What is the difference between speculation and investment? An old chestnut circulating on stock markets worldwide says: If I made a quick killing on the deal, it's speculation. If I lost money on it, it's an investment. If I lost my pants, it's a long-term investment.
More seriously, answers in the literature focus on themes of risk and time. The risk-based definition is this: A speculation is a transaction with a high risk element, such as buying participation units in oil drilling partnerships. Investment is a solid deal with a high chance of receiving a moderate return. The time-based definition is rather like the joke, holding that speculation is based on a rapid return: buy, sell; in, out. Investment is a long-term prospect.
Those definitions sound very clear-cut in theory, but in real life there are shades of gray. Take this example: Someone buys stock in Teva Pharmaceutical Industries, a company that has been consistently growing for years. In fact, he puts all his money into the company. Suddenly the stock plunges 10% and the investor decides to cut his losses and sells. Did that deal make him a speculator?
Or take real estate. Buying a home is usually considered an investment because of the low fluctuation in pricing levels and long possession time. But paying for 90% of that home using borrowed money changes the risk profile of the transaction, making it highly speculative.
In other words, there is no clear answer to the difference between speculation and investment.
Yet the American legislature recently addressed that very question. The Dodd-Frank law, named for its sponsors, doesn't discuss private investors or even investment managers, just banks. It rules - though the details haven't been finalized - that banks may not invest on their own behalf. They may not, in a word, speculate.
Dodd-Frank is of course an upshot of the global financial crisis, which proved that banks had been speculating massively and dangerously. Many collapsed. Bear Stearns, Merrill Lynch and Lehman Brothers vanished or were acquired. Almost all the big banks needed a bailout. The bill came to trillions of dollars, courtesy of the taxpayer.
So to prevent recidivism, the banks are being prohibited from indulging in proprietary trading. They may broker deals for clients. No more.
The law is ruffling feathers up and down Wall Street. The banks naturally object and are wielding all their clout to influence the subsidiary regulations, which are still being written, so as to undermine or at least soften the law - for instance, by allowing proprietary trades through subsidiaries. That is because proprietary trades are one of their biggest profit sources, possibly even the biggest.
Dazed and confused
The banks claim it's hard to tell when a transaction is being done for a client (service ) or for themselves (speculation ). Since these activities can't be distinguished, they argue, their activities can't be constrained.
Paul Volcker, the man behind the law, snorts. "Bankers know when they're doing a proprietary trade, I assure you," the former Fed chairman told Reuters last Wednesday. "If they don't know, they shouldn't be in the business."
Still can't tell? Volcker is there to help. "If there are big unhedged positions constantly, then it's proprietary trading," Volcker said. (An unhedged position involves a bank taking risk and not offloading it through other securities or derivatives, Reuters explains. )
Volcker feels the law is powerful enough, yet he remains worried. He's afraid the powers on the Street will water it down and the banks will party on unhindered. Banks that can't adhere to proprietary trading restrictions probably shouldn't be eligible for the protections and funding advantages that are part and parcel of the Federal Reserve system, he told Reuters.
If the Volcker law is defanged, it wouldn't be the first time the finance lobby has prevented a crackdown. That's how the rich and America's financial establishment, abetted by the politicians, led in less than 30 years to a situation in which 0.1% of the population earns 20% of all income. Via laws that benefited them, and mainly by shooting down laws that would have tightened supervision and distributed income more fairly, the Wall Street lobby forged the golem that enriched it and, finally, caused the worst financial crisis in 70 years.
What did the investigation into the crisis uncover? That regulation had collapsed, enabling the banks to take gigantic risks using other people's money - that of shareholders, bondholders, depositors. When the risk paid off, the bank managers shared out the loot, giving some to the workers through gigantic bonuses that came to billions of dollars a year. When the risk didn't pay, the taxpayer was handed the bill.
Israel didn't have a crisis of that kind. But we're no different. Here, too, the top bankers, the tycoons with holding companies, the financiers whose faces grace the gossip columns all follow the same principles. The method is to borrow from the public, speculate in the markets and take home the profits. And if the risk materializes, then go hat in hand to the state begging for help from taxpayers and savers, through exemptions, haircuts and debt deferrals.
Just like in the U.S., the only way to stop the wagon from careening on is by law: regulation and rules that derail the system by which riches pass from the many to the few.
That is why the tycoons and "economic leaders" are so fiercely opposed to any change in the law. They don't want to be Joe Investor, nameless and slow to earn. It's hard. It takes decades to build up wealth. You have to pay tax and don't wind up with much. Their business model is to use the public's money and speculate. In and out.
That is why they oppose the Sheshinski committee on gas royalties, the competitiveness committee, the executive pay committee, estate tax, changes in antitrust law. That is why they do everything in their power to frustrate, foil, halt and blur every reform that aspires to change the rules of the game.
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