David Brooks, "The Role of Uncle Sam": Pleasuring a Ghost

Personally, I'm not concerned about displeasing the ghost of Alexander Hamilton. Rather, I believe the US has reached a series of hurdles without the leadership, or potential leadership, to take it over or around these barriers.

In his latest New York Times op-ed, "The Role of Uncle Sam" (http://www.nytimes.com/2012/05/29/opinion/brooks-the-role-of-uncle-sam.html), David Brooks observes that a bloated American federal government has abandoned its pursuit of fostering innovation in favor pandering to voters’ transient desires. Brooks concludes:

"We’re not going back to the 19th-century governing philosophy of Hamilton, Clay and Lincoln. But that tradition offers guidance. The question is not whether government is inherently good or evil, but what government does.

Does government encourage long-term innovation or leave behind long-term debt for short-term expenditure? Does government nurture an enterprising citizenry, or a secure but less energetic one?

If the U.S. doesn’t modernize its governing institutions, the nation will stagnate. The ghost of Hamilton will be displeased."

Here Brooks and I don't see eye to eye.

First, there can be no ignoring the fact that unemployment has exceeded 8 percent for a record 39 months. Americans are in pain, and many need short-term assistance to bide them over these hard times.

However, questions then arise what caused these hard times, how long are these hard times are apt to persist, and what can lift America out of the muck of stagnation.

Notwithstanding the passage of another Memorial Day, largely absent from the debate between the Obama and Romney camps is an examination of America's ongoing ground presence in Afghanistan, which was foolishly escalated by Obama and which is bleeding the American economy white for no logical reason.

In addition, although America was promised "Change" by Obama in 2008, American banks are still engaged in reckless trading activity, as evidenced by the most recent JPMorgan Chase fiasco. Quite apart from the issue of whether US taxpayers should be expected to bail out banks for their excesses, the more fundamental question arises why banks, with their bailout money, were not forced to go back to the "boring" business of lending money to creditworthy individuals and corporations, thus jumpstarting the economy. It's time to reenact Glass-Steagall.

Worse still, innovation was devastated by the elimination by the SEC of the Uptick Rule.

The Uptick Rule went into effect in 1938 in response to market abuses that threatened the health of the US economy, and prohibited short sales of securities except on an "uptick". As summarized by the SEC:

"Rule 10a-1(a)(1) provided that, subject to certain exceptions, a listed security may be sold short (A) at a price above the price at which the immediately preceding sale was effected (plus tick), or (B) at the last sale price if it is higher than the last different price (zero-plus tick). Short sales were not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions."

The Uptick Rule was cancelled in 2007, thereby enabling hedge funds to short shares, i.e. sell shares they did not own, in almost unlimited, immediate quantities, and permitting them to benefit from resultant investor panic in almost any given traded company.

Example: Micro-cap company "X" has designed and patented a revolutionary widget. Recently, the achievements of "X" have made their way into the news, and its shares have risen. Farmer Joe, who attends night school and reads the financial news, decides to buy 1,000 shares of "X". However, unbeknownst to Farmer Joe, Slick Eddy at Hedge Fund "Z", who couldn't care less about the merits of company "X"'s widgets, has also noticed the rise in the share price of "X". With almost unlimited resources behind him, Eddy borrows "X" shares from various financial institutions and begins to sell vast quantities into the market, causing a precipitous decline in the market price of "X". Eddy then blocks any rally in the share price and immediately sells shares at the bid after any significant purchase. Worried by the huge downswing in the price of "X" accompanied by unusually high volume, and also concerned that at the end of each trading day "X" always goes down (Eddy always sells into the market in the last seconds of trading), Farmer Joe dumps his shares at an enormous loss ("Someone must know that something's wrong at 'X'"). Having succeeded in panicking Farmer Joe and other small investors in "X", Eddy buys back the shares at a significantly lower average price than that at which he sold them, resulting in enormous profits for Hedge Fund "Z". Eddy's bosses note his "fine" work and reward him with bonuses as the shares of "X" tumble.

Of course, there are those who will say that ultimately the stock market is "efficient", and the price of "X" will recover to an appropriate level. However, in the process we have witnessed the flow of wealth from Farmer Joe and other small investors to Hedge Fund "Z" and Slick Eddy.

Also, consider the damage to company "X", which, owing to doubt raised by the run on its shares, is suddenly unable to raise additional funds to finance production of a new line of widgets, declares bankruptcy and fires its staff.

It is widely thought that the elimination of the Uptick Rule significantly contributed to the 2008 financial crisis from which America has yet to recover. Why has the Uptick Rule not been reinstated? Obviously, there are powerful lobbyists from the financial industry opposed to its reenactment, which would kill this cash cow.

Yes, American government is bloated and needs an overhaul. Yes, government should be seeking to spur innovation. But more important, "Change" begins by ending meaningless foreign involvements and reining in the banks and hedge funds.