10.11.2008
October 31, 2008 (the date of publication in Russian)
Vladimir Sidorovich
AN ALTERNATIVE TO PYRAMIDS. Part 2
The crisis as a moment of truth: it is high time to reshape the financial market on a constructive principle
Part 1: http://www.rpmonitor.ru/en/en/detail.php?ID=11702
NEW PRINCIPLES OF REGULATION
What new principles of regulation of financial markets could compensate their negative effects?
Politicians, contrary to futurologists, are restricted in their capabilities. They are bound with the framework of the existing economic paradigm, and unwilling to change its basic foundations. According to Maxim Sokolov, qualitatively new basic principles are likely not to emerge from rational revision of the existing principles but from constituting the state of affairs on the ashes. At peacetime, we are likely to expect correction of the existing model and not a change of principles of economic policy.
It is also obvious than human passions of covetousness and pride, the major locomotors of financial speculation, cannot be cured by prohibition. On the other hand, the ontological destination of the state is "to restrict manifestations of evil and sin in the world". In the discussed context, that means that the state should drive players out of the sphere of speculative operations with fiscal levers, as well as with use of harsher methods, canalizing their energy into a more useful direction.
Regarding these considerations, we propose the following set of framework measures:
1. A tax on incomes from sale of shares.
The presently proposed tax relief for incomes, derived from sale of shares held in investor's portfolio for more than a year, is a correct measure. We believe that this term could be increased to two years, in order to more efficiently stimulate long-term investments.
However, this measure will not be workable without a significant increase of the tax rate on sales of shares held for less than two year. It is expedient to introduce a special tax for this purpose. The tax rate is to be sufficient for destimulating speculative operations, reaching 90% for the first and 50% for the second year, both for individuals and companies, regardless from tax jurisdiction.
Every FIFO transaction should be taxed as well. This requires changes in the infrastructure of the stock market which are anyway long overdue – for instance, establishing a single exchange, a single depository and registrar, as well as centralized clearing.
In early 2006, Oleg Vyugin, then-chair of the Federal Authority on Financial Markets and a well-informed official, confessed that the market infrastructure was conditioned for short-term speculative deals and not for investments. Is today's crisis not sufficient to initiate changes?
In addition, the tax reform will require a higher transparency of companies, as well as improvement of quality of corporate management. The only reasonable alternative for the special tax is return to progressive taxing of individuals.
2. A ban for unsecured short sales.
3. A ban for using shares for lending, as such deals are destined exceptionally for mastering tax-evading schemes.
4. Creation of tax levers destimulating speculative activity at derivative markets.
5. Severization of banking standards on investment in shares and short-term transactions.
6. A ban for crediting professional share trading parties and their subsidiaries as well as for any lending for purchase of shares.
As far back as in 2001, Bank of America's CEO foresaw that in several years, major investment banks would be merged by commercial banks that have a broader base of funding. Exactly this is happening today.
However, this luck of commercial banks is rather precarious. Their involvement in investing activity is fraught with temptation of using capitals of depositors – the base of funding – for covering losses emerging from risky investments. Regulating authorities are to be sufficiently competent for distinguishing more and less risky operations in the range of investment activities and to introduce adequate prudential restrictions protecting the bank from the fascination of top managers with dangerous kinds of operations.
7. A ban for stock market players to run any kind of transactions with residents of offshore zones, essential for restricting activity of international hedge funds which are not regulated by any institutions, as well as for reducing the possibility of "tax optimization: for domestic market players.
8. A ban for offshore registration of enterprises functioning predominantly on the territory of Russia and controlled by Russian citizens. In fact, according to Mr. Vyugin, "property rights of beneficiaries are outsourced to the jurisdiction of foreign states: businessmen drill, pump and saw in Russia and own and even extract profit in Cyprus, Holland, etc. Russian business in increasingly structured in the form of foreign holdings owning Russian assets, with the purpose of channeling these assets, already under foreign jurisdiction, to international capital markets".
9. A ban for IPO of Russian companies outside Russia, including the forms of ADR and GDR.
10. Toughening of prudential control over professional market parties.
11. In ads, leaflets and indentures concerning operations with shares, units of investment funds and in forward deals, it has to be written in capital letters – in a print as large as the text of the ad, leaflet or indenture – that investments in these instruments are fraught with loss of the whole invested capital.
12. For over two decades, one of the major problems of Russian economy is insufficiency of short-term resources. Mostly for that reason, Russian companies and banks (including those co-owned by the state) are forced to attract money at foreign markets. At the same time, the state allocates funds at the same foreign markets under significantly smaller interest. Therefore, one of the most immediate tasks of the state (represented by the Finance Ministry, the Bank of Russia, and the Ministry of Economic Development) is elaboration of mechanisms of long-term refinancing of banks and therefore economy. The market, especially with "infrastructure conditioned for short-term speculative operations", cannot solve this problem.
These measures, or some of them, will be undoubtedly encountered with violent resistance from the so-called professional parties of the stock market and their numerous lobbyists who will do their best to prove that in case new conditions are introduced, the market will lose liquidity, become unattractive for investments, and they escape to London.
"Not a single principle of the orthodox financial science is as antisocial as the fetish of liquidity", wrote J.M. Keynes in 1936.
It is true that a share is a part of the capital of a joint-stock company. Capital may be invested in material assets – for instance, in construction of a gas pipeline. Now imagine a pipeline that is assembled, then dismantled in an hour and assembled again. The dream of today's nomad is high liquidity of everything: any goods to be immediately purchased and resold. Today's financial market makes this dream true.
"If investment of capital, like marriage, could be made a long-term and indissoluble act, this would be a useful remedy from our current maladies. This would force the investor to focus on long-term perspectives and nothing else", wrote Keynes. He further points at the contradiction: "liquidity of investment markets rather benefits new investments then impedes them".
This dilemma, significant for Keynes' times, had been since relieved. The share of new investments in real assets in the turnover of financial markets progressively contracted: most of the reinvestment was directed into a pyramid, in which high liquidity enabled purchase of new players. According to Ruslan Grinberg's calculations, "only 2-3% of global financial operations are somehow related to the real sector, while the rest are related only to one another or to servicing the financial sector".
"We don't need your dividends!" – declared a shareholder at the recent assembly of the Russian Foreign Trade Bank (which had just decided to spend half of the net profit for dividends). This remark reflects the whole philosophy of today's financial market. A modern investor is interested only in growth of stock price and relevant speculative profit. He expects money to grow all by itself, no matter how the enterprise is working and whether it works at all. The typical dividend income is scales smaller than the return on deposits, and does not serve as an impetus for investments in shares. "Dividends are just a trammel", confessed an investment banker already in the 1990s.
It is essential to return back to the earth. The proposed measures are helpful. The chair of the Financial Markets Service also ostensibly wishes to "deter speculators". It is definitely necessary to analyze measures undertaken by European countries and creatively apply them. The principles of regulation of financial markets will be undoubtedly amended in Western countries. "Markets should serve to the society" – this assumption has become conventional in Western media and in speeches of Western politicians. The Russian financial market should also serve to the society, and not to a flock of speculators.
WILL RUSSIA BENEFIT FROM MAKING ITSELF THE FINANCIAL CENTER?
"Russia has to become a global financial center", declared our top officials last year. The idea could be quite acceptable in case the intention were focused on decoupling of the national currency from the US dollar, thus achieving independence from the US economy that was spectacularly approaching a crisis. In fact, the ruble was still pegged to the dollar, the emission of national currency depending from the dollar/ruble rate, restricting implementation of sovereign economic policy from outside.
It is true that we require a strong financial power. But what are we in fact going to create?
The sparse amount of information available from government experts suggests that the idea of the financial center was related only to the stock market. The only dream of government officials was to reap the laurels of New York and London as centers of stock exchange. "Stock exchange should be the nucleus of this center", declared the chair of the Federal Authority on Financial Markets. Naturally, the best instrument for Moscow's transformation into New York was tax relief. Smart Money Magazine reported that FAFM was going to "introduce a zero income tax rate for sale of shares for individuals, this indulgence consequently encompassing also investment companies".
Russian liberal officials obviously follow a primitive logic of mechanistic comparison: Western countries have a high level of life, and at the same time, a developed financial (stock) market, therefore, to live as nice as they do, we also require a developed financial market.
In fact, this pattern suggests copying and reproducing institutions and instruments with a doubtful substantiality. In fact, the dialectic of economic phenomena, their consistency and causality was neglected. Government dreamers overlooked the simple fact that in the West, the financial market has become a superstructure parasitizing on the already developed real sector and social state. Economic and social growth, ostensibly achieved due to the financial market, was in fact the consequence of global processes of redistribution – a form of neo-colonialism, achievable due to the underlying basis. Meanwhile, this basis was de facto challenged, immediate challenge, and sustainability of the Anglo-Saxon model was put under question.
The attempt to draw over these processes of redistribution in favor of Russia, for instance, in the form of a financial center, corresponds with imperial thinking but contradicts national interests. A developed and open financial (stock) market under the conditions of globalization is a means of attracting not direct but portfolio investments. To lure portfolio investments from the whole globe is equal to an attempt to tame locust. Regarding absence of an efficient productive basis and social protection, such kind of doting on bubbles is a pernicious occupation.
*Vladimir A. Sidorovich, Ph.D. (Econ.), is a postgraduate of the Moscow State University and a professional banker with experience of work in MMKB Bank (Moscow), Commerzbank (Germany, Russia), Bank of Moscow, KMB Bank (Moscow). He also had extensive training in BMW AG (Munich, 1992), ABN-Amro Bank (Wien, 1993), Dresdner Bank AG (Frankfurt, 2002), EBRD (London, 2002). Currently, Mr. Sidorovich is a managing partner of «Sidorovich & Partners» advisory services, a BoD member of the Far Eastern Bank and a member of the Independent Directors Association (Moscow).
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