The return of Political Economy

Finns rarely make the headlines, but their support of euro-skeptic True Finns has pushed political risks into the spotlight. Political economy is back and yes, how people think, vote and the varying frameworks embedding how they organize still matter.

The added value of rating agencies

The S&P alarm on US debt on April 18th moved stocks markets and triggered a lot of comments. The recurring ones are about the added value of Credit Rating Agencies (CRAs). The very existence of CRAs is being questionned every time financial news put them in the front row because it still not clear whether or not they passed a “market test”. Do they provide any extra information?

If the added value of CRA’s in the US is still a questionable, no wonder the rating industry has suffered a lot of criticism with regards to applying ratings to developing economies, especially after the Mexican and Asian crises. Ratings could indeed favor procyclical behavior or could be sticky, in that they would simply react to macro-economic parameters or market news, reinforcing arguments which claim they are, evidently, behind the market, since they use publicly available data. For Powell

while the rating agencies do not necessarily add to the sum of underlying knowledge, they change the degree of “common knowledge”. In other words, each analyst may have known what S&P knew, but they did not know for sure what all the others knew. All are now sure that at least all know S&P’s views.

So S&P issued a “warning” on US debt, stock markets then plunged and I am still wondering how information is treated where it matters. Because, as Krugman noted, the 10-year bond rate did not seem to integrate the S&P signal.

Robots are going to the BRIC

HFT growth has supposedly peaked in Western Europe, so the industry is moving to the BRIC markets where exchanges are modernizing their systems to charm these players. The Russian legal system regarding financial transactions is incoherent and  full of contradictions and supervision of regular trading is already a challenge. If HFT is an issue in countries with sophisticated regulatory structures (notwithstanding the huge lack of funding) and has blurred the lines between cheating, betting and investing, I truly wonder how the practices associated with HFT will adapt to a weak institutional environment like Russia.

Hostages of Wall Street ?

The political weight of Wall Street - that increased over the past decades - could be viewed as a stage of a financialization process. Proponents of this concept have advanced the idea that the financial sector is increasing in size and taking a life of its own. The phenomenon can express itself in terms of the increasing level of debt as percentage of GDP. For example the total debt in the U.S. rose from 140 percent to 328.6 percent from 1973 to 2005. Pay increased dramatically, so did the financial-industry profits as a share of U.S. business profits. 

The U.S. financial sector gained so much power that S. Johnson, former chief economist at the International Monetary Fund and a professor at the MIT, actually argues that it has become a kind of oligarchy:

There’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.

The inside job, a film directed by Charles Fergusson, does a great job at describing the rise of the financial leviathan, depicting the "Wall Street - Washington corridor" that Johnson wrote about. It has become a ideology battle that involves government and their regulatory agencies, investment banks and investors and academic. For the Universities - Wall Street corridor, see J. Fox.

Financial Terminator

High Frequency Trading is thrilling for someone interested in the social meaning and function of finance, because it now uses technology to bridge finance and philosophy. What are Quants to answer B. Ritholz' worries about the new Robot Uprising ?

The paradox of efficiency - Robot trading

High Frequency Trading strategies which use robots to trade is the result of a process of financial development and its quest for efficiency. But we begin to see the limits of this development which lead sometimes to contradictions, such as the "Hathaway effect”. The theory is still to be proven, but the bluntly put (from the FT):

if Ms Hathaway is in the news, Warren Buffett’s Berkshire Hathaway stock jumps too.

Mr Mirvish, the blogger who spotted the trend

pointed the finger at confused robotraders – the complex algorithms that execute 70 per cent of stock trades, sometimes by scanning news stories for trends.

A tale of two trials

The trial of Raj Rajaratnam, a billionaire hedge fund manager, for insider-trading has just begun. This trial strike at the heart of corporate America, for Rajaratnam was getting information from a managing director of McKinsey, Anil Kumar. As if finance, and especially hedge funds - the villain of financial sectors in the eyes of the public - needed more bad publicity to hit rock bottom. 

Zingales thinks that for the industry to avoid being associated with the growing list of rogue traders, legitimate hedge funds should proactively disclose their past trades that are at least two years old. That suggestion prompted a reply from Stone Street Advisors, invoking hedge funds's "trade secrets" to argue that Zingales should get out of his office a bit more. I think the interesting point is that trading strategies, which HF fear could be reverse engineer, are elaborated in the perpetual quest of some kind of modern philosophical stone: the Alfa. Patterson's book on Quants gives a good account of that quest and its sociological underpinning. That being said, I think the bottom line is that some think it's naive to expect disclosure from hedge funds, because HF view their trading strategies as intellectual property.  It would be akin to ask pharmaceutical companies to be allow generic drug. Which they do ! and the period of time protecting their Intellectual Property (IP) cannot enter the line of arguments, because, as Zingales reminds us, the life of most trading strategies is very short.  The IP card cannot be played here. The benefit of invention, a common good, is usually the rational to protect, temporarily, Intellectual Property. So after all, so what ? if other investors can reverse engineer strategies that are more than two year old. It is not like everybody has benefited of the marvelous inventions of financial engineering.

The other trial ended up in a ruling of the German Federal Court of Justice against Deutsche Bank and in favor of Ille Papier-Service. 24 pending cases are still to come. The Court considered the structured product which took a bet on interested-rate spread - with 4 % of commission in it - sold by DB to that company as inappropriate. The complexity of these products and the trials that follow highlight a fundamental question: who are the financial sectors to serve (or to screw) ? SME's don't (and shouldn't) have the necessary financial literacy to fully understand these financial products, whose structures are so complex that it can hide large commissions and make their market value so hard to establish, that we begin to see intermediaries appearing between issuers such as DB and customer. It seems financial engineering has not been beneficial to SME's either.