Opinion

Felix Salmon

Why the stock market is increasingly irrelevant

By Felix Salmon
February 14, 2011

I’m sad that my NYT op-ed on the decline of stock exchanges went to press too late to include the bonkers rhetoric emanating from Chuck Schumer:

The New York Stock Exchange is the cradle of American capitalism. It is a national treasure. In America, we start each day in our Congress and in our classrooms with the Pledge of Allegiance, and we also start it with the ringing of the bell on the floor of the stock exchange.

The NYSE is in no sense the cradle of anything. A cradle is a safe place for the young to develop until they grow up and become more self-sufficient. Y Combinator is a cradle. The NYSE is place for algorithms and speculators to make bets on financial assets. It last funneled real amounts of money into the broader economy during the dot-com boom, leaving behind a lot of Aeron chairs and little else. Since then, I get the feeling that the big capital raises on U.S. exchanges have been by financial institutions, rather than the real economy; maybe someone can find a breakdown for me of which sectors raised the most money in primary and secondary offerings over the past ten years.

As for the idea that the NYSE is a national treasure akin to the Pledge of Allegiance, well, yes. Which is to say, its value is symbolic, and rooted in the days of old, when “allegiance” meant something more than who you’re friends with on Facebook, and when institutions were judged on the size and weight of their Corinthian columns.

There’s one other point I would have liked to make in my piece, which is that the tax code is a large part of the reason why the stock market is bad at capital formation. Look at the trillions of dollars cash on corporate balance sheets: why aren’t those companies paying it out as dividends to their shareholders? In an efficient capital market, they would do just that, and then raise new equity capital as and when they needed it in future. After all, sitting on billions of dollars in cash is hardly a core competency of most exchange-listed corporations.

But companies don’t do that. It’s partly because they fear that the money might not be there when they need it. But it’s also because the cost to shareholders of dividending out money now and then getting it back again in future is enormous. For one thing, the underwriters of the secondary offering are likely to require a hefty seven-figure fee when you ask them to raise that money for you. And more importantly than that, the shareholders you send the dividend to are going to have to pay income tax on it, at rates in the region of 35% to 40%. There’s no way that can be efficient.

I’m not saying that we should abolish the income tax on dividends. But it does help to explain why U.S. capitalism can be very inefficient, and why the stock market, broadly speaking isn’t working very well these days when it comes to its core function of capital allocation.

Comments
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the dividend to are going to have to pay income tax on it, at rates in the region of 35% to 40%.

Thought it was 15% now in the US, income tax on dividends?

Posted by TimWorstall | Report as abusive
 

The tax on dividends gives executives of publicly owned corporations an excuse to hoard cash, which hurts the economy as profits are not being recycled into new investments. At the very least, the amount of money a company pays in dividends should be deducted from their taxable income; this would reduce the incentive to hoard. And this exclusion should be combined with the ability of shareholders to defer taxes on divdends that are re-invested in new ventures (secondary offerings do not count).

U.S. capitalism is inefficent because the executives of publicly traded companies make their decisions based on what’s best for themselves, not the companies they manage. The two goals are not always aligned.

And who says the core function of the stock makret is capital allocation? Isn’t it more for providing liquidity for original shareholders, and then a place to gamble, I mean, trade?

Posted by KenG_CA | Report as abusive
 

The following comment is my response on http://www.timun.net to the NY Times OPED piece.

WALL STREET’S DEAD END AND THE TFD GLOBAL GOVERNANCE SYSTEM
February 14, 2011
Felix Salman, the finance blogger at Reuters, argues in the New York Times of February 14, 2011 that Wall Street is heading towards a dead end. Since 1997, the peak year with its 7000 public companies, the listing has steadily gone down, so that presently only 4000 are listed. Those that are listed do not reflect the vibrancy in the economic sector where innovative companies such as Apple find their financing from private and, generally, large institutions. Thus, American style capitalism of shareholder companies that are part of a regulated financial system is disappearing.
One of the effects of this decline is the increased and unregulated power of large financial institutions and super rich elites who determine the direction of the various markets in the global economy. Their decisions do not foremost allocate capital based upon the need of the real economies of nations and regions, but upon their outsized desire of making money on their money by betting on those markets. Given the lack of an effective global regulatory structure, much of this “investing” is not monitored, let alone regulated. While nations battle with huge sovereign debts and have to resort to drastic budget cuts, huge global financial resources with its increasing financial concentration are directed towards non-productive users.
Should nations and civil society try to reform the present financial system and make public exchanges more effective in allocating capital for the real needs of people and planet? Should developing countries continue to set up their own stock exchanges or opt for an overhaul of the global financial system? How should the international community deal with a connected global economy that is so well described in Connected by Daniel Altman who analyzed the global economy by watching it for 24 hours on June 15, 2005 and who, several years later in Outrageous Fortunes , has been looking for the “deep factors” that would determine its future?
The Tierra Solution gives an answer to those questions. Its TFD global governance system would utilize a carbon-based international monetary system to combat the climate crisis by advancing low carbon and climate-resilient development. It would monitor and regulate all the various sources of financing, be they stock exchanges, private funds, sovereign wealth funds, hedge funds etc., and thus create a level playing field in the financial and monetary sectors. By being able to monitor, regulate, and engage in credit and money creation its Global Central Bank would have the authority to direct the world’s existing capital and the new credit and liquidity requirements for climate and development policies, programs and projects towards productive uses in the real economies of its member nations. Though this high level of collaboration of a global monetary union may seem unattainable in the next couple of years, the vision of and reason for such global governance system may be precipitated during this decade by an ever increasing awareness of the ineffectiveness of the present monetary and financial systems and the ascendancy of financial black markets and by the global serious impoverishments in food, health and housing of a looming climate catastrophe.

Posted by fcvnyc | Report as abusive
 

Felix, maybe this is old hat for you, but congratulations on making the NYT op-ed page. That’s some prime journalistic real estate.

Maybe you could offer your opinion on the following sometime: If we’re shifting from a model of broad shareholder ownership, how much of this is attributable to loss of confidence in gatekeepers (rating agencies, auditors, analysts, etc.)? What different means of monitoring management will arise from the new forms of ownership? Will the old institutional gatekeepers evolve and adapt to the new ownserhip arrangements, or will they be replaced by something entirely new–and if so, what?

Just a suggestion….

Posted by EconWatcher | Report as abusive
 

TimWorstall: Dividends are taxed differently than capital gains.

http://en.wikipedia.org/wiki/Dividend_ta x#United_States

Posted by la_dave | Report as abusive
 

la_dave, qualified dividends and long-term capital gains are currently treated very similarly. That could change in 2013, but ANYTHING could change by then.

Posted by TFF | Report as abusive
 

“It is a national treasure”.

No kidding Felix? So Chuck actually said that….recently? Wow. Well, it’s surely a treasure for some of us.

It’s been my experience that the buyer gets to pick the name of the new firm.

Well I can sleep better now knowing that the cradle of capitalism was up again today on little volume.

MIA

Posted by Missinginaction | Report as abusive
 

Felix — Thanks for that sweet NYT piece. The only question I have is how much longer Wall Street, the place, can fend off the online market. Why do we even need a physical Wall Street? I thought the whole point is more and more efficiency, no?

Posted by Samdog_07 | Report as abusive
 

Really now, somebody actually still owns stocks? How quaint ..

Posted by Woltmann | Report as abusive
 

ownership society? it seems to me that the more stock americans owned..the worse the market has performed..
what were mutual funds in the 50′s thru 70′s? Only rich people seemed to own stocks..Once the mutual fund craze hit in the wild 80′s ..leading to the 87 crash..what followed?
the 2001 crash, the 2007 thru 2009 crash..Too bad I was too stupid to buy at 7000 just recently. You are correct this is just a casino , not a serious investment platform..maybe our brightest members of society can spend their time doing something really productive.

Posted by artammer | Report as abusive
 

Felix is the winner again! Financials aren’t everything. There is still a big workforce to organize and attention to people is still at the top of the corporate mission.

Posted by adamt78 | Report as abusive
 

Re. your income tax point, do you think it’s the role of firms to think about the taxes which their shareholders have to pay? I know as a law abiding citizen that I have to pay taxes on income. Why should a firm be making decisions for me as to when I can earn money or not? If I don’t want to pay taxes on any earnings, then I shouldn’t bother making any earnings (legally speaking)… so why invest in a company!?

Posted by sanchk | Report as abusive
 

Perceptive comments about the vanishing US equity markets. However, the implications are even greater than Felix suggests. Our entire retirement system depends upon robust
capital markets and open access to these markets.

I’ve written further about this, please see: http://bit.ly/gG7npz.

Thanks.

Posted by MShames | Report as abusive
 

The capital markets will continue to attract funds as long as the profit motive is strong enough. The Stock Exchanges will continue to perform their role till a more transparent and efficient form of trading comes into existence. Algorithms may drive trading, but never, investing.
Way forward: Abolish tax on dividends, as profits are distributed only after payment of Corporate Taxes. This will make dividend distribution and capital raising a two way street.

Posted by Ugottabesick | Report as abusive
 

@sanchk: It definitely is, because some firm decisions, such as the choice of dividends vs. repurchases, can affect the tax paid by shareholders and thus the value of the stock.

Posted by guanix | Report as abusive
 

“The NYSE is place for algorithms and speculators to make bets on financial assets.” Well put. I’da been disagreeable if you had said “place bets”, which is what they’d have you believe. They’re manufactured. Just like the pokies.

Posted by Guambat | Report as abusive
 

Sir, how _dare_ you!

LOL.

Was there ever really a golden age of allocative efficiency?

Isn’t the goal of most private equity strategies to eventually dump their stock, to cash out, even if it means paying big-board fees? (Did I say “dump” – I meant, lovingly “share”, pun intended).

You ignore the role of price discovery. Apple may not have issued since forever, but they sure like the currency of a highly valued stock, even more so when everyone can see just how big it is.

Posted by AmicusAlso | Report as abusive
 

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