Bypassing Wall Street


                                               What Government Could Do


Experience suggests that the answer to what government could do to solve the problems caused by Wall Street’s monopoly is:  Not much, and anything government does is likely to make it worse.  "Capitalists turning their problems over to modern American government is like the myopic handing their glasses to the blind: once they've done it neither of them can see where they are going."  [Arthur Jones, The Decline of Capital, Thomas Y. Crowell Company, 1976, page 80]  That said, these are some suggestions.  There are more in the next section of Bypassing Wall Street, “Proposals for Change.”


Proclaim National Policies


There have been occasions in our political history when Congress, the President or both have announced a consensus on national values and priorities, like the Monroe Doctrine, Emancipation Proclamation, Marshall Plan, Full Employment Act.  Much was left to be done to implement the declarations, but the objective was clear and emphatic.  We need a statement of government policy and intention for changing the way shareownership in businesses is marketed and owned.  The statement could include these policies:


Broaden the Ownership of Capital.  A beginning was made toward adopting this national policy, in the majority section of the 1976 Report of the Joint Economic Committee of Congress:  “To begin to diffuse the ownership of capital and to provide an opportunity for citizens of moderate incomes to become owners of capital rather than relying solely on their labor as a source of income and security, the Committee recommends the adoption of a national policy to foster the goal of broadened ownership.” 

The fundamental reason for proposing a national policy of broadened capital ownership is, in the words of the 1976 Report, to provide people an opportunity “to become owners of capital rather than relying solely on their labor as a source of income and security.” 


Whenever there is a recession, the rhetoric from politicians, academics and the media is all about “job creation.”  President Truman, worried about a return to 1930s-level  unemployment after the end of World War II, proposed a Full Employment Bill, which became the Employment Act of 1946 [15 U.S.C. §1021,].  Congress broadened the focus from full employment to include “balanced growth, a balanced Federal budget, adequate productivity growth, proper attention to national priorities, achievement of an improved trade balance through increased exports and improvement in the international competitiveness of agriculture, business, and industry, and reasonable price stability.”  It even added a section calling upon the federal government “to provide sufficient incentives to assure meeting the investment needs of private enterprise, including the needs of small and medium sized businesses . . ..”  [15 U.S.C. §1021(i)]


It’s not “all about job creation.”  It’s about providing individuals with a source of income.  For most of us, it’s still true that our only income source will be a steady job.  It may come from having developed skills for which there is constant demand.  Later in life, a good living standard may come from a lifetime of work, combining social security with a retirement account.  We have programs under way to increase the availability of jobs and to raise wages.  But work does not have to be the only path to a reliable income.  It can’t be.  There won’t be enough work at enough pay to take care of all of us.


Keeping our economy healthy by creating jobs is a doomed policy.  Nearly every business is trying to reduce the use of human labor, through investment in equipment and software.  Money used to acquire intelligent machines can be returned many times over, from the money that is no longer spent paying people to do all the work.  The more that consumers and the government spend for products and services, the greater the incentive to replace employees with less expensive automated processes.  Individual business owners have often resisted cutting jobs, but lower prices by their competitors usually force them to follow suit.  Some may turn to buying their products from low-wage countries but even if employers were somehow to stop outsourcing work to other countries, the drive to automate work would continue.  Economists maintain a “capital-labor ratio,” which is the amount of capital invested in a year, as a percentage of the number of hours worked in the year.  The ratio increased by 29% from 1990 to 2008; for capital invested in equipment and information processing, the ratio increased by 310%.   “When the ratio rises, it shows companies are spending more on labor-saving machinery than on workers.”  Christopher Power, “Machines Don’t Get Paid Overtime,” Bloomberg Businessweek, August 2-8, 2010, page 13]


Government policy should be modified to go with the inevitable flow.  If capital is replacing jobs, then accept the fact that income from capital ownership is replacing income from work.  What is needed is to broaden the ownership of capital, so that more and more of us have income from the use of money we have chosen to invest rather than to spend or gamble. 


Reverse the Culture of Spending and Support Investing.  We’ve had a culture of spending since World War II.  Many believed that the war’s huge expenditures brought us out of what would have become a permanent depression.  The postwar issue became:  How to direct money into spending, without having the government collect and spend high taxes?  The solution was to induce individuals—now called “consumers”—to spend on newly built homes in the suburbs, things to put in the homes and cars to drive from the suburbs to work.  The constant barrage of marketing, encouraging us to buy and borrow, has been supported by government legislation and official pronouncements.  It seems to be our national policy to encourage spending on consumer products.  Even our income is no limitation on spending, because we’ve been urged to take cash out of our home ownership, by refinancing our mortgages and home equity lines of credit, to run unpaid balances on credit cards and to finance or lease our automobiles. 


John Maynard Keynes dominated our economic thinking after his suggestions to Roosevelt about how to spend our way out of the Depression.  His “paradox of thrift” told us that saving might be good for the individual but, if we all save instead of spend on credit, we’ll have another depression.  It’s good for a single family to save for the future, but its bad for our economy if we all save rather than spend. He also preached the “multiplier effect,” that spending provided money for more spending.  The amount of our spending is multiplied, as the people from whom we buy goods or services spend that money to pay their employees and vendors.  Presidents have pushed spending as the solution to all kinds of problems.  In 1971, when Richard Nixon proclaimed “We’re all Keynesians now.”  []


Whether it is a national security crisis like 9/11 or worrisome economic news, our leaders in recent years seem increasingly determined to insist on the catchall economic salve of prodigious consumer spending.  But this is, at best, partial and misleading advice in a society marked by dangerously high levels of debt and dangerously low levels of saving. Perhaps it is time to balance the message of more spending with a message of more saving and wealth building. [“A Nation in Debt:  How we killed thrift, enthroned loan sharks and undermined American prosperity,” by B


The argument for spending our way to prosperity is based upon a pair of flawed premises.  Government has told us that (1) happiness is increased by spending on consumable things and that (2) spending depends upon having income from a job.  We are learning from studies that happiness is not a product of spending.  It doesn’t even correlate with income, once above the poverty level.  The lead author of the Gallup World Poll summarized its findings:  “‘Does money make people happy?’ – we must say it increases the likelihood that they will be satisfied a lot, but it only somewhat increases the probability they will enjoy life.”  [“Some Answers for Journalists,” July, 2010, University of Illinois and the Gallup Organization, Wealth and Happiness Across the World: Material Prosperity Predicts Life Evaluation, Whereas Psychosocial Prosperity Predicts Positive Feeling,]  Gregg Easterbrook concludes from his  review of happiness/money research that "once the middle-class level is reached, money decouples from happiness and the two cease having anything to do with each other."  [The Progress Paradox: How Life Gets Better While People Feel Worse, Random House, 2003, page 169.  See the Index of Social Health, Institute for Innovation in Social Policy,]


Perhaps we need a new vocabulary.  “Spending” conjures buying things that are quickly consumed and gone forever, while “saving” seems to mean taking money out of circulation and immobilizing it under the mattress.  When we talk about “investing,” we’re usually referring to sending our money to Wall Street, for gambling in the trading markets or the mutual funds that buy and sell stocks and bonds.  That’s not investing.  The money we may think we’re putting into a business actually goes out to someone who is selling the securities.  Very little of what we call investing results in money flowing from individuals to business managers who are making payrolls and trying to grow.


If we choose to bypass Wall Street and send our money directly to a business we believe in, we have avoided Keynes’ paradox of thrift.  That money we invest will be spent by the business to pay workers and suppliers.  The multiplier effect will be in full force as the workers and suppliers pass it on.  The neo-Keynesians might argue that investing will lead to greater production and less demand, that we already have more supply than demand.  That is indeed a problem when borrowed money goes to big business, where it is used to gain market share through greater production and lower price competition.  But money invested in small business equity is likely to be used for long-term risk capital.  These entrepreneurial businesses use the money they receive from selling shares for the development and marketing of new products and services.


Providing money directly for use by a business, unlike spending for consumables, can create a future stream of income for us to use.  When we turn our money over to a business, we get an agreement for the return of that money plus a reward for letting it be used.  The agreement may be the ownership of shares in the business and the right to receive dividends from future profits, or to sell the shares into a trading market.  Or the agreement may be a bond, a promise to pay the money back at a future date together with interest.  If we choose successful businesses, the income we receive from their securities can supplement and even someday replace our earnings from work


We may finally be entering an era of saving.  After 17 years of steadily spending our way into $2.6 trillion of personal debt, consumer borrowing is going down a bit.  Perhaps we need a new vocabulary.  “Saving” seems to mean taking money out of circulation and immobilizing it under the mattress.  “Spending” conjures buying things that are quickly consumed and gone forever.  When we talk about “investing,” we’re usually referring to the stock market, or the mutual funds and retirement plans that buy and sell stocks and bonds.  But these days, this kind of participation in the trading markets is more like gambling at the casino or races.  The money we think we’re putting into a business actually goes out to someone who is selling.  Very little of what we call investing results in money flowing from individuals to business managers who are making payrolls and trying to grow.


We aren’t limited to a choice between spending it or putting it in “the market.” Rather than this stereotype of “saving” and “investing,” we can talk about choosing to bypass the Wall Street casino and send our money directly to a business we believe in, for the business to spend on payrolls, inventories, expansion, etc.  This path also bypasses Keynes’ paradox of thrift.  The money we choose not to spend on consumer products will be spent by our selected businesses to pay workers and suppliers.  The multiplier effect will be in full force as the workers and suppliers pass it on. Before we can start our program, we may need to change the way we think about our “discretionary funds”--money available for what we want, not just what we truly need.  Studies by the Kauffman Foundation show that investment in entrepreneurial businesses stimulates economic growth and job creation more than government spending.  [Robert E. Litan, "Inventive Billion Dollar Firms: A Faster Way to Grow, Ewing Marion Kauffman Foundation," December 2010,, Tim Kane, "The Importance of Startups in Job Creation and Job Destruction," Ewing Marion Kauffman Foundation, July 2010, and Vivek Wadhwa, "To Spur Economic Growth, Bet on 60 Startups," Bloomberg Businessweek, December 22, 2010,]


Providing money directly for use by a business can create a future stream of income for us to use.  When we turn our money over to a business, we can look forward to the return of that money plus a reward for letting it be used.  The security we receive may be the ownership of shares in the business and the right to receive dividends from future profits.  Or it may be a bond, a promise to pay the money back at a future date together with interest.  If we choose the right businesses, the income we receive from their securities will one day replace our earnings from work. 


There are some new ways to put money directly into businesses, without going through Wall Street.  Many are described in the section “Direct Investing Routes Open Now.” You can also search terms like “peer-to-peer lending,” “social investing” and “direct public offerings,” to see examples of direct finance.  But we need political leadership to take away some of the barriers.

Government policy can change our propensity to spend or save.  During World War II, Americans saved at extraordinarily high rates—about 25 percent on average. This impressive display of thrift and sacrifice was driven primarily by the war, but it also had a more proximate source: The U.S. government, collaborating with civil society leaders, actively stressed the importance of saving for the war effort while also providing a specific new savings tool in the form of war bonds. Perhaps the time is right to re-establish a pro-thrift public education campaign. Similar campaigns to reduce drunk driving and smoking and to encourage seat belt use appear to have had a demonstrable impact on people’s behavior in recent years. Why not thrift and investing?

Government could start by very publicly adopting a policy to turn from a borrow-and-spend culture to a build-our-economic-freedom culture, to “spread the wealth” without “redistributing income.”  We don’t have to take away from the rich to provide a source to pay living expenses for the middle class.  New wealth can be created.


If encouraging consumption has been our national policy, maybe it was the right one for a while.  By now, however, it is clear that (1) while our “living standards” have increased, our “happiness” has decreased and (2) our consumption is killing the earth we live on.  [Many of the studies and writings supporting these conclusions are mentioned by Vicki Robin, in Your Money or Your Life, Penguin Books, 2009]


Recapture the Rhetoric.  Speeches and comments by today’s political leaders about Wall Street are ambivalent at best.  They seem to say that:  “Some on Wall Street went a little too far but we can’t get along without them.”  That expressed attitude has led to the government bailing out Wall Street, while just making a few changes in the rules of engagement for the future business-as-usual.  Namby-pamby statements about Wall Street prepared us for giving the naughty children billions of taxpayer dollars and admonishing them not to do it again.


Our governments need to encourage us to bypass Wall Street and create our own direct routes for individuals to invest in useful businesses and local government projects.  "We need to recall and reclaim the fundamental purpose of credit and capital market--channeling funds from investors to entrepreneurs.  The whole business has become riddled with middlemen who invent complex products that add little to the efficiency of credit markets, magnify systemic risks, and mainly serve to line their own pockets and corrupt their confederates."  [Robert Kuttner, Obama's Challenge: America's Economic Crisis and the Power of a Transformative Presidency, Chelsea Green Publishing, 2008, page 140]  Here are a couple examples of the 1930s rhetoric:


President Roosevelt:  “Business enterprise needs new vitality and the flexibility that comes from the diversified efforts, independent judgments and vibrant energies of thousands upon thousands of independent business men.  The individual must be encouraged to exercise his own judgment and to venture his own small savings, not in stock gambling but in new enterprise investment. . . . The power of a few to manage the economic life of the nation must be diffused among the many or transferred to the public and its democratically responsible government.”  [Franklin D. Roosevelt, "Recommendations to the Congress to Curb Monopolies and the Concentration of Economic Power," April 29, 1938, in The Public Papers and Addresses of Franklin D. Roosevelt, ed. Samuel I. Rosenman, vol. 7, (New York, MacMillan: 1941), pp. 30p and 313, available as the 1938 volume at]


William O. Douglas, Chairman of the SEC, before becoming a U. S. Supreme Court Justice, referred to “those who practice the art of predatory or high finance” as “financial termites” who “feed and thrive on other people’s money.”  He said they “destroy the legitimate function of finance and become a common enemy of investors and business . . . one of the chief characteristics of such finance has been its inhumanity, its disregard of social and human values.”  [Democracy and Finance; The Addresses and Public Statements of William O. Douglas as Member and Chairman of the Securities and Exchange Commission, edited with an introduction and notes by James Allen, Yale University Press, 1940, page 8ff., quoted in Charles R. Geist, Wall Street: A History, Oxford University Press, 1997, page  248.] 


President Woodrow Wilson:  “No country can afford to have its prosperity originated by a small controlling class. . . .  Every country is renewed out of the ranks of the unknown, not out of the ranks of the already famous and powerful in control.”  [Quoted by Louis D. Brandeis, who later became a U.S. Supreme Court Justice, in his book, Other People’s Money: And How the Bankers Use It, Frederick A. Stokes Company, 1914, republished by National Home Library Foundation, 1933, Kessinger Publishing’s Rare Reprints, pages 141and 152]  Brandeis could have been relating what we hear from government officials defending the 2008 Wall Street bailout:  “It has been urged that in view of the heavy burdens which the leaders of finance assume in directing Business-America, we should be patient of error and refrain from criticism, lest the leaders be deterred from continuing to perform this public service.”  Brandeis’ response:  “The American people have as little need of oligarchy in business as in politics.”


We need to purify some rhetoric that has been appropriated by Wall Street’s supporters.  For instance, “free market” is being used as if it only meant no government interference with business.  What about interference from monopoly or oligopoly?  What about interference from governmental preferences lobbied and paid for by big business?  "The Wall Street banks are the new American oligarchy--a group that gains political power because of its economic power, and then uses that political power for its own benefit.  Runaway profits and bonuses in the financial sector were transmuted into political power through campaign contributions and the attraction of the revolving door."  [Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, Pantheon Books, 2010, page 6]


Abandon Single-Industry Regulation of Securities.  Our history also proves that we make things worse by having complex rules administered by bureaucracies that are assigned to oversee a particular industry.  When Congress set up the Securities and Exchange Commission in 1934, it decided that the common law of fraud could not be enforced against Wall Street, either by government or private actions.  Instead, Congress enacted a special definition of securities fraud and said it could only be prosecuted by the SEC and, in limited cases, by defrauded investors.  The SEC had the power to define and limit the definition of securities fraud and what could be done about investigating and enforcing violations.


This experiment in single industry consumer protection has been a clear and consistent failure.  The industry has captured the regulator.  The only effect of SEC law enforcement has been to protect the industry’s monopoly over the movement of money through the selling and buying of securities.  The consumer of the monopoly’s services has been left without remedy for what we all know is plain old fraud. 


When Wall Street fraud does get exposed, the proffered remedy is still tuning the failed regulatory framework.  The political skirmish after the Panic of 2008 has been about how little re-regulation will suffice to make it look as if it won’t happen again.  The Dodd-Frank law skirts around the complex edges to create an appearance of limiting Wall Street’s exercise of its monopoly.  There have been no serious proposals to end that monopoly, to open a free market for money to flow from individuals to businesses.  “If you believe (as I do) that intelligently regulated market capitalism is the best hope for spreading prosperity, it's essential to rescue the U.S. economy from Wall Street's ‘heads-I-win-tails-you-lose’ perversion that threatens to discredit America's model altogether.”  [Matt Miller, “Rescuing Capitalism from Wall Street,” Washington Post, April 8, 2010,]


The failure of the securities laws cannot be patched up so that it works.  The concept is all wrong.  When elected representatives shrug off their duties onto a president-appointed commission and its civil service staff, the connection to the electorate is lost—we the people become powerless, lacking any effective political remedy.  We can’t go to our police, we can’t sue for fraud, our member of Congress and Senators send us to the commission.  The Supreme Court rules that only the SEC can go after the perpetrators.  We can’t take our investing business away from Wall Street, because it has a government-enforced monopoly in the securities business.  Wall Street is not going to police itself.  Fifty years of experience with “Self Regulatory Organizations” and voluntary compliance programs have proven that Wall Street doesn’t do self-regulation in the public interest.


What happens under the current system is that rules replace principles; technicalities supplant conscience and we are blinded to our sense of what’s right and wrong.  The response from Wall Street to our disgust is that what they did “was perfectly legal.”  Usually, they’re right.  The rules were fashioned to accommodate the immoral games they play.  Which one among us can be sure we wouldn’t find ourselves saying—and believing—that what we were doing was OK because it was within the legal rules? 


If the economy gets fixed and we turn finance back over to Wall Street, we’ll be back here again.  Regulating Wall Street is just rewarding the cunning, the ones who have abandoned any sense of personal morality.  The only limitation upon their actions is what can fit within the government’s maze of rules, how they can avoid being charged with a violation.   Adding more regulation mostly means more opportunities for the unprincipled to manipulate the system, more job security for their lawyers.  


Two steps need to be taken.  One is to take away the SEC’s monopoly over fraud definition and enforcement.  We need to be given back the remedies that we have over other businesses.  Second is to do away with all of the rules generated under federal securities laws about what is and isn’t fraud.  The common law of fraud is far from a perfect remedy.  We have to hire a lawyer, or convince a government prosecutor that our case is just and winnable.  The judge may not be experienced in financial issues.  The legal precedents may not have kept up with current practices.  A jury may not understand what happened.  But it puts us, and the people who cheated us, on the same basis as other businesses and customers.  That basis has generally worked over the long haul.  We can’t let the perfect be the enemy of the good.  What we have now is bad. 


We need a foundation in political philosophy, supported by the voters, before we can expect any action by the government to change from single-industry regulation of a Wall Street monopoly over investment.  If not “free market” or “regulated capitalism,” what could work as a philosophical foundation for what out government could do?  


Phillip Blond has recommended that the British Conservative party undertake these tasks: relocalising our banking system, developing local capital, helping normal people gain new assets and breaking up big business monopolies.”  Blond then describes steps toward a “property owning democracy” and argues that the “final piece of the puzzle is for Conservatives to break with big business.”  [Phillip Blond, director of the progressive conservatism project at the think tank Demos, “Rise of the red Tories,” Prospect, February 28, 2009,]  In another article, Blond describes the needed objectives as “the re-moralisation of the market, re-localisation of the economy, and re-capitalisation of the poor.”  To implement “a new popular philosophy of asset extension and stakeholder equity capitalism,” he calls for “the extension of wealth, assets and the benefits of ecological and social well being to all. Freedom from the monopoly dominance of state bureaucracy and market power would allow independence for the formation of community and autonomy and a rebalancing of the demands of work, family and childcare.”  [Phillip Blond, “The Civic State,” Res Publica, October 3, 2009,]


For the United States, the philosophy must include opening up Wall Street’s monopoly over the flow of money from investors to businesses.  Without a change in our philosophical consensus, abolishing that monopoly is just not politically possible within this century.  Wall Street and large corporations largely own the government.  To change the ownership of government, we need to change the ownership of business.  So long as there is concentration of control, through ownership or management, regulation will be influenced to favor the regulated.  The election and lobbying “reforms” have ineffectively treated the symptoms.  Nothing will really change until we diffuse that concentration of power.


It may be that we’ll get some help from the 2010 United States Supreme Court decision in Citizens United v. Federal Election Commission.  []  One newsletter points out:  “One topic not addressed so far in the media pieces we have read is how Citizens United may impact the boardroom. Given that a company's board will likely be the greatest influence on how a company spends money in political campaigns, we imagine the politics of each director could well be scrutinized now and perhaps it's more likely that third-parties will attempt to place alternative candidates - ones with a different political bent - on a company's ballot. Plus, Senator Schumer is talking about Congress adopting a law that would require shareholder approval of political expenditures as one of several alternatives to limit the decision's impact. A true mix of politics and investing.”  []


Limit Wall Street’s Power to Harm Us


After the Panic of 2008, Congressional leaders made some strong statements about what they needed to do.  In a January 2010 article, Bloomberg Business Week quoted Barney Frank, Chairman of the House Financial Services Committee:  “You need a new tool kit for new phenomena, and our job next year is to develop that toolkit.”  But the article described the political realities, including: “Since the start of the 2008 election cycle, the financial industry has donated $24.9 million to members of the New Democrats, some 14% of the total funds the lawmakers have collected, according to the Center for Responsive Politics.”  [Alison Veekshin and Dawn Kopecki, “Not So Radical Reform,” Bloomberg Business Week, January 11, 2010, pages 26 and 27] 


The two decades building up to the 2008 crisis gave us painful lessons in what government should not do.  First of all, it should not let Wall Street regulate itself.  We now have the history of the way it was before government regulation came in the 1930s, what it was like during the next 50 years of regulation and what has happened during deregulation.  It is clearly not an option to let Wall Street take care of itself, and of the rest of us who are affected by Wall Street.


The Dodd-Frank Wall Street Reform and Consumer Protection Act may protect us from some of the harm which Wall Street would have caused to our economy and personal lives.  []   It did very little to change the Wall Street way.  As Elizabeth Warren put it:  “I would have expected the financial crisis to sweep through Wall Street like a hundred-year flood — wiping out old business practices and changing the ecology profoundly. So far, the financial services industry has seemed to treat the crisis like a little rainfall — inconvenient, but no significant changes needed.”  [Lynn Parramore interview, July 13, 2010,]  Bill Gross, founder of the hugely successful PIMCO funds, said of Dodd-Frank:  “Wall Street still owns Washington.  Better to have appointed Volcker ‘Dictator-In-Chief’ than to have let the lobbyists dilute what needed to be done.”  [“Experts Grade the Legislation,” The Wall Street Journal, July 16, 2010, page A5]


To more effectively limit Wall Street’s power to harm us, Congress could simply finish passing legislation which Wall Street’s lobbyists and contributions have stymied.  For instance:

•  Securities firms must either be brokers for customers or dealers trading for themselves.

•  Brokers have a fiduciary duty to their customers, rather than a “suitability” standard.

•  Banks can either accept FDIC insured deposits or conduct a securities business.

•  The Consumer Financial Protection Agency is independent of the Federal Reserve.

•  Neither banks, brokers nor dealers can operate trading markets.


Separate brokers and dealers.  A major piece of unfinished business in the New Deal was the proposed separation of securities brokers from securities dealers.  A broker executes trades in securities on behalf of customers, usually providing information and advice as well.  A dealer buys and sells securities with the firm’s own money, the so-called “proprietary trading.” Many of the abuses on Wall Street flow from the conflicts of interest that are inherent in being both an investor and the agent of other investors.  That is especially true where the action was technically legal but seems morally wrong.  The Securities Exchange Act of 1934 was drafted to require Wall Street firms to choose between being a broker or being a dealer.  The provision was lobbied out in the final negotiations.  It needs to be done now.  The 2010 hearings on financial regulatory reform put the broker vs. dealer conflicts in bold relief once again.


Stop Brokers and Dealers from Operating Trading Markets.  Wall Street got its start when brokers and dealers formed the New York Stock Exchange in 1792, pledging to conduct all their trades through the Exchange.  There have been other exchanges over the years, as well as an “over-the-counter” market, where individual broker-dealers matched buy and sell orders.  Like the Big Board, these other markets were conducted out in the open, with information reported for trading amounts and prices.  The first derivatives, futures and options, were traded on specialized exchanges.  However, in recent years, the huge trading in derivatives has mostly been handled through “dark markets,” operated by major Wall Street brokers and dealers.  We’ve heard their executives say that their customers knew the firms were providing a market, that they traded for their own account in that market and that there was no duty to tell the customer about other trades or warn them that the firm was on the other side of a trade with the customer.  The fact is that neither regulators, the media nor customers can know what is going on in these “dark markets” and how they might affect other markets and the economy.


Return to the fiduciary duty standard.  The common law has a standard for the obligation of someone with whom we trust our money.  It’s called a “fiduciary duty” and it requires that your money be treated the way that prudent persons would handle their own money.  But the securities industry doesn’t have to comply with the fiduciary duty standard.  Instead, it has a “suitability rule,” which means your broker “must have a reasonable basis for believing that the recommendation is suitable for you.”  []   The suitability rule is actually defined and enforced by the securities industry’s own “self-regulatory organization,” the Financial Industry Regulatory Authority.  The current version says the broker “shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.”  The broker “shall make reasonable efforts to obtain information concerning” the customer's financial and tax status and investment objectives. [Rule 2310,]  These steps apply, whether or not the customer is wealthy, is an experienced investor and whether the security offered is SEC-registered or a private offering.  [FINRA Regulatory Notice 10-22,]


There is no definition of fiduciary duty in the securities rules--only this “check-off” list of steps.  We all can sense that fiduciary duty is simply undivided loyalty, a duty to act in the best interests of another person, without any conflict of interest.  There is no list of elements that could let someone get away with disloyal conduct.  The Dodd-Frank Wall Street Reform and Consumer Protection Act, section 913(g) calls upon the SEC to study the issue and report back in six months to Congress.  It is given authority to make rules about the standard of care, including a fiduciary standard.  In its required "Study on Investment Advisors and Broker-Dealers," the SEC recommended that Congress apply the same standard to investment advisors and broker-dealers "when providing personalized investment advice about securities to retail investors." That standard "shall be to act in the best interest of the customer without regard to the financial or other interest of
the broker, dealer, or investment adviser providing the advice."  The Study even recommends:  "The Commission should consider additional investor education outreach as an important complement to the uniform fiduciary standard."  [, pages vi, vii]  By a 3-2 vote, the Commission recommended that the fiduciary duty be extended to retail brokers.  After strong objections from some in Congress, the SEC delayed any action.  []


Separate trading for derivatives from trading shares and bonds.  We can’t prohibit gambling and make it stick.  Regulating Wall Street trading markets will never prevent new games being invented, tried and abused.  One suggestion is that the government stop treating derivatives gambling as if it were an integral part of raising capital for business.  History shows that the only effect of tightening the rules is that the gamblers have some new challenges to their games.  They’ll find ever more complex angles to play and even more devastating side effects from the linkage between derivatives games and the trading markets for stocks and bonds.  [Sarah N. Lynch, “Gensler Blames the Math for May 6: CFTC Chairman Says ‘Preprogrammed Algorithms’ Went Wrong During the ‘Flash Crash’, The Wall Street Journal, May 21, 2010, page C2] 


The trading markets for derivatives can be separated from the markets for buying and selling shareownership and borrowings of real businesses.  Having the casino detached from the market for real securities might have helped with the May 6, 2010 mystery “flash crash” of nearly a thousand points in the Dow-Jones Industrial Average of common stock prices.  What happened was like some far-out fantasy story:  Nassim Nicholas Taleb is the author of Black Swan: The Impact of the Highly Improbable, a book which basically says we can’t foresee every possibility.  [Random House, 2007]  Mr. Taleb also invests in and advises the hedge fund, Universa Investments LP, which bought 50,000 options that would pay off if the Standard & Poor’s index of 500 stocks were to go below 800 in June 2010.  The persons on the other side of the trade hedged their position by selling S&P 500 shares at current prices.  This selling caused price drops, which triggered stop-loss orders and other computer programmed sales.  [Scott Patterson and Tom Lauricella, “Did a Big Bet Help Trigger ‘Black Swan’ Stock Swoon,” The Wall Street Journal, May 11, 2010, C1, C2]  If a person’s gambling den of choice is betting on the future price of stocks, they should not also be using the trading market for shareownership to offset their positions.  Any method for keeping the markets separate will likely have leakage.  But someone will come up with ways to at least substantially reduce the harm done to those who are simply investing in businesses.  


Return securities firms to the partnership form.  Regulation may be enough to protect us from harm caused by commercial banks, credit unions and a few other intermediaries that are restricted in the scope of their activities.  But securities firms—brokers and investment bankers—advise their clients and customers, knowing that their advice will be trusted.  Like physicians and lawyers, they should not be relating to us as publicly-traded corporations.  Until the 1950s, most major securities firms still operated as partnerships.  There was no legal requirement against incorporation; it was a choice made to instill confidence in their customers, who knew that the personal wealth of every partner stood behind the firm’s words and actions.  Each partner in the firms would have an extra consideration before making any significant decision:  “Could this come back to hurt me and my partners if I’m wrong?”  Cutting corners and giving in to short-term greed might fail that test.  Personal liability also meant that partners kept an eye on each other, enforcing systems of disclosure, review and approval over the kinds of decisions that could mean serious loss to them all.  For example:  “Few partnerships would leverage themselves to the hilt to load up on risky subprime loans.”  [James K. Glassman and William T. Nolan, “Bankers Need More Skin in the Game,” The Wall Street Journal, February 25, 2009, page A15]


Wall Street has almost completely converted to the corporate form of doing business.  The acknowledged reason was the desire for more capital to compete, especially as giant commercial banks edged into the securities business.  A major result was that many former partnerships became giant hedge funds, using the new money to trade for corporate profits—and to pay the huge bonuses for traders and managers.  Going public was the real mother lode for Wall Street firms.  Instead of just selling advice and processing services, they could step into the game as principals.  With the equity money from a public share offering, they could borrow 30 or 40 times that much to make plays in the markets for their own account.  The winnings would first show up in their bonuses and then in the increased market value of the shares they received before the public offering.  As for mistakes and bad luck, Wall Street employees might get a few million shaved from their bonuses and the price of the firm shares they owned could go down.  But they didn’t have to worry about losing anything else.  The very worst case would be the firm’s failure.  In that case, they could move to another corporate shop and keep going.


For those of us not on Wall Street, incorporation of its businesses was all bad.  If we were customers, we lost the comfort of knowing that the firm’s partners were on the line for the behavior of each partner and their employees.  For the country as a whole, we suffer for the monstrous excesses of corporate irresponsibility:  Stock market panics, money diverted from funding real businesses and, instead, used for playing no-win casino games, frozen credit markets and serious recessions.


Make CPAs choose between auditing and advising.  Wall Street did not create the present structure by itself.  It’s been aided and abetted by third party service providers.  Perhaps the most important are the certified public accountants who conduct audits and issue opinions on the fairness of financial statements, while also advising on taxes, mergers and acquisitions, executive pay, corporate strategy and many other areas.


When the new deal was being formulated, some proposed having audits of public companies done by a government agency.  Others wanted CPAs to conduct audits but would have the government formulate and enforce accounting principles and auditing standards.  In the end, accountants were left without government control.  The issuance and enforcement of accounting principles and auditing standards was left to self-regulation.  The American Institute of Certified Public Accounts is the successor to the accountants’ professional organization begun in 1887, growing to only 1,150 members by 1916 and on to over 350,000 members in 2009.  Under the continuing prospect of government regulation, the AICPA created what is now called the Auditing Standards Board, which issued its first auditing standards in 1939.  It is still part of the AICPA, although it “carefully considers the views of the SEC’s Chief Accountant.”  The AICPA was also left to formulate generally accepted accounting principles (GAAP).  This was done by its Accounting Principles Board until 1972, when the responsibility was shifted to the full-time Financial Accounting Standards Board (FASB), funded by the Financial Accounting Foundation.  Members are appointed by several accounting organizations, in addition to the AICPA. [History of the AICPA,; Bateman & Co., Inc., P.C., A History of Accounting and Auditing Standards,


The AICPA finally lost its complete self-regulation after the Enron, WorldCom, etc., scandals, when Congress adopted the Sarbanes-Oxley Act of 2002.  It created the Public Company Accounting Oversight Board, with its five members all appointed by the SEC.  []  A big part of the new Board’s job is to oversee and participate in “peer reviews,” where CPA firms go over each other’s working papers to check whether auditing standards and accounting principles have been followed.


The regulatory structure may be sufficient at this point to assure competency.  However, there is still a heavy load of conflicts of interest.  The same partners who deal with the client’s officers and its board—who even are present at shareholder meetings—are also rewarded by their firm for selling consulting and tax advisory services.  These services are mostly performed by different members of the firm’s staff than the auditors.  Nevertheless, there is pressure to keep and expand revenue from a client.  To avoid the conflicts of interest from this brand-extension marketing, CPA firm professionals should include only certified public accountants, in sole proprietorship or as partners.  Their practice should be limited to attesting on conditions and results.  They would continue to be paid by the client for whom they were attesting.  While that is a clear conflict of interest, that is why they are professionals.  Their professional societies can take away their license to practice.  At least they would not be selling any other services on the side.  We pay our physicians and therapists, but we don’t expect them always to tell us what we’d like to hear.


(My first job after school was as a beginning accountant with one of the now Big Four firms of Certified Public Accountants.  Our office had 80 accountants in those days.  Three of them prepared tax returns and took questions about tax issues.  All of the rest worked on audits.  There was no consulting department.  When I came back, nearly 30 years later as partner in another Big Four firm, the 300 or so professionals in our office were about evenly divided among audit, tax and consulting.  The tax department spent more of its time selling advice tax planning than preparing tax returns.  The consulting department was staffed with experts in management information systems, marketing strategy and other non-accountant services.  These experts could not be called “partners,” because they weren’t CPAs, so they were called “principals” and shared the firm’s profits just like partners.


(When my partners would ask for ideas about how we could grow bigger and more profitable, I would propose that they drop every service except the “attest” function.  That’s the term used in accounting literature and includes the opinion that financial statements fairly present a company’s financial condition and the results of its operations.  There are many other decisions people make that would be helped if an independent expert would attest to some fact or characteristic.  For instance, there is a demand for certification that a product or business meets a set of environmental standards, that a fund portfolio invests only in businesses that fit within stated parameters.  The CPA’s market position would be that of firm that has both the expertise and the complete absence of conflicting interests.  My partners never expressed any interest in that concept.)


Other professions used in business are not so easily restructured to avoid conflicts of interest.  Lawyers just don’t fit in any category of independent third party.  They are agents of their clients, bound to serve no conflicting interest without first having their client’s permission.  Yes, they are “officers of the court,” and must turn their clients in to the authorities if they are unable to keep them from committing a crime.  But that is simply the minimum level of citizenship.  With that exception, lawyers owe greater allegiance to serving their clients’ interest than to their own.  The answer for relying on lawyers may simply be not to do so, unless you’re the one who hired them.


Securities rating agencies have been in the position of professionals—paid by the businesses they rate, for opinions to be relied upon by investors.  What they have lacked seems to be the professional society and standards.


End Wall Street’s Monopoly Over the Flow of Investment Money


Franklin Delano Roosevelt announced what has been called our “Second Bill of Rights,” including:  “The right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home or abroad.”  [State of the Union Address to Congress on January 11, 1944, John T. Woolley and Gerhard Peters, The American Presidency Project, Santa Barbara, California, See Cass R. Sunstein, The Second Bill of Rights:  FDR’s Unfinished Revolution and Whey we Need It More than Ever, Basic Books, 2004, Appendix I, page 243]  The most important action government could take to fulfill the promise of this freedom from domination by monopolies is to stop protecting Wall Street’s monopoly over the flow of money.  Next would be to stop bailing out Wall Street whenever it suffered from its own excesses.  The government should let the free market operate for Wall Street the way it does for restaurants, auto mechanics, plumbers and other suppliers of important services.


(In my early years as a securities lawyer, I also worked for members of a wholesale meat trade association.  I was struck by how similar were the two businesses.  They each were intermediaries, buying and selling very expensive products—meat and money.  Each of them bought and sold in a rapidly changing market, so that their profit could be multiplied or decimated within minutes. They were both tempted to speculate on market price changes for their product, by trading in derivatives for their own account.  A big difference in the two businesses came from the role of government in each.  For the meat industry, that role was all about protecting the consumers of the end product and protecting the workers in the meat plants.  In the money business, the government’s concern was to protect the health of the businesses themselves, telling us how “the economy” would be hurt if money intermediaries were allowed to fail.  Regulators for the meat companies never said anything like that.


When the September 2008 economic crisis hit, the government told us that our money had to be given to Wall Street, so that it could deliver money to businesses which, in turn, would be able to pay employees and suppliers.  Can you imagine the government’s response if the meat companies had shut down because of losses from speculating on the future price of meat?  Would taxpayer money have been used to buy the rotten meat at the prices for healthy meat, giving the companies record profits and executive bonuses within a year?   Or compare the 2010 Gulf oil spill.  BP caused it and has said it would pay for all the resulting harm.  Wall Street caused the Panic of 2008 and the Great Recession that followed.  No one suggested that Wall Street pay for the damage it caused.  Instead, the government paid Wall Street for its losses.)


How should money for investment be allocated and who should be in charge of doing it?  Following the communist and socialist experiments of the last century, government ownership of the means of allocating capital is not being seriously considered in the United States.  At the other extreme, there is presently no widespread support for leaving government completely out of the capital market.  Iceland provided a recent crucible for testing these two extremes of government ownership and unfettered market.  In 1991, the government owned its banks.  A new prime minister sold them all to private interests, saying that Iceland’s slow growth was due to “the iron grip that the Icelandic state had on all business activity through its ownership of the commercial banks.”  [David Oddsson, quoted in Charles Forelle’s “The Isle That Rattled the World,” The Wall Street Journal, December 27, 2008, page A1]  By 2008 the banks had increased as much as 30 times in size.  Shares of the three main banks accounted for 75% of the country’s entire stock market value. They gathered money from around the world by offering higher interest rates.  When confidence waned and the run began, the banks failed. 


We have tried the political philosophy of regulated capitalism and the philosophy of leaving capitalism to a free market.  Both of those philosophies have silently assumed that Wall Street would continue its monopoly over the origination and trading of securities.  Leaving Wall Street in control, and calling that a “free market,” has been disastrous.  As David Brooks put it:  “The free-market revolution didn’t create the pluralistic decentralized economy.  It created a centralized financial monoculture, which requires a gigantic government to audit its activities.”  [David Brooks, “The Broken Society,” The New York Times, March 19, 2010,]  


Instead of trying to regulate Wall Street, the government should just enforce the existing antitrust laws and take away Wall Street’s monopoly over buying and selling securities.  Competition is the best regulator, the best restraint upon predatory and deceptive tactics.  Government should end the monopoly and encourage competition, by making information freely available to investors and entrepreneurs.  Hazel Henderson has said: 

“Local people around the world are realizing that they can simply bypass big banks, stock exchanges and create all these services locally.” [Hazel Henderson, “Democratizing Finance,”]  On the international finance level, “the new financiers will be the high-level information and knowledge brokers – and they will aggregate the new research on global change.”  [Hazel Henderson, “The New Financiers,” 2009,]


The history of relationships between government and Wall Street tells us how foolish it would be to hope for a broad-brush end to Wall Street’s monopoly.  We can simply accept what’s almost certain, that the government will not disturb the existing capital markets, except to fix the gaping flaws after crashes and panics and frauds, to “prevent this from ever happening again”—until the next time.  We might as well accept that state of affairs as it is and let the big corporations and Wall Street continue their games, with protections to ameliorate the harm to the rest of us.  Government can use the existing mechanics to regulate securities trading and new securities underwritings for big business.  Government’s role would continue to be like a referee in a neighborhood pickup game.  We can hope that the Financial Stability Oversight Board, established by the Emergency Economic Stabilization Act of 2008, and The Financial Stability Oversight Council, created by the Dodd-Frank Act, will pay more attention to the Wall Street risks that affect our economy.  And it would be a leap forward for corporate democracy if brokers and their street name nominee firms were required to tell companies the names and addresses of the real owners of their securities.


The Securities and Exchange Commission would keep on being as marginally effective as it is and the states would remain impotent to interfere with Wall Street’s games.  Most of what the SEC does these days is directed to trading in existing securities and their derivatives.  Its work under the Securities Act of 1933, which regulates the initial issuance of securities, is primarily on making rules and reviewing filings for big corporations and the securities analysts who recommend buying and selling big corporation securities.


If Wall Street and big business are left with their existing monopoly protection and light regulation, then what is to become of the individuals who would like to invest money in businesses?  As individuals have wised up to the rigged market in big corporate securities, “they are a declining force in a market that is increasingly dominated by professionals . . .  at the mercy of anonymous companies that trade with powerful computers.”  [E. S. Browning, “Small Investors Flee Stocks, Changing Market Dynamics,” The Wall Street Journal, July 12, 2010, page A1.  Browning’s article points out:  “But in the past decade, big U.S. stocks have had the worst performance of nine major investment classes tracked by investment research firm Morningstar.  The Standard & Poor’s 500 stock index has fallen at an annualized rate of 3% a year over the past 10 years, including dividends and controlling for inflation.”]


Government can implement ways to open the flow of money from individuals for investment.  It can create and encourage competition from other intermediaries, to influence the allocation of capital toward a consensus of the common interest.  For instance, when the federal government wanted to stimulate housing purchases and construction in 1935, it chose to license mutual savings and loan associations to draw money from the middle class into a single, local intermediary, owned by its customers.  For a few decades, they really did work in the way portrayed for Bailey Bros. Building and Loan in the movie, “It’s a Wonderful Life.” 


Programs government has used to help big business could be models for encouraging individuals to invest in shares of small business.  For instance, one of the existing direct markets for money is the one for commercial paper, which are promises to repay money within periods of no more than 270 days.  Big corporations with temporary excesses of cash earn interest by lending it to other big corporations with temporary cash needs.  Much of the business is done directly between the corporations’ chief financial officers.  On October 7, 2008, in response to the September Panic, the Federal Reserve Board of Governors established a “Commercial Paper Funding Facility” for “eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations.”  []   Small businesses who met minimum qualifications could be backed with a similar government guarantee.


New financial intermediaries would need to be licensed, and tied to a central banker, as most are now.  Licensing financial intermediaries would be primarily for the purpose of having current information about who and where they are.  No more self-regulatory organizations.  Conventions and other trade gatherings would be discouraged, not promoted.  As Adam Smith warned: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”  [Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations, The Modern Library, 1937, page 128]    The new intermediaries source of funds would need to be matched with their use of funds, on risk and maturity, if not denomination. 


The federal government could encourage individual shareownership and direct marketing by revisiting ERISA.  That law has directed retirement savings to Wall Street’s buy side, which then delivers it to Wall Street’s sell side to play games with existing securities, derivatives and other products manufactured by Wall Street.  Congress could add an alternative program that would protect our savings and fund businesses that are serving our needs.  A government-sponsored insurance entity could collect an insurance premium from businesses that passed a screen for fiscal quality and social benefit.  Individuals investing directly in their shares would be insured against loss on, say 80% of the amount they invested.


A big step toward ending Wall Street’s monopoly over the capital markets would be to stop directing individual retirement money through Wall Street.  When it comes to retirement planning, Wall Street has come first with the federal government.  The extreme is the continuing proposal to “privatize social security” by redirecting contributions to Wall Street.  Less obvious has been the way we have moved from employer financing of defined benefit programs to employee financing of 401(k) plans, all the while, keeping Wall Street in the middle.  Defined benefit plans are near extinction outside government jobs.  They were set up during World War II, to get around a freeze on wage increases.  Employers could, instead, increase compensation by putting money into a fund to pay retired employees a fixed percentage of what they had been earning.  As lifetime employment with giant corporations began to go away, defined benefit programs lost much of their usefulness.  The actuarial projection of future benefits resulted in huge charges against current income, an anathema to Wall Street’s growing obsession with short-term earnings per share.  Change was going to be made, with or without the government.


Congress and President Ford stepped in with the Employee Retirement Income Security Act of 1974, which told employers how they had to handle employee retirement plans.  It led to Individual Retirement Accounts, Simplified Employee Pension Plans and, since 1980, the 401(k) plans.  They all require a “fiduciary,” to invest contributions.  Guess who was set up to be the fiduciary—the people who sold investment products.  Congress and the administrations saw nothing wrong with having retirement funds entrusted to those in the business of trading in securities.  [For information about the history and status of retirement benefit programs, see and Christopher Farrell, “Fine-Tuning the 401(k),” Bloomberg BusinessWeek, April 5, 2010, page 80]  


 (In advising clients on direct public offerings, we had to come up with ways for their communities to buy through their IRA, SEP or 401(k) plan.  Nearly all of the available “fiduciaries” are banks, insurance companies and brokerage firms, some of which will only allow investments in their own deposits, policies and managed mutual funds.  Others forbid investment in any security that is not traded on an exchange.  We had to find the few independent trustees who would let their beneficiaries buy securities directly from our clients.)


The result has been that government forces us to put our retirement savings into the trading markets for securities.  Our money ends up being used to play the zero sum game of buying and selling betting markers, contributing nothing to our country’s economy and subjecting us to the ups and downs of a gambling den.  Our money is not available to finance growing businesses and we are left having to protect ourselves from Wall Street’s conflicts of interest and neglect.


Rather than just changing the way retirement funds are channeled through Wall Street, another way to encourage individuals to invest in shares of small businesses would be to end employer-sponsored retirement plans altogether, coupled with programs to encourage direct investment by individuals in small business.  This could be accomplished by dropping the tax deduction for employer contributions.  Some employers still have company-wide retirement plans, while others have gone to sponsoring individual retirement programs, the IRAs and 401ks.  All of these severely limit the individual’s choice of investments, often to a few selected mutual funds or the employer’s own shares.  When the money has been passed through Wall Street’s buy side and onto Wall Street’s sell side, nearly all of the amount left after fees gets invested in existing securities.  The money is used to buy what some other investor or speculator is selling and it rarely gets used to finance business operations or growth.


An argument for employer-sponsored retirement plans is that employees wouldn’t save for their retirement without the employer’s contribution and the convenience of paycheck deductions.  In fact, only a minority of employees choose to participate in their employer plans anyway.  How about trying other ways to get individuals to invest in businesses that mean something to them, that offer them satisfaction and a visible potential for financial reward?  Nongovernmental, nonemployer organizations could show the way, providing models used in poor countries that could be adapted for use in rich countries.  For instance, NGOs sponsor saving and microlending, coupled with training both in how to use money in a business and how to manage money by saving and investing.  Oxfam America started a “Saving for Change” program in 2005 and more than 100,000 poor women and men in Mali, Senegal, Burkina Faso and Cambodia have saved nearly $1.3 million.  “This membership milestone demonstrates the potential of Saving for Change as a model that can truly reach large numbers of poor people. . . . “We hope to build Saving for Change membership to one million villagers over the next five years.”  [Vinod Parmeshwar, Community Finance Specialist at Oxfam America, and]


Government has experience in changing entire paths of commerce.  It opened the way for transportation through canals, then railroads and interstate highways.  It helped develop and install the new communications media of telegraph, telephone, radio, television and the Internet.  Now, government can take the lead in using direct methods to gather investment money.  One way is for government to make direct investments "by fostering 'pioneer firms' that will develop the new operating principles and products, leaping beyon market's hesitation."  [ [William Greider, One World, Ready or Not: The Manic Logic of Global Capitalism, Simon & Schuster, 1997, page 465]


Government itself has been a financial intermediary, using taxpayer funds or borrowing to finance new technologies in transportation, communication and other developments.  Instead of collecting money and distributing it, government could bring individuals into risk capital investing for new technology and applications.  America has a long and successful history in using government to start big concepts.  Looking through that history, we can imagine the difference it might have made if the government had sponsored investment by individuals directly, through guaranteed, nonrecourse loans, for instance.


Many of our greatest advances in business have come from direct funding by the federal government.  Government has paid for the research and development, carrying out the beta testing and even beginning operations.  When entrepreneurs have seen how the model works and how it could be profitable, they’ve jumped in with their own innovations.  Instead of the government making the investments, it could be an insurer or guarantor behind individual investors. 


We think of Silicon Valley being built by entrepreneurs and venture capitalists, beginning in a garage with Hewlett-Packard in 1938 and leaping forward to Steve Jobs’ garage with Apple Computing.  But it was the U.S. Department of Defense that paid a billion dollars for semiconductor research from 1958 to 1974.  [John Micklethwait and Adrian Wooldridge, The Company: A Short History of a Revolutionary Idea, The Modern Library, 2003, page 143]  “Then there were the forty years of government investment that designed and implemented the Internet, including most of its core technologies, built it into a working worldwide system, and developed the strategy and organizational model for shifting the Internet from government to private-sector control in 1995.”  [Charles R. Morris, The Trillion Dollar Meltdown, PublicAffairs, 2008] The Defense Advanced Research Projects Agency (DARPA) was created after Russia launched Sputnik into orbit.  It linked computers together at different locations in the 1960s, creating ARPANET, which became the Internet.  Other advances it funded include Global Positioning Satellites (GPS), the UNIX operating system, parallel computing and the computer mouse.  DARPA is currently spending $100 million a year to find alternative ways of generating energy, bridging the gap between basic research and commercial development.  It pays private companies to come up with specific solutions, such as palm-size fuel cells, miniature solar cells and fuel made from algae.  [Steve LeVine, “Can the Military Find the Answer to Alternative Energy?”, Business Week, August 3, 2009, page 033.]  Fuel efficient cars, to be built in the United States, are to be supported by $25 billion in federal government money.  Congress authorized the program in the 2007 energy bill and funded it in 2008.  The first loans, announced in June 2009, were $5.9 billion to Ford for retooling plants to produce fuel-efficient vehicles, $1.6 billion to Nissan and $465 million to Tesla Motors to begin production of electric car models.  [Kendra Marr, “U.S. to Lend Billions to Ford, Nissan for Fuel-Efficient Vehicles,” Washington Post, June 23, 2009,]


The Community Development Financial Institutions program was created in 1994 "to use federal resources to invest in and build the capacity of CDFIs to serve low-income people and communities lacking adequate access to affordable financial products and services. Since its inception, the Fund has made more than $500 million in awards to loan funds, banks, credit unions, and community development venture capital funds.”  []  There are now more than 700 CDFIs managing $30 billion in loans.  The first participants were socially motivated investors, such as faith-based organizations.  Now they are mostly sponsored by the large commercial banks.  [Mark Pinsky, "Help for Small Businesses: Loans are Just the Start," Bloomberg Businessweek, October 225-31, 1010, page 74]That happened because commercial banks are required to place a portion of their assets back into the communities from which they draw deposits.  [] Noncompliance can mean a bank’s regulator may deny its next merger or other action requiring approval.  The huge banks have found that they can meet their Community Reinvestment Act requirements by investing in CDFIs, most of which are good credit risks because they provide technical assistance to entrepreneurs.  [John Tozzi, “How Goldman Profits from Nonprofits,” Bloomberg BusinessWeek, February 15, 2010, page 64.]


Government participation in broadening ownership of property, while funding innovation and development, is also a big part of American history.  “In its earliest decades, the makeup of the United States was similar to that of many European nations:  a small, wealthy class of aristocrats and merchants, and the rest of society, whether farmers or landless workers, all scraping to get by.  . . . It was government policy in the early years of our history that turned a land of largely poor people into the middle-class nation of today.  Despite the lingering image of strong-willed, hard-working, self-made men, America’s comfortable middle class was made possible by concerted government policies.”  [J. Larry Brown, Robert Kuttner and Thomas M. Shapiro, Building a Real “Ownership Society”, The Century Foundation Press, 2005, page 7]  Perhaps robotics is a way to make manufacturing productive enough to bring offshore plants back to America.  It could be financed by the direct marketing of shareownership, with a government guarantee against much of the investment risk.  [Jeff Burnstein, president of the Robotic Industries Assn., “Robots Can Create Jobs, Too,” Bloomberg Businessweek, June 1, 2010,]  In the early 1980s, some believed thtat "Robots promise to bring about an era of riches unmatched in the past fifty years."  [Bruce Nussbaum, The World After Oil: The Shifting Axis of Power and Wealth, Simon and Schuster, 1983, page 35]  After the 1961 introduction of industrial robots, the United States fell behind other nations but has recently come back with service robots.  [Brian Bremner, "Rise of the Machines (Again),"    Bloomberg Businessweek, March 7-13, 2011, page 32]


The United States has set the pattern among nations for developing a middle class.  Thomas Jefferson pushed through a series of land tenure laws intended to assure that the expanded land ownership in the United States went to a broad segment of the citizenry, rather that European-style concentration in a few families.  When Lincoln was president, the 1862 Homestead Act gave 160-acre parcels of government-owned land to more than two million people, in exchange only for their improving and living on the property.  [J. Larry Brown, Robert Kuttner and Thomas M. Shapiro, Building a Real “Ownership Society,” The Century Foundation Press, 2005, page 9]  Congress adopted the Morrill Act, also in 1862, giving federal land in each state for a college or university that would teach agricultural and classical courses, as well as do research to benefit farmers.  More recently, the last of Roosevelt’s New Deal legislation was the Servicemen’s Readjustment Act of 1944, better known as “The G.I. Bill.”  It paid veterans for college education, provided living expenses while they found jobs, furnished free health care and low-interest home mortgages.  It also provided loans for veterans to start or acquire their own businesses.  In the last 25 years, IRAs and 401(k)s tax subsidies have been justified by the need to increase middle class retirement savings.  [These programs are described in J. Larry Brown, Robert Kuttner and Thomas M. Shapiro, Building a Real "Ownership Society," The Century Foundation Press, 2005, pages 8-14]


Free Small Business from Wall Street Regulation


The government could open the market for the flow of money from individuals to small businesses—an activity in which Wall Street hasn’t had any real interest anyway.  Federal and state governments could start by removing the barriers for individuals to invest directly in small business.  This would allow a separate capital market to develop for small business, including access to trading markets.  This is not to suggest complete deregulation of the flow of money from securities offerings made to the public.  Raising capital has always been fraught with lies and omissions.  It probably always will be.  Nowhere does cheating appear to pay as well as in the money business.  The greater the amount involved in the transaction, the more lucrative it is to make off with even a small percentage of it.  There’s no need for the perpetrators to fence stolen property, since money is what they stole.  It would be hard to prove whether there is more or less fraud in raising capital as a result of the ’33 Act.  What is clear is that raising capital is immensely complex, costly and discouraging because of all the regulations and practices involving the ’33 Act.


Before 1933, securities fraud was prosecuted under state laws.  If the perpetrators had used the U.S. Postal Service, they could be found guilty of mail fraud, a federal crime.  The Securities Act of 1933 made two basic changes.  One was to impose administrative, civil and criminal penalties for obtaining money by means of a lie or omission.  [Sections 8A, 12 and 17,].  The other was to require delivery of written information, cleared by the SEC and meeting detailed standards.  [Sections 6, 7, 8 and 10,].  There had to be a communication using some means of interstate commerce, like the telephone.


Because of the ’33 Act requirement for delivery of written information, the process of offering securities to the public centers around preparation and review of the prospectus.  Thousands of hours are required from lawyers, accountants and company management, all trying to protect themselves in case anything goes wrong.  And yet, the prospectus is not even seen by investors in a Wall Street underwritten offering until they have already purchased the securities.  When investors do get it, most find it unreadable, despite the periodic efforts by the SEC to impose “plain English.”  (We used to say that only three people ever read the prospectus: we who drafted it, the SEC staff who reviewed it and the plaintiff’s lawyer who was consulted by a disappointed investor.  We went on to say that it was this last person for whom we were really preparing the prospectus.  As a result, it was almost completely a liability defense document.  It had very little to do with what securities brokers were saying in meetings and telephone calls to prospective investors.)


What the federal government could do is to overhaul the Securities Act of 1933, to follow an alternative enforcement path.  It could use the model of New York State, which has a procedure entirely different from the SEC and the other states.  It requires filing a form that includes the names and residence addresses of all the principals involved in the company and its securities offering.  That way, it has a head start in finding people in a fraud investigation.  Second, it calls for filing any prospectus used, but without a review or clearance requirement.  We’d suggest retaining one other element, already in the ‘33Act: a set of standards for what should be in a prospectus.  [Schedules A and B to the Securities Act of 1933, and


This approach leaves the government out of the review and pre-clearance of a prospectus.  It leaves it up to the business and its advisors to decide, before they start selling securities, if the story has been told truthfully and completely.  If the investors lose money, they, or their lawyers and accountants, will review what they were told.  If they believe they were not given the full picture, they may try to recover their losses in court.  They may seek criminal punishment through the SEC, a state securities regulator or prosecuting attorney.  All of this is what happens now, even with SEC review of the prospectus.


What really goes on with SEC registration and review is an immense amount of attention not just to the individual trees in the forest but the bark and leaves on each of those trees.  The test is not for full and fair presentation of what an investor should be told.  The test is for compliance with the minute details of rules and regulations which were designed for big business offerings.  The existing process really serves only the interests of the mandarin class of lawyers, accountants and analysts who work for the SEC, Wall Street and the big legal and accounting firms. 


Periodically, Congress pushes the SEC to relieve small businesses of the regulatory burdens under the federal securities laws.  The early 1980s was one of those times and resulted in Regulation S-B, the Integrated Disclosure System for Small Business Issuers.  Special filing forms were available for registering public offerings.  That special track was eliminated by the SEC 25 years later. 


The Securities Act of 1933 could exempt offerings of securities issued by businesses that aren’t already “reporting companies,” those required to file financial and other documents with the SEC.  Reporting companies are those registered under the Securities Exchange Act of 1934, because they’re traded on an exchange or have at least 500 shareowners and $10 million in assets.  [Securities Exchange Act of 1934, section 12(g)(1),, and Rule 12g-1,]  It also includes companies that have completed a securities offering that was registered under the Securities Act of 1933. [Securities Exchange Act of 1934, section 15(d) and Rule 15d-1, and]  For those now required to make filings, the SEC has a definition for “smaller reporting companies,” which may use somewhat simplified filings.  They are businesses that have a “public float” of less than $75 million.  [Rule 10(f)(1) of Regulation S-K, “Public float” means the market price per share times the number of shares held by people who aren’t officers, directors or controlling shareowners] 


Small businesses could be exempted from all SEC regulation, under both the ’33 and ’34 Acts, except that those businesses with more than, say, 50 shareowners would make public filings of financial reports with the SEC’s Edgar system [Electronic Data Gathering, Analysis, and Retrieval System] and its successor IDEA [Interactive Data Electronic Applications]. The SEC could prosecute these businesses for securities fraud.  The states could also prosecute for fraud but Congress could preempt the states from any requirements for screening securities offerings.  To be exempt from SEC and state review of their securities sales, a business would have to notify the SEC and state regulators of an offering, providing names and addresses for officers and directors, so the regulators could follow up any investor inquiries or complaints.  The businesses would also have to file with the SEC’s public website their audited annual reports and quarterly reports certified by management.  Audits would be governed by Generally Accepted Accounting Standards of the accounting profession, not by SEC accounting requirements.


The small businesses with over 50 securities holders would maintain their own website for investors.  This would include their financial reports and any other information that would be important to individuals making a decision to buy or sell the company’s securities.  The website would also operate an order-matching service, to match offers to buy and sell the company’s shares and bonds.  [This was authorized by the SEC in a series of “no-action letters.”  Real Goods Trading Corporation (June 24, 1996), Perfect Data Corp. (August 5, 1996), Flamemaster Corporation (October 29, 1996) and Portland Brewing Company (December 14, 1999.)]  An SEC-registered stock transfer agent provides a website for an order-matching service board.  []


Another approach would be for the federal government to let state regulators oversee how individuals provide money to businesses.  Every state has a structure and staff for regulating the way businesses sell their securities.  But federal securities laws also apply to every sale of a security anywhere in the United States, with some exemptions.  Recent history demonstrates that it is these state regulators who actually catch and punish fraud.  Yet, paradoxically, the federal government has used the legal doctrine of preemption to take away the state’s authority.  In 1996, Congress passed the National Securities Markets Improvements Act, preventing the states from screening sales of new securities made through Wall Street.  That left any direct offerings to comply both with state laws and with the increasingly complex requirements of the federal Securities and Exchange Commission.  Congress should either leave the states to review all offerings or none, whether they are made through Wall Street or directly.


If states are the gatekeepers for securities offerings, they could have their own exemptions for smaller companies.  For instance, the California Department of Corporations makes it relatively easy for corporations with revenues of not more than $25 million to sell shares to “small investors,” defined as individuals who purchase not more than $2,500 each.  [Rule 260.140.01(e), California Administrative Code Title 10,]  Most states have exemptions for sales to a limited number of investors and they could provide a basis for expanding to broader small business/individual investor exemptions.  The North American Securities Administrators Association has been effective in building uniformity among state regulators and could have a larger role if the federal government left regulation up to the states.  []   


Both the SEC and state regulators also require that persons involved in selling securities be licensed or registered.  The SEC and most states provide exemptions or relatively simple registration for employees of a company offering its own shares.  [Rule 3a4-1 under the Securities Exchange Act of 1934,]  Independent advisors to companies doing direct offerings are not treated as selling securities, so long as they do not communicate with investors and do not receive commission-type compensation for their advice.  This regulation could be continued through an increased development of direct offerings.


To encourage the flow of investment money from individuals to businesses, Congress needs to make some amendments to the Securities Exchange Act of 1934, which deals mostly with the exchanges, brokers and transactions in already issued securities.  Current law requires a business to register under the ’34 Act if it is listed with a trading market or has at least 500 shareowners and at least $10 million in assets.  [The law says $1 million in assets  [Securities Exchange Act of 1934, section 12(g)(1),] but the SEC regulations  have raised that to $10 million. [General Rules and Regulations under the Securities Exchange Act of 1934, Rule 12g-1,]  Each of those tests has gaps between intention and reality. 


The asset test may be appropriate for businesses that have large investments in plants, equipment and inventories.  But those who sell software and services, or those who lease their facilities, may be large by other standards but still own less than $10 million in assets.  If the purpose is to have public information available for shareowners, the asset size doesn’t really have anything to do with the objective.  It could be dropped.


The problem with the number of shareowners test is in knowing how many “real” shareowners there are.  With retirement accounts and brokerage accounts, most individuals today have their shares held by a nominee, in “street name.”  This means that one nominal owner on the corporate shareowner records may actually hold shares for hundreds of individual accounts.  It is very difficult for the business to have its shareownership traced to the people who have the economic interest.  There have been proposals over the years to deal with this, with much resistance from Wall Street brokerage firms, who use street name holdings to lend shares to short sellers for a fee.


Street name holdings also make it easier to increase commissions through buying and selling securities, when the customer doesn’t have to find a certificate, sign a stock power and get it all to the broker.  Brokers also get paid for forwarding annual reports, proxy statements and other communications from the company, often at disputed cost reimbursements.  Resistance to disclosing real ownership also comes from speculators who don’t want anyone to know they are buying or selling shares.  If Congress were to require that any business file financial reports if it had more than 50 securities holders, then it could limit the full ’34 Act registration to businesses listed on an exchange or inter-dealer quotation system.


There are two parts of the ‘34 Act that Congress should repeal.  One is the requirement that a business which has completed a Securities Act of 1933 registration must file the same type of reports as registered companies.  [Section 15(d)]  These reports must meet standards meant for big business securities analysts, including the Sarbanes-Oxley amendments that created such a fuss when they were adopted in response to the Enron, etc. scandals.  One small step toward removing the hurdles for individual investment in small business is the Adler-Garrett amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act.  It made permanent an exemption from the Sarbanes-Oxley provision that requires audits of a company’s system of internal controls.  The exemption is for reporting companies with market capitalizations under $75 million.  [Title 9, section 989G,]  The SEC opposed the exemption and heavy lobbying against it came from the CPA societies.  [John Berlau, Director of the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute, “Obama can aid small businesses by providing regulatory relief,” The Daily Caller, July 13, 2010,]  The amendment also directed the SEC to study whether extending the exemption to companies with market caps up to $250 million “would encourage companies to list on exchanges in the United States in their initial public offerings.”  [989G(b)]

State regulation could be changed to remove obstacles for small business offerings to individual investors.  They could adopt the New York model, to require current information about who the officers and directors are and where to find them.   Names, perhaps fingerprints, would be in a national registry, to check for criminals.  Fees for filing notices of securities issuance would cover the cost of investigations, audits and enforcement actions.  An alternative to the states making changes would be for Congress to include small business offerings in the state law preemptions that Congress gave Wall Street for large company offerings, by adding those made under Section 3(b) of the ’33 Act.  []   That could go along with some modifications to the SEC’s Regulation A exemption for offerings of not more than $5 million a year.  A set of suggestions have been made by Professor Rutheford B. Campbell, Jr. of the University of Kentucky College of Law, who said:  “The SEC and state securities regulators are to blame for the impotency of Regulation A. For their part, the SEC seems never to have understood small businesses, their capital needs, their importance to our economy, and the special circumstances they face when they attempt to access external capital. States, on their side, seem always to resist attempts to formulate exemptions that allow small issuers to search widely and efficiently for capital.  . . .  The Commission has the power to transform Regulation A from its present fallow state into a useable tool that promotes efficient capital formation by small businesses and appropriately protects investors.” [Rutheford B. Campbell, Jr., “Regulation A: Small Businesses’ Search for ‘A Moderate Capital’", 31 Delaware Journal of Corporate Law, No. 1, pages 77-123, 2005.  Quotation from Abstract,]


(It was government encouragement that helped launch direct public offerings.  I am eternally grateful to an anonymous regulator who drafted federal rules governing mutual to stock conversions.  The rules require that shares in the converting association must first be offered to its account holders.  Remaining shares “shall be sold either in a public offering through an underwriter or directly by the converting savings association in a direct community offering . . ..”  [12 Code of Federal Regulations 563b.3(c)(6)]  Shortly before the mutual-to-stock conversions were permitted, I had helped a stock savings and loan complete two direct public offerings to its depositors and others in its communities.  Several of the early associations to convert asked me to advise them on marketing shares to their depositors and in a “direct community offering.”  The very large ones also had an underwritten public offering, so we had some tension around how much we could sell directly and what would be left for the investment bankers to sell.)


Educate Individuals to be Shareowners


Wall Street gets away with many of its harmful practices because so many of us just can’t begin to understand financial transactions.  Our ignorance is Wall Street’s big advantage.  It also keeps us from seeing the government’s complicity in protecting Wall Street, both from its victims and from competition.  If we are ever to bypass Wall Street, we will need to have a better understanding of basic corporate and government finance.


Thomas Jefferson said that general education was necessary “to enable every man to judge for himself what will secure or endanger his freedom.”  [Thomas Jefferson in a letter to John Tyler, 1810,  See]  Today, we need education furnished to all so that we know what “will secure or endanger” our financial freedom.  We need to understand financial transactions, “the market” and “the economy.”


Some steps are already underway to broaden education about finance. The President’s Advisory Council on Financial Literacy was created by President George W. Bush on January 22, 2008 and issued its first annual report a year later.  It turns out, the real concern of the Council is that, “Sadly, far too many Americans do not have the basic financial skills to develop and maintain a budget, to understand credit, to understand investment vehicles, or to take advantage of our banking system.”  Part of the 15 recommendations of the Council’s first year was to “Increase Access to Financial Services for the millions of unbanked and underserved Americans.”  []  Rather than becoming a shill for Wall Street banks and brokers, the Council could develop the confidence in individuals to choose direct investments in businesses.  So many of us stay away from investing because we feel ignorant.  We think the Wall Street types have all the access and understanding—if we don’t let them invest for us, we’ll surely lose. 


The cure for this ignorance is education.  There are government and nongovernmental organizations already making some headway in “financial literacy.”  [,,]  Some nonprofit organizations have stepped in to help, without waiting for public school boards and administrators to take action.  For instance, the Council for Economic Education provides materials and training to schools for economic and financial education.  While a few of the contributors to this nonprofit organization are financial intermediaries, most are foundations and individuals.  [


The next year, President Obama created the President’s Advisory Council on Financial Capability.  His Department of Education has said it will promote including finance in the public school curriculum, beginning with kindergarten.  Congress has at least proposed legislation to require taking a course in financial literacy as a condition of getting a college student loan.  Any college receiving federal funding would have to offer a financial literacy course.  [John Hope Bryant, founder of Operation HOPE, a financial literacy nonprofit, “A Type of Learning That Pays Dividends,” Bloomberg BusinessWeek, April 25, 2010, page 68] 


We make a lot of mistakes managing our money.  Everyone is frequently wrong about predicting the future.  But many of us don’t even know what’s available and where to start in becoming shareowners in businesses.  Government could experiment with ways for teaching us how to allocate some money for buying shares and maintain our shareownership.  Investment courses could be on a par with civics. Investing in shareownership is as important as voting in elections, since we our lives are as affected by corporations as by governments.  However, public schools may not be the place to teach shareownership.  We tend to dump our social problems on the schools, like drivers’ education, sex education and drug education.  There are other media for helping individuals prepare for participating in shareownership.  


There is a continuous stream of information available about investing in shares, but the media for communicating it belongs to the Wall Street money managers who sell mutual funds, hedge funds, insurance products and other investments.  Economist Robert Shiller suggests federal subsidization of independent financial advice to make it available to everyone, with a co-pay similar to Medicare. [The Subprime Solution, Princeton, 2008, page 125]  Small business owners could be taught how to attract investment in their shares, like the Agricultural Extension Service teaches farmers the latest in how to farm [] Teaching how to market securities directly to individuals could be done through the network of Small Business Development Centers that were set up by the U.S. Small Business Administration.  [


The truth about investment diversification, for example, could give us comfort investing in shares of a business.  Mutual fund marketers offer diversification as a solution for the fearful.  Yet, studies show that the standard deviation of returns on a portfolio of only one stock is 34.6 percent, while one with a hundred stocks is “completely diversified” at 20.0 percent.  With only eight securities, the standard deviation is 22.4 percent.  Knowing this could help individuals select a few companies to own directly, rather than putting it all with an index fund, for which they pay a management fee and give up all control over how their money is used.   [Marshall E. Blume and Irwin Friend, The Changing Role of the Individual Investor: A Twentieth Century Fund Report, John Wiley & Sons, 1978, page 57-58]


Government could also educate the entrepreneurs and managers who seek long-term money.  Small businesses could learn from research in behavioral economics, by Harvard’s David Laibson and others, about how individuals make financial decisions.  For instance, they could make investing in their shares it a simple process, having understood the “present bias” phenomenon, which says that people are more influenced by the difficulty of changing than by the future benefits from the change.  [Matthew Boyle, “Coaxing Patients Out of the Drugstore: Express Scripts is using behavioral economics to get consumers to fill prescriptions by mail,” Business Week, July 27, 2009, page 058]  Pipeline Fund is venture capital fund investing in socially-responsible businesses.  It also trains women to become venture capital or angel investors.  [; Nick Leiber, "Boot Camp for Women Angels," Bloomberg Businessweek, November 22-28, 2010, page 71]  The trainees pay for a six-month internship with an experienced investor and commit $5,000 to a pool for investment in businesses run by women.  It works with the Angel Capital Education Foundation.  []


Public relations and advertising could be part of the education about shareownership.  We have seen government and nonprofit organizations use these tools to educate us about  smoking, seat belt use and drunk driving.  Educational methods used in microfinance can be adapted to teaching about saving and investing in shareownership, for those of us living in developed countries.  [Oxfam America’s Saving for Change,]


Electronic communication tools give us the most effective financial education media for individuals.  One place the SEC has been very helpful is in showing the way for companies using the Internet to provide information for their individual investors.  [Securities and Exchange Commission, Commission Guidance on the Use of Company Web Sites, August 8, 2008, Release Nos. 34-58288, IC-28351; File No. S7-23-08,]


Encourage Individuals to Invest in Small Business


How should decisions be made about who gets equity money to start or expand a business?  Some countries have made the allocation of equity money a function of their governments.  We’ve left it up to Wall Street, the investment bankers and venture capital funds.  How about letting the people decide?  Government could stop subsidizing businesses, with investment tax credits, etc.   Those businesses are largely owned by speculators and the wealthy class.  Instead, subsidies would go to the individuals who invest in businesses they select or create.  The standards for activities the government wants to promote would determine the inducement to investors.


The people need two things before they can invest in shares of small businesses.  One is enough education about finance and business to discern the good investments from the bad.  The other is money they can afford to lose.  That money will have to come from a source beyond individual savings.  Most of us aren’t going to accumulate enough out of our earnings to risk on shareownership.  We need to borrow most of the amount we invest, and we need to know that, if the investment goes bad, we’re not personally on the hook to repay the entire loan.  To accomplish those objectives, a government program can make nonrecourse loans to taxpayers, taking back the title to the shares they get from the businesses they select.  Participants in the program would need to demonstrate a basic education to understand the role of a small business shareowner.  The federal government could exempt these transactions from the federal and state securities laws.  Companies financed would pay no corporate tax if at least a majority of their income is paid in dividends on the shares.  Those dividends would first go to pay interest and then principal on the loans.


A nonrecourse loan means that the lender cannot go after the borrower’s income or personal assets for payment on the loan.  The borrower can lose the asset purchased with the borrowed funds but is not responsible beyond that.  Lenders can be protected by insurance that pays the shortfall if the lender has to take over and sell the shares purchased with the loan money. 


Insured loans would be available to individuals to borrow money for buying shares and the insurance would protect lenders from default by individuals on loans made to purchase shares.  The models are the Federal Housing Administration and the Veterans Administration.  When FHA was created, in 1934, mortgages were usually limited to fifty percent of the home value and repayment was due over three to five years.  Only four in ten households owned their homes, compared to over six in ten now.    The VA home loan program was set up by the Servicemen's Readjustment Act of 1944.  [United States Department of Veterans Affairs,]  Over 18 million home loans have been VA guaranteed.  A 2004 study of the program found “that the program costs the taxpayer relatively little or no money.”  [Evaluation of VA’s Home Loan Guaranty Program, Economic Systems Inc., ORC Macro, The Hay Group, July 2004, page ES-2]  The VA program charges borrowers a funding fee, payable from the loan proceeds, of from 2.2 to 3.3 percent of the loan amount.


For a while, VA loans were also available to finance a veteran’s investment in a small business. The Veterans’ Benefits Readjustment Act of 1966, in authorizing the VA loan guaranty program for Cold War veterans, left out the business loan guarantees.  The Veteran’s Housing Act of 1974 repealed business and farm loans completely, saying it was “because of the restrictive nature of the VA programs, and the availability of more attractive options by the Small Business Administration and the Farmers Home Administration.”  [The Evaluation, mentioned in preceding reference, Appendix C, page C-41.]  A program could be reinstated, for veterans of Iraq/Afghanistan to issue bonds or shares in their businesses, with guarantees to the investors. 


The veterans’ bonds for business program would have a major difference from the earlier VA model.  The money would not come from a bank or other financial intermediary.  Instead, the business would sell bonds to individual investors.  Payment of principal and interest on the bonds would be guaranteed by a government agency.  The veterans would not be personally liable on the securities, although they would lose the business if it didn’t meet its obligations.  Investors might pledge the bonds as collateral for bank loans, and loan payments might be met with the interest and dividends received on the bonds of established businesses.  For early stage businesses, part or all of the loan payments would have to come from the individual’s other income.  Young people with sufficient work income could choose to buy securities in young, growing businesses.  They would figure that, some years out, the dividends and interest would have increased with the growth and profitability of the business.


There would be qualifications for the businesses, their owners and for investors.  Borrowers would need to meet experience or education standards for being a business shareowner.  Community colleges and other educators could provide training and certify the ability to make investment decisions.  Or, investors could rely on licensed, independent financial advisors.  Businesses selling securities would be required to have management and a business plan that would pass muster with state securities regulators and the insurer.  The government, in setting up and monitoring the program, could exclude some business categories, while others might receive preference, based upon “what’s good for the country.”  Private casualty insurance companies or others might choose to enter the credit insurance business, basically what they have been doing with credit default swaps.  To prevent the abuses that the swap market created, the government would regulate their financial responsibility and practices.


We have seen how Congress and several administrations have favored Wall Street with deregulation, tax breaks and protection of its monopolies.  It is now clear that this cozy complicity has caused grave financial hardship to most Americans and a massive shift in wealth to a few financial intermediaries and speculators.  What has been done must now be undone.  “The government must figure out how to deploy its power to shift the flow of investment capital out of the minefields of speculative paper transactions and back into productive channels that will help meet the material needs of American society.”  [Steve Fraser, “Wall Street and Washington:  How the Rules of the Game Have Changed, The Nation, September 19, 2008, [ and  Steve Fraser is the author of Wall Street: America’s Dream Palace, Yale University Press, 2008]


There have been rare moments in the past when government has taken steps to promote alternatives to Wall Street.  Louis Brandeis, in his 1914 book, describes the first chartering of credit unions and the cooperative building and loan associations.  “There is reason to believe that these people’s banks will spread rapidly in the United States and that they will succeed.”  After describing ways that individuals are doing without Wall Street, he observes, “Thus farmers, workingmen, and clerks are learning to use their little capital and their savings to help one another instead of turning over their money to the great bankers for safe keeping, and to be themselves exploited.”  [Louis D. Brandeis, Other People’s Money: And How the Bankers Use It, Frederick A. Stokes Company, 1914, republished by National Home Library Foundation, 1933, Kessinger Publishing’s Rare Reprints, pages 151, 152]


Broadening the ownership of business is an idea that has come into the consciousness of our political leaders, and then faded before any real action was taken.  For instance, this is from what has been called our “Second Bill of Rights,” in Franklin Delano Roosevelt’s 1944 State of the Union Address to Congress:  “The right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home or abroad.”  [See Cass R. Sunstein, The Second Bill of Rights:  FDR’s Unfinished Revolution and Whey we Need It More than Ever, Basic Books, 2004, Appendix I, page 243]


This is from the majority section of the 1976 Report of the Joint Economic Committee of Congress: 

     “To begin to diffuse the ownership of capital and to provide an opportunity for citizens of

     moderate incomes to become owners of capital rather than relying solely on their labor as

     a source of income and security, the Committee recommends the adoption of a national policy

     to foster the goal of broadened ownership.”


One of the New Deal alternatives to Wall Street was to increase mortgage lending by creating federally-chartered savings and loan associations.  They had to be “mutual” corporations, that is, the only ownership would be in the depositors and borrowers.  When some of these mutuals began to use state laws to convert to stock ownership, the federal government declared a moratorium on conversions.  In the early 1960s, conversions began to be allowed, but only if the new ownership shares were distributed free to the depositors.  That was quickly stopped, as speculators moved large deposits around in anticipation of a conversion.  [Dwight C. Smith and James H. Underwood, Mutual Savings Associations and Conversion to Stock Form, Office of Thrift Supervision, Department of the Treasury, May 1997]  In 1974, conversion regulations were adopted that gave depositors the right to buy shares in proportion to the amount of their deposits.  The price was to be set by an independent appraiser. 


Wall Street conducted hundreds of underwritten initial public offerings of these converted mutuals.  But someone insisted on retaining a direct relationship with the customers and the conversion regulations by requiring a “direct community offering” of shares to the depositors.  Shares that are not purchased by depositors can be sold “either in a public offering through an underwriter or directly by the converting savings association in a direct community offering . . ..”  [12 Code of Federal Regulations §563.b(c)(6).]   (I’ve never learned who came up with the term “direct community offering” or got it into the regulations.  Whoever it was has become a personal hero for me.  We built a business in the early 1980s doing direct community offerings for converting savings associations.  The techniques we learned became the basis for our advisory business and books on direct public offerings.)


There is an existing government program to encourage individuals to invest in small business: The Individual Development Account under the 1998 Assets for Independence Act.  IDAs were suggested by Michael Sherraden in his 1991 book, Assets and the Poor: A New American Welfare Policy, pages 220-279.  [M.E. Sharpe]  The implementation history of IDAs is described in a 2005 book edited by Michael Sherraden, Inclusion in the American Dream: Assets, Poverty, and Public Policy. [Oxford University Press, 2005, pages 43-45, 185-237]  According to the "Assets for Independence" (AFI) website of the U.S. Department of Health and Human Services:  “Every dollar in savings deposited into an IDA by participants is matched (from $1 to $8 combined Federal and nonfederal funds) by the AFI project, promoting savings and enabling participants to acquire a lasting asset. AFI project families use their IDA savings, including the matching funds, to achieve any of three objectives: acquiring a first home; capitalizing a small business; or enrolling in postsecondary education or training.  Additionally, all AFI projects provide basic financial management training and supportive services, such as financial education . . ..”

[]  To begin an IDA, participants need to have assets of not more than $10,000 in value (excluding a residence and one car) and total household income of less than two times the Federal poverty line.  One state’s program, North Carolina, has 32 local IDA sites providing “matching funds and support to more than 500 low-income account holders.”  []  Federal funding of IDAs has been at the "token level" of $25 million a year.  [J. Larry Brown, Robert Kuttner and Thomas M. Shapiro, Building a Real "Ownership Society," The Century Foundation Press,2005, page 17]  Results of the IDA program are analyzed in Brookings Institute Policy Brief #32   [Ray Boshara, "Individual Development Accounts: Policies to Build Savings and Assets for the Poor," 2005,] and a Brookings Institute Paper [William Gregory Mills, William G. Gale, Rhiannon Patterson, and Emil Apostolov, "What do Individual Development Accounts Do?  Evidence from a Controlled Experiment," July 11, 2006,]


Perhaps the best step for government to take, for opening the capital flow from individuals to businesses, would be to remove some of the artificial barriers Wall Street has built.  The President’s National Economic Council issued a paper on innovation in 2009, committing to:  “Support open capital markets that allocate resources to the most promising ideas.  Open capital markets are one of the greatest strengths of the American economy, and the President is committed to making sure these markets work.”  [“A Strategy for American Innovation: Driving Towards Sustainable Growth and Quality Jobs,” Executive Office of the President, National Economic Council, Office of Science and Technology Policy, September 2009, page 15]  The specific steps outlined, however, have only to do with increased regulation of the existing financial intermediaries.  In the spirit of “American Innovation,” perhaps the Administration will at least look at supporting experiments in bypassing Wall Street.


Direct, measurable benefits for investors can appear quickly when markets are opened and formerly secret transactions become transparent.  An example is TRACE, the Trade Reporting and Compliance Engine.  Originally proposed by Arthur Levitt, SEC Chairman from 1993 to 2001,  Operated by the National Association of Securities Dealers, it posts prices of trades on all registered corporate bonds, 15 minutes after they occur.  The effects of TRACE have been dramatic.  In an October 2009 report: “Wall Street’s customers paid $1.24 per $1,000 bond to trade last month, according to a review of 5,086 trades involving 22 of the most-active top-rated issues in the investment-grade Bloomberg-NASD bond index. Four years ago, it was $2.80 per bond . . ..  Bond traders lost $1 billion in fees from mid-2002 to mid-2003, or about $2,000 a trade . . ..”  [Mark Pittman and Caroline Salas, “Bond Traders Lose $1 million Incomes as Transparency Cuts Jobs,” Bonds Online, October 24, 2009]


Small business capital formation got a boost from the SEC in the early 1990s.  One big move was the adoption of Regulation S-B in 1992, providing less complex registration and reporting procedures for companies with not more than $25 million in revenue, or in the value of shares held by the public. [] Small businesses used these simpler forms to complete direct public offerings, but  they were taken away by the SEC in 2007, in a release ironically titled “Smaller Reporting Company Regulatory Relief and Simplification.”  []


The SEC also had a period of concern with small business in the early 1980s and one result was Regulation D, ostensibly for helping businesses do small securities offerings with a minimum of SEC regulation.  []  It set out three ways for offering securities without SEC registration.  Its Rule 504, for offerings of not more than $1 million a year, is genuinely of help for young companies.  It allows them to do public offerings, to any number of investors, either directly or through brokers.  The other two rules allow offerings without registration, if made to “accredited investors,” which includes individuals with at least a million-dollar net worth, and to not more than 35 nonaccredited investors.  Rule 505 is for offerings of not more than $5 million a year, while Rule 506 allows offerings of any amount.


Wall Street has been the principal beneficiary of Regulation D.  When investment bankers do a “private placement” that includes individual investors, they generally use Rule 506.  When the securities industry lobbied Congress to exempt underwritten offerings from state regulation, it also included offerings made using Rule 506.  [Securities Act of 1933, section 18(b)(4)(D),] Their only filing requirement with the states is a notification form.  Rule 506 says a prospectus is supposed to be used, but it is not reviewed or even filed with the SEC.  The private placement can be sold to thousands of investors, so long as all but 35 of them are millionaires. 


What if governments promoted individual investment in small business shareownership the way federal and state governments heavily promote gambling, through lotteries and casinos.  Americans spend nearly $100 billion on legalized gambling, while they put only about half that into savings and investment.  Why are we induced into putting so much money into gambling and so little into savings and investments?  Behavioral psychologists tell us that’s because we “tend to overestimate the odds of rare events.”  Even when we are told about how much of our lottery ticket goes to the state, or the percentage taken off by the casino, we just know that the odds don’t apply to us.  [2007 information furnished by Christiansen Capital Advisors and U.S. Bureau of Economic Analysis, reported by Jason Zweig, “Using the Lottery Effect to Make People Save,” The Wall Street Journal, July 18-19, 2009, page B1]  Governments get a lot of the gambling money, either through running their own lotteries or taxes on gambling operators, while Indian casinos arguably reduce the need for payments through the federal Bureau of Indian Affairs.  Harvard Business School professor Peter Tufano designed a program around this long-shot thinking, called “Save to Win” and offered in 2009 by eight Michigan credit unions.    Anyone who puts at least $25 into a one-year certificate of deposit is eligible for a monthly “savings raffle,” with prizes in amounts up to $400.  They are also entered in a yearly raffle for $100,000.  Interest rates are slightly lower than on conventional CDs.  In the first 25 weeks, the program drew in $3.1 million in new deposits.  []


People in Congress and the Administration talk a lot about how small business as the engine for economic growth, job creation, etc.  Somehow, the programs they promote end up benefiting big business, through tax breaks and subsidized bank loans.  Small business needs money that is available right now, doesn’t have to be paid back and doesn’t have to pay interest.  That is the definition of equity money, received from selling shares of common stock.  Government encourages individuals to save and invest money by providing  tax deductions for putting money into retirement plans.  Those plans discriminate heavily in favor of big business, shutting out small businesses.  Individuals have to turn their money over to trustees and plan managers, who invest in big business.  Most trustees for self-directed funds won't let individuals buy any securities that aren't traded on an exchange.   Congress needs to at least put small business on equal footing with Wall Street's buy side.

Demonstrate Direct Offerings of  Government Securities

On the face of it, raising money to finance government projects, particularly local government, would seem like a natural for direct marketing.  The community of prospective buyers is clearly defined.  There is usually a data base of taxpayers, voters or residents of the community and the particular project being financed can have strong community support. 


The federal government’s Treasury Direct program has shown how direct securities offerings can be operated very effectively through a website.   The U.S. Treasury has already developed a highly successful example of raising capital by selling Treasury securities in Internet direct public offerings.  The Treasury’s program, Treasury Direct, makes it easy for individuals to purchase securities directly from the U.S. Treasury.  [  See “Treasury Direct” in the section on Direct Investing Routes Open Now]  There’s no charge to open an account and the website works as clearly and efficiently as the best online retailers.  Explanations and how-to messages are geared to the very novice prospective investor.  The securities industry “allowed” this to happen, because the commissions on retail purchases of Treasury bonds are so little that brokers would rather not be bothered.  Treasury Direct could be publicized as a model for other governmental and private entities to raise capital through direct public offerings and for individuals to learn of a way to invest without going through Wall Street. All federal, state and local governments could set up similar online marketing operations.  Government-sponsored entities could participate.  Direct marketing is also available to hospitals and other nonprofits that can issue tax-exempt bonds.  So far, all but the U.S. Treasury still rely upon Wall Street underwriters, selling in minimum $5,000 amounts.  For many smaller issues, these underwritten “public offerings” will have only one investor, an institutional money manager who does business regularly with the underwriter. 


There are many reasons why a local government, or a hospital or other tax exempt nonprofit, should market bonds to individuals in the community it serves.  The most obvious is the frequent ability to get a much lower interest rate.  For instance, in early 2009, the U.S. Treasury’s ten-year bonds were yielding 2.125% to their owners, while triple AAA-rated tax-exempt bonds were at a tax equivalent yield of 4.64%.  For bonds due in 30 years, the rates were 2.26% and 6.85%.      []  Part of that big spread is explained by the “flight to safety” that makes some people unwilling to own anything but an obligation from the single government entity, like the U.S. Treasury, which can always print money to pay its debts.  Others might argue that the difference in yield is because the trading market for tax exempts is a hit-and-miss thing, compared to U.S. treasuries.  That argument is a circular one, however.  The market for local government bonds is thin because a few hundred money managers are almost the only buyers.   If tax-exempt bonds were marketed directly to individuals, then the aftermarket would have far more participants.  If the middle class were included in the initial marketing, especially within the issuers’ own communities, the greater awareness and participation would carry over to the period between new bond issues.  That buying interest in existing bonds would appear in the trading market and result in upward price momentum.  The more active buy interest could significantly reduce the premium for local government bonds over Treasuries which would, in turn, reduce the cost of money to the agency or nonprofit.


Even when local governments have sought to raise money from their local communities, they would still use investment bankers and brokers.  Several local governments have tried using small denomination bonds, even using publicity aimed at local individuals, but still making them available only through securities brokers.  Ohio offered $30 million of Site Development General Obligation Bonds, through any broker or financial adviser selected by the investor.  "We get calls on a fairly regular basis from people who want to invest in Ohio bonds," said Kurt Kauffman, debt manager for the state Office of Budget and Management.  "But if you don't have an account with one of the offering firms, you're out of luck. We felt this was advantageous for Ohioans who are interested in buying our bonds. It really allows any of the firms and any of the brokers . . . to participate in the sale." [Teresa Dixon Murray, Cleveland Plain Dealer, November 11, 2006]  The City of Chicago sold bonds in 2005, through a website, (no longer accessible.)  From that website:  “Individual investors can purchase City of Chicago General Obligation Direct Access Bonds through a national network of broker-dealers at par. Typically, individual investors obtain municipal bonds from the secondary market, where securities are bought and sold after their original issuance.”


Few areas of finance are so tightly bound up with financial intermediaries as the bonds issued by state and local governments.  Yet, over the years, local governments have successfully sold bonds in a few direct marketing programs.  [See “Direct Local Government Bond Offerings” in the section on Direct Investing Routes Open Now]  

There have been brief periods, for more than a century, in which local governments were active in the direct marketing of municipal bonds to local individuals.  The issuing agencies either provided for redemption of a bond before maturity, or maintained an order-matching service for persons wanting to buy or sell bonds.  The most recent direct offerings were from about 1970 to the early 1990s.  Many of the bonds were offered in minimum purchases of much less than the traditional $5,000, earning them the sobriquet “minibonds.”  A pioneer in direct marketing of minibonds is L. Mason Neely, Department of Finance Head, East Brunswick, New Jersey.  East Brunswick had their bonds and dated checks for interest payments all bound together in a “checkbook” format.  When a payment became due, the investor could tear out a check and deposit it like any other. 


California encouraged minibonds through the California Debt and Investment Advisory Commission: “Minibonds typically are marketed and serviced by public agencies through their finance departments.  The issuances offer the local investor tax-exempt interest, as well as provide the citizens in a community the opportunity to participate in community growth and development.”  [Debt Line, Volume 9, No. 2, February 1990]  The Modesto Irrigation District divided a $40 million bond issue into a $38 million underwriting and $2 million issuer-marketed minibonds.  The District’s Treasurer, Robert de la Cruz, said the 1989 sale “sold out in three days and was oversubscribed by $100,000.”  Other California minibond issues made that year were Trinity County Public Utility District, for $500,000, and the City of Hemet for $2 million.  [California Debt Advisory Commission Annual Report 1989: Summary of California Public Debt, page 5]  Two cities marketed bonds in 1990, Mission Viejo for $141,000 and Atwater for $250,000.  [California Debt Advisory Commission Annual Report 1990: Summary of California Public Debt, page 6]  The Commission doesn’t show any further issuances for other years.

The City of Boston sold bonds in 1984, with denominations as small as $100.  “The city initially intended to issue $1 million of bonds.  After the issue was sold out on Monday, the city council authorized the city treasurer to sell another $1 million, which were snapped up Tuesday.  The bond issue was publicized through stories in Boston neighborhood newspapers, brochures in neighborhood libraries and paid advertisements.  The city treasurer sold the bonds to investors who walked into city hall off the streets.”  Johnnie Roberts, “Boston’s Offering of ‘Minibonds’ Proves Good Lure,” The Wall Street Journal, September 13, 1984, page 37]  During two days in March, 1979, the Town of Framingham, Massachusetts sold $600,000 of bonds directly, in denominations of $1,000, with a $10,000 maximum purchase.  In January 1979, The Commonwealth of Massachusetts sold $1 million of $100, $500 and $1,000 5-year bonds.  [Savings and Loan Investor, March 19, 1979, page 2040.

The City of Dallas, in preparation for bringing to town the National Basketball Association team, the Mavericks, sold nearly $7 million of tax exempt bonds to finance construction of parking facilities at the Reunion Arena.  The bonds had a $250 minimum and $3,000 maximum denomination and included an option to get first selection of season tickets to sports events at the Arena.  As the Mavericks moved up from last place in their division, the $3,000 bonds were selling in 1984 at $10,000.  [Forbes, November 1984, page 14]


Sometimes, the politicians have enacted minibond programs, only to have them thwarted by the government officials who were to have carried them out.  In 1969, the Pennsylvania legislature required that a small percentage of every bond issue would be sold in $100 denominations.  But they were routinely all purchased by local banks and not distributed to individuals.  The law was repealed in 1978.  New York’s Municipal Assistance Corporation planned to issue low-priced “miniMACs” in 1977.  It was abandoned without ever coming to market.  The reason given was that it involved too much paper work.


There have been plenty of local projects that could lend themselves to the direct offering of minibonds, but with no hint that they were even considered.  When the oil embargo hit in the late 1970s, there was a surge of interest in communities taking charge of their energy sources.  A retired schoolteacher in Stockbridge, Massachusetts purchased one of America’s more than 5,600 abandoned hydroelectric dams and restored its ability to provide electricity to 250 homes.  [“Mary’s Power Plant,” Readers Digest, February 1980, page 51]  Lawrence, Massachusetts also revamped a local dam, while Ames, Iowa began burning garbage to generate electricity.  [Sandra Blakeslee, “Cities, Towns Taking Over Energy Issues,” Los Angeles Times, October 7, 1979, Part II, page 5]  Many of these projects were financed by local government agency bonds, about $3.5 billion in 1976 and $5 billion in 1977.  [Byron Klapper, “More Cities Start Own Electric Operations as Private Utilities Encounter Problems,” The Wall Street Journal, December 27, 1977] 

By 1977, “Garbage Power” articles appeared in The Wall Street Journal [Liz Roman Gallese, “Garbage Power: Art of Turning Waste Into Useful Fuel Gains in Popularity Rapidly,” The Wall Street Journal, August 4, 1977, page 1] and Forbes [“Garbage Power: Trash into energy is not just an idea anymore; it’s slowly becoming an industry,” Forbes, May 1, 1977]


Thirty years later, it was “what ever happened to” local energy projects financed by tax-exempt bonds?  Measured by society’s best return on investment, it doesn’t make sense that these projects had been abandoned.  Yet it was part of a slide in infrastructure expenditures that began in the late 1960’s.  In 1968, capital outlays for highways, mass transit, airports, waterways, water supply and waste disposal were at 2.4% of gross national products.  They declined steadily over the next 20 years, to about 1% in 1988.  [Commerce Department data, presented by Gene Koretz, “Crumbling Roads and Bridges:  Their Heavy Toll on the Economy,” Business Week, August 7, 1989, page 18] 


Here are some sources of information about direct public offerings of municipal bonds:


Municipal Minibonds: Small Denomination Direct Issuances by State and Local Governments, by Lawrence Pierce, Percy R. Aguila, Jr. and John E. Petersen, Government Finance Research Center of the Government Finance Officers Association (February 1989).  This is a thorough, professional “how-to” publication for any government agency wishing to raise capital by marketing bonds to its community.  From the Foreword by John E. Petersen, Senior Director of the Research Center:  “Minibonds are small denomination securities, generally $500 or $1,000, sold directly by governments to the investing public.  . . . By broadening the market and tapping local sources of capital, the minibond issuance promises to access an important niche of the market and is capable of both reducing issuance costs and fostering community participation in and support of capital financing programs.”


“The ‘Mini’ Trend in Municipal Finance: Minibonds,” Comment by Christina L. Jadach, Harvard Journal on Legislation, Volume 19:393, Summer 1982.  “Minibonds—small-denomination securities which states and municipalities sell directly to local investors—may transform municipal credit markets by permitting direct citizen investment in state and local governments.” page 409.


“Mini-Municipals: A Quiet Revolution in Tax-Exempt Finance is Afoot, Barron’s, August 6, 1979, page 11.


“Boston’s Offering of Minibonds’ Proves Good Lure,” by Johnnie L. Roberts, The Wall Street Journal, September 13, 1984, page 37.


 “Issue of ‘MiniMacs’ Pleases Politicians, Riles Bond Lawyers,” by Daniel Hertzberg, The Wall Street Journal, June 8, 1977, about New York’s Municipal Assistance Corporation proposal. 


“The Muni E-Bond Revolution,” by John E. Petersen, The Magazine of States and Localities, April 2000.  “With the e-trade revolution in full swing in the bond markets, issuers will increasingly auction bonds directly to investors. That will include individual investors, who shoulder the bulk of the load when it comes to holding tax-exempts. This end run around broker-dealers will be a test for Wall Street.”


South Carolina’s program, and


Sales of ten-year bonds in Bergen County, New Jersey,


New York City bonds,    


Denver Justice Center bonds,


The economic studies certainly confirm a huge incentive to have money spent on infrastructure projects.  A Federal Reserve Bank of Chicago study showed that infrastructure investment lowers the operating costs of private businesses, raising their rate of return.  A dollar spent on public infrastructure projects stimulates four to seven dollars in private investment.  [David A. Aschauer, Staff Memorandum, 1987, referred to in Business Week, August 7, 1989, page 18.]  The study showed that the countries in the Group of Seven that spent the most on public investment had the highest productivity growth, while those that spent the least had the slowest productivity growth. 


Our own country’s history supports the value of financing infrastructure.  The great development of transportation and population centers in the United States has come from the incentives of public spending.  Canals in the early 1800s, and railroads later in the century, were financed by selling securities and supported by government land grants and other subsidies.  Cities were made possible by public spending on streets and mass transit.  Massive public spending on highways made possible the auto and truck industries, while publicly-financed airports brought us air travel. The American Recovery and Reinvestment Tax Act of 2009 recognized the importance of infrastructure by authorizing several tax exempt bonds for purposes such as schools, high-speed rail, energy conservation, renewable energy and manufacturing in recovery zones. []


Internet technology is making some inroads into the cozy marketing process Wall Street uses for local government bonds.  The so-called municipal bond market has been closely tied into the broker-dealer which placed the original issue.  If you want to sell a bond before it matures, you’ve needed to go back to the firm that sold it to you.  They’ll tell you whether someone else may be interested in buying it.  Or they’ll offer to purchase it themselves, usually at a big discount.


That may be about to change, thanks to the use of Internet tools and the growing influence of Wall Street’s 
buy side.  “With the e-trade revolution in full swing in the bond markets, issuers will increasingly auction 
bonds directly to investors. That will include individual investors, who shoulder the bulk of the load when it 
comes to holding tax-exempts. This end run around broker-dealers will be a test for Wall Street.”  [John E. 
Petersen, “The Muni E-Bond Revolution,” Governing Magazine: The Magazine of States and Localities, 
published by Congressional Quarterly, Inc.  April 2000]  

Interest in direct investing of local government securities has come from Wall Street’s buy side.  Mutual fund managers have become major buyers of muni bonds and many of them were stung by the auction-rate securities problem, when they couldn’t sell bonds they held.  Their trade association, the Investment Company Institute, has encouraged the SEC to start a website database.  Called EMMA, for Electronic Municipal Market Access, it is like AMMINET, the attempt we worked on for the mortgage market.  [See “Dead Ends—Direct Routes That Were Blocked” in the section on Direct Investing Routes Open Now]   According to the website, [] it is the source for offering documents and “real-time trade price information on municipal securities.”  Offering documents for new issues of municipal bonds can be submitted by underwriters “and issuers,” so that these changes could be friendlier to direct offerings.  The site is operated by the Municipal Securities Rulemaking Board, which Congress designated in 1975 to regulate securities firms and banks in underwriting and trading in municipal securities. 


Historically, the MSRB was a “self regulatory” body controlled by the municipal securities dealers who were two-thirds of its membership, and was subject to oversight by the SEC.   Municipal securities dealers will now constitute only a minority of the MSRB’s membership.  As of October 1, 2010, “Public Members” must be a majority and must be persons “not associated with any broker, dealer, municipal securities dealer, or municipal advisor.” []  Private website providers are also entering the municipal bond issuing and trading market.  The Grant Street Group conducts auctions for new issues of municipal securities. []  Knight BondPoint is an anonymous web-based marketplace for municipal and corporate securities.  []


Income Tax Rules Could Favor Shareownership


Archeologists of a future millennia, searching for why the United States became an extinct nation, could find an answer in a time capsule, containing copies of the Internal Revenue Code and its Regulations.  With every election cycle, we hear promises to “simplify” our tax maze.  Laws are even passed with titles like “tax simplification” and “tax reform.”  Inevitably, they add hundreds more pages to the law, with Byzantine cross-references to exceptions and qualifications.  Maybe the “flat tax” or “fair tax” or “value added tax” advocates will one day actually get something done about the whole system of income taxation.  For the time being, this is a modest proposal about only one part of the problem, the tax rate on corporations and on income from dividends and long-term capital gains.


Our current system puts the very highest tax burden on income from work.  Not only do we pay the full income tax rates, but we also pay social security and Medicare taxes, now at a combined rate of 15.3%.  []   If you are filing a single return, with taxable income between $30,651 and $74,200, you will pay 40.3% of the amount over $30,650, including the 7.65% social security portion paid by your employer.  Work earnings over $102,000 are free from the social security tax.  By contrast, income from bank accounts, money market funds, etc., is taxed the same way as our income from work, but earnings from investments are exempt from both social security and Medicare taxes.  So is any profit we make on selling securities.


The lowest income tax rates are on income we receive from owning corporate shares, either from dividends or from selling the shares at a profit.  The justification for a lower rate on dividends and long-term capital gains is that people should be encouraged to invest in American business, to help it grow and be strong against foreign competition and difficult conditions.  A study by The Twentieth Century Fund found that share ownership by individuals would be encouraged by eliminating the double taxation of dividend income.  [Marshall E. Blume and Irwin Friend, The Changing Role of the Individual Investor: A Twentieth Century Fund Report, John Wiley & Sons, 1978, page 3]  However, the dividend incentive argument doesn’t fit the facts.  Most shares in U.S. public companies are owned by investors who never pay any income tax at all—pension funds, individual retirement accounts, foundations and mutual funds, which pass through income to their investors.  [The Conference Board, Institutional Investment Report,]  They don’t care at all about the tax rates on capital gains or dividends.


Even for the investors who pay taxes, dividends are not much of a decision factor, because most share buyers are looking for profits on reselling within a short period.  This behavior seems especially shortsighted, since “dividends have accounted for more than 40% of the annual returns of the Standard & Poor's 500 since 1926, and more than 100% of the returns over the past 10 years -- the lost decade, during which the index declined. . . .]  Despite that history, currently:  “Fifteen of the top 100 S&P 500 members, ranked by stock-market value, pay no dividend.”  []  The average dividend rate for the S&P is only about two percent of the stock’s market value and, for stocks in the NASDAQ index, its just half of one percent.  [


Big corporations build equity capital by retaining earnings, rather than paying them out in dividends.  They rarely sell any new stock to the public and they borrow any cash they need.  The interest they pay on loans is deductible for corporate income tax, while dividends are not.  As a result, our tax structure encourages borrowing to meet capital needs, rather than raising money from stock sales.  Consider the largest U.S. diversified corporation, General Electric.  [ and] From its beginning through 1999, GE had raised a total of only $702 million from issuing stock.  Meanwhile, GE has repurchased its own shares, at market prices, for a cumulative total of nearly $37 billion at the end of 2007.  []  The company has paid out over 50 times as much money to buy back its own stock as it has ever gotten from issuing the shares.  Meanwhile, it has been paying out about half of each year’s earnings in dividends.  By keeping the rest of its earnings, it has increased its retained earnings to $126 billion!  That has allowed GE to borrow cash, to a total of over $510 billion at the end of 2009.  GE also raises cash from its ability to avoid paying corporate income tax.  [David Kocieniewski, "GE's Strategies Let It Avoid Taxes Altogether, The New York Times, March 24, 2011,]


How does GE’s experience fit with the policy argument for a favored rate on dividend income?  First of all, 58% of GE’s shares are owned by institutions.  [] They don’t care what the tax rate is on dividends, since they don’t pay taxes.  A much stronger factor against a policy of lower taxes on dividends is that big corporations aren’t issuing new shares.  General Electric does not raise capital anymore by issuing new shares.  It gets the equity capital it needs by retaining half its earnings each year, plus the gain it makes on repurchasing its own shares in the market and reselling them to its managers when they exercise stock options.  As for its cash needs, GE can borrow most of that, deducting its servicing cost as interest expense


If most American businesses aren’t even trying to raise capital from new stock issues, what good are tax incentives to buy stock?  How can favoring dividends and capital gains support providing capital to these businesses?  The 15% tax rate on dividends really benefits those who control a privately-owned corporation and can take out past earnings in low-taxed dividends.  For instance, hedge funds and private equity firms will buy a public corporation and then drain its retained earnings by paying themselves dividends.  Because the funds are partnerships, the 15% tax rate gets passed through to their wealthy owners and managers.  The capital gain benefit goes primarily to stock market speculators, who buy existing shares in the market with the expectation that they will sell after a year and pay only 15% of their profit.  They aren’t funding American businesses.  They’re buying “previously owned” shares that may have been first sold decades ago.  The effect of the low tax is to encourage gambling on stocks over other games, where winnings are taxed at maximum rates.


There are a couple of “fairness” arguments for giving a tax break to dividends and capital gains.  The one for capital gains is that part of the price increase in the stock sold will have come from inflation, not from the performance of the corporation or the skill of the stock picker.  This seems like a weak excuse for taxing stock profits at a far lower rate than wages.  Instead, the complaint could be met by using an inflation adjustment in calculating how much of the investment came from a real increase in market value.


The fairness argument for dividends is much stronger.  Taxing dividends represents a double tax, since the corporation has already paid a tax on its income before passing it out to shareowners.  Dividends are paid from “after-tax” income.  Since they have already been taxed at the corporate level, at up to a 35% rate, the argument is that they shouldn’t have to pay a full additional tax when paid out to shareowners.     


One way to eliminate this double tax is to allow corporations to deduct dividends before they calculate taxable income, just like they do for interest paid on borrowed money.  That would have a very uneven effect, since many corporations already pay little or no tax, with all the credits, deductions and exemptions available.  According to a study of our largest corporations by the Government Accountability Office, the percentage of corporations reporting no tax liability for [1998-2005] ranged between 61% and 69% for U.S. corporations and 67% to 72% for foreign corporations.  Many of the smaller companies used tax structures that pass through their income to owners.  The income reported by these limited liability companies, Subchapter S corporations, mutual funds or real estate investment trusts, would be subject to individual income tax.  However, the GAO study separated out the percentages for large corporations, defined as those having over $250 million in assets or $50 million in annual revenue.  Few of those would have qualified for the pass through treatment.  And yet, the percentages of these large corporations having no tax liability at all ranged from 23% to 38% for U.S. corporations and 29% to 50% for foreign corporations.  [GAO-08-957, “Tax Administration: Comparison of the Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations, 1998-2005,” August 12, 2008,]


The other way past double taxation is to eliminate the dividend tax on taxpaying shareowners.  That would benefit individuals who own shares in their own names directly, while having no effect on those who invested through retirement plans or on the tax-exempt institutions.


What is a fair solution, one which will really promote investment in American business?  Let’s look at fairness in the competition for capital among businesses.  Established companies have retained their after-tax earnings, building a stockpile of capital.  They can acquire or start other businesses, develop new products and markets, all without asking anyone to invest.  By contrast, the entrepreneur must have personal wealth to do the same thing, or, most likely, must raise capital from friends, family, venture capitalists or others.


One approach would be to allow corporate earnings to be included as income to the shareowners, without any tax at the corporate level.  Many businesses already operate within this tax structure.  They have chosen to avoid corporate tax by distributing all of their income—for accounting purposes, not in cash—to their owners.  These include mutual funds, real estate investment trusts, corporations with no more than 100 shareowners and those doing business as partnerships.  Some of these businesses also distribute cash, at least in an amount to cover the shareowner’s tax liability on the distributed income.  However, there is a big unfairness in taking away the corporate tax and increasing the taxable income to shareowners.  Tax-exempt owners, who own most of the stock in large corporations, would pay no tax on the distributed income.  In addition, the loss of revenue from the corporate tax would have to be made up from higher rates on individuals.


Some have argued for treating interest on corporate debt the same way as dividends.  That would mean that corporations could no longer deduct interest they paid before computing their taxable income.  “Governments should phase out the tax-deductibility of interest payments, so that taxes are paid on operating profits.  To make the effect on businesses as a whole neutral, corporate tax rates should be cut.”  [Hugo Dixon, “Not Just Mortgages,” BreakingViews, April 7, 2009, deductible debt.aspx?email]  This could theoretically encourage corporations to sell more shares to raise capital, rather than relying on as much borrowing as they do now.


The preferred path would be to eliminate the corporate income tax, provided that corporations pay out all of their income in dividends to shareowners.  Our big corporations get all the money they need by simply holding on to their after-tax profits.  They rarely have to ask anyone to buy their shares.  Even if they pay some dividends, corporate managers still keep a large chunk of each year’s earnings for expansion, acquisitions or just earning interest.  This is a huge competitive advantage over entrepreneurial businesses that must keep asking for more money to survive and grow.  All corporations should pay out all of their earnings to shareowners.  They can then all compete in attracting new money for their plans.  Dividend tax rates for shareowners could be adjusted to make up the lost corporate tax.


There has been a big push to lower corporate income tax rates, using the argument that the U.S. is at a competitive disadvantage to other countries with lower rates.  The fact is, of course, that deductions, exclusions and credits allow many of our biggest corporations to pay little or no corporate tax.  Why not eliminate the corporate tax entirely—so long as a corporation pays all of its net income out to its shareowners as dividends?  Corporate managers who wanted more capital could compete for it by marketing securities to their shareowners or others, telling them how they propose to use the new money.  This would put all managers, for corporations of all sizes, on an equal footing.


When management wanted cash to expand, or provide a safety cushion, they would ask for it.  Shares would be offered, to existing shareowners and others.  Investors would choose among businesses, old and young, based upon past performance and future promise.  Most corporations would probably ask their shareowners to return the cash dividends, net of taxes shareowners paid, for use by the business.  Many corporations already have dividend reinvestment plans, which automatically reinvest a shareowner’s dividends in more stock.  They usually allow for additional amounts to be purchased directly from the corporation. The great majority of shareowners would probably elect to have their payouts reinvested in more shares.  But they would have the choice.


What would be the effect on the stock market if corporations paid all their income out in dividends to their shareowners?  The fundamental analysis for a company’s market price is the present value of its projected future earnings.  When those earnings are expected to be kept within the business, the investor needs to guess about how they will be used by management.  But if the earnings are all paid out to shareowners, then managers will have to go into the market and offer more shares, explaining what they intend to do with the money.


Short-term trading has been the bane of businesses seeking long-term capital.  It seems that everyone with money to buy securities is interested only in quick games for immediate results.  To combat this short-term trading, John Maynard Keynes, 70 years ago, suggested a tax on all transactions in stocks.  Investors would hardly care about a few pennies in tax per share for an investment they intended to hold for several years.  But it could make the game too costly for traders, who bought and sold huge numbers of shares within seconds, hours or days.  Stacy Mitchell more recently put it this way:  “How can we reconnect capital with community needs? . . . One way we might begin to reorient the financial system is to establish a modest tax on all financial transactions, including international currency trades. This would lessen the appeal of high-frequency speculative trading.  [Stacy Mitchell, “A New Deal for Local Economies, Lecture at the Bristol Schumacher Conference at Bristol, England, October 17, 2009,  reprinted at “Making Money Work: How Can We Reconnect Capital with Community? Our investments tend to fund consolidation and speculation. But new models are emerging that allow us to finance the economy we really want,” April 23, 2010, and excerpted in]


Make Corporate Charters Conditional and Revocable

Wall Street caters to very short-term desires.  Its principal raw material is the corporation, from which it manufactures and sells stocks, bonds, derivatives, mergers and acquisitions.  While Wall Street is having its way with these byproducts, the corporation’s officers and directors come to focus their attention on how to make the corporation more attractive to Wall Street, and how to feed their own pride and greed.  Whatever the corporate purpose may have once been, it becomes entirely one of feeding Wall Street’s games.  As someone said about Silicon Valley:  “It was great until it switched from making products to making stocks.”

The government could go a long way to bring the purpose of corporations away from serving Wall Street and back to serving the people.  The charters that create corporations today leave them free to engage in any lawful business.  There is no limit on how long they can live, regardless of their behavior.  It wasn’t always that way.  The first Amercan corporations were chartered by the states with limited lifetimes of up to 25 years.  Their lives could be cut short if they failed to live up to the conditions of their charter.  The United States Supreme Court, in the 1815 decision Terrett v. Taylor, declared, in the language of the times, it “was the common law of the land” that:  “A private corporation created by the legislature may loose its franchises by a misuser or a nonuser of them.” [13 U.S. 43, 51,]

The limited life of corporations, as well as any conditions on their operations, was diminished and eventually eliminated by two campaigns.  One was the competition for fees from being a favored state for incorporation.  By 1900, New Jersey was the chartering state for 95% of America’s largest corporations, bringing such a large volume of revenues that its citizens paid it no taxes.  After New Jersey Governor Woodrow Wilson put a stop to increased permissiveness in the state’s corporate chartering, Delaware took the lead it still has today.  Its 1899 General Incorporation Law gave corporations freedoms “far beyond New Jersey.” [Charles Derber, Corporation Nation: How Corporations Are Taking Over Our Lives and What We Can Do About It, St. Martin’s Press, 1998, pages 131-134]


The other campaign to let corporations do anything, and do it forever, was a series of interpretations of Article I, section 8 of the United States Constitution, which grants Congress the power to regulate commerce among the states.  Just as the states were making corporations free of any limitations on their powers, the United States Supreme Court was granting corporations the Constitutional rights equivalent to those of human beings.  Thom Hartman argues that the remedy “means changing our laws and, probably will require amending our Constitution.”  [Thom Hartman, Unequal Protection: The Rise of Corporate Dominance and the Theft of Human Rights, Berrett-Koehler Publishers, Inc. 2002, page 282] 


State courts also contributed to making corporations serve only the interests of traders in their securities.  It is the state governments that create nearly all of our corporations, so it is state law that applies to how a corporation is governed and what duties it owes to its shareowners.  A consistent principle of corporate law was established when shareowners of Ford Motor Company sued to force Henry Ford to pay more dividends, rather than using the corporation’s money to create more jobs, at higher wages, and charge lower prices for its cars.  [Dodge v. Ford Motor Company, 204 Mich. 459, 170 N.W. 668 (Mich. 1919)]  Ford argued that the shareowners had already received more in dividends than they paid for their shares and that a five percent dividend was sufficient for the future.  The trial court ordered that half of the company’s accumulated cash be paid out as a special dividend.  The Michigan Supreme Court upheld that decision.  The most famous recent exposition of the profit-is-the-only-corporate-objective doctrine is the statement by Nobel prizewinning economist Milton Friedman, in his book Capitalism and Freedom.  Dr. Friedman described his position forcefully in an essay, “The Social Responsibility of Business is to Increase Its Profits.”  [The New York Times Magazine, September 13, 1970]  


Governments have attempted end runs around the conflict between maximizing short-term gain to Wall Street and long-term gain to the community.  They have authorized corporations that do not issue shares, at least not the kind that could be publicly traded.  An early one is the cooperative corporation, which Louis Brandeis described:  “If industrial democracy—true cooperation—should be substituted for industrial absolutism, there would be no lack of industrial leaders.” [Louis D. Brandeis, Other People’s Money: And How the Bankers Use It, Frederick A. Stokes Company, 1914, republished by National Home Library Foundation, 1933, Kessinger Publishing’s Rare Reprints, page 141]  The example Brandeis described in 1913 was the Cooperative Wholesale Society in England, founded in 1844.  It still thrives today, as Co-Operative Group, Ltd., with sales of nearly $10 billion a year.  It aims “to put co-operative values into everyday practice; to strive for the highest professional standards; to work for the long-term success of the co-operative sector; to act openly and responsibly.” [  See David Ellerman, "The Mondragon Cooperative Movement," Harvard Business School paper,]


Mutual savings banks were chartered by some states in the 1800s, to be owned by their depositors and borrowers.  When people opened a savings account or closed on a loan, they also got voting rights to elect a board of directors.  Nearly everyone also signed a proxy, so that management could cast their vote.  However, the right to change management did exist and was occasionally exercised. 


The New Deal created federally chartered mutual savings and loan associations, to increase home ownership in America.  However, Wall Street cast its avaricious eye on mutual S&Ls in the 1970s and, 20 years later, the mutuals were nearly all gone.  First, lobbyists succeeded in expanding their authority, so they could invest in Wall Street products far a field from individual home loans.  Then they were allowed to convert from the mutual to stock form of ownership.  That created a bonanza for Wall Street underwriters who underpriced new shares, sold billions of them to their money manager customers, and then resold them as brokers for quick profits.  In the Wall Street pattern, they went on to consolidate these newly public companies through mergers and acquisitions and began the quarter-to-quarter earnings management that professional securities analysts demand.  The result was riskier management decisions, bets against interest rates and economic cycles, some fraud, financial disaster and taxpayer bailout.


There are efforts being made to bring back conditions in corporate charters.  On April 13, 2010, the State of Maryland signed into law an incorporation statute which allows corporate management to “spell out their values in their charters, report annually on activities that benefit the public, and submit to third-party auditing of the societal impact.”  Changing to, or from, this corporate status takes a two-thirds vote of shareowners.  [John Tozzi, “The Ben & Jerry’s Law: Principles Before Profit,” Bloomberg Business Week, April 26-May 2, 2010, page 69]  According to the nonprofit organization called B Lab, the Maryland law “empowers directors of Benefit Corporations to consider employees, community and the environment in addition to shareholder value when they make operating and liquidity decisions. And, it offers them legal protection for those considerations.” []  Several other states have similar bills in their legislatures.