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Why is finance so complex?
December 29, 2011 3:26 AM   Subscribe

"You can have opacity and an industrial economy, or you can have transparency and herd goats"
posted by Philosopher's Beard (97 comments total) 20 users marked this as a favorite

 
If only everyone would invest, there’s a pretty good chance that we’d all be better off, on average our investments would succeed. But if an individual invests while the rest of the world does not, the expected outcome is a loss.

It's the classic Supply and Demand curve. If there is more Demand than Supply, prices go up. More Supply than Demand, they go down. Unfortunately, this has no real relationship to the needs of funding economic enterprises, which is EXACTLY why the "Stock Market" is so great at increasing shareholder value while destroying everything else.
posted by oneswellfoop at 3:45 AM on December 29, 2011 [7 favorites]


I was thinking along similar lines recently - the reason finance stuff tends towards complexity is because of constant patching with legislations and workarounds of said legislation, with the neat (for some) side effect that complexity produces profitable little niches for those that understand them. Or in other words, if our money system was beautifully simple then banker types would have a much harder job making out like bandits.
posted by memebake at 3:46 AM on December 29, 2011 [7 favorites]


Opacity is not something that can be reformed away, because it is essential to banks’ economic function of mobilizing the risk-bearing capacity of people who, if fully informed, wouldn’t bear the risk. Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper.

That's a pretty tall claim, and from what I can tell it's not really supported by the rest of the article. What he's talking about boils down to the already well-known greater fool theory, but it's certainly not the only kind of investment - value investing is a common alternative. I must be missing something.
posted by vanar sena at 3:53 AM on December 29, 2011 [3 favorites]


It's wrong in that ignores risk pooling and the idea that risk averse people will invest if returns are sufficiently high, but I guess that's done for rhetorical effect.
posted by hawthorne at 3:58 AM on December 29, 2011


... for example, a bank loans capital to some dude to start a bakery, with the expectation that the bakery's profits will cover the loan repayment plus interest. What's the role of information asymmetry here?
posted by vanar sena at 3:59 AM on December 29, 2011 [2 favorites]


While we're here, here's a question I've been pondering that I'd like to throw out for the economists - my understanding is that although people tend to think of the money in their bank account as 'theirs', in practice they have 'lent' the money to the bank who then lend it to other people but promise to give it back to the lender if they need it (as often noted, a promise they can only keep under certain conditions). So really the money is only 'theirs' if they keep it under their mattress or something.

Now, it seems that in the modern world, for all intents and purposes, having a bank account is pretty much vital if you want to do anything at all - e.g. try getting your employer to pay your salary if you don't have a bank account - so we now live in a society where lending money to banks is (for all intents and purposes) mandatory. I have a feeling this should change our whole concept of what money is and several of the fundamental principles underpinning it. So: How does 'mandatory' banking affect the theory of money?
posted by memebake at 4:04 AM on December 29, 2011 [11 favorites]


Vanar Well, would you loan money to your brother to open a bakery? What about some stranger? Of course not, almost all small businesses fold.
posted by Philosopher's Beard at 4:08 AM on December 29, 2011


Opacity is not something that can be reformed away, because it is essential to banks’ economic function of mobilizing the risk-bearing capacity of people who, if fully informed, wouldn’t bear the risk. Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper.

Bullshit!

People understand that risk and return rates are related. In the past, before the banksters managed to convince people that they could be separated, everyone agreed on this as a core societal value. Now with the derivatives market outgrowing legitimate savings and investment by orders of magnitude, the traditional model has been destroyed, on purpose, by those who are plundering OUR life savings.

This is one of the many attempts to deflect blame in advance of the revolt that is coming like a freight train down the tracks of history. Its not going to work, people will see past this kind of bullshit. Soon you will see banksters and all of their lackies be swinging from the yardarms in the public square, or having their heads roll in to baskets, while dogs drink their blood from the ground. (Not that I'm bitter, or anything

There is a wave of anger rising, and if we can keep the rage in check, we can use it to fix things, and get back to the business of supplying the needs of ourselves, or families, communities, and society, instead of providing perverse incentives to those who would suck our lives blood and treat us as chattel.
posted by MikeWarot at 4:11 AM on December 29, 2011 [50 favorites]


I have presented an overly flattering case for the status quo here.

No, really?

What's particularly worrisome is his definition (or lack thereof) of opacity. After all, the system can't be completely opaque to the people running it or it wouldn't work at all.

So really what he's arguing for is a system that is opaque enough that the punters will invest but that those in the know (and thus everyone else indirectly) can continue to reap the benefits. Don't worry punters, you're better off in ignorance.

From his perspective the true problem of reform is not that it would suddenly make everything transparent but rather that any single act of simplification makes the insider group slightly larger. You could drop 90% of the complexity from the existing financial framework and not make things significantly clearer to the average holder of a bank account -- but every extra person who did understand it would be a threat.

Particularly fearsome would be the small group of educated non-bankers that would emerge, looking to closely and competently examine the finance system in a way no congressional committee ever could. Drop the barrier of understanding and suddenly you've got actual oversight going on -- that has got to be scary as hell for an industry that usually only airs its dirty laundry every ten years or so.

In short even if his argument that the ignorance of the masses is necessary is correct, his presentation of reform as "completely (almost) opaque"/"completely transparent" completely misses the mark.

On the other hand, from a banker's perspective reform that allows meaningful oversight is probably just as bad as redoing the financial system from scratch. Worse in some ways as oversight can only make their lives worse, whereas a complete rescramble would allow new some opportunities.

In any case, not a very successful argument for the status quo.
posted by Tell Me No Lies at 4:12 AM on December 29, 2011 [7 favorites]


If only everyone would invest, there’s a pretty good chance that we’d all be better off, on average our investments would succeed. But if an individual invests while the rest of the world does not, the expected outcome is a loss.

This basically describes a Ponzi scheme. If one wanted to make investing seem like a reasonable activity, one would say that the startup capital allows businesses to build into something worth more than the initial loan, thus increasing the value of the investment. But the honesty here is refreshing.
posted by snofoam at 4:13 AM on December 29, 2011 [5 favorites]


Philosopher's Beard: "Of course not, almost all small businesses fold."

That's just straight risk assessment, and it's not terribly hard to spread the risk across many investments if you have a lot of capital to begin with.

Take credit card fraud, as an example - the CC companies have enough data to assume they will lose some X% from fraud, so they adjust the interest rates on every credit card to cover that eventuality. The X% (don't recall the exact number, sorry) is not really a secret. There's no basic need for information asymmetry in this case either.
posted by vanar sena at 4:15 AM on December 29, 2011 [2 favorites]


He point out that banks do make investment safer (for lower yield), then goes on to assume without supporting it that this is still not enough for people to invest unless they can be deluded into doing so. I don't see any reason to accept that.

And this line "Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper" rings all sorts of rhetorical alarm bells to me.
posted by -harlequin- at 4:19 AM on December 29, 2011 [1 favorite]


The analogy I would choose is finance as placebo. Financial systems are sugar pills by which we collectively embolden ourselves to bear economic risk. As with any good placebo, we must never understand that it is just a bit of sugar. We must believe the concoction we are taking to be the product of brilliant science, the details of which we could never understand. The financial placebo peddlers make it so.
We are not intelligent enough to comprehend the complexity of financial systems, but those few who do are working brilliantly and tirelessly to make sure that as potential investors, our best interests are being looked after.

But the honesty here is refreshing.

This person can collectively embolden themselves by jumping into an industrial sized document shredder.
posted by clearly at 4:28 AM on December 29, 2011 [4 favorites]


Where I lost any modicum of respect for his argument was when he claimed that in an agricultural society it would be impossible to start a car factory, but how does he think the industrial revolution ever got started?
posted by MartinWisse at 4:44 AM on December 29, 2011 [6 favorites]


Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper.

Define "prosper," pal. Faintly fraudulent societies aren't prosperous. They are socially impoverished. That is, unless you want to extend this argument out to "culture" as a whole, which one could argue (especially in a Durkheimian mode that emphasizes its contiguity with kinship, categorical reason, ritual, and religion especially) is a "faintly fraudulent" system for keeping humans together in groups without killing each other or committing incest. It's a thin line between humans for the last few thousand years and primates for much longer than that.
posted by spitbull at 5:02 AM on December 29, 2011


It's a thin line between humans for the last few thousand years and primates for much longer than that.

And it's even a thinner line between humans today and humans a few hundred years ago. Electricity, hot water, indoor plumbing, global instantaneous communication, internet porn.... the average human being lives a life today which is not only more prosperous, but far more more luxurious than any 17th century king.

Say what you want, but the United States went from an agricultural slave society to putting a man on the moon and electing a black man president in less than 250 years. If this is the result of an opaque, slightly fraudulent financial system, then the ends justify the means.
posted by three blind mice at 5:10 AM on December 29, 2011


three blind mice: "agricultural slave society to putting a man on the moon"

I'd like to point out that Soviet Russia did that in a similar timeframe. Not supporting Stalinism as such, just a reminder of the difference between correlation and causation.

a black man president in less than 250 years

Doesn't follow, for the same reason. What does the global financial system have to do with racism?
posted by vanar sena at 5:21 AM on December 29, 2011 [4 favorites]


Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper.

Do we have lists of societies that have (or had) "opaque, faintly fraudulent, financial systems" and societies that do (or did) not?

Say what you want, but

at least it's an ethos.

I'm not convinced that the US wouldn't have done these if it had had a more open and honest financial system.
posted by pracowity at 5:22 AM on December 29, 2011


I don't find that argument particularly plausible and it has a strong similarity to how most pro-financial conservatism arguments basically boil down to taking the entire system hostage. (I don't know enough about the author to accuse him of being a Randian conservative - earlier posts of his suggest a quite different point of view).

I personally can't stand that right-wing argument that "greed is good". It seems to be an argument that the ends justify the means and I see very little evidence that supports it. There is at least as much evidence that left-wing approaches work at least as well - so why not go for them, rather than supporting greed? You get to be a decent person and have at least as good a chance that things will turn out alright.

Also, I am highly skeptical about this theory's historical veracity. The financial sector has relatively little to do with the industrial revolution - certainly not in its present form, with relatively recent forms of complex derivatives. Yes, debt financing helped to create, for example, the English navy, but financial bubbles and what Minsky calls "Ponzi finance" existed long before either the industrial or agricultural revolutions. These things are not actually productive ways of deceiving people into undervaluing risk (as he suggests). They involve overvaluing assets.

Furthermore, the events that lead to the breakdown of the system are not cases of people saying "Hey, this actually really risky, maybe somebody else needs to cover this". As far as I can tell, they begin - before that moment of realisation - with people grossly overvaluing assets. And that comes from an opaque system that is complex enough for worries to be handwaved away. The opaque system creates the heightened risk - and allows it to grow beyond the ability of society to cope with it when people finally twig to what's really going on.

Finally - and this is just a woolly emotional response, but I think it matters too - I also strongly resent the idea that somehow social progress is due to the financial sector.

The United States has travelled as far as it has because of free thinkers, scientists, progressives, social activists and members of the middle class who have actually made things or learned and developed useful skills, pushing forward the boundaries of what we all know and can do. The super-rich and the financial sector deserve very little of the credit for that and have often served to hold that progress back. If anything, in the past twenty years, because the financial sector is the only area where wages have kept ahead of the cost of living, it has lured a lot of people (especially mathematicians) into doing things that turned out to be useless or even destructive.

The whole theory feels like some perverse satirical version of the fable of the grasshopper and the ant. These grasshoppers want to storm in and steal what the ants have built - but nowadays, rather than resorting to contrite begging or to force (a la A Bugs Life), they just claim that they are the ones who are really responsible for everything the ants have created. Somehow.
posted by lucien_reeve at 5:31 AM on December 29, 2011 [30 favorites]


Now, it seems that in the modern world, for all intents and purposes, having a bank account is pretty much vital if you want to do anything at all - e.g. try getting your employer to pay your salary if you don't have a bank account ...

What? I have had a lot of jobs, and not one of them told me I had to have a bank account. You may be thinking that I'd have to have one to cash my paycheck, but even that is not really true.
posted by Kirth Gerson at 5:35 AM on December 29, 2011


"agricultural slave society to putting a man on the moon"

I'd like to point out that Soviet Russia did that in a similar timeframe.


They did? When did they do that?
posted by Kirth Gerson at 5:38 AM on December 29, 2011 [1 favorite]


"You can have opacity and an industrial economy, or you can have transparency and herd goats"

False dichotomies are never impressive. False dichotomies constructed from shameless, self-serving lies are immoral, too.

Who is this guy, anyway? What are his credentials? I've only done a quick Googling but he seems remarkably quiet about them on this blog and elsewhere.
posted by Decani at 5:38 AM on December 29, 2011 [1 favorite]


You can have opacity and an industrial economy, or you can have transparency and herd goats

You know, I sometimes think that my life would be better if I herded goats. Of course, I'd probably just wind up with a crazy goat herding boss who demanded that I undertake a huge goat herding project that was completely undersupported by any principle of goat herding and that had to be completed by last Thursday.
posted by Bulgaroktonos at 5:43 AM on December 29, 2011 [10 favorites]


Finance has always been complex. More precisely it has always been opaque, and complexity is a means of rationalizing opacity in societies that pretend to transparency.

This is very much false, in the same way that the complexity of the books in the library isn't a way of rationalizing illiteracy. Further, his assertion that "winners depend upon the existence of the losers" is, in additional to being reprehensible, likewise false; economic transactions don't require fraudulent acts or negative outcomes to avoid being zero-sum.

It may be that opacity is required in order to create giant edifices of fictional wealth, but that isn't nearly the same thing, and if true would badly undermine his original claim.
posted by mhoye at 5:44 AM on December 29, 2011 [4 favorites]


The core purpose of status quo finance is to coax people into accepting risks that they would not, if fully informed, consent to bear.
I have a conjecture that the core purpose of status quo essay writing is to coax people into reading poorly-thought-through bullshit they would not, if fully informed, waste their time on.
posted by Western Infidels at 5:52 AM on December 29, 2011 [11 favorites]


Where I lost any modicum of respect for his argument was when he claimed that in an agricultural society it would be impossible to start a car factory, but how does he think the industrial revolution ever got started?

With textiles, if I remember correctly. That was a particularly ridiculous example because, of course, it wouldn't work. You don't go from goat herding to building cars for local sale in a short time span. The Industrial Revolution started with products that, you know, people wanted to buy. Not that it didn't cause its fair share of disruptions, mind you....
posted by GenjiandProust at 5:53 AM on December 29, 2011


A fine apologia for horrible behavior. Corruption, fraud, and theft are a necessary evil! The only alternative is stagnation and poverty! Plus, as a bonus, we've always done things this way and things have tended to improve, from a socio-economic and quality of life standpoint, so IT MUST BE A DIRECT RESULT of the institutional corruption, fraud, and theft!

Well in America in 2011, we have stagnation and poverty AND we have corruption, fraud and (institutional level) theft. Best of both worlds!
posted by Mister_A at 5:57 AM on December 29, 2011 [5 favorites]


I flagged this post because I don't want anyone else to wander into that essay expecting something thought-provoking or interesting.
posted by Mister_A at 5:59 AM on December 29, 2011 [3 favorites]


So transparent herds of goats aren't a good investment?
posted by Kirth Gerson at 6:00 AM on December 29, 2011


Are the goats transparent individually or only collectively?
posted by Mister_A at 6:02 AM on December 29, 2011


I can see right through these goats, and they're mainly full of crap.
posted by cromagnon at 6:08 AM on December 29, 2011


It's nice to know the rising anger of the American populace is causing enough anxiety in the ruler class that they've resorted to commissioning propaganda. Gives one a tiny bit of hope.
posted by emjaybee at 6:10 AM on December 29, 2011 [7 favorites]


Kirth Gerson: "They did? When did they do that?"

Yeah, a dumb comment I admit, but Korolev could well have pulled it off. I hope I made my point though - there were plenty of quite socialist aspects to many of the things that put America ahead of the game in the past hundred years, from the New Deal and GI Bill to the NSF and NASA. Claiming those things as victories for the entrenched financial system require evidence.
posted by vanar sena at 6:15 AM on December 29, 2011 [1 favorite]


A lot of people seem to be reading this guy as an apologist for the status quo, but I don't think that was the intention - eg see the notes at the end.
posted by memebake at 6:26 AM on December 29, 2011


There are so many deep pockets guaranteeing our bank! There will always be someone out there to take the loss. We’re not sure exactly who, but it will not be you! They tell this to everyone as well. Without blushing...

Opacity is not something that can be reformed away, because it is essential to banks’ economic function of mobilizing the risk-bearing capacity of people who, if fully informed, wouldn’t bear the risk.


Or, the shorter version — privatize profits and socialize losses, as hinted at succinctly in Syriana:

No, I tell you. No, sir! Corruption charges! Corruption? Corruption is government intrusion into market efficiencies in the form of regulations. That's Milton Friedman. He got a goddamn Nobel Prize. We have laws against it precisely so we can get away with it. Corruption is our protection. Corruption keeps us safe and warm. Corruption is why you and I are prancing around in here instead of fighting over scraps of meat out in the streets. Corruption is why we win.
posted by Blazecock Pileon at 6:31 AM on December 29, 2011 [1 favorite]


The article's fundamental flaw is the notion that the weighted average posture of investors is one of risk aversion, which financial intermediaries must overcome by means of obscuring the risk the investor is being asked to take. The evidence tends to support the opposite, that investors on the whole are risk seeking, shooting for the moon when they'd be better off flying to Des Moines. Financial intermediaries if anything mitigate that tendency by aggregating risk investment and efficiently diversifying it.

The current financial crisis was absolutely driven by risk-seeking -- a majority of decision makers at some of the most sophisticated financial institutions in the world looking at the housing market in 2005 and saying "this can never go down." While some of the ways they expressed this view were complex (synthetic CDOs) some were completely simple (95% LTV subprime mortgage loans to buy houses at three times their 1990s price).
posted by MattD at 6:35 AM on December 29, 2011 [4 favorites]


A lamentable side effect of opacity, of course, is that it enables a great deal of theft by those placed at the center of the shell game. But surely that is a small price to pay for civilization itself. No?

Civilization is advanced by science and the open exchange of falsifiable ideas, not by con artists who call themselves bankers. If we had invested the same amount of money into renewable energy and transportation restructuring that we flushed down the toilet of derivatives markets, we would have created million of jobs and possibly reduced the effect of global warming.

Economic theory is largely bullshit in our current system because unless all else is equal, the graphs don't mean a thing. There can't be a market without equal players making equally informed decisions. So if you want a market that works, and that doesn't fall apart like pressboard furniture every five years, you should be demanding that government ensure transparency so markets can exist in the first place.

Finally, this guy's argument breaks down to believing that greed would stop people from making risky investment decisions if they had all of the information that the banks have. People play the lottery all the time, and the odds are presented on the backside of their tickets. Human nature provides plenty of opportunities for entrepreneurs to find investment in any market, but I'd rather a company like Tesla Motors receive billions of dollars of investment instead of Bernie Madoff. It would be better for the investors and for society, full stop.
posted by deanklear at 6:36 AM on December 29, 2011 [14 favorites]


If only everyone would invest, there’s a pretty good chance that we’d all be better off, on average our investments would succeed.

Ignoring the cute game theory smoke and mirrors, what's on offer is a perpetual motion machine. Waldman takes for granted the growth of industrial activity, the accelerating consumption of real resources that is the driving force behind growth. Resources including not only minerals and non-renewable energy but also human labor, biological systems, and healthy air/land/water. These resources are assumed to be inexhaustible, and their depletion or degradation considered to be "externalities". What makes it seem to sort of work is that the biggest ramifications of constantly accelerating growth take longer time to emerge than any of our investment cycles last.

It's fashionable now to claim the patently corrupt derivative finance industry is essentially different from industrialism on the whole, but that's wrong. Sure we put a man on the moon, but we also dismantled small farming in the same time frame.

To the extent that we insist the perpetual motion machine exists, we can look forward to something much worse than that favorite modern boogeyman of being reduced to goat herding.
posted by maniabug at 6:45 AM on December 29, 2011 [4 favorites]


The core purpose of status quo finance is to coax people into accepting risks that they would not, if fully informed, consent to bear.

I don't understand the argument here. I mean, I accept this as a candid admission of the state of modern finance, but it seems to me that this situation is optimal only when a) it is impossible to accurately price risk, or b) when the social / other external benefits to certain projects are such that it would be impossible to internalize those benefits and clear the price of the risk.

As to a), Humans are famously bad at pricing risk, but it's by no means impossible. This is what actuarial science was invented for. Is it inexact? Perhaps at times. Counterintuitive? Sure. But possible. Surely he's not arguing that it is impossible to price the risk of an investment.

As to b), this is what government spending is for: to invest in those projects which have real benefits which are nevertheless difficult to internalize (I believe these are called "public goods"); things like parks and bridges and roads and military defense. Surely he's not suggesting that every investment is in the nature of a public good.

Am I missing something here?
posted by gauche at 6:51 AM on December 29, 2011 [1 favorite]


Wow! this is amazingly classist!


but honest.

now back to the mines, you slaves!
posted by eustatic at 6:54 AM on December 29, 2011


It comes down to whether trust (faith, credit, alliance) is seen as "fraudulent" or not. One can argue that modern finance is based in principle on the guaranteeing of trust relationships.

Unfortunately, it's the taxpayers who do the guaranteeing.
posted by spitbull at 6:54 AM on December 29, 2011


Maybe I'm just dense, but I always thought that the markets are not there to amp things up - they exist to find the real values. Rational actors will use information in their own self-interest and real pricing will result.

Opaqueness is the antithesis of free-market.

(I don't necessarily support free market economics, but I'm really fucking tired of a system where everything is constantly redefined to help the truly greedy among us.)
posted by Benny Andajetz at 6:57 AM on December 29, 2011 [2 favorites]


Well, I thought that was very interesting. "Investing makes no sense: it's too risky. So we have to lie to investors. And that's how we finance progress." I don't see that as far from the Keynesian idea of "animal spirits" that is currently so very naturally in vogue.

There's a great apologia at the end of the play ENRON, by Lucy Prebble, that'll I quote here, delivered by the disgraced CEO Jeff Skilling direct to the audience:
I'm not a bad man. I'm not an unusual man. I just wanted to change the world. And I think there'll come a time when everyone understands that. They'll realise they were banishing something of themselves along with me. I believe that.

I know it's hard to understand. How can something be worth a million dollars in the morning and nothing by the afternoon? Same way a man goes from captain of industry to a fraud sitting in jail. You want to look at something and know it has... a worth, a fundamental value? Bullshit. You're making the same mistake as any religious person. You wanna hold a mirror up to nature.

The huge crack along the wall of the building glows from behind and becomes the jagged line graph of the Dow Jones Index over the last century.

The line on the graph/crack glows.

There's your mirror. Every dip, every crash, every bubble that's burst, that's you. Your brilliant stupidity. This one gave us the railroads. This one the Internet. This one the slave trade. And if you wanna do something about saving the environment or reaching other worlds, you'll need a bubble for that too. Everything I've ever done in my life worth anything has been done in a bubble; in a state of extreme hope and trust and stupidity. Would you have gotten married if you could see her face twenty years on turn to you through tears, saying "You never knew me at all"?

September the eleventh. 1929. Beginning of the Great Depression, and Washington Post prints Mark Twain: "Don't part with your illusions. When they have gone you may still exist, but you have ceased to live."

He points to spikes and dips on the graph.

All humanity is here. There's Greed, there's Fear, Joy, Faith, Hope...

And the greatest of these... is Money.

The sound of prison doors slamming.
posted by alasdair at 7:08 AM on December 29, 2011 [1 favorite]


"Dude, if you knew what we put it this stuff you sooo wouldn't eat it!"

"Enjoy!"
posted by fullerine at 7:08 AM on December 29, 2011


The current financial crisis was absolutely driven by risk-seeking -- a majority of decision makers at some of the most sophisticated financial institutions in the world looking at the housing market in 2005 and saying "this can never go down.

This sentence manages to contradict itself. The crisis was certainly driven by the desire for returns, but the fact that many, many financial professionals believed some (generally highly caveated and expertly-justified) version of the second bolded claim is evidence against risk-seeking.

And that's Waldman's point: we generally assume that risk and returns will be perfectly mirrored, but finance seems to encourage saving by promising outsized returns at low risk. If people understood the true extent of the risks, they would demand higher returns in exchange for their hard-earned savings, and many fewer investments would meet this criteria, and thus many fewer incalculable opportunities to succeed wildly would be lost. Since returns are never fully internalized by the company (Apple shareholders gets rich but consumers get a better product and many workers are employed along the way in the US and China) we are better off if there are more risks taken.

Of course, this could just as easily go the other way: since neither risks nor returns are transparently communicated, investments are much less intelligent than they might otherwise be. And this is also Waldman's point:

I have presented an overly flattering case for the status quo here. The (real!) benefits to opacity that I’ve described must be weighed against the profound, even apocalyptic social costs that obtain when the placebo fails, especially given the likelihood that placebo peddlars will continue their con long after good opportunities for investment at scale have been exhausted. By hiding real economic risks from those who ultimately bear them, status quo financial systems blunt incentives for high-quality capital allocation. We get capital allocation in bulk, but of low quality.

The question that remains is whether the crowd of investors will make more intelligent decisions if fully-informed. Most efficient market types assume so, but it's actually progressives that usually argue otherwise: neither experts nor groups are particularly good at making these calculations, so it could be the case that more, dumber experiments are better than fewer smarter experiments. Or it might not be. These are hard things to test, and the weak kinds of comparative political economics available (the West v. the rest) are highly contested.
posted by anotherpanacea at 7:08 AM on December 29, 2011 [1 favorite]


many fewer incalculable opportunities to succeed wildly would be lost

Sorry, that should be many fewer incalculable opportunities to succeed wildly would be lost

edit window
posted by anotherpanacea at 7:11 AM on December 29, 2011


Maybe I'm just dense, but I always thought that the markets are not there to amp things up - they exist to find the real values.

Well, maybe it used to work that way, but QE I and II and ultimately III and IV and infinity basically means it's impossible to find the real value of anything.

For me the key line in the essay is "Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper." For at least a decade, and probably longer, our system hasn't been "faintly" fraudulent, it's been overtly fraudulent. See Timberwolf; see synthetic CDOs. We didn't merely have complexity; the financial system increased complexity in the belief that the more complex a transaction or an instrument was, the more likely it was to generate higher returns, and that worked for a while. Primarily, for the financial industry itself.
posted by kgasmart at 7:29 AM on December 29, 2011 [1 favorite]


I'm fairly sure that people's risk-aversion happily accommodates reality, including the idea that people who take no risks earn no interest. And obfuscating risk is straight up fraud. Ergo, Steve Waldman is spouting bullshit to advocate fraud.
posted by jeffburdges at 7:30 AM on December 29, 2011


I'm fairly sure that people's risk-aversion happily accommodates reality

Well if you're fairly sure, then I guess we can ignore these.
posted by anotherpanacea at 7:43 AM on December 29, 2011


Are we all reading the same article? The one I read ended with:
Nick Rowe memorably described finance as magic. The analogy I would choose is finance as placebo. Financial systems are sugar pills by which we collectively embolden ourselves to bear economic risk. As with any good placebo, we must never understand that it is just a bit of sugar ... I do think there are alternatives to goat-herding and kleptocratically opaque semi-fraudulent banking. But adopting those would require not “reform” but a wholesale reimagining of status quo finance .... The (real!) benefits to opacity that I’ve described must be weighed against the profound, even apocalyptic social costs that obtain when the placebo fails, especially given the likelihood that placebo peddlars will continue their con long after good opportunities for investment at scale have been exhausted.
So he describes the financial system as being based on kleptocratic fraudulent opacity, outlines the apocalyptic risks of that opacity, and suggests that the solution lies not in small 'reforms' but in a wholesale re-imagining of the financial system.
posted by memebake at 7:45 AM on December 29, 2011 [2 favorites]


Since returns are never fully internalized by the company (Apple shareholders gets rich but consumers get a better product and many workers are employed along the way in the US and China) we are better off if there are more risks taken.

That depends on what the risks are taken on. In that case, we invested to destroy a good portion of our manufacturing sector, since Apple is only concerned with short-term profit and it's cheaper to have things manufactured in a state with no environmental controls. In reality, what we did is trade our ability to manufacture our own goods and the sustainability of our planet for some iPads and a shinier interface for our computers. That's the flipside of externalities: someone will end up with the short end of the stick, and a company's goal is not to ensure they don't extort anyone, but in fact, to ensure that someone does lose so they can win more.

The winners in our market are not the companies who most efficiently produce a given product or service. They are the ones who are most effective at skirting the law and exploiting the planet and its people.
posted by deanklear at 7:46 AM on December 29, 2011 [3 favorites]


That depends on what the risks are taken on.

Which is why right after the portion you quoted, I wrote: "Of course, this could just as easily go the other way."
posted by anotherpanacea at 7:55 AM on December 29, 2011 [1 favorite]


Investors simply choose amongst the available options, anotherpanacea, although I'll grant that "reality" isn't the best way to describe this process. lol

We accept that people should make big money only when they take big risks. If said risks are transparent, enough people will still take them. If risks are opaque, then investors eventually start distrusting the financial industry broadly.
posted by jeffburdges at 8:18 AM on December 29, 2011 [1 favorite]


Sorry, anotherpanacea. I need to do a better job of reading until the end.
posted by deanklear at 8:23 AM on December 29, 2011 [1 favorite]


MattD: The current financial crisis was absolutely driven by risk-seeking -- a majority of decision makers at some of the most sophisticated financial institutions in the world looking at the housing market in 2005 and saying "this can never go down." While some of the ways they expressed this view were complex (synthetic CDOs) some were completely simple (95% LTV subprime mortgage loans to buy houses at three times their 1990s price).

I disagree that it was risk-seeking. The "this can never go down" attitude you describe is more like risk-myopia. And the whole CDO thing was the result of banks exploiting the risk-calculating algorithms of the ratings agencies (apparently with the help of the ratings agencies themselves) until they were able to hack together packages of garbage that somehow got labelled AAA.

In one of Waldman's posts from 2008 he says roughly the same thing:
One of the more depressing bits of emerging conventional wisdom is the notion that the financial system took on “too much risk” in recent years. I think it is equally accurate to suggest that the financial system took on too little risk ... The big central banks, whose investment largely drove the credit boom, were (and still are) seeking safety, not risk. The banks and SIVs that bought up “super-senior AAA” tranches of CDOs were looking for safe assets, not risky assets.
posted by memebake at 8:32 AM on December 29, 2011


We could perhaps create a vastly more transparent society than anybody here ever considered by instituting FOIA-like requests for corporate information that substantially impacts the livelihood or health of enough people, like say 100k.
posted by jeffburdges at 8:52 AM on December 29, 2011 [2 favorites]


HERDING GOATS IS ENORMOUSLY RISKY YOU FUCK

Seriously, you got weather problems, you got disease, you got accidents, you got goats that don't breed, you got goats that don't put out milk, you got meadows you have to protect or maintain, you got wolves and dogs, you got transport problems of your product, you got market pricing problems, you got wars, brigands, rustlers ...
posted by seanmpuckett at 8:53 AM on December 29, 2011 [4 favorites]


If said risks are transparent, enough people will still take them.

This might be true, but I don't see any reason to believe it yet. Why isn't it possible that the individually rational thing to do in risk is actually the communally irrational thing? Remember that this is the anemic economic sense of rationality, and that there is plenty of evidence that in the economic sense we have to overcome these collective action problems in many other areas of our lives. Why not in savings and investment?

For instance, most college students look like a bad risk at 17, but we bet on them anyway. Though many of them fail, many of them succeed, too. Various incentives aimed at students are designed to obscure the real risks of a college education, and for many individual students this will lead to lost time and money. But every so often a student will turn a supposedly obscure and wasteful calligraphy class into the Macbook, as Steve Jobs did, and I think we do all benefit from such a highly educated population even if the 28% of the population who actually get degrees benefit even more.

We know that we have recently misjudged systemic risks: isn't it at least possible that we're currently misjudging "systemic returns"?
posted by anotherpanacea at 8:55 AM on December 29, 2011 [1 favorite]


So would computerized trading algorithms be herd goats in this analogy? Algorithms aren't impressed by the banker's nice suit or the size of his asset pool - they work on mathematics, and are complex enough to handle the deliberate obfuscation of financiers. If he's right about this, the preponderance of algorithmic trading is probably making the market more risk averse and less likely to reach that positive equilibrium.
posted by Kevin Street at 8:59 AM on December 29, 2011


In Spanish this dilemma is known as: Cabras or chupacabras.
posted by dances_with_sneetches at 9:01 AM on December 29, 2011 [4 favorites]


The late-bubble investments in housing securities were very much risk-seeking. Investors knew it was a bubble and were making a gamble that this was one bubble that wouldn't pop anytime soon because of the (inherently aggressive) assertion that housing couldn't decline nationwide.

To see this it's important to understand that investing happens in bands of risk-reward.

The people who were buying AAA-rated "super senior" CDOs were not seeking safety, they were aggressively taking risk in order to be paid the significant premium carried by AAA-rated CDOs versus (for example) AAA-rated industrials, or US Treasuries. The people who were buying the equity tranches were making a comparable calculation albeit in a much more aggressive risk-reward band (equity tranche of CDO vs. say the Russell 2000 equity index).
posted by MattD at 9:10 AM on December 29, 2011


Kevin Street: I'd go even farther. Insofar as any hedge funds arbitrages a true risk-free return, they are, on net, taking capital away from the productive and innovative parts of the economy, redirecting savings from investment to rent-seeking liquidity traps. This is the more populist model of finance and, frankly, it's the one that Waldman seems to prefer in his other posts and closing paragraph here.

But again, it could also be wrong in the long view.

MattD: they were taking risks, but they were taking underpriced risks.
posted by anotherpanacea at 9:17 AM on December 29, 2011 [1 favorite]


The finance system reminds me a lot of Skyrim.
Both video games and finance seek to create abstract models of reality by eliminating the features of reality that are least relevant to what you are interested in. So if you are playing an rpg there will be a lot of attention paid to how many times you can hit a rat with a mace before it dies and zero attention paid to how the cabbage tastes. As technology increases you can model more and more features of reality; you can model how much stuff you can carry and how quickly you can learn spells. Instead of terrain being discretely navigable or not it becomes a function of slope and specific topography.

But the ability to increase the accuracy of modeling has an important consequence. With added complexity the ability exploit the model expands. You can create powerful weapons by forging hundreds of iron daggers. You can cast spells for free by stacking additive enchantments you can scale impassible terrain by hopping backwards.

The consequence of this is that efforts to model reality result in introducing incomplete exploitable complexity that makes things less realistic. This is especially true if players are not interested in participating in the illusion and are instead interested in accumulating advantage. It probably seems more realistic to factor in armor type, sneaking skill, action attempted, spell effects, enchanted equipment effects, encumbrance, radius, race, target perception, line of sight, etc in determining when a bear moves becomes hostile, rather than a bear simply becoming hostile at a fixed radius. The actual result is quite different; since a motivated party can exploit the incomplete nature of the simulation instead of slightly strange things happening, like a man in plate mail making the same amount of noise as a man in robes, very weird things happen, like a man in plate mail making less noise than a man in robes because he was once in an inn and put pots on everyone’s head and walked backwards against a wall for 45 minutes.

Now this analogy has been one sided, because I am much more familiar with Skyrim than the financial system and because glitches in the financial system are costly they are more likely to be secret/patched. But really things aren’t so different. Take securitized mortgages. It might seem unrealistic that owning fifty portions of fifty mortgages to be treated as similarly safe to a single mortgage, and it is, but the attempt to incompletely model this lead to ‘a pots on the head walking away from a wall’ outcome. The model was more complete to be sure but it replaced some limiting abstractions with broadening assumptions. This expanded the opportunities to exploit the system. The consequences of this were disastrous.

Skyrim is a game, your experience with it is significantly contingent on you suspending disbelief and taking things on its own terms. The purpose of all these complex systems is to create a compelling illusion of being a particularly powerful warrior with a versatile bag of tricks and the ability to create significant changes in the world around you. The finance system has a similar sort of objective built in, it is supposed to effect the movement of resources to those opportunities that have relatively superior expected values subject to the constraints of individuals risk tolerance. Plenty of effort goes to doing just this. It is what people think of when they think of finance, but this isn’t where the brightest minds go, and this isn’t where the big rewards are. Instead we have some real no fooling geniuses doing the equivalent of making potions that enhance enchantment and enchanting armor that enhances alchemy and using this loop to create a necklace of +x who gives a fuck and by the time people wise up to oh wait that isn’t how things actually work and patch it they’ve already taken billions of dollars of money that could actually be put into use to…. I don’t know, upgrade Breezehome? Pac Man might not be so bad.
posted by I Foody at 9:21 AM on December 29, 2011 [8 favorites]


There is a wave of anger rising, and if we can keep the rage in check, we can use it to fix things
This philosophy's naivete and indefatigable popularity would be adorable if only its failure mechanism wasn't so tragic.
posted by roystgnr at 9:26 AM on December 29, 2011 [2 favorites]


metafilter: using rage to fix things
posted by memebake at 9:30 AM on December 29, 2011 [1 favorite]


re: CDOs: My understanding was that part of the CDO/AAA problem was that pension funds and other entities can only invest in AAA funds and are also legally obliged to find the best returns, so that when the AAA CDOs appeared they had no choice but to buy them. I might be wrong about the details.

This graph from the Basel Committee is pretty funny - its the world issue of AAA bonds by year since 1990. Goes from practically nothing to way too much. It also shows the proportion of AAA debt as part of the bond market as a whole. Felix Salmon spells out the horror:
Then look at the green line. Triple-A debt wasn’t a huge part of the bond market back in the early 90s, but for the past decade it has invariably accounted for somewhere between 50% and 60% of total global fixed income issuance. That’s possibly the most horrifying bit of all: it simply defies credulity for anybody to be asked to believe that more than half the bonds issued in any given year are essentially free of any credit risk.
As I said before, the rating agencies have a lot of answer for.
posted by memebake at 9:46 AM on December 29, 2011 [2 favorites]


The current financial crisis was absolutely driven by risk-seeking -- a majority of decision makers at some of the most sophisticated financial institutions in the world looking at the housing market in 2005 and saying "this can never go down.

No. It was risk-hiding and risk-shifting. I'm fairly certain that just about all players knew that the housing bubble wouldn't last, but instead of prudence, they devised ways to hide the risk and play 'Hot Potato' as they passed the risk around.

And the finance industry's investment in politicians paid a fat dividend when the Hot Potato finally landed, and most players weren't punished, they were rewarded by bailouts and TARP, which were new, string-free sources of low cost capital.

My naive opinion is that investing and the stock market are important components of a healthy free market. But absent sufficient oversight and regulation, they have ceased to serve the economy, they have become the economy itself... producing nothing except profits. They have sucked capital and talent away from more productive (in real terms) enterprises, and apparently are going to be allowed to continue to do so.

[computerized trading] Algorithms aren't impressed by the banker's nice suit or the size of his asset pool - they work on mathematics, and are complex enough to handle the deliberate obfuscation of financiers. If he's right about this, the preponderance of algorithmic trading is probably making the market more risk averse and less likely to reach that positive equilibrium.

No, it's the converse. Computerized algorithmic trading is going to the nth degree to maximize every possible asymmetry - reaction time, open-close times and other rules and limitations in human-based systems, chaos theory, etc. The fact that computerized trading is even allowed should be clear evidence that the financial system has grown too large and self-important to serve the greater economy.

Again, in my naive ideal economy ("Galt's Co-op"?), there would be no financial products beyond the complexity of stocks and bonds allowed. Mutuals, indexed bonds, ok. Derivatives. CDOs, and other progressively obscure and increasingly fictitious financial abstractions should not be allowed.

Not gonna happen, I know.
posted by Artful Codger at 9:55 AM on December 29, 2011


memebake: Is "risk-myopia" the same as Greed, or just its evil henchman?

I Foody: Best use of a game analogy to explain financial systems. Please acceept this checkbook +2 (Improved impulse control) with my compliments.
posted by sneebler at 9:59 AM on December 29, 2011


The fact that computerized trading is even allowed should be clear evidence that the financial system has grown too large and self-important to serve the greater economy.

Yep. Mom and pop investors - to the extent that there still are any - are the goldfish among sharks, foolish to even be in this pool.

Who has faith in the stock markets anymore? Faith that "true values" are reflected; faith that these markets could even survive without government intervention. I'll steal this line from what I just read over at The Automatic Earth because I think it's true: bailouts and "easing" don't inspire confidence, they undermine it. Same is true of computerized trading.
posted by kgasmart at 10:01 AM on December 29, 2011 [3 favorites]


This reminds me that Aristotle described a sort of financial derivative in Politics, Chapter One, Part XI ("Thales the Milesian and his financial device"). Being able to predict the weather months in advance is pretty opaque.
posted by exogenous at 10:07 AM on December 29, 2011


kgasmart: Yep. Mom and pop investors - to the extent that there still are any - are the goldfish among sharks, foolish to even be in this pool.

You get it.

Like many, perhaps most people, I didn't want to be 'in' the market. I have a job where I do something and someone pays me, I use the money to feed and clothe and house me and my family, and I've saved some for retirement in some conventional government-recognized retirement products like mutuals, indexed funds etc.

I accept that my retirement stuff is subject to the ups and downs of the financial market. What I didn't buy into was that our worship of the market would lead to layoffs, job loss, neglected infrastructure, underwater mortgages and stagnating income.

We are the first in several generations who are about to hand our kids a world with worse prospects that the one we had. Worse jobs, lower earnings, longer time to retire. Haven't even mentioned resources or the environment.
posted by Artful Codger at 10:12 AM on December 29, 2011 [2 favorites]


and I've saved some for retirement in some conventional government-recognized retirement products like mutuals, indexed funds etc.

I accept that my retirement stuff is subject to the ups and downs of the financial market.


If I had the option I wouldn't even be putting money into my 401(k) mutuals, but the conundrum becomes that the company matches a certain percentage of your contribution, to just not contribute anything and take it in the paycheck means no additional contribution, and there are no non-"market" investment options.

Bottom line, I'm in this market even though I'd rather not be, because it's gamed. It's all bullshit, it's a lie, and ultimately I'm depending on the lie being true, or partially true, to help finance my retirement.

Right.

Related: Matt Yglesias on "the old-time insight that financial markets are no place for average people":

But the best way to "save" for retirement is to live in a country with a properly functioning Social Security system. The way a system like this works is that a certain share of national income is set aside to support the living standards of elderly people. ...


Instead we moved in the opposite direction, turning tens of millions of middle class Americans into "retail investors" who don't know what they're doing and don't save enough.

The result is nice, I guess, for the guys who collect the management fees and print the 401(k) brochures but it makes no sense as a social arrangement. It doesn't work as a way of ensuring that people have adequate financial resources in old age, and the idea that a mass market of retail investors ineptly attempting to maintain a balanced diverse portfolio serves a useful role in steering capital to productive uses doesn't pass the laugh test.

posted by kgasmart at 10:18 AM on December 29, 2011 [5 favorites]


Heh. I was just reading that article in another tab.

No question about it, most people shouldn't be (and probably don't want to be) investing in the market. They've got enough real life concerns without trying to navigate their assets through the modern cyber-jungle.

That's why banks work in a properly functioning economy. They do all that for you.
posted by Kevin Street at 10:28 AM on December 29, 2011


We moved in the opposite direction I suppose because someone saw the utility in leveraging the romantic individualism in American culture, along with cold war rhetoric, to discredit collective projects like social security and steer the public's savings into a sucker trap that favors professional investors.

Still, even social security depends on extended growth, which is not realistic in any civilization. What was the plan for managing eventual contraction in the real economy when social security was devised? What is the plan for managing contraction now? Probably we would need to acknowledge it first.
posted by maniabug at 10:31 AM on December 29, 2011


But the best way to "save" for retirement is to live in a country with a properly functioning Social Security system. The way a system like this works is that a certain share of national income is set aside to support the living standards of elderly people. ...

Wait, isn't that Socialism?
posted by sneebler at 10:32 AM on December 29, 2011 [1 favorite]


Still, even social security depends on extended growth, which is not realistic in any civilization. What was the plan for managing eventual contraction in the real economy when social security was devised? What is the plan for managing contraction now? Probably we would need to acknowledge it first.

I agree, although if we get to the point where both Social Security and the markets are inherently a scam, the mattress becomes the only viable "retirement plan," or not retiring at all. The latter being where most of us will probably end up.

"Grandpa, what was this thing they used to call 'retirement?' "
posted by kgasmart at 10:36 AM on December 29, 2011 [1 favorite]


"Wait, isn't that Socialism?"

It's leveling the darn playing field, that's what it is. Next thing you know, some darn fool will suggest doing the same thing for sick people and poor people, and how is the market supposed to sort out winners from losers then? Galt would roll over in his grave if he existed.

Everyone would "win" in such a society, which is clearly unacceptable. It's an abdigation of the Darwinianism that we're not supposed to believe in.
posted by Kevin Street at 10:40 AM on December 29, 2011 [4 favorites]


Afaik, all the biggest risks like space travel, collage education, health insurance, nuclear power, etc. actually benefit the most from the greatest transparency, and least privatization, anotherpanacea. There is simply less liability when the profits are socialized because people acknowledge that stuff goes wrong.
posted by jeffburdges at 10:42 AM on December 29, 2011 [1 favorite]


What kind of transparency do people on the blue want to see?
posted by otto42 at 11:19 AM on December 29, 2011


What kind of transparency...?

Well, someone in another thread yesterday (Empath?) suggested that government-style FOI requests should apply to corporations, so that people could at least get some level of basic information about the company and its operations.

"We need a square playing field!" as one of my former managers used to say.
posted by sneebler at 11:40 AM on December 29, 2011


That should probably say "...a thread I was reading yesterday..."
posted by sneebler at 11:41 AM on December 29, 2011


What would you ask for in the FOIA requests that already isn't available. Public companies already report their financial reports quarterly. Would daily or weekly reports help make investing decisions? Can companies have secrets? Should Coke reveal its secret recipe?

Keep in mind that any additional information that a company would be forced to disclose will be used by the same actors to exploit market inefficiencies. To the extent company information is already available, professional investors will always have an edge over occasional investors given the resources (staff, expensive subscriptions to data services, time) they command.

Increased disclosure would be great, but it won't even out the playing field.
posted by otto42 at 11:54 AM on December 29, 2011


I think transparency is a red herring, here, because this isn't really about secrets as much as it is about needless complexity (or complexity that produces information or processing asymmetries and no other value.)

That said, forcing more of these transactions onto a clearinghouse (and banning over-the-counter transactions that can't be cleared safely) might go some way to reducing the impact of bespoke financial engineering.
posted by anotherpanacea at 12:12 PM on December 29, 2011


Certainly a more accurate ability to evaluate risk would probably create quite different behaviour. People are terrible at evaluating risk. That's why people drive kids to church schools rather than walk them to public ones - because they're worried about the near-non-existant danger of their kid being abducted off the street by child molesters, but aren't worried about the well-known driving fatality statistics. Or, you know, the other thing. People travel on planes in a state of near-catatonic fear after happily driving to and from the airport. People imagine they can "win" day-trading against algorithmic trading engines developed by the kinds of companies that can afford to hire brilliant Linux kernel engineers to drive a few milliseconds of latency out of the kernel of their servers. They invest in unsecured debentures to get a couple of percent interest over their savings account, because a famous rugby player fronted the ad campaign.

There may have been a golden era where you could read a company's annual reports, buy some stock, and expect a combination of dividends and modest capital gains to be a worthwhile return, but if it ever existed, it's long gone. The stockmarket is driven entirely by greater fool profit taking, and most investors are the greater fools. I can understand why the author might be terrified of people realising this. And yes, it would hurt a lot of business models that rely on creating a dubiously-profitable business and hoping to profit of capital gains from your ownership of said company. You know what? I don't think that would actually be that big a loss for society, the author's polemic aside.

"Grandpa, what was this thing they used to call 'retirement?' "

"It's why I have all this time to tell you to get off your lazy arse and pay some more taxes, so I can afford that next trip to Bali."

HERDING GOATS IS ENORMOUSLY RISKY YOU FUCK

And let us not speak of the goat-fuckers.
posted by rodgerd at 12:41 PM on December 29, 2011 [1 favorite]


Somehow I doubt that in a world of perfect information symmetry we would all be goat herds.

Also claiming that you are promoting information asymmetry in some overwrought justification of of opacity...is the rationalization of a liar and a thief.
posted by Xoebe at 4:16 PM on December 29, 2011 [1 favorite]


If you run a business that can only profit so long as people are tricked into playing along, your are no actually a business, you are merely a more austere seeming carnival game.
posted by Slackermagee at 6:36 PM on December 29, 2011 [2 favorites]


What a crock of shit.

You know what would work even better? Back to the feudal system. Nothing needs to be divulged, because it's none of our business.

Ya got your royalty (politicians, bankers, stockbrokers and CEOs) and you got the peasants.

That's the rest of us, in case you're wondering.

Some of the peasants may have a few more goats, but you're still not invited to the castle.
posted by BlueHorse at 7:07 PM on December 29, 2011


Waldman isn't saying that this is the best system we can have, he's saying that opaque semi-flimflam finance is the best system we have right now. As he puts it, there's a collective action problem. If everyone invests their savings it creates an economy that works most effectively for everyone - but that decision to invest doesn't always make sense for individuals. Individuals trying to help themselves would often be better off keeping their money under the mattress (or a government insured bank account), but if everyone did that there'd be no investment and the economy would stagnate.
posted by Kevin Street at 9:31 PM on December 29, 2011 [1 favorite]


At present. corporations provide their own opinions about their financial situation, subject to their accounting firms regulations and/or honesty, otto42. I donno if you could make the accounting firm's less beholden to the corporations they investigate, but maybe.

In government, FIOAs go way beyond mere finances into decision making, internal documents, etc. Imagine being able to compel the release of BoA's executive's emails without standing to sue.
posted by jeffburdges at 10:50 PM on December 29, 2011


I think transparency as a buzzword is being used as a smokescreen to marginalize questions about enforcement. This way we can all argue about whether or not there should be corporate FOIAs or whatever instead of why the SEC is so bad at enforcing its own rules that Federal judges are even starting to call them on their shit.
posted by feloniousmonk at 1:31 AM on December 30, 2011


Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper. generate massive banking profits.

Transparency is necessary for a perfect market. If investors had perfect information, they would choose investments that offered the lowest fees while meeting their desired risk/reward ratio. Competition eats into profits - financial products are complicated in order to obfuscate the risk and extract as much from the customer in fees as possible. In the ultimate form of this, customers just give you their money to do with as you see fit and you skim a percentage off the top.
posted by heathkit at 1:16 PM on December 30, 2011


Also, this is a pretty creative use of the tragedy of the commons to justify swindling people out of their money.
posted by heathkit at 1:17 PM on December 30, 2011


Transparency is necessary for a perfect market. If investors had perfect information, they would choose investments that offered the lowest fees while meeting their desired risk/reward ratio.

You'd think, but back when I was involved with market research it became clear that even when all participants had perfect information many investors made poor decisions.

What became clear through our experiments was that no matter what you did to the market -- delayed information, delayed buying opportunities, significant differences in starting capital etc. -- about 1 in 20 people were super-traders who would kick everyone else's ass. We had to keep track of them as their presence in any experiment would significantly alter the results.

My conclusion from this is that any economic model that assumes investors are basically interchangeable is not going to be useful in the real world. You have to keep track of these super-traders -- who they work for, where they congregate, etc. -- if you want an accurate model.
posted by Tell Me No Lies at 2:04 PM on December 30, 2011


"What became clear through our experiments" ---> "What also became clear through our experiments"
posted by Tell Me No Lies at 2:05 PM on December 30, 2011


Still, even social security depends on extended growth, which is not realistic in any civilization.

...not yet realistic. But we are possibly beyond the period of 'world' wars, and who knows... maybe 200 years away from the end of most wars. And classical economics doesn't yet factor in new developments such as the growth and success of the 'open-source' development model, and how the Internet has smashed communication barriers. By no means has the intelligent socialization of things like health care and retirement funding been proven ultimately unworkable.

We also have to get some new yardsticks for measuring value and growth; that's a different thread...

But this is all digression. The biggest problem facing the world economy isn't lack of growth, it's the growth of the financial sector to a size far beyond that necessary for healthy economies. In the absence of sensible regulation, it's grown like a cancer. The financial sector IS now the economy, and all economic action is centered on what would benefit them. I spouted off enough about this...

Who gets the bailout when the sh!t hit the fan, and who hasn't yet been forced to devalue bad debt they created by marking to market? The US housing stock is being gutted by banks forcing foreclosure instead of renegotiation, and the empty houses are often neglected by the banks holding them. And many large corporations are sitting on cash.

Here's my naive ideas for a US reset:

- Break up all 'too big to fail' corporations, and block their reformation
- no more private regulators and rating agencies. Government or non-profit regulators and agencies, paid for by a tax on all stock transactions.
- An end to unregulated and overly abstracted financial instruments. No more derivatives, CDOs and other opaque products. No robo-trading.
- short-term: higher cost to just sitting on corporate cash reserves, paired with greater write-offs for investments in research and productivity.

Crown jewel:
- All underwater US consumer mortgages - devalued by at least 25% and renegotiated. Banks must prove they engaged in good-faith negotiations, including writedowns before permission to foreclose is granted. No more robo-signing and fast-lane foreclosures.
- Any foreclosed and/or vacant house becomes the property of the municipality after one year if left vacant, or neglected.

The banks caused the housing mess (and benefited mightily from it); they can clean it up.
posted by Artful Codger at 8:37 AM on January 1, 2012


There is a major 'mathematical' problem with outlawing derivatives that the Black-Scholes equation "proves derivatives exist". In other words, you cannot outlaw derivatives for large players because anyone large enough to buy transactions in bulk can simulate any option payout they want through a series of transactions in the ordinary instrument. And you don't want the insurance function of derivatives restricted to large players anyways.

I'd consider the real issue to be "risk fraud" through obfuscation, willful ignorance, etc., which you could fix through very conservative accounting practices. You could even say only software with publicly published and reviewed source code may be used for risk assessment of investments by pension plans or something.
posted by jeffburdges at 10:36 AM on January 1, 2012 [1 favorite]


To Codger's list, I would add: no more revolving doors for regulators. No executives to become regulators of their industries, and no regulators can become executives of industries they regulated. This also applies to military officers and defense contractors.
posted by Kirth Gerson at 10:53 AM on January 1, 2012 [1 favorite]


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