by Dr. Angelika Brinkmann
The 2005 movie the Squid and the Whale presents an intimate look at a family coming apart at the seams in 1980s Brooklyn. Today's world is in a period of profound changes in international relations and economic policy. These developments call attention to the state of our knowledge about economic and financial processes. How to solve the financial crisis? This question has been the focus of an intense and virtually continuous global debate since the beginning of the breakdown of Lehman Brothers in September 2008. This essay reviews recent developments like the rise of the occupy movement, discusses the lack of financial market regulationand problems in high frequency trading. It proposes to take a closer look at 'transparent capitalism'.
A movie testing heredity vs. environment by switching a 'have' (Dan Akroyd) and a 'have not' (stre Eddie Murphy) It is rather unlikely that the protesters long for such a switch. The occupy movement's existence is merly to state their discontent and lack of hope. It's members aren't asking for a handout. The 'occupy movement' represents a lot of frustration with the global effects of capitalism without offering specific suggestions as to what could be done differently.
But it is not the job of protesters to find solutions. Their job is to let politicians know that people have had enough. Given the sometimes stubborn deafness of politicians, that's a tough job in itself.
Finding solutions is the job of parliaments. It's up to them to make decisions and regulations to protect the well-being of citizens, but they haven't. Instead, people are convinced that decisions of politicians protect bankers and investors who may or may not finance their political ambitions. In the U.S. the bank bailout was sold to the people as the only way to save the economy, but is perceived to have further fattened Wall Street.
There cannot be a simplistic call for the end of capitalism but a general expression of discontent. The occupy movement questions the financial pracitices, whether they serve those who need to be served, or have simply become trohpy that themselves deemed uncritical service.
The 2010 documentary "Inside Job" takes a closer look at how we got into the financial crisis of 2008. It offers a comprehensive analysis of how we got into the worst financial crisis since the great depression. It presents detailed research and remarkable interviews with key financial players, journalists and academics.
There is widespread exasperation with the financial establishment that shows no sign of diminishing. There is still a powerful feeling – true or not – of a whole society paying for the neoliberal financial reforms and the irresponsibility of bankers.There is the impression of a retun to 'business as usual' mirrored by still soaring bonusses and little visible change in banking practices.
The financial crisis of 2008 created a demanding case for financial reform and better risk management. So regulation provisions like Basel III, the Dodd-Frank Act and the European Systemic Risc Board were enacted. This ment an overload of paperwork, hard to digest and to manage. The sheer complexity and opacity of this bulk of information and rules makes it hard for most people, parlamentarians and experts alike not to mention the average citizen to predict what the net effects will be. This irritating process is creating ample opportunity by 'insiders' or those with privileged means to dodge the rules by moving across borders.
This lack of transparency creates a deficit for democracy, i.e. the political process. The need for political leaders to depend on expert technicians in order to make critical decisions is more and more a characteristic of modern life. In such highly technical areas as electronic trading those who must take responsibility for making decisions cannot begin to absorb and master all of the factual and analytical work that must precede such decisions. In the vast majority of cases policy makers and bankers have only the vaguest understanding of the technical details of the systems they are controlling.It is not clear yet, if the installment of a centralized European DataWarehouse means relief or will add to these already complex and intransparent structures.[Sapient Global Markets für die Erstellung des europäischen DataWarehouses ausgewählt, 3.11.2011; http://finanzen.net]
With the “emergency war funding bill”, voted on March 23, 2007, Congress opted for an additional funding which adds 1.2 bill$ to the president's request to fight al-Quaeda and the resurgent Taliban in Afghanistan, as well as $3.5bill to improve military and veterans' health, to end e.g. the problems uncovered at Walter Reed Army Medical Center. It also sets a deadline for troop withdrawal for August 31, 2008.
Much can be said about turning bills into a spending-spree but the most crucial aspect is the unflexible timetable. This is an invitation to enemies of all kinds to focus any strategy of their own on this particular date. So far, House and Senate have set different deadlines and requirements, but the general goal of both is to have most U.S. combat troops out of Iraq before election day 2008. Even though both chambers may agree on the same date it is rather unlikely that the president's announcement to veto such a bill can be overriden.
Whereas the 'cut and run' approach has proved to be ineffective, the president's
veto may buy enough time to find out whether his 'troop surge' is working.
The U.S. commander inm Iraq has said he expects to start seeing results by
late summer. If the plan fails, there is no alternative but withdrawal. Should
the plan succeed, it will also buy time to plan a withdrawal/retreat that
plays to the advantage of the U.S..
Instead of threatening to veto bills the president could point out that the benchmarks he set out for Iraqi leaders in January are written into both funding measures:
Taking charge of security throughout Iraq by November
ensuring that oil revenues are shared by all Iraqis
holding provincial elections this year
setting up a process for amending the Iraqi constitution
The newly appointed general to command the troops in Iraq, David Patreaus, promised a basic change of strategy. He needs time to prove he is on the road to success.
So, at the very momen that progress may be on the way, Congress wants to weaken General Patraeus and his troops by setting an inflexible and arbitrary deadline. A premature withdrawal without considering the real situation in Iraq, despite the opinion of the militay commanders in place, would weaken the U.S.' own security and reliability as a decision-making power. It was wrong to start this war in the first place, but as sure as there is no guarantee for success as has been before, a deadline for withdrawal will result in failure. The U.S. and Congress should aim to keep options open in Iraq for progress. Two minusses do not automatically result in a plus.
Unlike in previous years postponing solutions into the far future, one would have liked to hear a confession that the war in Iraq was wrong; instead, to name jbut one issue, a acknowedgement that his tax cuts and the Medicare drug plan let to an increase of the budget deficit would have been reasonable. As a 'bonus' the president could have promised to revisit his tax cuts and to definitely improve the controlling of expenses. As long as there is more short-term hurray than long term doubts, the state of the Union remains shaky and the future a mystery.
On February 5, the president proposed the customary five-year budget, showing
declining deficits every year and a surplus in 2012.
Information through messaging is the 'food' of trading systems. A message, whether data or a trade, is sent across platforms and fibre optic cables. Banks, hedge funds and other investment firms use high-frequency trading strategies to gain a trading edge. Equity markets are also heavily populated by firms using these techniques, which rely on sending and receiving high volumes of messages to exchanges and trading platforms as part of market-making activities.
The cutting edge lies with companies who have the newest technology whereas places with older technology have difficulties to catch up. This is a delicate infrastructure which at certain points starts to crack.
About ten years ago, a study came up with these remarkable findings:"In particular we found evidence of unobserved heterogeneity among the population of active trades, which may be caused by differences in individual specific characteristics. Also, we found our results to be consistent with an asymetric version of the sequential trade model, in which buyers and sellers have different trade arrival dates. The basic model assumes instead, that arrival rates of buyers and sellers are the same.
Furthermore, our results indicate that informational epochs may have variable lengths, while the basic model assumes that all information epochs have the same length, namely one trading day.
Our evidence thus describes an intradaly trading process, that operates in absence of information events for long periods of time, driven mainly by uninformed transaction demands. These periods of 'normal' trading are frequently disrupted. Such interruptions are typically short-lived and appear to be caused by the occurrence of information events, during which a higher level of trading security on one or both sides of the market is observed.
We also observe overshooting market reactions during such informational epochs, i.e. the trading process is characterized by frequent switches between the good and bad news regime rather than by a persistant stay in either one of the two information regimes. "[Stefan Kokot: The Econometrics of Sequential Trade Models. Theory and Applications Using High Frequency Data, 2003, p.145]
Unlike in the comedy and dark satire 'Risky Business' which is about a teenager who goes a bit wild while his parents are out of town, high-frequency trading can go wild any time without warning.
Only five years later, things have accelerated: "As the raw material of finance has transformed from hard-to-ship bars of gold to near-light-spead bits of data, the manias for cliff-diving come more frequently and sweep in more and more bystanders. Although regulators can almost never prevent crashes, they need to be quicker with the cold compresses when fevers start to build, if only so the lemmings plunge from lower heights." [Charles R. Morris, The Trillion Dollar Meltdown. Easy Money, High Rollers, and the Great Credit Crash, 2008, p. 162]
Electronic trading systems are extremly vulnerable. They carry record numbers of messages and dealing instructions and data which can knock out systems. They generate a lot of messages. The market is dominated by electronic trading, in particular the use of sophisticated computer algorithms that either react to news or data or are programmed to try to anticipate it. That can cause suddden, sharp movemnts in prices.
But what is actually missing is a manual control device, like the one ocurring e.g. in the movie "The Taking of Pelham 123 (1974)": Four men hijack a N.Y.C. subway train, hold passengers for one million in cash – to be delivered in one hour! The Train has to be stopped. The subway is supposed to stop automatically at the next red light, only, someone has switched all the lights to green.
It is not only the technical complexity of the data that is inaccessible to decision makers, but also their sheer volume. The market for derivatives proves especially challenging.[Venkatachalam Shunmugam: Diverse regulatory tools and pracitices in markets: The need for global coordination, 9 April, 2011; http://www.voxeu.org]
In many cases the simple release of information data will mostly be useless in informing the public.
As long as confidence remains in the essential objectivity and integrity of the experts, their technical and human limitations can be accepted as a fact of life without compromsing the value of what they do produce. [A detailed description of this process is given in: Betting on insecurity, Corporate Europe Observatory, February 2011, http://www.corporateeurope.org]
These requirements clearly define the problems of expertise. However sophisticated the hard- and software becomes there will always be interesting, possibly critical, data which will just be beyond the reach of experts, and however well trained the experts, there will inevitably be mistakes, misinterpretations and lack of initiative to contend with.
A semantic construction makes the word 'market' a constant term, meaning on the one hand activities like buying food for our table; on the other hand the term market is accompanied by all kinds of variables like 'financial, money, commodity' etc. meaning trade with all kinds of assets. This latter definition makes it difficult for most people to seperate the virtue of the 'open space food market' with the latter.
The core distinction between a market economy and a command economy and the one that accounts for the huge disparity in their performances is the different ways in which they harness information and incentives. Given that resources are scarce, economic decisions involve a series of trade-offs. In order to make these trade-offs successfully, command economies demand that all fragments of knowledge existing in different minds be brought together in the mind of the central planer, an impossible information requirement.
It is over four years since the financial crisis began. But only now, protesters, like the 'occupy' movement are raising important questions. As of today though, there is lack of ideology like socialism in the early 19th and 20th century. Socialism helped to establish the welfare state with the help of strong unions and organized labor. An international economy has diminished its influence not only in Germany but the industrial countries overall, with strongholds mostly in the public sector or special interest groups.
Another ideology is the so-called 'free market economy', but it too does offer more problems than solutions. Today's problem is not so much an ideological one, but a form/matter of political substance., i.e. not a lack of ideology but a lack of transparency, mirrored by phrases like inside trading, a way to create and/or exploit subsidies and tax loopholes to benefit and enrich the insiders. The need to rescue banks made people furious. To the wider public it is clear that we have moved from an 'open access' system into a 'closed shop' where political influence is decisive. Wealth is not perceived as bad overall but there is a difference between those who prosper without government money (apple/Steve Jobs) and those whose business had to be saved like banks.
Market capitalism creates instability and extremes of inequality.The market-dominated financial system has taken off all by itself; All humans are equal, but some are more equal than others. The ones believed to be more equal than others are accused of having wrigged their fortunes rather than won in an honest competition.
Growth is needed to pay off debt. Countries can run budget deficits during recession because they anticipate reducing debt when growth rebounds. This is sensible if the debt to income ratio is modest and if higher growth in the future is realistic without austerity now.
The eurozone crisis has exposed a crucial link between growth and debt. As a part of the union Greece has been able to benefit from low interest rates that allowed it to delay difficult reforms.
In the U.S. President Obama's preferred policy is growth first, austerity later.
As for the plans of the European Commission to replace national debt issuance with so-called "stability or common bonds" it remains unclear if this will be met with success. The rather intrusive policy measures required – to enforce budget discipline in the eurozone there is a proposal to give Brussels the power to see and pass judgement on national budgets before they are published; furthermore to request a revised draft budgetary plan if the draft measures fall short of EU rules will face strong opposition from many member states. The recommendations are not binding, but they would be made public in order to increase pressure on the government to comply.
The outcome remains shaky. For as long as a national government is accountable to its citizens and parliamentarians want to be reelected, a parliament or a government may not feel obliged to render that much power to the commission and look for other solutions. [For more discussion see: Nicolas Véron: Europe needs institutional creativity, 26 November 2011; http://www.voxeu.org]
An indication as to what could be done may come from a remakable statemant on the financial situation published by the varican.[http://ncronline.org/news/justice/pontifical-council-justice-and-peace-urges-major-economic-reform] (Oct. 25, 2011) This statement, from the Pontificial Council for Justice and Peace, is entitled "Towards Reforming the International and Monetary System in the Context of Global Public Authority." It presents with sharp critical analysis, a rather utopian vision of regulation. But it offers recommendations that seek not to change everything at once. It rather suggests to minimize the damage of certain practicies and assumptions.
To name a few:
This has won backing of experts like George Soros, Bill Gates and even a strong statement from German finance minister Wolfgang Schäuble.
There are pressures to take political positions in the debate external to the policy-making process are compinded by the pressures to produce politically and bureaucratically 'acceptable' analyses within the process. There are many bureaucratic levels between raw financial data and the final decision makers, and at these levels are career officials who probably have a strong interest in cooking raw data to make their masters' favorite dishes.
Automated systems threaten the oligopoly of information that has underpinned profits. These new systems gather and publish information on the prices and quantity of dealing instructions as they are actually traded. Inn order to get closer to a transparent capitalism we have to ask governments to pursue a strong regulatory and accounting framework. [Mark Chandler discusses aspects of transparent capitalism in: Making sense of the dollar, exposing dangerous myths about trade, 2009, p. 148]
Markets work because economic decisions are made by those who have the information necessary to determine the trade-offs that must be made and the suitability of those trade-offs given their own unique skills, circumstance and preferences combined with market prices that signal the relative value and costs placed on those activities by society.
This essay intends to urge attention to factors like lack of transparency due to he burden of financial information and high frequency trading as major contributors to the financial crisis.
At the core of the 2008 crisis was the impossibility that few financers and most non-financers had an idea how finance worked. The 21st century banking process had become so complex and opaque that there was little, basically no external oversight, but endless opportunity for arbitrage.
Now the flames are reappearing in disguise. There are still opaque financial products, mirrored by complex reform processes; Accompanied by political leaders who have to explain these processes to their parliaments and their voters.
We need a perspective in the international system (with regard to the financial crisis) that change is a decision process. Of course, major shifts in the international political and economic system can pose significant requirements for the modification of financial policies. But policymakers can either anticipate these international changes, respond just in time, or only after suffering dramatic consequences. In an ideal world there could have been pragmatic global solutions that could ensure that banks could safely fail and at the same time create measures to reduce the chance of such failures. But in the real world pragmatic solutions usually fall wayside to political power requirements.
We may have entered a period of human history where not only is the rate of change acccelerating in political, social, and economic arenas of domestic and international life, but where we are on the dividing line between epochs. The performance of existing policies to meet present and emerging needs must be carefully and creatively examined. Both the opportunities and the dangers that can result from failing to deal with the changes that beset us are too great to be ignored
November 30, 2011