When Ryan Howard of the Philadelphia Phillies finished the 2006 regular season with 58 home runs, some commentators referred to the feat as the closest “real” effort to eclipse the single-season record of 61 home runs set by Roger Maris in 1961. Though baseball analogies can be tricky, I thought about that during the last couple of weeks, as the Dow ventured above the 12,000 mark. The record highs set by the blue-chip stock index were remarkable — “real” milestones untainted by the previous decade’s performance-enhancers of dot.com “irrational exuberance,” analyst hype-for-pay, inflated earnings, and “creative” accounting.
For me, the recent stock market development signifies a welcome departure from a 1990s’ culture of “competitive advantage,” a term often translated to mean “if everyone else is cheating to win, I’ll be darned if I don’t.” That culture has been replaced by a greater appreciation, in the last few years, of “competitive integrity,” whereby it is better to know the truth, even if the numbers are lower, than it is to celebrate false highs. It’s a culture whereby high achievement, if reached, can be unreservedly hailed for genuine excellence, hard-earned and fairly won.
This context is helpful when you hear people cite the Clinton years in making the argument that the market likes it better when Democrats are in power. (On that score, I have greater trust in a recent academic study that demonstrates just the opposite to be the case.) More persuasive than preference, however, is performance, particularly when the Dow climbs to new highs off a solid and sustained economic foundation.
Despite the shocks of a burst dot.com bubble, the terror attacks of 9/11, corporate scandals, and the hurricanes of 2005, the economy has maintained historically low inflation, interest rates, and unemployment since May 2003, while adding more than six million new jobs and growing at a robust average rate of more than 3 percent. The extraordinary resiliency of the American economy is the great untold story of our day.
This surge did not come about by accident or artifice. Instead, it was unleashed by the creative energies of the American people, and touched off by the passage of investor-class tax cuts on capital gains and dividends by the Republican-controlled Congress in May 2003. The result has been the creation of $5.7 trillion in new investor wealth and an increase to $14.4 trillion in household net worth.
When Democrats talk about how they plan to rollback only “tax cuts for the wealthy,” it’s a safe bet that these are precisely the tax cuts, and investor gains, they have in mind to cancel. If you are among the 91 million Americans (or more than half of all American households) who now own stocks directly or indirectly through mutual funds and 401(k)s, don’t be surprised to discover that you are precisely the “wealthy” folks that Democrats have in their crosshairs.
But the ability to keep, save, reinvest, and retire with more of what you earn, though crucial, is only half the story of recent investor success. The other half is historical, and has to do with the long-standing preeminence of American capital markets as the deepest, most liquid, and most efficient markets across the globe.
We take pride in the fact, even if we sometimes take it for granted, that U.S. markets are the envy of the world. We understand the truth of John F. Kennedy’s aphorism, seemingly long forgotten by his Democratic party, that “a rising tide lifts all boats.” When U.S. markets serve as the trusted destination for capital the world over, business creation, corporate expansion, job formation, and technological innovation are supercharged, a process that circles back to greater returns on investment.
And yet much of this is today at risk.
WHAT’S AT STAKE
Recent trends suggest that the preeminence of the U.S. markets may not be a permanent phenomenon. As economists R. Glenn Hubbard and John L. Thornton pointed out in a recent Wall Street Journal column,
In 2000, 90% of the funds raised by foreign companies through new stock offerings were raised in the U.S. The ‘90% rule’ held in 2005, too, but in reverse — 90% of the funds raised by foreign firms through new listings occurred in Europe and other non-U.S. markets. Last year, only two of the world’s 25 largest initial public offerings listed in the U.S. In the universe of global IPOs, the fraction of non-U.S. IPOs listed in the U.S. has fallen to under 10% so far in 2006 from 37% in 2000.
While the strength of foreign markets is something to cheer, this trend would pose a significant threat to American investors were it to continue. It also points to the clear need for a new “global competitiveness” agenda, one that will make sure U.S. markets stay on top.
We can start by taking a candid look at the challenges that may have contributed to the current situation.
Beginning in 2001, the Republican-led House Financial Services Committee began the first inquiries into analyst conflicts of interest, held the first hearings on Enron, and led the way on tougher oversight for scandal-plagued Fannie Mae and Freddie Mac as well as mutual fund reform. And all this occurred before various state regulators embarked upon their own high-publicity cases in these matters.
Over the years I have defended state officials in their pursuit of justice. I have been less appreciative of some of their remedies, such as working behind closed doors not only to reach financial settlements, but also to unilaterally impose changes to market structures and practices that would impact the entire securities industry. For pointing out these undemocratic methods, I have on occasion been attacked as being a selective proponent of states rights, even as these charges conveniently distort one of the chief benefits of federalism — the assurance, especially with regard to interstate commerce, that one state cannot dictate the rules to all the others.
Equally troubling was the pattern these cases followed, whereby much of the money obtained through compensatory settlements was funneled into various state coffers. I have likened this to the sheriff giving you the good news that he’s found your stolen car, with the bad news that he likes it so much he’s going to keep it.
In contrast, when negotiating the Sarbanes-Oxley Act, House Republicans insisted on the creation of the Fair Fund for Investors, which made it possible for all fines obtained in SEC enforcement actions to be distributed to the offended investors. Prior to 2002, all civil penalties obtained by the SEC in securities enforcement actions were deposited in the general fund of the U.S. Treasury. To date, the SEC has collected approximately $3.3 billion in funds and has distributed more than $770 million to injured investors.
Being from Louisiana, I know a thing or two about politicians who claim to fight for the “little guy,” when in reality they’re accumulating more power for themselves and raising the costs for everyone else. This results in little perceivable benefit for those they purport to protect. House Republicans, on the other hand, have pushed for tough market reforms — have actually helped wronged investors — while understanding that investors are in the market to make money and that no one ultimately wins when overreaching government interventions bring down the whole market.
Runaway litigation also has dealt a blow to the confidence of our markets. Here, rather than proud risk takers, investors are viewed as potential victims.
Just look at the law firm of Milberg Weiss, which Fortune editor-at-large Peter Elkind called “the lawsuit factory that took corporations for $45 billion.” Wrote Elkind,
In the most extraordinary federal case now afoot in the land, Milberg Weiss has been indicted for allegedly paying three plaintiffs $11.4 million in illegal kickbacks in about 180 cases spanning 25 years — and then repeatedly lying about it to the courts.
Frivolous lawsuits are undeniably and unnecessarily raising the costs of doing business in America, and frightening off investors. I am convinced that common-sense securities-litigation class-action reform is not only a necessary component for safeguarding our global competitiveness, but that it also will cut the costs for plaintiffs in legitimate suits without diminishing the quality of representation. And while it is encouraging to see New York’s Democratic Sen. Chuck Schumer write in the Wall Street Journal this week that “it may be time to revisit the best way to reduce frivolous lawsuits without eliminating meritorious ones,” I would be more confident in the prospect of bipartisan collaboration on this effort were it not for the hundreds of millions of dollars in campaign contributions the Democrats reap from these firms — Milberg Weiss among them.
In the same vein, we need to be more forward-looking in terms of harnessing technology to enhance corporate transparency and disclosures. In particular, by expanding the use of eXtensible Business Reporting Language (XBRL), shareholders will have access to more complete, real-time, and easily understandable information on which to base their investment actions.
There needs to be a proper balance between regulation and providing investors the tools they need for success, so that the two are not mutually exclusive but in fact complimentary. Similarly, since so many of our securities laws were enacted in 1933 and 1934, at a time when nobody even contemplated the use of derivatives and hedge funds, it is essential that all of our rules for the marketplace, including the much bemoaned Section 404 of the Sarbanes-Oxley Act, undergo a careful review. By weighing costs against benefits, we can discover which regulations place an undue burden on market performance, and from there pursue pro-investor and market-competitiveness reforms accordingly.
SOME FRANK ADVICE
How does all this relate to the upcoming congressional elections? Well, on an ideological level, consider one of the most talked about liberal books in recent years, What’s the Matter with Kansas?, by Thomas Frank. This book proposes that more average Americans would vote Democratic if they only realized their own economic interests. This arrogant condescension notwithstanding, I long have held that there exists a form of liberalism that, when it sees a profit, moves to tax it. And if that doesn’t do the trick, it then tries to regulate it. And if there’s anything left over after that, it takes steps to sue it. I just never thought I’d live to see the day when liberals would, as they have with relation to the markets, so openly advocate more taxation, more regulation, and more litigation, and, with a straight face, argue that most Americans would find this to be an attractive prescription for their financial well-being.
On a more practical level, the election will determine who becomes chairman of the House Financial Services Committee, which has oversight jurisdiction of our capital markets. On the Republican side, due to term limits established after 1994, a selection process will determine who next heads the committee. The two most spoken of leading candidates, myself and Rep. Spencer Bachus of Alabama, are focused right now on helping maintain the Republican House majority. I believe either of us, given the opportunity, would provide strong leadership on Financial Services — guidance that would be informed by conservative principles, as evidenced by our most recent rankings in the National Journal on economic policy. (We were scored as more conservative than 86 and 83 percent of our fellow lawmakers, respectively.)
On the other side of the aisle, seniority alone indicates that a Democratic House majority will see Rep. Barney Frank of Massachusetts ascend to committee chairman. I have tremendous respect for Rep. Frank’s keen intelligence and sharp wit, and enjoy the intellectual combat we engage in over policy. However, I strongly believe it will be better for the nation if he is on the defensive against our conservative agenda, and not the other way around.
To get a sense of what Frank’s agenda would be like, look no further than those same National Journal rankings, where Frank was scored more conservative than zero percent of his colleagues. Or you can turn to his announcement this past week that he would consider the creation of a “global regulator” to share oversight of American financial markets with the SEC.
According to Frank,
Joint action is theoretically [good] but what does that mean? In American baseball, if the runner and the ball arrive at the base at the same time, the tie goes to the fielder. Who breaks a tie if there is a disagreement over policy between the SEC and [the UK’s Financial Services authority]?
It’s one thing that the honorable gentleman from Massachusetts doesn’t quite grasp the most easily learned rule of baseball: a tie goes to the runner. More frightening is his admission that he can contemplate a world in which foreign regulators will have an equal claim to governing U.S. capital markets. On the question of global competitiveness, the Democratic position appears to be that we have met the enemy, and he is us.
In fairness, baseball analogies, like I said at the start, can be tricky. So let me put all this in the clearest possible terms for America’s 91 million investors: For the sake of your 401(k), and your family, vote Republican on November 7.
– Rep. Baker (R-La.) serves as chairman of the House Financial Services Committee’s Subcommittee on Capital Markets.