Monday, 16 March 2009

High Finance Theory Comes Round To Common Sense

One of the few points of agreement between a basic leftwing view of the world and the general opinion of the famous man or woman on the Clapham omnibus is that , in essence, the Stock Market is little more than gambling. This opinion is routinely patronised as not understanding the essence of high finance in almost all public discussions. We have been endlessly assured that the Stock Market allocates capital to productive enterprises in an efficient way.

I only mention this embarrassing feature of 'leftwing common sense' because, it appears, it is gaining some support in unexpected places. Willem Buiter of the LSE and FT - and formerly of the Monetary Policy Committee - wants the derivative markets to operate on an insurance basis rather than a gambling one. Only things which can be owned in some real sense - rather than just bet against - can be insured. This would massively downscale such trades in his view:

"It is certainly likely that notional outstanding stocks of derivatives and the trading volumes would fall to a quarter or less of their 2007 levels if derivatives could be used only to buy insurance, not to place bets."

But this is necessary because, actually, leaving things as they are is a recipe for proving those simple minded leftwingers - and the folk on that Clapham bus - right:

"The lotteries or bets that are the essence of contingent claims/derivatives markets could increase allocative efficiency if they permitted the given, exogenous risk in the economy to be born by those most able to bear it. Instead that risk has ended up with those most willing but not, judging by results, most able to bear it. .... It creates more opportunities for going bankrupt. Defaults and fear of defaults ..... are a source of macro-endogenous risk, even if no individual trader has market power or attempts to manipulate markets. Bets taken in the CDS markets..... or through spread betting cause massive redistributions of wealth and income that can destroy real resources, influence the prices of ‘outside’ assets and bring down otherwise viable economic entities. "

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