A reader (well, this Pulitzer-winning genius newspaper columnist of a reader), e-mails after reading my book:
From the very beginning of financial capitalism, the goal seems to have been to beat the market, which is to say, anticipate and profit the upside and downside of the market—not the industry or business of the stock traded. Basically, to make money on nothing, returning no value to the world. I always thought the goal of the stock market was to capitalize growing businesses so they could return value to the world. …
Why didn’t any of these smart guys, Fisher et al., realize that in developing various kinds of mathematical models to conceptualize the “market,” they were succumbing to what seems to me a fundamentally anti-capitalistic temptation? To just be money traders and NOT makers of value.
And when I look at high-speed, supercomputer-assisted trading that goes on today, squeezing out profit in the nanoseconds fluctuations in stock prices, I’m appalled. I also think big, mature companies—without reasonable expectation of growth—should get out of the market, because shareholders’ spiraling expectations of profit almost inevitably hollow out value in the core company, and cause companies to make products cheaper, move labor off shore, etc.
Interestingly, that last paragraph sounds a bit like Michael Jensen’s famous 1989 Harvard Business Review article ‘The Eclipse of the Public Corporation.’ (Since I don’t work at HBR until next week, here’s a free version too.) Jensen argued that being publicly traded was a poor fit for big, mature companies. More controversially, he argued that leveraged buyouts—what we now call private equity—provided the perfect solution to this problem.
But that’s not really the main point my reader was trying to get at. It’s that a big share of financial market activity doesn’t seem to generate any real value for the rest of the economy. Everybody agrees that raising money for new ventures is important for the economy, but such fund-raising constitutes only a tiny portion of Wall Street activity. The rest can only be justified as (1) providing liquidity, so the economy’s actual creators of value are able to cash in on their efforts and (2) allocating capital efficiently, by correctly setting the prices of financial assets.
Financial markets clearly aren’t very good at (2), at least not on a short- to medium-term basis. Case in point: the fact that worthless “old GM” currently has a market cap of $500 million. I doubt anybody else (government, for example) would be any better at it. But I don’t buy that today’s financial markets are much more efficient (in the capital-allocation sense) than the vastly smaller markets of 40 years ago—which leaves only liquidity provision as justification for the giant size of our financial sector and the giant paychecks pulled down by some of those who labor in it.
A lot of high-frequency stock trading is explicitly geared toward liquidity provision. A few big firms have taken over on electronic markets the role that specialists play on the floor of the New York Stock Exchange—that is, they’re always willing to take the other side in a stock trade. These firms pay the bills by exploiting their high-speed trading capabilities and exchange rules that pay tiny premiums to liquidity providers. As I’ve written before, I’m not sure this is a bad thing—although there is a certain Skynettish, computers-taking-over-the-world aspect to it that’s somewhat disturbing. (By the way, what does James Cameron have against the sky? First Skynet. Now Sky People.)
The bigger issue is that so much of Wall Street failed at liquidity provision in 2007 and 2008. Opaque, poorly organized debt-securitization and derivatives markets froze up in the summer of 2007 and in many cases still haven’t reopened. My sense is that Wall Street firms resisted bringing all these new financial products onto organized exchanges (and are still resisting it) mainly because opacity and disorganization allow them to book higher profits. I can’t think of a way to justify those profits. Can any of you?
