Washington's war against short-term stock traders

Recently, voices on both the left and the right have bemoaned "short-termism" in financial markets, blaming hedge funds for this problem, and urging instead that government policy should promote long-term profits in corporate America. Sounds reasonable at first glance, right? And yet such a shift would undermine everything that makes the American economy the envy of the world. Using government policy to promote long-term horizons in corporate America would promote an insidious form of government cronyism.


The AFL-CIO recently released a statement on hedge funds, complaining that "strategies employed by activist hedge funds can put pressure on companies to ... cause stock prices to go up in the short-term but undermine long-term viability of target companies." In a fact sheet released after former Secretary of State Hillary ClintonHillary Diane Rodham ClintonWhite House denies pausing military aid package to Ukraine Monica Lewinsky responds to viral HBO intern's mistake: 'It gets better' Virginia governor's race poses crucial test for GOP MORE's (D) second major economic speech of her campaign last year, she urged reform to stop hedge fund "shareholders when they focus on short-term profits at the expense of future growth" and advocated "shedding light on excessive buybacks that could take resources away from long-term investment."

Republicans are also often tempted to join this obsession with preferring "long-term" investments over "short-term" investments. Former Rep. Bob Barr (R-Ga.) urged last year that Republicans should rein in short-sale manipulators who are unfairly harming particular companies.

(This is where financial economists will argue that stock price doesn't really differentiate between long-term and short-term value. In the market, a company's stock price reflects the current value of future profits looking ahead for as long as the company survives.)

The government policy of promoting long-term profits is bad economics, and even worse, it is engineered to favor incumbent firms and stifle innovation. When the government gets to decide the proper term of your investments, it constitutes the same form of cronyism as when campaign donors are directly given sacks of cash by the government officials they donated to when they were candidates.

A guiding principle in our economy is Joseph Schumpeter's theory of "creative destruction." Just as some forests need to burn in order to clear away brush and make way for more robust growth, economic innovation also requires that old and outdated companies be broken up for new replacements to take root. Recently, Americans have received an education in this principle by watching Uber's challenge to the taxi cab incumbents.

The American capitalist economic system is at its best when guided by the principle that no firm is too big or special to fail. While corporate executives may feel such a jungle atmosphere is harsh and unforgiving, don't forget that customers who buy products and investors of capital are at the top of the food chain in this jungle. Wall Street banks and corporate executives are the prey! Protecting failing companies and subsidizing politically powerful incumbent firms, under the false guise of promoting long-term value, is simply un-American.

Readers may feel that we've already opened that Pandora's box with the bailouts of 2008, when some large banks were deemed "too big to fail." While that's right, it's also not too late to close the box. Consider the case of David Einhorn at Greenlight Capital, who famously bet against Lehman Brothers a year before it failed. At the time, hedge fund investors like him were pilloried, and the Securities and Exchange Commission even imposed a short-term ban on betting against companies in the midst of the crisis.

What if we had hundreds more investors just like Einhorn, betting against the firms that failed in 2008 years before they became so large and interconnected that they were able to threaten the global financial system? The sound you hear, as you consider that hypothetical, is Pandora's box being slammed shut.

If we want a safer and more robust economy, we should make it easier for shareholders to bet against a company's rise in stock price, not harder. We should also make it easier for shareholders to buy up enough shares to obtain control of a company and kick poorly performing managers out.

Warren Buffett once observed that, like economic crises reveal financial frauds, "only when the tide goes out do you discover who's been swimming naked." Hedge funds have often been described as shark investors. In light of the events of 2008, maybe we need more sharks in the water.

Verret is a senior scholar with the Mercatus Center at George Mason University and an assistant professor at George Mason University School of Law.