Last Updated: July 12, 2010 08:06am ET
TrendCzar by Jonathan D. Miller

Incenting Long-Term Investing

By Jonathan D. Miller
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The New York Timeson Sunday led its front page with an article about stepped up Wall Street hiring as a sign of anticipated economic recovery. TARP bailouts helped limit bank job losses, but Street firms still have a long ways to go before they ramp up personnel counts to frothy 2007 levels at the peak of transaction mania. This all brings up a question not addressed by any of the recent financial reform legislation—do we want to return to the pre crash markets of quick fire real estate deals and trades where investors look for short-term opportunistic gains in appreciation over long-term investment results from husbanding property cash flows?

Of course, Wall Street firms and many real estate middlemen (brokers, lawyers, advisors) make their livings off transaction volumes.  The more trades the more fees and cuts of the action. Where owners just buy and hold, many middlemen are largely cut out. Fewer deals mean fewer jobs and lower incomes so the markets orient toward generating big transaction volumes.

I was discussing the transaction reality with a Texas developer last week. He reasons that the economy would be better served if investors of all stripes—in companies, real estate, stocks and bonds-- were oriented to longer-term holding periods. Instead of concentrating on trading and short-term gains developers and owners would build businesses and projects with greater staying power.  If a merchant builder orients to constructing a project that he plans to flip out of as soon as it’s leased up, he’ll be more likely to cut corners and go more commodity than if he were to own it long-term and have to deal with the consequences of cheaper design. The private equity investor, who buys a company to restructure it and sell out in a few years, really isn’t interested in building employee loyalty or ensuring the entity has a growth plan that will extend much beyond his limited holding period. And for all the pr spin, R&D too easily takes a back seat to quarterly returns.

My Texas developer friend suggests the result of investment myopia is assets get “marginalized” in excess volatility, bubbles, and business strategies that work against building long-term value.  He places the blame for our short-sightedness on the tax system, which gives investors no incentive to hold long-term.   After only one year, the long-term capital gain tax rate kicks in—whether you hold for 13 months or 13 years you pay the same percentage tax. He suggests increasing and extending the short-term tax burden on a sliding scale—making early year selling more punative than the current ordinary income rate (35%) and reducing the capital gains tax to below the current 15% rate for extended holding periods of ten years or more.

The resulting change in business behavior could shift away from always trying to make the quick killing to shaping businesses that have staying power, invest in their employees, and take a greater stake in local communities.

It’s much easier to trade assets than create and build them into something more. But easy money doesn’t usually endure... witness recent history.       

 

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