On Mon, 3 Jul 2006, Doug Henwood wrote:
> On Jul 3, 2006, at 10:49 AM, Dennis Perrin wrote:
>
>> From Cockburn's C-Punch column:
>>
>> <snip> [I]t's clear, as we head into the summer of 2006, that the world
>> capitalist system is out of control. Literally so. In the older order of
>> things, international bodies such as the International Monetary Fund, the
>> central banks and kindred bodies could claim to have some purchase on the
>> overall situation. Not anymore. The major players these days are
>> thousands of managers of private equity funds-traders in shares, bonds,
>> derivatives and other instruments of a complexity that would require the
>> genius of the late Stanislaw Lem to evoke, as he did the planet of
>> Solaris."
>>
>> <http://www.counterpunch.org/cockburn07032006.html>
>
> <snip>
>
> He's got half a point, but not a full one. Just because Cockburn doesn't
> understand an inverse floater, that doesn't mean that no one does.
Fair enough. Cockburn is no economist and clearly this is just stopped-clock crisis mongering. If there is a serious downturn, you don't get any credit for predicting it if that's all you ever predict twice a year for decades.
But just on the theoretical side, aren't there at least two reasonably substantial reasons why a large increase in the complexity and novelty of financial instruments increases the risk of a collapse of confidence? Namely
1) The cycle of innovation and fraud. I think I get this idea from both you (in your Wall Street book) and Nomi (in Other People's Money): the idea that a lot of financial innovation is driven by the desire to escape regulations that limit profits. So that there is a continuing cycle wherein innovation continually increases until it gets to the point where regulators don't have a handle on it. And then you usually get a lot of fraud, and eventually a massive fraud, simply because people aren't being effectively watched. Then it gets unearthed, there's a collapse of confidence -- and then it there's an investigation, everyone gets the confidence back, new regulations and procedures and understanding make that particular kind of fraud harder to commit, and the cycle of financial tunnelling under the walls begins again. In short, the Enron risk.
and
2) The more interconnected the financial system becomes, and the faster the speed of those connections, the more systemic risk rises -- and the more novel that risk is, the more it is systematically underestimated, and the higher the risk that it will catch even sophisticated investors entirely by surprise and loaded on one side. In short, the Long-Term capital risk.
Of course precisely because these cycles are so regular, it's clear they don't delegitimate the system. The rituals of cleaning up and relegitimating afterwards are just as regular, they've always been effective, and there's no reason given by Cockburn to think things will be any different next time.
I guess then the real question would be: is the complex side of the derivative market substantially bigger than it was say 5 or 10 years ago? Because Jordan suggests a lot of the increase in the hedge fund sector is stuff we've always known just with a new sexy name.
Although I guess that raises on more question -- when they call themselves a hedge fund, even if they are using old means, are they substantially less supervised and freer to do riskier things with old means than if they were called a mutual fund?
Michael