Derivatives need a priest

Published on naked capitalism (first on MacroBusiness), by Sell on News, a macro equities analyst, MAY 19, 2012.

Imagine two ways of framing a financial trading choice. The first way is in the pseudo scientific language of finance. “An optimal trading strategy will be to go short on Greek and Spanish government bonds to exploit a high likelihood of sell off and debt restructuring which will keep portfolio returns well above inflation going forward.” Or consider the same thing expressed this way: 

“If we sell off Greek and Spanish government bonds it will push Greek pensioners into poverty, cause deep harm to the social fabric, lead to destabilising political unrest and threaten the stability of the world financial system.” The first way of framing the choice is treating the financial strategy as a way of dealing with a machine; the language has nothing to do with people. The second way of framing it is moral: starting with the effects on people.

Of course, the latter way of framing the choice is never used by traders, analysts or economists. The assumption is that the global financial markets are there to serve capital, not people (if it benefits people, fine, but that is after the fact). It is conceived as a giant piece of machinery whose behaviour can be successfully interpreted by those clever enough. Of course, it is an illusion. The machinery is impelled by people trying to interpret the machinery; that is why forecasts and predictions have such a poor track record. Because markets are full of people with minds, predicting what those minds will think and do requires much more than a mechanistic analysis. Nevertheless, the capital markets are seen as a piece of machinery. If one looks at the metaphors, capital “flows”, for instance, is a sort of liquid looking for equilibrium (another popular metaphor).

Robert Shiller argues for a return to morality, as discussed last week. James Montier of GMO argues that there should be a Hippocratic Oath in finance, an ethical standard that would restore some standards. But he, too, goes for an explicit scientific metaphor, physics in this case. He is trying to find ethics in the wrong place: … //

… What happens in markets has little to do with the behaviour of feathers or bricks, because feathers and bricks have no self awareness. This is typical of the positivism (something is only real if it can be measured) and reification (making inanimate things seem like animate things) that is inevitable when a pseudo-scientific approach is adopted. What I think is needed instead is the posing of two questions:

  • 1. What is needed to make the system behave more responsibly towards people?
  • 2. What should be the purpose of the financial system?

Neither question will be answered by looking to scientific method. Science only answers “what” questions” not “why” questions. It is silent on questions about meaning or purpose, they are outside its range. Yet the above two questions are really the questions that should be posed to regulators and governments, who at this point are cowed, or bought off, by the bullies in the large financial institutions.

The sometimes insightful, if a little odd, Robert Gottliebsen argues that banks should return to the Glass-Steagall separation That would be a start. But he also reckons that Wall Street is too powerful, and that attempts to rein in derivatives are doomed because the politicians are outgunned: Obama after the GFC and probably Romney too, if he wins. That may be true, but the fight is worth it.

So here’s an idea. Maybe we can ask how it was that a system created for people ended being blind to people, especially weaker people in places like Greece? In this anthrosphere we have created, the one thing we seem most averse to is putting human beings at the centre. Much better to see it as a machine, and to spend our time poking it to see how it works. (full text).


Europe is Falling Apart;

Tom Ferguson: Senate Banking Chair Calls Jamie Dimon to Testify – But JP Morgan Chase is His Biggest Contributor;

The Flaws of Finance.

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