The Georgian parliamentary election

All night long, group of people were honking the street of Tbilisi.  It is still not official, but the by exit polls and main voting station, opposition won. Tbilisi voted against Micha. As the Economist wrote, this election was dangerously polarized. Myriad of buses loaded with (paid) supporters came from the various regions to Tbilisi on Friday and Saturday, armed with flags. For a look at the sometimes empty economic reforms and the neoliberal window dressing used by the power since the Rose Revolution, see my piece in, s'il vous plait, le Monde Diplomatique. 

The need for simple financial regulations

As argued previously (here and there), financial sectors need simple regulations, not more complicated ones. This is being voiced more frequently than ever. Nicholas Brady calls for a new simplicity agenda, in the FT:

Regulators need a clear “bright line” that they can apply to bank activities. The aim should be to permit innovation, and prudent risk taking, while also creating less varied and complex boundaries that banks cannot cross and that everyone can understand. The new simplicity should establish a clear ability to determine when to say yes, and when to say no; and the meaning of “no” should be unambiguous.The debate should shift to focus on the total leverage permitted in the bank’s books – that is the “bright line”. Banks should be permitted to devise their own strategies and use trading as they see fit, but they should be restricted from taking positions that use leverage of more than “X-to-1”. That may limit the upside of their operations, but at the same time it will limit the downside for taxpayers. It also puts responsibility for operational decisions where they belong, in the hands of the bankers themselves. What should be the boundary? Will it take additional time to design? Yes, but it will be worth it. For a change the public will both understand and agree with it.

The case of "less is better" is gaining more weight against the traditional paradigm of regulation. Some are indeed pushing for more and different way of data gathering about risks and quantities. But the last financial crisis reminded us of the difference between risks (quantifiable) and uncertainty (which is not). It took back from the shelf Knight, Keynes and Minsky and  in a speech at the Fed's Jackson Hole conference, Mr. Haldane from the Bank of England:

The degree of complexity also raises serious questions about the robustness of the regulatory framework given its degree of over-parameterisation. This million-dimension parameter set is based on the in-sample statistical fit of models drawn from short historical samples. If previous studies tell us it may take 250 years of data for a complex asset pricing model to beat a simple one, it is difficult to imagine how long a sample would be needed to justify a million-digit parameter set.

The visible hands of financial markets

A stream of study reveal that formal institutions and regulations were not and are not the only elements allowing for financial markets to emerge. Late 17th century England  financial revolution provides valuable lessons for todays regulators and all the parties interested in making financial markets more efficient and less risky: formal complex regulation is not the answer. Formal simple regulation might address the need to rebuild confidence in the solvency of financial firms, but Western economies needs to think of mechanisms to address the loss of trust. Financial history perspectives are insightful in that regard. Carlos, Key amd Dupree showed that learning took place before the official establishement of the financial market and how crucial it was for its emergence and proper functionning:

The key is learning. Individual investors learned how to make (and lose) money in ways that did not directly involve productive processes. They learned how to share risk in commercial and financial endeavors; how to buy and sell, and where to buy and sell. They learned about the financial rewards and losses they could incur. Concomitant with this was the learning by specialized brokers who managed the trade during these early years. The goldsmith bankers increased their expertise in the equity section of the market

Google, math and the physics of finance

The algorithm on which google is based, PageRank, could be replicated and applied to finance, so as to measure the extent to which financial institutions are interconnected. PageRank links pages to each others and the ones most connected to other important ones will be ranked accordingly. In others words, the algorythm captures the circularity of interconnection. Buchanan explains Bloomberg the parrallel with an algorithm European phycisits and economist developed:

Their algorithm, DebtRank, seeks to measure the total economic value that would be destroyed if a bank became distressed or went into default. It does so by moving outward from the bank through the web of links in the financial system to estimate all the various consequences likely to accrue from one failure. Banks connected to more banks with high DebtRank scores would, naturally, have higher DebtRank scores themselves.

The increasing interdependence between financial media and market participants

The picture above is of Jim Cramer, a financial news anchor, host of Mad Money. The one beaten up by  John Stewart  there and there. The whole clash is a must-see and is about the transmission of information. On one side, the financial news industry in the US and probably to a lesser extent in Europe is simplifying the complicated intricacies of modern financial sectors. Because educating wouldn't be good for ratings. This is about the diffusion of financial news to the wider public with the mask of entertainment. But the relationship between media and finance at the beginning of the transmission belt is problematic too. Oberlechner and Hocking studied empirically the linkages between financial journalists and analysts: 

More than two thirds of journalists agree strongly or agree that market participants can influence news providers (87%), that news media and market participants have become more dependent on each other (75%), and that the immediate reporting of events has significantly gained in importance vis-a-vis background analyses (67%). Sixty three percent of financial journalists agree that they depend on market participants to interpret news. More than half of the journalists agree that new technology has brought along an increased risk to report unverified news (59%), and that speed has become more decisive than contents in financial news reporting (55%). [...] Foreign exchange traders and financial wire journalists mutually rate each other as the most important information source. The most important informa- tion sources of wire journalists, their personal contacts at commercial banks, are also the main customers of the financial wire services. Consequently, information of the news services often consists of trading participants' perceptions and interpretations of the market, which are fed back to the traders in the market. As a result, a highly circular cycle of collective information processing in the market emerges. The finding that for non-wire financial journalists, the wire services are the most important sources of information further enhances this circularity of information gathering and disseminating in the foreign exchange market

 More photos of Jim after the jump.

Central banks and the media

A new study by the Swiss National Bank compares the two ways central banks have to reduce financial markets overreaction to their statements: "disclosing information to a fraction of market participants only (partial publicity) or by disclosing information to all participants but with ambiguity (partial transparency)". 

I would love to be able the comment on the mathematical formulas in it or, even better, refine it...but...

How to finance the missing middle

Debt or stocks ? Banks or equity markets ? As France fears for its petite et moyennes enterprises, whose access to bank loans is going to be more expensive, the chief executive of the London Stock Exchange Group insists that even small entreprises could be financed through equity. The biggest problem of financing SMEs is informational asymmetries, as the reason why they are financed by debt where the interest rate of the loan function as a risk management mechanisms. So Mr. Rollet seems to think simple disclosure would be enough:

The cost of satisfying disclosure requirements must be reduced, as well as the time required to bring an issue to market. A shelf registration system would allow companies greater flexibility, accessing the public funding markets while satisfying all applicable disclosure requirements. The recent US JOBS Act – Jump Start our Business Start-ups – is designed to reinvigorate access to equity funding for entrepreneurs. The UK needs its own JOBS Act.

He misses two points, to my opinion: 

1. He seems to equates information with knowledge. SMEs businesses are blurry and banks are reluctant to finance them if they do, the costs of capital - the interest rate - reflect the uncertainty inherent in any young business. But disclosing more accounting data or being more transparent will not reduce this uncertainty. The right equity investors for SMEs are the one capable of manufacturing knowledge with information. 

2. And that is why SMEs need finance accompanied with management and experience. So I don't think that the "hands off" approach to equity finance of SMEs through stock market that Mr. Rollet advocates is the right one. The "hands in" approach to private equity though, might be much more appropriate. New studies (NBER, University of Chicago) show that private equity contributes greatly to employment through SMEs growth.