6/23/2005

Government and the Inequality Gap
    or
The Mastiff Channels Marx!

Much has been made in recent years over the growing "inequality gap" or differences in wealth between the rich and the poor. Various means have been proposed to correct this gap, most of which involve (surprise!) redistributive taxation and government spending. This is yet another example of what Howard Jarvis meant when he said, "An election year is the time politicians promise to get us out of the trouble they got us into in the first place."

What? Do I mean to say that government, that great defender of the poor and oppressed against the rapacious capitalist exploiters, has caused this problem to begin with? Perhaps not entirely, but they certainly have a lot to do with it.

How is it that the rich make money? Either they invest in the stock market, or else they build or finance new businesses. "Yes," you say, "but can’t we do those things too?" Sure. But, thanks to government regulations found in the Securities Act of 1933 and the Investment Advisors Act of 1940, those of us not already rich are operating with a serious handicap.

When a new business seeks to raise money, it has a few options. It could theoretically sell registered securities on the broad market through an IPO or bond offering; but that is expensive, and government regulations require that the company already have significant assets before it can do so (something of a catch-22). Or, the business can make a private offering, the usual course of action. Private offerings are when the first real investors get on board, buying shares for less than a dollar per share in many cases. They are taking a large risk, as many companies fail before the investors can make back their stake.

At the same time, the potential for profit is huge. Once companies get established, they usually hold IPO’s. At that point, the easy money has already been made; the original private investors are making many times their original investment on the starting IPO price alone, to say nothing of what the stock can do later. Compared to them, buyers on the public exchanges are playing for pennies.

But here’s the catch: thanks to the aforementioned government regulation, only "accredited investors" can buy into private stock offerings. And accredited investors are defined as people who either are buying on behalf of a financial institution, or make $200,000 per year, or have a net worth of $1 million. In other words, only those who are already rich are allowed to make the most money.

(Comparatively, we are pretty well off today. Imagine what those numbers meant back in 1940!)

Now the government defended the regulations as necessary to protect unsophisticated investors with little to lose from the risk of private placements, which do after all have a high rate of failure. But investing in the broad market is not much safer for those who lack the discipline to invest properly. And purchasing options and futures are incredibly risky when not part of a comprehensive strategy—believe me, I know—yet there are no restrictions on them (nor should there be).

Worst of all, governments are quite willing to use state lotteries to pad their own balance sheets. If you want a risky activity, you can’t get much worse than this. People, often relatively poor people, pay hundreds of dollars per year to the state, and get back nearly nothing. And government has the audacity to tell us that private stock placements are restricted for our own good?

Plain and simple, this is a government policy to enrich those already on top at the expense of everyone else. Investing should be on a level playing field, not rigged to favor Washington's bankrollers. The American tradition is one of limitless opportunity for those with audacity and vision; how can we deny opportunities to the poor in the name of risk-aversion?

And it is not only investors who are hurt. Business owners, to get the funding they need, must kowtow to wealthy investors, often signing away large portions of their businesses. And such wealthy investors have demands on their time, and are relatively few in number; who can say how many fledgling businesses collapsed due to lack of funding, simply because there was no good way to let the millions of small investors in America buy in?

Indeed, this is the true function of the stock market: to enable companies to raise funds. But for most of us, unless we buy into an IPO (when the easy money has already been made), our purchases do practically nothing for the companies we trade; we are essentially trading expensive baseball cards. (Ask shareholders of WorldCom how much of the company they “owned,” and how much benefit they got when it was bought out by MCI. I’ll tell you: none. The stock shares themselves were devalued and replaced by a new issue, none of which went to the original owners.)

If we are serious about reversing the trend towards concentration of wealth, we need to work for the good of the small investor, and the small business owner. It is unconscionable that only the wealthy may participate in the best way to make money in America, the true engine of our growth. The accredited-investor caste must be abolished.

1 comment:

Half Sigma said...

I have to agree with you that it's extremely hypocritical for government to advertise lotteries, and then prohibit people from investing.

Although it's state governments doing the lotteries and the federal government prohibiting investing in private placements.