The Transformation of Finance

As a follow up to John’s post,  Andrei Shleifer’s lecture at the recent AFA meetings analyses different theories of the crisis: the slides are here. His focus: “neglected risk”.

14 replies on “The Transformation of Finance”

Thanks for pointing to this Philip.

I think this is a really interesting lecture and would urge anyone with an interest in the causes of the crisis to take a look. Compared to my braod ideal types of rotten institutions and blameness bubble, Andrei Shleifer helpfully hones in on what he sees as the two most promising hypotheses: agency failures (within financial institutions) and neglected risks (with interesting behavioural hypotheses for why those risks were neglected en masse). The first is a version of the rotten institutions idea; the latter a possible explanation for why the bubble was able to grow for so long

To understand the crisis we may have to go beyond the rather lazy “there all a bunch of crooks” approach that is so prevalent. There is a magnificient surfeit of wisdom after the fact.

It seems the financial economics community is still in a state of shock. I quite liked the understated “efficient markets is no longer an empirically
interesting hypothesis”. I suspect many of the academic economists who were well rewarded to puff this hypothesis are maintaining a sheepish low profile. They still seem to be struggling to get to grips with what happened and, as a result, are quite a bit away from why. ‘Local thinking’

Apologies.. hitting buttons at random…continues

..seems interesting as a hypothesis, but it might be no more than very localised thinking as in ‘how big will my bonus be?’

There is an obvious reluctance to ‘name the beast’ and financial capitalism is the most virulent form of capitalism – and, like any virus, it mutates constantly. Roosevelt’s ‘trust-busters’ in the early years of the last century weren’t slow in recognising what they were dealing with; nor were those commissioned by his Democrat cousin in the 1930s. It’s impossible to prevent the bouts of havoc wreaked by financial capitalism, but it may be possible to limit the incidence and severity. Gaining a better understanding of what we’re dealing with is the best place to start. But I fear this presentation will get us very far.

“Mark to market is the critical risk management tool”

Any thoughts on this? I think mark to market can be very dangerous in rising markets. Pro cyclicality wasn’t very good for Ireland.


Responding with “it all depends” is usually considered not to be very helpful, but in this case it’s probably all that’s on offer. It depends on what you’re ‘marking’ and it depends on the ‘market’ to which the marking is being done. If what is being marked are highly complex instruments and the markets are opaque OTC confections, then god alone knows what might emerge. Even exchange-based trading of standardised products in a reasonably transparent and well-regulated manner can generate nonsense if the market lacks depth and liquidity. Financial capitalists can’t see a market without trying to work out ways to subvert, rig, undermine it, or exercise market power or capture rents.

‘caveat emptor’ remains the best advice. Many moons ago, JK Galbraith noted how the emphasis on markets provides capitalists with a very convenient functional anonymity. Even the conference Brian Lucey is advertising – which, at first sight, looks very interesting – just can’t bring itself to name the beast. It has “actors” – actors I ask you. These are financial capitalists whose primary objective is to make money. And their peers at the top levels in other industries have the same objective. The goods and services their firms produce are largely irrelevant; what matters is how much money they make. If you want evidence, look at General Electric or supermarkets getting into banking.

But, of course, you can’t call these ‘actors’ capitalists – they might withdraw their funding and sponsorship.

@Paul H
Well, they arent actually sponsoring or funding anything. We have two small sponsors , one a US software co, the other an international bank. Its all pretty much done on fees. So we can call them what we like. I think you noticed that I dont shirk from the fight… So im not sure what your beef is with the conference? Why not come along and critique. Seriously. Or better yet, put a paper in.

@Brian L,

Many thanks for the clarification – and I have no specific beef with the conference. And no, I’m not looking for a fight either..well, at least, not with you. I’m just making a general observation that any reform of the national, EU or even global banking and financial architecture will require a number of brutal, adversarial bouts of fisticuffs between the financial capitalists and those who craft policy and enforce regulation in the public interest.

For the last 30 years, policy-makers and regulators in the major developed economies have been captured by the financial capitalists. The final consumer, the poor sap who pays for everything, doesn’t get a look in. And it’s the same in other sectors. And thank you for the invitation to put a paper in. But I don’t think I have the necessary detailed knowledge or credibility in this area. However, I don’t hold back when it comes to the energy sector where I might have some.


Useful to laymen_an_women

I’ve been pretty sick of the so-called ‘efficient market hypothesis’ and the ontological poverty of agency theory and ‘IM’MORAL Hazard (sic) for quite some time ……… yet both appear to be prerequisites for entry to, and promotion within, business schools ……… one suspects that an awful lot of Non-Sense has been, and continues to be, taught ……….. (-;

I think youll find that its mostly the economists who think markets are moderatly efficient….most bschool people i meet arent that pushed.

@Brian Lucey

I tend to place economics within the broad business school …… I’m not what one of the commenters here terms ‘ a trained economist’ (-; [should I be thankful?]… but a mere €90 billion [at least] on the back of the serfs does tend to debunk the dominance of ‘moral hazard’ [which I really am sick of seeing] in economic discourse… and ‘efficient market’ …. to speak of ‘moral’ implies an unavoidable link to ‘justice’ … and there ain’t any justice around here at the mo ….

Best with the conference ……….

@Brian L,

“I think youll find that its mostly the economists who think markets are moderatly efficient….most bschool people i meet arent that pushed.”

Which, I think, confirms the main point I’ve being trying to make. Business schools train the budding capitalists to shield themselves from, to evade or to undermine the impact of competition in markets and to remove or defang any policy or regulatory constraints on their pursuit of profits. And so, for example, we get the wonders of Corporate Social Responsibility. Friedman, at least, was honest when he said the social responsibility of business is to make profit.

Many economists – and particularly those most influential – have gone along with the focus on markets which provides capitalists with a very convenient functional anonymity – and quite a few have been well-rewarded for their idiotic usefulness.

But nobody seems to be focused on providing the kind of training required by those who make policy and who regulate in the public interest.

“Business schools train the budding capitalists to shield themselves from, to evade or to undermine the impact of competition in markets and to remove or defang any policy or regulatory constraints on their pursuit of profits. ”
Really? Really? I mean really is that what we do? Care to give any facts on that?

The elite Business Schools in the US do exactly what PH says. In countries other than the US where big business has not bought big Gov’t defanging policy or regulatory restraints is not a viable business proposition. There are academics in the Elite Schools who are appalled with that behaviour but being in the real world they have to go with the flow.

As for Ireland, everything has its price in both the Public and Private sectors.

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