Saturday, September 3, 2016

Does Wall Street Do “God’s Work”? Or Even Anything Useful?

It’s time to challenge the idea that Wall Street trading helps allocate society’s resources more efficiently

Lynn Stout is the Distinguished Professor of Corporate and Business Law at Cornell Law School. Professor Stout is an internationally-recognized expert in corporate governance, financial regulation, and moral behavior.

It looks like Lynn Stout doesn't believe that the financial sector doesn't do anything useful at all. It's just away for the One Percent to suck off the profits from other people's hard work. In the City of London, top mathematicians, rocket scientists, the best physicists and engineers are all in on the racket, their talent wasted. They could be designing superb products that people find useful, or be working on environmental projects; and they would be earning a decent wage while doing it getting good job satisfaction too. A life probably far more interesting. 


Finally, let’s turn to the claim that Wall Street trading helps allocate society’s resources more efficiently by ensuring securities are priced accurately. This argument is based on the notion of “price discovery”–the idea that the promise of speculative profits motivates traders to do research that uncovers socially useful information. The classic example is a wheat futures trader who researches weather patterns. If the trader accurately predicts a drought, the trader buys wheat futures, driving up wheat prices, causing farmers to plant more wheat, helping alleviate the effects of the drought. Thus (the argument goes) the trader’s profits from speculating in wheat futures are just compensation for providing socially valuable “price discovery.” Once again, however, this cheerful banker “just-so story” turns out to be unsupported by any significant evidence. Let’s start with the questionable premise that the average trader earns profits from doing good research. The well-established fact that very few actively-managed mutual funds routinely outperform the market undermines the claim that most trading is driven by truly superior information.

But even more significantly, the fact that a trader with superior information can move prices in the “correct” direction does not necessarily mean that society will benefit. It’s all a question of timing.  As famous economist Jack Hirshleifer pointed out many years ago, trading that makes prices more accurate when it’s too late to do anything about it is privately profitable but not socially beneficial. Most Wall Street trading in stocks, bonds, and derivatives moves information into prices only days–sometimes only microseconds–before it would arrive anyway. No real resources are reallocated in such a short time span.

So, what does Wall Street do that benefits society? Doctors and nurses make patients healthier. Firefighters and EMTs save lives. Telecommunications companies and smart phone manufacturers permit people to communicate with each other at a distance. Automobile executives and airline pilots help people close that distance. Teachers and professors help students learn. Wall Street bankers help—mostly just themselves.


Ralph Musgrave said...

Or as Adair Turner, former head of the UK's Financial Services Authority put it, much of what the financial sector does is "socially useless".

Matt Franko said...

Well I thought that every now and then a helpful mutation occurs?

So you have this normally harmful process going on, then every once in a while randomly something constructive comes out....

Textbook Darwin 101.

What is wrong with this process?

It's the same process that resulted in our very existence so why F with it?

Andrew Anderson said...

Wall Street bankers help—mostly just themselves.

So why do some insist on continuing privileges for the banks such as government-provided deposit insurance?

Honest capitalism is possible and we'd all be better off with it.

Kaivey said...

An interesting article. So even Lord Turner is saying this.

Gary Hart said...

No, Wall Street does nothing useful. The people on WS gamble with fictitious capital in order to drain the wealth from the country. Wall Street is simply an extension of the City of London. If the people ever get control the government then Wall Street should be dismantled.