Big Drop Thursday: Market plunge shows why we need a transaction tax
Today’s stunning market plunge and rebound, in which the Dow Jones Industrial Average swung 874 points in 13 minutes, is Exhibit A in why a transaction tax on stock trades is a good idea.
I’ve been a buy-and-hold investor since the late 1980’s, so while I don’t look at the daily fluctuations I think I would have noticed a day with such a dramatic swing, and I sure don’t remember one. (If I’m wrong, please correct me in the comments; I’d look through the charts myself but it would cause me to miss a deadline.)
The remarkable turn of events appears to be the result of computer-driven trading, in which trading firms employ software algorithms that automatically generate transactions. (For one thing, humans can’t trade at the speed required to move the market so far, so quickly.) These programs were blamed for much of the markets’ losses in late 2008 and early 2009, which saw a lot of days on which indices would plunge around 3pm after falling slightly, or even trying to rally, earlier on; the programs see a certain set of factors in place at a certain time of day and it sets off alarm bells, generating frenzied automatic selling no matter the stock and no matter the news.
There’s nothing wrong with these programs per se—in fact I’m sure they’ve helped market efficiency in some ways—but when a perfect storm happens they can wipe out trillions in shareholder value overnight, with no basis in fundamentals like EPS or EBITDA. When that happens, they’re acting on trends, not on the inherent value of companies which we’re supposed to be investing in. These algorithms are both a function and a cause of the transition of stock trading in recent decades from an emotion-driven casino where people and computers are betting on share price, instead of a rational market in which investors are buying a share of a company’s future earnings.
When I started watching the markets, a day in which a billion shares were traded was considered heavy volume. Today that’s typical for a Friday before a long weekend. A transaction tax would keep things from boiling over so frequently by putting a lid on much of the meaningless but stress-inducing volatility that gives traders and investors heart attacks.
A transaction tax—there are various proposals, but the one proposed in Congress would place a 0.25% levy on trades of $100,000 or more, and 2% on derivatives—would cause these algorithms to be recalculated on the side of caution. This wouldn’t affect Main Street investors, who generally don’t fool around with 100 grand at a pop and to whom the derivative markets aren’t open, but it’s estimated this plan would raise $150bn a year. It’s true that big institutional investors are trading with pension funds that affect regular folks’ pocketbooks and retirements, but the costs would be so spread out as to be barely noticeable, and in exchange we’d get a lot of market stability and send a lot of foolhardy players messing around with other people’s money to the sidelines.
Ask anyone who planned to tap their 401(k) or whose pension vested in late ‘08 or ‘09 if they’d give up a few dollars for every $100k of their nest egg in exchange for that.
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