Loose Ends

A recent survey of “America’s Capital Markets� in The Economist concluded with these words of warning: “All this means that these are times of mounting risk not only for America’s capital markets but also for the world financial system.�

This view is shared by many experts, but the concern has motivated neither public nor private responses that address the underlying problem and propose serious remedies. New York’s Wall Street and Chicago’s futures markets are populated by people behaving as if nothing was learned last October. This has been a year of “frenzy,� to use The Economist’s word for it, in the merger and acquisition business. Banks, struggling to find new profit sources to compensate for their failed loans to developing nations, are funding leveraged buy-outs, accepting the high risk to earn premium interest rates. Savings-and-loans are overloaded with junk bonds.

Fortunately, there are some voices speaking out for reform, unafraid to challenge the casino mentality that now controls so much of the securities marketing, and willing to offer specific proposals for correction. One of them is Felix G. Rohatyn, a partner in Lazard Freres & Co.

“I would suggest that the fundamental weakness in the securities markets worldwide is the result of excessive speculation, excessive use of credit, and inadequate regulation,� he told a House subcommittee the other day. “Curbing speculation and promoting investment must be the objective of reform.�

His testimony included a sobering reminder that all American taxpayers are going to be forced to pay for the problems that are developing. “The price that the taxpayers will pay for deregulation and laxness in oversight is deliberately murky at this time but in the long run will be staggering. Bail-outs such as the rescue of Continental-Illinois Bank and the present efforts to rescue First Republic of Dallas will cost the taxpayers billions of dollars. Estimates of the ultimate cost of bailing out the S&Ls; increase almost daily, with some experts estimating $50 billion to $75 billion as the possible cost to the taxpayers,� he said.

“It is obvious that the speculative behavior of institutions is affected by financial deregulation as a whole, by the laxness of regulators with respect to these regulations that remain, and by the drive for short-term performance, at the expense of long-term safety, by the asset managers,� Rohatyn noted.

His proposals for changing the behavior of institutions are interesting because they address the fundamentals, including the incentives for speculation, rather than being limited to tinkering with market mechanisms. He has four proposals: (1) a tax of at least 50% on profits from the sale of securities held for less than a year, together with a reduced capital-gains tax of 15%, or a sliding scale, on gains made on securities held for more than five years; (2) strict limits on speculative investments that are held by federally and state-insured institutions; (3) tighter care and diligence standards for those who are responsible for investments made by the federally and state-insured institutions, and (4) tax-law reform to encourage equity investment and to discourage excessive debt holding.

But Rohatyn is a realist. After observing the virtual inaction of the government in the nine months since the crash, he is convinced that nothing will be done until there is another crash. In the meantime he sees complacency. But perhaps his counsel will reawaken a sense of responsibility within Congress to take steps, all the clearer now, to reduce the pressures for speculation and to strengthen the market for the capital investments that, as Rohatyn testified, “we so desperately need to regain our global competitive stature.�