Sunday, 4 October 2015

Chasing the Tape

Is information in capital markets a commodity or a public resource? If it is a resource, how much information should be distributed to the public, at what cost to the producer, and on what terms?

These are the sorts of questions that Chasing the Tape: Information Law and Policy in Capital Markets (MIT Press, 2015), by Onnig Dombalagian, tries to answer.

The author argues that the existing responses to these questions are being challenged by new technologies used in financial markets. Foremost amongst these are the proliferation of electronic trading networks and high frequency trading strategies. Another, more fundamental, challenge comes from the field of behavioural economics.

Even if information were efficiently distributed, would it be rationally used by participants? Moreover, how much are policy makers' decisions about the transparency of, and access to, information affected by similar behavioural biases? These issues seem to call into question the central idea of 'informational efficiency' with which this work is concerned.

However, as Dombalagian notes, the maintenance of well-informed markets continues to be seen as a desirable regulatory outcome: "the immediate legislative response to the [financial] crisis reflects the importance of information flows". This is despite some participants' concerns that recent transparency initiatives will impact on the profits of information producers and traders, without benefiting the public.

The author's ambition is to develop a set of principles to guide information policy in capital markets. Existing policy, he contends, is overly reliant on the analysis of particular institutional forms and 'arbitrary classifications', rendered obsolete by new technology.

Of course, technology has always disrupted stock markets' ability to maintain their viability. For example, the telegraph and the telephone challenged the London Stock Exchange's status as a national exchange by allowing brokers to distribute prices - which could then be used as the basis for in-house crossings or over-the-counter trades.

Markets traditionally dealt with this problem by prohibiting members from participating in off-venue trading.

The difference nowadays is that states have dismantled these sorts of competitive restrictions, in recognition of the public resource attributes of pre- and post- trade information. As Dombalagian says, "information policy must increasingly consider the value of information to users, and not just the cost to originators". Since the distribution of information has been defined as a regulatory problem, the state now has the problem of determining the proper balance of information flows.

In the final analysis, it is questionable whether the author has developed any new principles to determine the balance of transparency and disclosure of information in capital markets. In this field the law is heavily dependent on the axioms of information economics, and any real innovation has to tackle these assumptions - for example, in the way that behavioural economists have done. However, in this work Dombalagian has usefully outlined the current state of play, and the challenges that technology presents policy makers seeking the efficient distribution of capital market information.

Friday, 25 May 2012

About Keynes

Keynes's General Theory of Employment, Interest and Money is probably close to the best book on capitalist economics ever written. I doubt whether it is required reading on any economics course these days. In my opinion it should be read before embarking on any such program. The risk is that no course of economics as currently taught would subsequently be of any interest.

It is not any easy book, and the general reader probably needs a few years study of the financial press, at least, to make sense of it. But it is exciting, in the same way that Schumpeter's Capitalism, Socialism and Democracy is, and for similar reasons. It forces economic theory to adapt to the real world of capitalism, rather than forcing capitalism into a sterile theoretical mould.

It can of course be read from beginning to end. But chapter two, which is the real beginning of the book (chapter one is a single page), begins with a complex rebuttal of the theory of supply and demand for labor. Therefore, perhaps the best place to start is on p 27*, where Keynes gives a summary outline of his theory. Here Keynes says:

"The outline of the theory can be expressed as follows. When employment increases, aggregate real income is increased. The psychology of the community is such that when aggregate real income is increased aggregate consumption is increased, but not by so much as income.... Thus, to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level....what we shall call the community's propensity to consume.... The amount of current investment will depend in turn on what we shall call the inducement to invest; and the inducement to invest will be found to depend on the relation between the schedule of the marginal efficiency of capital and the complex of rates of interest on loans.... Thus given the propensity to consume and the rate of new investment, there will be only one level of employment consistent with equilibrium... But there is no reason in general for expecting it to be equal to full employment."

In this summary we are left with the awareness of the importance to employment of the spending of the community's income. Income is of course spent in consumption. But consumption does not increase by so much as income, because of a psychological tendency Keynes calls the propensity to consume. So there is generally a gap which must be filled in order to maintain employment at its level.

The gap can only be filled by investment. But entrepreneurs' willingness to invest the required amount is not guaranteed. The motivation to invest depends on the expected marginal efficiency of capital (the expected future yield on new investment) as compared to the rate of interest. Keynes might have added that the rate of interest depends on the liquidity preference of the community (the desire to hold cash rather than to lend money at interest). Thus we are left with three critical explanatory variables in Keynes's theory of capitalist economies:

- the propensity to consume;
- the current expectation of future cash flows on new investment; and
- the preference for holding cash rather than making loans at interest.

* Note: I have a First Harvest 1964 edition, with the same pagination as the original.

Monday, 2 August 2010

A New Approach To Financial Regulation in the UK: Lessons from Australia

HM Treasury’s recent consultation paper A New Approach To Financial Regulation: Judgement, Focus And Stability sets out the Government’s detailed plans for the new “twin peaks” model of financial services regulation and supervision in the UK.

As has been noted in the Financial Times (Bank given clear responsibility for financial stability - June 17 2010), Australia has some experience in this area.

In mid-1999 Australia finalised its new financial services regime, comprising a separate prudential regulator and consumer protection commission. Eighteen months later the largest corporate insolvency in Australia’s history occurred - in a general insurer under the supervision of the new Australian Prudential Regulation Authority (APRA).

The collapse of the HIH Insurance group led to the establishment of a Royal Commission to inquire into the reasons for the failure, and to suggest any desirable changes in regulation.

The Royal Commissioner, Justice Neville Owen, found that the regulator was handicapped in its supervision of the insurer by the teething problems of the new regulatory regime, which distracted senior executives and led to staff attrition and loss of skills – a finding in itself worth noting. However he also concluded that many reforms to APRA were needed in the areas of governance, organisation and resources, and supervisory approach.

A key recommendation to improve accountability was that the largely part-time, non-executive board of APRA be replaced by a small full-time executive, comprising a chief executive and two or three commissioners. Another was that the involvement on the board of APRA of representatives of the central bank and the consumer protection commission end. It distracted the focus of the board member concerned, put the chief executive in the difficult position of being assessed by the standards of different agencies, and did little to contribute to inter-agency coordination.

The UK Government’s proposals take a different approach. Whether consciously or not, the suggested arrangements for governance of the new Prudential Regulation Authority emulate the pre-Royal Commission structure of APRA, favouring a largely non-executive governing board and cross-memberships of boards of the co-regulators.

The HIH collapse has been referred to as a “defining moment” in the life of APRA. Beyond governance, the Royal Commission’s recommendations on APRA’s resources and supervisory attitude were also crucial. APRA itself recently acknowledged that the “scrutiny and soul-searching” occasioned by the event strengthened the Australian regulatory regime for the unprecedented stress of recent years.

It would be unfortunate if the new British arrangements failed to benefit from insights hard-won in Australia.

Wednesday, 28 July 2010

Hayek's Road to Serfdom: Radical, Relevant?

Hayek’s book The Road to Serfdom has had a burst of popularity recently. It’s notorious, of course, and I had read excerpts and accounts of it. But I’d never read it cover-to-cover. My general impression, mostly garnered from second-hand interpretations of the work over the years, was that it was radically right-wing.

Having just read it, I find that interpretation untrue. I find very little in the book that the Labo(u)r parties of the UK and Australia would reject. This is probably partly a function of the move toward markets since the 1980’s. But partly it is because the views expressed really are simply those of a classic European liberal.

However, I am genuinely puzzled why anyone would think the book was particularly relevant today. It argues against centralised planning of the economy, ie, state ownership of the means of production. Who is advocating that today? States had to be forced into part-ownership of financial institutions during the financial crisis. The refusal to bail out Lehman Brothers shows clearly the extent of government reluctance to own these firms.

Read the rest of my review here.