Posted by: Dirk | June 25, 2009

Christopher Whalen on financial markets

I have suggested recently that Mancur Olson’s logic of collective actions could be used to describe the behaviour of firms in the global financial markets. A statement by Christopher Wahlen before the US Senate’s Subcommittee on Securities, Insurance, and Investment confirms this story in a shocking way. Here is an excerpt (OTC = over the counter = non-regulated exchanges):

Simply stated, the supra-normal returns paid to the dealers in the closed OTC derivatives market are effectively a tax on other market participants, especially investors who trade on open, public exchanges and markets. The deliberate inefficiency of the OTC derivatives market results in a dedicated tax or subsidy meant to benefit one class of financial institutions, namely the largest OTC dealer banks, at the expense of other market participants. Every investor in the global markets pay the OTC tax via wider bid-offer spreads for OTC derivatives contracts than would apply on an organized exchange.

The taxpayers in the industrial nations also pay a tax through periodic losses to the system caused by the failure of the victims of OTC derivatives and complex structured assets such as AIGs and Citigroup (NYSE:C). And most important, the regulators who are supposed to protect the taxpayer from the costs of cleaning up these periodic loss events are so captive by the very industry they are charged by law to regulate as to be entirely ineffective. As the Committee proceeds in its deliberations about reforming OTC derivatives, the views of the existing financial regulatory agencies and particularly the Federal Reserve Board and Treasury, should get no consideration from the Committee since the view of these agencies are largely duplicative of the views of JPM and the large OTC dealers.

Since next semester I will participate in our module Advanced Macroeconomics, this makes me think about how the economy really works. Probably we have to focus more on institutions and political economy and less on mathematics. Mr Whalen’s earlier statement from March 2009 also seems very interesting.

UPDATE 26/06/2009: See econbrowser for another case of fraudulent behaviour on the financial market which might be legal. The financial market efficient? These kind of things make a nice example for the issue of asymmetric information.

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