Financial markets need regulation—they also need high-risk hedge fundsby Oliver Kamm / December 17, 2005 / Leave a comment
The apparent arbitrariness and irrationality of financial markets do not inspire the admiration of liberal-inclined people. But many professionals in the financial markets also accept that there are structural failings in the system. Financial capitalism needs reform if it is to have popular legitimacy, but it needs the right kind of reform. Tighter regulation to constrain footloose capital is mainly a chimera.
Recent events have intensified popular suspicion of financial markets. Since the collapse of the bull market of the late 1990s, the most newsworthy financial stories have concerned corporate scandal and market abuse. The failures of Enron and WorldCom amid huge fraud are notorious. A few weeks ago a large US broker, Refco, filed for bankruptcy as news emerged that its chief executive had been charged with concealing a $430m debt.
The charge sheet against the US/ British model of shareholder capitalism is longer than the issue of malpractice. Commentators such as the Financial Times columnist John Plender, in his book Going Off the Rails, argue that the debacle of the dotcoms merely served to emphasise structural weaknesses in the system.
The most prominent academic critic of excessive faith in stock markets, the Yale economist Robert Shiller, has long been associated with the judgement that stock markets exhibit “excess volatility”—that is, prices are more volatile than would be justified by the variability of corporate dividends over the long term. At the peak of the bull market, he argued prophetically that “there is a whiff of extravagant expectation, if not irrational exuberance, in the air.” His public policy advice has been to modify schemes that encourage people to devote their personal pension schemes to the stock market, and against proposals to privatise social security.
Moreover, there is evidence that successful businesses are reluctant to seek stock market listings because of the unrealistic demands of shareholders. It is the opposite of what liquid stock markets are supposed to do, and provides retrospective weight for the thesis argued a decade ago by Will Hutton, in The State We’re In, that stock markets are too short-term in their investment horizons. The danger, however, is that because financial markets are the most visible part of the economy, public opinion may infer that the financial sector is parasitic on the real economy, or even that the market economy itself is a rapacious and anarchic force.
Takeover activity tends to reinforce this view. And there…