Yesterday’s 2:45 Crash Boosts The Case For A Financial Transactions Tax

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AP091021033310Yesterday, at about 2:45 p.m., the stock market abruptly fell by more than 900 points, the largest intraday plunge on record. The fall lasted only 16 minutes, with the Dow closing down by about 350 points, but as the New York Times put it, the quick plunge “left Wall Street experts and ordinary investors alike struggling to come to grips with what had happened — and fearful of where the markets might go from here.”

The reason for the fall, and quick rebound, is still being parsed, but it seems to be some combination of serious jitters over the situation in Greece, as well as the unfortunate simultaneous firing of computers programmed to sell stock in response to events and market levels. “We have a market that responds in milliseconds, but the humans monitoring respond in minutes, and unfortunately billions of dollars of damage can occur in the meantime,” said James Angel, a professor of finance at Georgetown University.

The computerization of stock trading has significantly increased the flow of stock trading, but by leaving so much up to pre-set formulas, the sort of volatility that occurred yesterday can snowball out of control. But as Reuters’ Felix Salmon explained, “a simple way to deal with nearly all of these problems, at a single stroke, would be to implement a tiny tax on financial transactions”:

Historically, people have complained that such a tax harms liquidity, which is true. But the fact is that it harms the bad kind of liquidity — the liquidity which dries up to zero just when you need it most. Liquidity, if it’s spread across multiple electronic exchanges and can disappear in a microsecond, does very little actual good, and in fact does harm during tail events like this. Let’s tax it, and raise some money for the public fisc at the same time as slowing down markets and making them think before doing a trade.

Mother Jones’ Kevin Drum added, “our financial system really needs a little bit of sand in the gears to bring it back down to human speeds. [A transactions tax] would be a good way to do it, and would probably have other benefits too (quite aside from the money it raises). Count me as a fan.” You can count me as a fan too.

Capitol Hill has had an on-again, off-again relationship with the financial transactions tax recently, while the Obama administration has been staunchly opposed. But such a tax would serve a plethora of sound economic causes. It will help temper trading for trading’s sake and excessive speculation, particularly in the form of high-frequency trading, which only major Wall Street players have the infrastructure to engage in and which will become far more expensive. And it could be a serious revenue raiser in an era of unsustainable deficits, as even a tiny transactions tax has the potential to raise $150 billion annually.

As Center for Economic and Policy Research Director Dean Baker wrote, “if a financial transactions tax reduces the volume of trading, and therefore the resources used by [the financial] sector, without harming the sector’s ability to allocate capital, then it will be making the sector more efficient and freeing up resources for more productive uses.” Baker estimates that a transactions tax will free up $60 billion a year in capital for productive uses.