If the commodity at the core of grain markets is grain, and of oil markets is oil, what is at the core of the financial markets? Information. It is an information system, and it is essential that it be accurate or all kinds of bad things happen.
This is an extension of a concept from Hernando de Soto, an economist from Peru. He wrote a widely praised book that explained a reason why some economies haven't developed. They don't have an infrastructure of laws and records. So although everyone may know that Juan's family has owned 20 acres in a given spot for generations, he can't prove that. So he can't sell it and buy better land, or take a loan against it to invest in improvements, or stop the government from selling it to outsiders because "no one owns it."
So while producing goods and value is the heart of a developed economy, it couldn't do much with them if it didn't have this system of records - public and verifiable records on stocks, deeds, contracts, patents, corporate reports, titles to land and buildings, etc. Those verifiable, public records allow investors to understand value and risks and invest in efficient ways that produce more value.
That's important because a well operating financial market is what allocates capital effectively. The very kinds of speculation that crashed the economy, when they're done right and responsibly, and without lies, are great for market efficiency. Hedges against failure can help producers smooth out the highs and lows of their market. Investors can decide some company is overvalued and bet against it and put pressure on the market to bring its value into line with reality. A company that's poorly run can become vulnerable to take-over and its value better used by new management. Done right the market is good at using capital.
De Soto recently expanded his idea in an article in Bloomberg Businessweek to bemoan the flip side: the damage that is done when what had been a good system of records gets corrupted. And that this is exactly what most leading financial outfits have been working very hard and very cleverly at for the last couple of decades, corrupting that system of records. They did this so they could hide the real value, or lack of it, of complex investments - so they could sell a progressively higher mix of dross as gold.
They started with foreign currency exchange deals that were purposely complex and seemed to be more likely to pay off than they were, or seemed to pay more than they would. At first, high-end investors were not used to major financial banks selling them junk, because traditionally these banks were investing in the same things, and their wealth came from helping their clients do well. Much as old-fashioned homebuyers would never have expected a bank to push a mortgage they couldn't handle because traditionally the banks would lose money if they didn't pay. The financial players managed to change the rules so the old assumptions didn't hold. Banks started pushing mortgages they knew borrowers didn't qualify for, and they sold investments they knew were no good. At least no good to their suckers ... uh, investors.
They ramped this game up, getting ever better at it - hiding the risk of what an investment was based on, like bad mortgages; getting rating houses to give inflated ratings; claiming the investment was insured when the insurers, like AIG, didn't have the funds to insure it.
I'm sure there are ways the financial markets need to be regulated, but mostly what they need is getting the investors accurate information. Regulators need to think of our financial system as an information system, and accurate information as almost sacred.
One way they could do that is to be sort of a team of financial mythbusters, or fact-checkers. Investors, even sophisticated ones, often can't know all the underlying data, whether some far-flung, complex corporation is being truthful in reports that define its value (remember Enron?), whether an investment insurer can really deliver. Regulators could watch for what new kinds of investments are becoming popular, or what companies are gaining value, use their regulatory power to require the underlying documents, apply that small army of accountants no one else has, and report how true the information is. That way some bubbles could be popped, and some lies exposed, when they're small.
Otherwise we slide backward, closer to those countries who can't thrive because they don't have a sound information system.
Tom Cantlon is a longtime local resident, business owner and writer. Contact him at TomCantlon@TomCantlon.com.