Saturday, April 14, 2012

Wall Street then and now

Thomas Philippon, from NYU, has a new paper with this simple abstract:
Despite its fast computers and credit derivatives, the current financial system does not seem better at transferring funds from savers to borrowers than the financial system of 1910.
Now, before even reading the paper, I can already envision my Austrian economics professor starting his explanation of how the government has bogged down efficiency. Which - I would argue against. A lot of regulation has surrounded around making information about transactions more transparent.

Philippon points out that "compensation for financial intermediaries" is at 9% of GDP (an all time high).

Here is more:
Trading costs have decreased (Hasbrouck (2009)), but the costs of active fund management are large. French (2008) estimates that investors spend 0.67% of asset value trying (in vain, by definition) to beat the market. 
In the absence of evidence that increased trading led to either better prices or better risk sharing, we would have to conclude that the finance industry's share of GDP is about 2 percentage points higher than it needs to be and this would represent an annual misallocation of resources of about $280 billions for the U.S. alone.
I'm not really in a place to give commentary in this issue. Though I'm glad it's being looked at. The real question is why? Trading is up substantially, which is a result of the democratization of finance (i.e. eTrade and such). But are people really better off? I guess the more important question is how much people think they are better off.  Philippson finds that prices aren't any more informative of what's really happening in the markets. (I know, shocking.)

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