worse. This is a very real risk to us all. Our security is better preserved with transparency, data collection, bank monitoring, effective governance, useful regulation, and behavior modification.
Tax Payers and the Tea Party
Tax payers and the Tea Party don’t want wasteful government spending. And the OWS movement is aware, at least in a rough conceptual way, that each American now owes $46K to pay off the total deficit. It cannot be business as usual. It is now time to modify the behavior that creates expensive government partnerships with corporations. Let’s end corporate welfare. Can we be sure federal stimulus dollars are not simply going into someone’s pocket rather than benefitting the broader economy? Can we limit government stimulus projects to primarily fund highways, bridges, municipal buildings, water, sewer, landfills, and public transportation hubs? Can public debate and visibility finally define the limits of public works projects?
When federal dollars are part of free enterprise projects with private interests, then the tax payer can’t clearly understand the public benefit. It is intangible at best when government funds go toward subsidies, private businesses, toll roads, golf courses, casinos, parking lots, and ball stadiums. Cost/benefit analysis and development models could be used to minimize spending to government infrastructure (or, better stated, maximize the efficiency of the spending).
Transportation policy also has to be improved to prevent earmarks for highways and bridges to nowhere. This behavior could be modified through clear government review, management, guidelines, prohibitions and exceptions for funding approval of “public benefit only projects”.
Socialization of Corporate Interests
Corporate interests are asking for social handouts when they ask for government partnerships. Corporate interests ask for tax breaks and partnerships with the government because they give an advantage in competition, lower costs, and can grease the wheels with local government offices. But that doesn’t mean we have to agree!
Much has been written about tax loops holes in federal legislation (to benefit the few). In 2010 GE is marked as a case for tax cuts although GE didn’t pay any tax in 2010 and made billions in revenue (the corporate tax rate of 35% and the capital gains tax rate are questioned). It appears that GE pays taxes in 250 different tax jurisdictions as a multinational corporation. Behavior modification would look at simplifying taxes, but be firm about excluding a tax holiday under future administrations to avoid profit/tax sandbagging overseas.
Supporting capitalism and free markets mean allowing banks to fail as we have (25 banks 2008, 140 Banks 2009, 157 Banks 2010). It also means not allowing banks to become TBTF and ensure they pay for their bailout in fees, bonuses, wages, ratings, taxes, and reputation. How can the general public ever know the truth about TBTF if we continue business and bonuses as usual.
Thousands of Federal Contractors Abuse the Federal Tax System
One side of the corporate coin is employment, wages, taxes paid, progress, American free enterprise. The flip side is of the coin appears to be greed and gross government negligence. For instance, according to the GAO (Government Accounting Office) thousands of federal contractors don’t pay taxes. The GAO finds this is a clear abuse of the tax code. We would like businesses and corporations to pay a minimum tax to avoid (or at least reduce) such abuses. We need to look at the tax code for small businesses, taxes paid by small business owner’s salaries, and make sure the tax model is appropriate for small businesses (with a minimum tax and tax review of qualified federal contractors). The tax code and its enforcement should be aimed at modifying abusive behaviors such as identified by the GAO.
Control of Tax Breaks and Federal Subsidies
Clearly there is room for control and improvement in federal spending on public projects. A Cato Institute study found there were a total of 1696 specific federal subsidies in 2006 and they had increased by 44% over the previous 16 years. These programs fund “hundreds of billions of dollars annually to state governments, businesses, nonprofit groups, and individuals.” (Quote from the Cato report.)
Why should governments join projects for arenas that benefit private enterprise. Studies ( here and here indicate that Wal-mart has received many subsidies to help them build warehouses. Is this needed? Does anyone really believe the oil industry requires tax subsidies for our common national defense ($90B). The highest number of federal subsidies goes to the Health and Human Services Department (334 in 2006 increased to 442 l in 2011). There is no effective control of tax breaks and federal subsidies. Cato says, ”politicians have their hands in the cookie jar.”
The study of economics and government requires clear control, metrics and data measurement. Science requires control over the experiment or subject. Let’s shorten the tax code and simplify. The US tax system and the Federal Government can’t be understood by any one man due to its immensity.
Understanding where the money goes is crucial. Pure public projects like highways, bridges, dikes and water treatment are understood. Corporate subsidies, sports stadiums and other tax supported adventures are not.
Many U.S. citizens would like simple government systems that function in an obvious way without numerous and unknown tax loop holes and complex government subsidizes called partnerships with industry that require tax payer funding for private projects. Without clear control and transparency we can’t understand the results. Many federal partnerships with businesses should be eliminated. The resulting behavior modification would be that businesses would start or continue ventures because they make business sense and not because they can get a government handout. It’s called the free enterprise system.
Relationship to OWS
Clearly there are many social issues related to OWS. Many of the individuals involved could not begin to discuss very many of the issues, but there are many factors involved. Here is a (partial) list:
- 1) Divisive politics are always a reason to protest;
2) Jobs disappearing due to off-shoring and outsourcing;
3) Often new US jobs created are for low paying retail jobs;
4) Government wars overseas are too expensive;
5) High unemployment and underemployment for multiple years;
6) Many mortgages are behind on payments or in foreclosure;
7) Education is increasingly considered too expensive (bad capitalism?);
8) There are no tariffs or other programs to protect US manufacturing jobs;
9) Federal contracting jobs or government jobs are better protected than private sector manufacturing jobs (socialism?);
10) Minimal US fractional reserve requirements promote risky behavior and create a casino type atmosphere (banker socialism?);
11) Fear of global financial links like CDS and CDO investments over hang the US economy and banks;
12) Depository Institutions Deregulation and Monetary Control Act of 1980 and Gramm–Leach–Bliley Act deregulated banking and creates systemic risk in the US (bad capitalism?).
OWS will not be a process that leads to resolution of any of the problems. It can be a means by which frustration can be expressed. It can be a vehicle that brings more public attention to things that need to be fixed.
Conclusion
We depend on a political process to run our country, but we are left with political gridlock and political status quo (inaction and no material changes). But we need behavior modification to curb excesses and restore efficiencies in government. We can’t vote directly for change in this republic, so we get social movements like the Tea Party and protests like OWS.
Changed behavior can be obtained if we:
- 1) Control corrupt accounting practices;
2) Better regulate public and private banks and financial firms;
3) Eliminate many federal partnerships (earmarks) with business activity (free enterprise system);
4) Simplify and establish minimum small businesses tax code to increase revenues from federal contractors;
5) Simplify corporate taxes;
6) Create clear government exceptions for funding “public benefit only projects” to preclude funding to private business projects;
7) Implement better banking metrics, transparency, and conservative banking actions.
Links to Background Material
Derivatives Market $531T in 2008: Taking Hard New Look at a Greenspan Legacy (New York Times)
CDS Market in 2008: The $55 trillion question (CNN Money)
Study finds more than 240 cases in which the construction of a new Wal-Mart facility was assisted by taxpayers: World’s Biggest Corporation is a Welfare Queen (The Progress Report)
90% of Walmart warehouses are government subsidized: Corporate Welfare (Campaign for America’s Future / Institute for America’s Future)
Cato Institute 2006 study: Number of Federal Subsidy Programs Is Soaring (pdf)
Statement of Gregory D. Kutz, Managing DirectorForensic Audits and Special Investigations to the United States Government Accountability Office (GAO-07-742T): Thousands of FederalContractors Abuse theFederal Tax System (pdf)
Wasteful earmarks for highways: Elimination of the most Wasteful, Environmentally Harmful Highway Projects would save Billions (CommonDreams.org)
Full listing of all Federal programs available to State and local governments from cfda.gov: Catalog of Domestic Programs and Subsidies
List of bank failures in the United States (2008–present) (Wikipedia)
Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You with the Bill) by David Cay Johnston (Amazon book page)
Presentation by MaryAnn DiMaggio, Director of Global Fixed Income Research at Evaluation Associates. Particpiants in CDO CDS: Financial Derivatives – A Guide to CDO and CDS (pdf)
Robert J. Samuelson: GE makes case for lower U.S. corporate tax rates (Billings Gazette)
Out-source of painUS companies moving jobs offshore at record pace (New York Post)
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