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Figure 5.1 speaks for itself. You can see the tremendous bulge in the size of the deficit and the increase in the national debt that occurred in 2009, as federal programs were put into play to alleviate the effects of the Great Recession. Economists consider part of the deficit as structural, recurring as part of government’s overall initiatives and priorities, and some of it as cyclical, as in the medicine applied to fix the banks, reduce unemployment, and so forth. You can see that as some of the economic stimulus takes hold, the deficits and increases in debt are declining slowly, but still considerably exceed earlier figures, and for that matter, any time in history.
Figure 5.1 Projected Deficits and Debt Increases, 2001–2012
Source: Congressional Budget Office, U.S. Treasury
If there is any good news about deficits and debt, it is that they are still moderate compared to the size of the national economy. Government spending in the United States runs about 25 percent of GDP, compared to figures of 50 percent and higher for many other developed Western nations. The deficits, while huge in absolute dollars, have run somewhere in the range of 3 to 5 percent of GDP historically—again, not a large number on the world stage, but with the recent increases in the deficits and accompanying moderation in GDP growth, the figure has risen to 6.2 percent most recently.
Why You Should Care
Different people feel differently about being in debt. Clearly, the rising levels of debt “put the burden on our children,” but that’s been said for years. It’s alarming to think that our national debt runs about $52,953 per person (that’s $212,000 for a family of four, up about 60 percent since 2009)—if you ran up such debt on your own you’d be in big trouble! But the government can print money, and other nations find it in their interest to support our debt. Inflation may take some of the sting out of the debt as well (see #34 Reflation). But it is still a big elephant in the room, one to be concerned about for the future, and it argues for all of us to reduce our spending habits and not get carried away trying to prevent economic downturns (see #59 Austrian School).
43. SECURITIES ACTS OF 1933, 1934, AND 1940
While the Great Recession was a big deal, and new legislation has emerged from it (see #39 Dodd-Frank), so far it has not been a watershed for new securities and investment laws, as were the 1929 stock market crash and the Great Depression. Those events brought Congress to pass a series of laws to regulate the heretofore largely unregulated securities industry. Many newer laws have come onto the scene, but the four “biggies” remain the set passed in 1933, 1934, and 1940.
What You Should Know
The four laws listed below set the ground rules for selling securities to the public and for trading those securities, and for investment companies and professional investment advisers. They also set up and defined the role for the Securities and Exchange Commission (see #44 SEC).
Securities Act of 1933 was designed to limit outright securities fraud; it requires disclosure of financial information for securities brought to public sale. It also prohibits “deceit, misrepresentation, or fraud” in the sale of securities. It is sometimes called the “truth in securities” law.
Securities Exchange Act of 1934 did two things. First, it created the SEC and empowered it to register, regulate, and oversee brokerage firms and firms otherwise dealing in securities transactions, and also set up a system whereby it could extend its reach by aligning with industry trade organizations like the Financial Industry Regulatory Authority (FINRA), formerly the National Association of Securities Dealers (see #82 Brokers, Broker Dealers, and RIAs), and the securities exchanges themselves. Second, it required regular financial reporting to holders of corporate securities.
Investment Company Act of 1940 regulates so-called investment companies—companies set up to invest in securities and then sell their own shares to the investing public. This law set the ground rules for mutual funds. Those ground rules include tax-free pass-through of income, a requirement that at least 90 percent of income generated is paid out, and limits to sales charges and fees. If you own a mutual fund, that fund is designed within and regulated by this law.
Investment Advisers Act of 1940 regulates professional investment advisers. This law requires advisers, within certain definitions and limits, to register with the SEC and conform to regulations designed to protect investors.
These laws provide a framework, but aren’t absolute in nature; the SEC can and does have authority to add rules to these laws to close gaps and accommodate new technology and methods.
Why You Should Care
While it’s easy to think that financial firms, investment funds, and advisers got away with murder during the recent crisis, you should know that there is a fairly substantial framework in which they operate. That said, the shortcomings of the SEC became apparent. As a prudent individual, you should always make sure any investment adviser you deal with is registered.
These laws don’t cover everything in the investment markets. If you’re thinking about hedge funds (see #72), realize they largely escape this framework because they are targeted toward certain qualified individuals, not the public at large. As we found out with the recent failure of MF Global, a commodities trading firm run by former New Jersey governor Jon Corzine, they don’t apply to commodities trading, either. That may change, and new laws may also emerge to counteract scandals like the Bernard Madoff debacle.
44. SECURITIES AND EXCHANGE COMMISSION (SEC)
The Securities and Exchange Commission is an independent public agency within the U.S. government, chartered primarily to enforce the major securities laws outlined in the previous entry. The SEC is a vital referee in a game that, without referees, might well go out of control, although it has been on the hot seat for some important “no-calls” and bad officiating in recent years.
What You Should Know
The SEC is a large and complex organization, but much of it is organized in the following four major groups, three of which loosely align with the major securities laws covered above:
Division of Corporation Finance primarily oversees proper disclosure of regular financial information to the public, like a
Division of Trading and Markets concerns itself with “maintaining fair, orderly, and efficient” markets. As such, this division makes sure exchanges, brokers, and others involved in trading securities follow the rules, especially those set forth in the 1934 law.
Division of Investment Management ensures proper registration and disclosure for funds, investment advisers, and investment managers—primarily the 1940 laws.
Division of Enforcement investigates violations and takes civil or administrative action when appropriate.
The SEC got into trouble in the aftermath of the Bernard Madoff scandal. In its defense, it simply doesn’t have the staff to properly police the rapidly expanding and ever-faster-moving securities markets. The staff of 4,000 must sift through 90,000 complaints brought to the SEC each year; out of these, some 794 enforcement actions took place in 2012. In addition to the complaints coming in, staff has a responsibility to examine things on its own to ensure compliance. Some still say the SEC is too cozy with big players, choosing to assume they’re right or to look the other way, while spending too much time enforcing registration and other minor compliance issues with smaller brokers and dealers. Under the leadership of Chair Mary Jo White, and with the backing of certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (See #39), the agency has taken many steps, including hiring more agents and reviewing internal processes, to deal with these issues. Today’s SEC is generally considered more aggressive in its investigation and enforcement of compliance within the securities industry