"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.

Tuesday, June 11, 2013

About that Robin Hood tax

The Financial Transition Tax (FTT) proposed by 11 EU countries (including France, Germany, Spain and Italy - but not Britain nor Sweden), coined the Robin Hood Tax is, conceptually, an old idea. The stamp duty, the oldest tax still in existence in the U.K., is a form of financial transaction tax. Keynes argued for the implementation of such a tax on Wall Street, and after the end of the Bretton Woods regime, Tobin proposed a tax on currency exchange.

The FTT supported by the EU 11 group is supposed to be implemented in 2014, but as mentioned earlier, it is not going to be so simple. If one steps away from the technicality of this new piece of legislation, it appears more clearly than it is also an attempt to "slow down the engine", to "throw some sand in the wheel of finance", as Tobin said. In this regards, this reform reflects the momentum taken by the idea that finance has to work for the economy.  It is finally getting acceptable to say that that the liquidity and volume of financial markets are not an end in itself. 

This reform and the reactions it triggered represents the tensions between risk management and investment. Keynes already voiced his concerns about this dilemma. On the one hand: “Liquidity of investment markets often facilitates, though is sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is “liquid” (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk. If individual purchases of investments were rendered illiquid, this might seriously impede new investment” (Keynes, 1935:133). On the other hand he warned that “when the capital development of a country becomes a by-product of the activities of a casino”, which is the outcome of “our having successfully organized “liquid” investment markets, the job is likely to be ill-done” (Keynes, 1935:133).

Monday, June 10, 2013

Behavioral finance is at the individual level

Courtesy of Kal, The Economist

Here are 7 psychology concepts showing that investors are not rational as orthodox financial economics holds. Investors have emotions and mental frameworks to process information that makes their decisions irrational, though perfectly "normal". 

But behavioral finance is at the individual level, not the group or the societal level. The title of the post linked above is clear: the biases examined by behavioral finance are psychological. At the group level, the dynamics might different, but to discover that, we need more work from the sociology of finance and crowd psychology. 

Friday, June 7, 2013

The politics of financial reform

The Financial Transaction Tax (FTT), otherwise known as the Robin Hood Tax, is likely going to be reviewed and postponed. It is a levy of 0.1 % on the trades of stocks and bonds and 0.01% on derivatives transactions involving at least one financial institutions based in the EU. The political tensions around this reform are mounting due to the design, feasability and the economic implications of the reform.

States dependency of finance means the tax base will be a crucial question. An FTT can tax stocks, bonds, forex, options and futures. It can tax the primary market and/or the secondary one, regulated market and/or OTC. If only one kind of instrument is targeted, the reform risks creating a bias in favor of others financial assets. If government bonds are not included in the tax base, it is likely to draw liquidity out of the corporate bond market, and raising the costs of capital. But taxing public sector debt is not uncontroversial either, as it will impose higher transaction costs, thereby raising government borrowing too. 

So support for the reform is starting to wane. Germany and France are worried about the backfire effect this tax could have. Austria and Belgium want an expection for pension funds. 

One argument concerns the impact it will have on European banks borrowing overnight using repurchase agreements (or repo). The borrowing bank sells liquid instruments that it agrees to repurchase later at a higher price. As the costs of borrowing overnight thourgh repo is very low, the tax would kill this segment. The ICMA, a lobby group, already made clear that the incidence of the reform over the repo market will be catastrophic. (That being said, the importance of the proper functioning of the repo market, not the most glamorous market of all, is often overlooked). The reform thus might need a carve-out for repo.