04
Oct
11

Let’s be a bit careful about fucking with finance, shall we?

Andrew Sullivan points us to an article by Robert H. Frank, which the Boston Globe doesn’t want to let me read.  Well, okay, if they don’t want ad views I’m happy to oblige them.  Sullivan follows up with an inlined observation:

He offers as an example the exorbitant amount of funds the financial industry spends on computer modeling systems: “You’re spending a lot of money for something that’s not really worth anything — getting the price 10 seconds earlier isn’t worth anything to society, but it’s worth a lot to the guy who gets the right price 10 seconds earlier.”

(Emphasis added.)

Bald assertions like that one make me shiver.  Not being able to read the original source, I can’t confirm this, but I suspect that what Frank means is “I can’t see any way in which getting the price 10 seconds earlier is worth anything to society”.  And in his defence, neither can I — or at least nothing to which I can point directly and say “Hey, stupid: there it is!”

But one thing I’ve been learning since, oh, the beginning of 2008 is that investment and finance are subtle beasts with broad influence over the larger economy.  That ten-second advantage in a single transaction might not appear to be worth anything “to society” when isolated from the rest of the market and taken on its own.  What are the second-order effects?  Someone’s willing to pay a lot of money to get the right price ten seconds (hell, ten milliseconds) earlier; why?  What’s going on in the price system that rewards the extra sliver of time efficiency?

Nearly everyone who’s not camped out on Wall Street will tell you that price systems are important, and if they don’t you have a moral duty to beat them with the economics cricket bat until they achieve enlightenment.  Baldly to assert that a ten-second discrepancy in price information working its way through a market isn’t worth anything to society is, well, taking an awful lot for granted.

And speaking of those folks who’re camped out on Wall Street: Mike Konczal recommends a Financial Transactions Tax.  He writes:

It is hard to think of something with such a boring name as a particularly radical solution, but an FTT would be an important first step toward remaking our economy so it is not so dependent on the financial sector.

Thanks to a wave of deregulation laws in the late 1970s and early 1980s, finance has been one of the fastest-growing sectors over the past 30 years. It’s become so important, in fact, that some argue the economy should be run in accordance with the ideas and goals of the financial sector.

What happens when you tax something, kids?  You get less of it.  Finance is about the flow of money between borrowers and creditors.  Throttling that flow at the beginning of what looks like the recession’s second dip would be a very fucking bad thing.  Oh, sure, it would really put the screws to those suit-wearing Patrick Batemans, haha, wouldn’t you love to see the looks on their faces if that happened!  Yeah, fine; if policy was all about schadenfreude an FTT would be a winner.  But policy is — or ought to be, at least — about a bit more than jumping up and down on anthills.

I’m reminded of Chesterton’s Fence:

There exists in such a case a certain institution or law; let us say, for the sake of simplicity, a fence or gate erected across a road. The more modern type of reformer goes gaily up to it and says, “I don’t see the use of this; let us clear it away.” To which the more intelligent type of reformer will do well to answer: “If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.”

This paradox rests on the most elementary common sense. The gate or fence did not grow there. It was not set up by somnambulists who built it in their sleep. It is highly improbable that it was put there by escaped lunatics who were for some reason loose in the street. Some person had some reason for thinking it would be a good thing for somebody. And until we know what the reason was, we really cannot judge whether the reason was reasonable. It is extremely probable that we have overlooked some whole aspect of the question, if something set up by human beings like ourselves seems to be entirely meaningless and mysterious. There are reformers who get over this difficulty by assuming that all their fathers were fools; but if that be so, we can only say that folly appears to be a hereditary disease. But the truth is that nobody has any business to destroy a social institution until he has really seen it as an historical institution. If he knows how it arose, and what purposes it was supposed to serve, he may really be able to say that they were bad purposes, that they have since become bad purposes, or that they are purposes which are no longer served. But if he simply stares at the thing as a senseless monstrosity that has somehow sprung up in his path, it is he and not the traditionalist who is suffering from an illusion.

All of these reactions to finance strike me very much as “I don’t see the use of this; let us clear it away.”  With the eurozone about to burst into flames — with all the risk-exposure issues that implies for the global banking system — and a thundering herd of medium-term debt issues that are becoming short-term debt issues with worrying alacrity, emotional populist meddling in the financial sector seems like a really fuckin’ bad plan.

Update: Ken Rogoff and Tim Harford advise against the EU’s proposal for an FTT.  If Ken Rogoff and Tim Harford told me the world was flat, I’d give their arguments serious consideration.  Click through and RTWT.

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7 Responses to “Let’s be a bit careful about fucking with finance, shall we?”


  1. October 4, 2011 at 13:40

    I had somehow never heard of Chesterton’s fence before. At first I thought I could get around it by doing a controlled trial, but even that doesn’t work. If I don’t know what the fence is for, how do I figure out what to control for?

    “or at least nothing to which I can point directly and say “Hey, stupid: there it is!””

    What about all subsequent trades happening ten seconds sooner – and themselves benefiting from similar software? I’m not sure what I’m controlling for here…but I’ll guess either the time take to trade or the timing of the trades.
    If the first, say a trade took one minute. If it gets ten seconds sooner, the market can perform 6/5 more trades each day.
    If the second, it’s literally moving the market ten seconds into the past – reaching ten seconds into the future, relative to the previous situation.
    These amount to basically the same thing. If it keeps improving and the market will reach equilibrium instantaneously after any shock, instead of going through wild oscillations.

    • October 4, 2011 at 16:50

      Yeah, I’m tempted to make an argument about “moving markets closer to the Efficient Market Hypothesis”, but I don’t think I understand the underlying system well enough to do that.

      I think the “benefit to society” would become more clear when we watch the system evolve in time. If Investment Bank A has access to prices 10s sooner than Investment Banks B..Z, they can in essence extract monopoly rents on those correct prices for 10s. That’s obviously long enough to be worth millions of dollars to Bank A. But Banks B..Z aren’t going to just shrug and accept the relative losses: they’re going to try to reduce their response times by 10s — or 11s — as well. Result: price information propagates more quickly, and presumably the market gets more efficient. Markets are all about transmitting information by prices, so we can suppose that this is a Good Thing.

      It’s a very nice, compelling story. I’d tell it in the main body of the post, but I don’t know that it actually corresponds to reality.

  2. 4 perlhaqr
    October 6, 2011 at 06:36

    I’m not sure the Chesterton’s Fence analogy really works, if we’re comparing laws to fences built by lunatic somnambulists. That’s pretty much how I’d describe Congress.

    • October 6, 2011 at 09:00

      Hey! Lunatic somnambulism is a tragic condition, and I won’t have those suffering from it insulted in my blog comments. Comparing lunatic somnambulists to Congressshitbags is offensive and uncalled-for.

      (Besides which, your analogy suggests that Congressshitbags are neither aware of what they’re doing nor responsible for their actions.)


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