ten fatal flaws of the financial markets

The cover story of this week’s Spiegel (issue 50, page 40) is a lengthy but very enlightening report on the role of “the markets” in the whole mess we’re in, culminating in a list of ten things that are catastrophically flawed in the global financial system. As I didn’t find an English version I could link to, here’s my own summary:

1. The trillions circulating in the parallel universe of complex finance products (exceeding the turnover of the real world economy of goods and services by more than an order of magnitude) tend to multiply in ways that produce speculative bubbles.
2. These funds go looking for returns that would be unrealistic in the real world markets, thus sucking more and more money out of the real markets into the parallel world.
3. Banks keep inventing new finance products which tend to be opaque and often carry high risks.
4. Banks operate with insufficient levels of own (real world) funds.
5. Financial markets are intransparent and their risks unknown.
6. Concentration in these markets has produced mega banks that are too big to fail and thus a risk to the whole system.
7. Computerised trading encourages herding effects which lead to positive feedback loops, hence, disaster.
8. Interconnectedness of financial markets via derivatives synchronises them, another positive feedback loop that puts oil on the fire of any crisis in one market.
9. Financial markets resist attempts at regulation or supervision, evading into even more opaque systems.
10. Financial markets undermine conventional market economy and democracy.

The article concludes that of these 10 “monstrous” dangers, the G20 countries are currently addressing a grand total of 2, namely No. 5 transparency and No. 4 the minimum capital of banks. (Well done to our politicians – even I as a complete lay person in all things financial was aware of at least three of these! OK, only since I wrote the feature on food speculation this summer).

Now I’m really scared.

I’m beginning to realise that anything we do down here in the real world will have no effect whatsoever on this monster that’s probably going to eat us some time soon. Somebody should develop a clever algorithm that stops all these problems, for instance by introducing negative feedback and punishing herding behaviour. Trouble is, most of the people clever enough to do this are bound to be very busy making the problems worse.



The €ye of the storm ... European Central Bank in Frankfurt.