Speculation and Finance: Good for you? (part III)
by Linda Beale
Speculation and Finance: Good for you? (part III)
In a couple of prior postings (Part 1 and Part 2), I considered (1) Darrell Duffie’s op-ed in the Wall St. Journal asserting that financial institution speculation in the markets is “good” for us and (2) the question of financial institution speculation in credit default swaps on Greek debt as a possible factor in the worsening of Greece’s financial situation.
Speculation seems to be on everybody’s mind these days. The Economist, for example, is running a debate on the question of the value of financial innovation, here. Volcker famously has commented that about the only financial innovation of the last century that was really worth anything was the ATM, as the moderator noted inher opening remarks.
A few years ago America’s sophisticated financial system was hailed as a pillar of its economic prowess. The geeks on Wall Street and their whizzy new products symbolised the success of American capitalism just as much as the geeks in Silicon Valley. Today things look very different. After the worst financial crisis and deepest recession since the 1930s, Wall Street has become synonymous with greed and irresponsibility in the public mind. And while no one doubts that financial innovation made a lot of financiers extremely rich, a growing number of people question whether it did much, if any, good for the broader economy. Paul Volcker, former chairman of the Federal Reserve and an advisor to President Obama, has famously claimed that he can find “very little evidence” that massive financial innovation in recent years has done anything to boost the economy. The most important recent innovation in finance, he argues, is the ATM. Id.
The debate is about cutting edge financial innovation as came into style in the 1980s–mortgage-backed securities, collateralized debt obligations, credit default swaps and other financially engineered derivative instruments and innovations like exchange-traded funds and inflation-protected bonds. So who are the voices for the Con and Pro side on “love that speculation and financial innovation” at The Economist? It’s Joe Stiglitz, Nobel prizewinning neo-Keynesian (who should, in my opinion, have been appointed to the position that Larry Summers holds in the Obama administration) arguing against the value of most financial innovation–the “right kind” he says, could help financial institutions fulfill their core functions more efficiently, saving money and therefore contributing to economic growth. “But for the most part, that’s not the kind of financial innovation we have had.” Most of the recent financial innovations have been primarily accounting gimmicks and inventions designed to game the tax system–In my terms, those are not productive investments that move technological innovation, but shell games to fool regulators and pocket the windfall for the wealthy few. Een the inventions that had the potential to stablize the financial system actually ended up destabilizing it, because of their abuse in the furtherance of greed. And in the other corner, it’s Ross Levine, Professor of Economics at Brown, who thinks financial innovation is “crucial, indeed indispensable” for economic growth.
Not surprisingly, I think Stiglitz has the winning argument here about the questionable value of most of the late 20th century financial innovation.
We should not be surprised that the so-called innovation did not yield the real growth benefits promised. The financial sector is rife with incentives (at both the organisational and individual levels) for excessive risk-taking and short-sighted behaviour. There are major misalignments between private rewards and social returns. There are pervasive externalities and agency problems. We have seen the consequences in the Great Recession which the financial sector brought upon the world’s economy. But the consequences are also reflected in the nature of innovation, which, for the most part, was not directed at enhancing the ability of the financial sector to perform its social functions, even though the innovations may have enhanced the private rewards of finance executives. (Indeed, it is not even clear that shareholders and bondholders benefited; we do know that the rest of society—homeowners, taxpayers and workers—suffered.)
Some of the innovations, had they been appropriately used, might have enabled the better management of risk. But, as Warren Buffett has pointed out, the derivatives were financial weapons of mass destruction. They were easier to abuse than to use well. And there were incentives for abuse.
I wonder why a financial transaction tax is not yet imposed to make speculators pay or make bankers in general to pay for their negative externalities (or polluters pay principle in financial markets). Although the idea now in circulation is sometimes called a Tobin Tax, my idea goes beyond the levy on currency transactions that American economist James Tobin proposed in the 1970s.
A tax on currency transactions and derivatives could be implemented immediately and painlessly, and would raise easily at EU level 100-200 billions euros. In the EU the U.K. raises more than $30 billion a year on a tax that applies only to stocks.
Well SOME level of speculation is certainly a good thing. But those who make their money pushing money and debt around Wall Street have done their best to convince everybody that MORE speculation is ALWAYS good. Just as they have tried to convince us that LESS taxes on them is good for everybody. Figuring exacly how much is the right ammount is very difficult. But I regard the fact that MOST of the money on Wall Street wasn’t being funneled into improved factories, or innovative new companies as evidence that there was too much speculation.
We don’t want the government deciding where all the money goes. But the fact that Wall Street couldn’t seem to find anything better to spend it on than obviously bad mortgages and various financial “innovations,” is prime evicence that there was simply too much money and too little regulation in the “financial industry.”
“…was not directed at enhancing the ability of the financial sector to perform its social functions,…”
What a curiosity to put it that way when all we hear today regarding anything concerning the purpose of business is that their purpose is to make money. Example: the health insurers can’t solve our problem because they are doing what they are suppose to do, make money.
Wouldn’t it be nice to hear that the solution to our business regulation starts with the purpose of performing it’s “social function”.