Investing Caffeine

King of Controversy Reveals Maverick Solution

May 12, 2010 at 1:29 am Leave a comment

Mark Cuban, provocative and brash owner of the Dallas Mavericks basketball team and #400 wealthiest person in the world ($2.4 billion net worth), according to Forbes, has never been shy about sharing his opinion. In fact, this multi-billionaire’s opinions have been discouraged on multiple occasions, as evidenced by the NBA (National Basketball Association) slapping Cuban with more than $1.6 million in fines for his outbursts.

Cuban doesn’t only provide his views on basketball, as a serial entrepreneur who cashed in his former company Broadcast.com to Yahoo! (YHOO) for $5.9 billion, he also is providing his thoughts on Wall Street and the 1,000 point “fat finger” trading meltdown from last week. What does Cuban say is the answer to the rampant speculation conducted by idiot financial engineers? “Tax the Hell Out of Wall Street,” says Cuban in his recent blog flagged by TRB’s Josh Brown.

A Taxing Solution

Specifically, Cuban wants to tax investors 25 cents per share (and 5 cents per share for stocks trading at $5 per share or less) in hopes of encouraging myopic speculating traders to become longer-term shareholders. Cuban believes this approach will weed out the day traders and investment renters who in reality “don’t add anything to the markets.”  Seems like a reasonable belief to me.

According to Cuban’s math, here are some of the benefits the tax would bring to the financial system:

“If the NYSE, Nasdaq, Amex and OTC are trading 2 Billion shares a day or more, like today, thats $ 500 Million Dollars PER DAY. If there are 260 trading days a year. Thats about 130 Billion dollars a year. If volumes drop because of the tax. It is still 10s of Billions of dollars per year. Thats real money for the US Treasury. Thats also an annual payment towards the next time Wall Street screws up and we have a black swan event that no one planned on.”

Practically speaking, a flat rate 25 cent tax per share is probably not the best way to go if you were to introduce a transaction tax, but the crux of Cuban’s argument essentially would not change. Creating a flat percentage tax (e.g., 1%) would likely make more sense, even if complexity may increase relative to the 25 cent tax. Take for example Citigroup (C) and Berkshire Hathaway Class A (BRKA). Cuban’s plan would result in paying 1.2% tax on a $4.17 share of Citigroup versus only 0.00022% tax for a $116,000.00 share of Berkshire Hathaway.  Simple accounting maneuvers such as reverse stock splits and slowing of stock dividends, along with reducing company dilution through share and option issuance, may be methods of circumventing some of the tax burden created under Cuban’s described proposal.

Politically, adding any tax to investing voters could be re-election suicide, so rather than calling it a trading tax, I suppose the politicians would have to come up with some other euphemism, such as “charitable administrative fee for speculative trading.” The financial industry has already become experts in taxing investors with fees (read Fees, Exploitation and Confusion),  so maybe Congress could give the banks and fund companies a call for some marketing ideas.

Step 1: Transparency

The murkiness and lack of transparency across derivatives markets is becoming more and more evident by the day. Some recent events that bolster the argument include: a) New CDO (Collateralized Debt Obligation) derivative allegations surfacing against Morgan Stanley (MS); b) The SEC (Securities and Exchange Commission) charges against Goldman Sachs (GS) in the Abacus synthetic CDO deal (see Goldman Sachs article); c) The collapse of AIG’s Credit Default Swap (CDS) department and subsequent push to transfer trading to open exchanges; and d) Now we’re dealing with last week’s cascading collapse of the equity markets within minutes. The brief cratering of multiple indexes points to a potential order entry blunder and/or absence of adequate and consistent circuit breakers across a web of disparate exchanges and ECNs (Electronic Communication Networks).

The mere fact we stand here five days later with no substantive explanation for the absurd trading anomalies (see Making Megabucks 13 Minutes at a Time) is proof positive changes in derivative and exchange transparency are absolutely essential.

Step 2: Incentives

In Freakonomics, the best-selling book authored by Steven Levitt, we learn that “Incentives are the cornerstone of modern life,” and “Economics is, at root, the study of incentives.”  Incentives are crucial in that they permeate virtually all aspects of financial markets, not only in assisting economic growth, but also the negative aspects of bursting financial bubbles.

Michael Mauboussin, the Chief Investment Strategist at Legg Mason (read more on Mauboussin), also expands on the role incentives played in the housing collapse:

“Many, if not most, of the parties involved in the mortgage meltdown were doing what makes sense for them—even if it wasn’t good for the system overall. Homeowners got to live in fancier homes, mortgage brokers earned fees on the mortgages they originated without having to worry about the quality of the loans, investment banks earned tidy fees buying, packaging, and selling these loans, rating agencies made money, and investors earned extra yield on so-called AAA securities. So it’s a big deal to watch and unpack incentives.”

Regulation, penalties, and fines are means of creating preventative incentives against improper or unfair behavior. Just as people have no incentive to wash a rental car, nor do high frequency traders have an incentive to invest in equity securities for any extended period of time. Adding a Cuban tax may not be a cure-all for all our country’s financial woes, but as the regulatory reform debate matures in Congress, this taxing idea emanating from the King of Controversy may be a good place to start.

Read full blog article written by Mark Cuban

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and an AIG subsidary structured security, but at the time of publishing SCM had no direct positions in YHOO, C, AIG, LM, GS, BRKA, or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

Entry filed under: Profiles, Trading. Tags: greed, investing, Mark Cuban, Mavericks, speculation, tax, Trading, Wall Street.