"Des waerelds doen en doolen, is maar een mallemoolen,"

"Des waerelds doen en doolen, is maar een mallemoolen," engraving from Het Groote Tafereel der Dwaasheid, 1720.

"The actions and designs of the world go round as if in a mill." South Sea bubble financial crisis.

Monday, September 26, 2011

Financial innovation with valuable social function ?


Peer-to-peer lending is on the rise. One could view this phenomenon through the perspective of a change of financial function. Traditional banks have a walk away from lending services and concentrate much more on transaction. The internet revolution aside, the rise of P2P might be a consequence of the move toward market-based systems. Wonga, a british P2P lending firm, has attracted much criticism. Its boss defends the firm's valuable social function:

They are picking on the wrong people. We are the good guys," Damelin says of his critics at Westminster, who refuse to meet him. "Yes, we're in a space that is controversial, that is polarising. But it is an important social service. To have social mobility you have to have credit available to people where its required and where it's appropriate .

Thursday, September 15, 2011

The persistance of ideas

We heard that buy and hold is a looser's strategy so many times before, here and here, that it's not sure the new report by Deutsche Bank will convince any more people. DB's  long-term asset study shows that:
Over the last 50 years, the real returns from equities have been lower than those from bonds in Germany, Japan and Italy. In the Italian case, the gap is almost three percentage points, and that is despite the recent bond sell-off.
 The U.S. case, which inspired all investor's wannabe is an historical anomaly.Now, is owning stocks for a millisecond capital allocation ? My take is that this shift from long-term to short-term reflects a shift from capital allocation to risk allocation, which is what Krugman meant by "from boring banking to fancy finance".

The several masks of uncertainty

There are lately many comments about uncertainty. Becker in a WSJ op-ed argues that changing the rules of the game in a recession fuels uncertainty, which slows business even more. So the focus is here on regulatory uncertainty and the rationale is basically: "don't introduce more regulation, we don't know yet how it will impact on the economy". Livingston disagreed and provides data showing that what business cares about is too little demand, and not too much regulation.  This Economist's excellent post structures the debate about red tape and recession.

The entering the territory of uncertainty with regulations suggests a view on the function of institutions.  That demands a clarification, because uncertainty has many masks. In other words: Is the world uncertain because we don’t know enough yet or is the world uncertain because it is just how the world is? Regulatory uncertainty is epistemological uncertainty,  similar to Taleb's Black Swan. It however not the same than fundamental or ontological uncertainty, the kind of which Keynes had in mind. Ontological uncertainty is possible only in a transmutable or creative reality. As Davidson writes:  

This nonergodic concept of uncertainty (the ontological one) implies that the future is transmutable or creative in the sense that future economic outcomes may be permanently changed in nature and substance by today’s actions of individuals.

A clarification on uncertainty is necessary because institutions play a different role, regarding how we view uncertainty. In a world where uncertainty is quantifiable (risks)  institutions has not to be included in economic theory. The path of economic development is predetermined and human action and the social devices they design do not interfere with it. In the second type of economic reality, law and rules find a place so as to facilitate coordinations or reduce asymmetric information for example. By the same token, institutions can be seen as providing a deeper cognitive function only if we assume that uncertainty has an ontological nature.

Tuesday, September 13, 2011

Stock Markets shaped like the coast of England...

...are becoming more frequent. Volatility is increasing and some analysts say it is now the new standard. The New York Times collects a number of figures: 
Since the start of this century, The Times found, price fluctuations of 4 percent or more during intraday sessions have occurred nearly six times more than they did on average in the four decades leading up to 2000.
As for closing prices, the more-frequent jumps could also be clearly spotted. Thirty percent of trading days since the start of 2010 were up or down more than 1 percent at the time of the closing bell. That’s far more than the 20 percent of such jumps in the 1990s. 
“The last few years have been the most volatile for all of recorded history,” said Andrew Lo, professor of finance at the M.I.T. Sloan School of Management. For evidence, he says that 10 of the biggest 20 daily upswings and 11 of the largest 20 daily drops since the beginning of 1980 to the end of last month have occurred in just the last three years.
This has consequences - undermining confidence, detering long-term investments, feedback loop problems where volatility feeds upon itself. But volatility is also a source of profit for the high-frequency trading industry and the segments of financial sectors that welcome it because it has the appropriate technology and ressources to deal with it. How this new standard advantages some and prejudice other is still unknown. Also, if one accepts that violent market swings are the norms, one has to admit that Mandelbrot was right and that the Bell's curve is not the appropriate description of how stock markets behave. Finally, one cannot help but note the shrewd comment of Prof James J. Angel, professor of finance at Georgetown University: "When there is uncertainty in the world, there is uncertainty in the market ". It is quite ironic because Financial Economics built itself distinguishing between uncertainty and risk and taking into account the later only. It tried dangerously to isolate itself from this "uncertainty in the world" (because it cannot really be measured) that it cannot grasp with it now.

Sunday, September 11, 2011

Economics is so f%&cked up, Krugman calls for sociologists to solve the profession's problems

Market Positioning by Lee Nielsen

Macroecomomics goes through a rough time to say the least. To steal Krugman's turn of phrase, it has entered a dark age,. Here's his address to the Eastern Economic Association and explanation of how economists failed. Good old sound (keynesian) knowledge about banking crisis and recession got lost througout the 1970' up to now. The dynamic at work he describes - a dominant approach casting aside academic production that doesn't correspond to the doxa it chose for itself - is one sociology of science knows well. So it seems reading Foucault's Archeology of Knowledge and Bourdieu's work on cultural and symbolic capital could be useful at last ;)
What we really need is a change in the destructive social dynamics that brought us to this point. And I wish I knew how to do that. But my problem is obvious: I’m an economist, and it seems that we need some kind of sociologist to solve our profession's problems.

Sunday, September 4, 2011

Financing innovation or speculation

The amazing story of the rise and fall of innovation clusters. Margaret Levenstein's business history perspective proves to be a useful one to distinguish the role of finance in it.

The bank's functions

Kal's cartoon - The Economist

Is to finance the economy. That is, to efficiently allocate capital. It is usually taken for granted that risk allocation, another function of financial systems, goes hand in hand with efficient capital allocation. Could it be argued, however, that there is a limit beyond which too much risk allocation is beneficial (or even detrimental indeed) to the financial system only ? That passed this point, the tow truck risk loosing its wheels ? The question is important because the financial sector is linked to the rest of the economy. When it is broken, the economy is dysfunctional. Kal's cartoon couldn't have captured it better.