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John Fullerton Headshot

Light for the Dark Age of Banking

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The Dark Age of Banking reaches its twelfth anniversary today, November 4. It would be simplistic and unfair to blame the near collapse of the global financial system on the Financial Modernization Act, signed into law on November 4, 1999, repealing Glass-Steagall. But history will no doubt judge it as the beginning of the dark, modern banking era.

My perspective, from nearly twenty years inside Morgan Guaranty Trust Company (the predecessor bank to JPMorgan) through the time I left after the merger with Chase in 2001, suggests a different narrative. It is a narrative marked by the advance and then abuse of technology, the competitive forces unleashed by this technological change and globalization, and a collective loss of our moral and systemic understanding of the public purpose of markets and of finance itself.

The core purpose of finance is to serve the real economy through the conversion of savings into productive investment. Speculation overwhelms such productive investment today, with profound costs to our shared prosperity. If managed for the public good, markets are effective tools of capitalist economies, mediating resource allocation efficiently. Yet in modern capital markets, with advances in technology and the related explosive growth of secondary trading, markets have become businesses with their own private interests, rather than public utilities serving the public interest. The tail of speculative secondary markets, which are aligned with the interests of private exchanges and Wall Street intermediaries, are wagging the real economy dog.

We cannot roll back technology, nor should we try. But we can learn to manage its impact on the financial system wisely. In addition to much needed regulatory boundaries across the system, policy makers should introduce feedback loops that shift the balance away from short term speculation toward longer term investment in the real economy, while enhancing market resiliency in the process. This was the central recommendation from the 2009 Aspen Institute gathering of prominent businesspeople including Warren Buffett, Felix Rohatyn, John Whitehead, and Pete Peterson who all signed onto a document that decried "high rates of portfolio turnover" by fund managers with little concern for long-term corporate performance or externalities. Preeminent economists including John Maynard Keynes, James Tobin, and even Larry Summers (in a 1989 paper) have all called for a financial transactions tax to "throw some sand into the gears" of our overly efficient financial markets, to use Professor Tobin's memorable phrase.

A well-structured and uniform financial transactions tax (FTT) as proposed by the European Commission accomplishes three goals. It will discourage short term speculative trading at the margin while encouraging longer holding periods, which makes the tax immaterial to investors. It will enhance trust and much needed market resiliency by reducing the dominant activity of certain leveraged speculators whose market making liquidity can be temporary and whose trend following trades contribute to near term volatility. Finally, a FTT will generate much needed revenues, perhaps $50 billion or more per year in the United States, to reduce our structural deficits.

Detractors who argue that a FTT will harm liquidity and therefore market efficiency confuse market efficiency with efficiency of the real economy. By shifting financial, technological, and human capital away from short-term speculation, and by enhancing market resiliency, the efficiency of the real economy will be enhanced, and therefore better able to deliver the job growth we need. These same detractors have recently tried to argue that an FTT will harm economic growth through raising the cost of capital. Such arguments do not hold up to scrutiny; the tax does not affect real capital raising activities. Were such an argument valid, the dramatic decline in transaction costs over the past decade would have created tremendous economic growth. But that's absurd. Arguments that traders will simply avoid the tax seem silly in the face of the well functioning FTTs in the United Kingdom, Switzerland, Singapore and Hong Kong.

Let me be clear. A FTT will not provide justice for the violence perpetrated on the citizenry and the real economy by the irresponsible and at times fraudulent financial industry behavior, nor will it address the unchecked power of the too-big-to-fail banks that have corrupted much needed financial reform. Rather, a FTT is a laser-sharp policy intervention that will combat (not fix) one of the most corrosive realities that is undermining capitalism itself: short-term speculation has displaced productive investment, transforming our economy into a bankrupt financial system that lacks morals and purpose.

This week, despite the abomination that is Dodd-Frank, and in the face of the continued failure of the justice system to adequately address systemic mortgage fraud, glimmers of light are appearing on the horizon to pull us out of the Dark Ages of Banking. A FTT is on the November G-20 Agenda. Senator Harkin and Representative DeFazio have reintroduced a Bill calling for a uniform FTT in the United States. Bill Gates has offered testimony to the G-20 in support of a Financial Transactions Tax as a source of revenue for foreign aid. Americans for Financial Reform have gathered hundreds of thousands of signatures showing strong public support for such a Bill. I stand with them.