Buiter: most finance is socially nefarious

The more I read Willem Buiter, the more I like him. This morning in the FT he denounces the financial sector as a harmful sector in some instances.


I believe that efficient financial intermediation and a dynamic financial sector are essential for the proper functioning of any decentralised market economy; I also believe that too much financial sector activity is not only socially worthless, but actually harmful. Take financial derivatives. A financial derivative is a bet created by the issuer whose payoff depends on some aspect of the performance of an underlying financial instrument. If the bet pays out when the buyer of the derivative is worse off, we call it insurance. If the bet pays off when the buyer of the derivative is no worse off, we call it speculation. Speculation need not be a problem; it is a necessary feature of the efficient allocation of risk, as long as only one party to the transaction is engaged in it. To tame the rampant excessive speculation in the derivatives markets, it is sufficient to require that at least one of the parties involved in a derivatives transaction has an insurable interest. The Tobin tax does nothing to achieve this. An example: credit default swaps (securities that pay the holder when a bond defaults) can be issued in amounts much larger than the value of the underlying bonds. Anyone who owns CDS in excess of the value of the bonds he owns benefits when the debt defaults, creating obvious moral hazard. The issuer of CDS whose value is much larger than the underlying bonds has the opposite moral hazard: there is an incentive artificially to reduce or eliminate default risk. The simplest solution is to require that CDS pay out only if the same amount of the underlying bond is presented.


Which is a long winded way to say "Ban naked CDS!". Interestingly I think his analysis of moral hazard is incomplete. Namely even if you hold the bond your interest is to see the company completely default in some way to see your CDS pay out in full.

Comments

Post a Comment

Popular posts from this blog

Thug vs Thug: Porsche 1, Hedge Funds: 0

The latest drama is fun. VW became the largest company in the world, in terms of market cap, ahead of EXXON on a little financial market coup d'etat orchestrated by Porsche. Apparently VW stocks was on the way down, I don't know the details but many Hedge Funds (HF) were short the position. Fine. The price goes down. Porsche starts buying the anonymous float (and probably some private too?), but the point is they build a 73% market share without many people noticing. In the US you would need disclosure after 10% or so. Point is, that many HF wake up and realize that their short position is about to lose a lot of money. So what do they do? those idiots? they short cover all together, which means they buy the stock to cover the short. The stock zooms up, by a full multiplier and overtakes EXXON. Porsche makes A KILLING in the process and has robbed the city robbers to the tune of "potentially $30B". Not bad for a days worth of work. PS: hey, psst Porsche! With t
Read more

Love ya 2 PTB!

Jules: I wouldn't go so far as to call a dog filthy but they're definitely dirty. But, a dog's got personality. Personality goes a long way. -- Pulp Fiction Jonathan Schwartz has this wonderful quote about me in a recent interview 15 minutes with the great man : Q:Turning to MySQL, how long do you think it will take before MySQL is fully integrated into Sun? We saw with Red Hat and its JBoss acquisition that this can be a slow, laborious process.... A: First, the personalities involved. Let's just say that integrating Marten Mickos into a company might be easier than assimilating a few of the JBoss personalities. Marten is a joy to work with and will make this integration work. I got to hand it to you Jonathan. You hit the nail on the head. JBoss was full of prima donnas, a lot of them actually; it drove me nuts. My developers were bitching all day long, my executives were even bigger fat cats, my sales guys were testosterone freaks. Even the receptionist had an att
Read more

Madrid Blog--We get sued

Image
...for having children If you are a foreigner and move to Madrid, do not, necessarily expect a warm welcome. Yesterday, we, or rather Don Mark Fleury and Dona Natali Manson ***note to Building Association of Serrrano XX, before you lawyer up, do your research. My husband spells his name "Marc" with a "c." and my first name is spelled "Nathalie;" not to mention that my honest English stone mason forbears would cringe at the misspelling of their last name to confound with that of the notorious 20th century serial killer. received an official communication from the Juzgado de Primera Instancia de Madrid, from one Don Ramiro Blah Blah, President of the Building Association of Serrano XX, a building of exactly 12 units, half of which were owned at one time by his father in law, in which it is alleged 1) "Mark Fleury and Natali Manson" have four children 2) these children own bicycles 3)and roller skates 4) and scooters ( Nathalie comment: nope sorry
Read more