information please

This is a quick follow-on to my note about the nature of financial markets.

It’s out of the remit of this blog, in that it has nothing to do with music, movies or the rest of the cultural products I so greedily consume.

But it is an obsession.

Ever since the weird market plunge last Thursday, I’m again leaving CNBC on as my daily background noise. It’s familiar turf – back in 2008, I got up one morning just before the Lehman Brothers collapse and without thinking much about it started watching CNBC.

As in constantly. As in, nothing else. It was on in my office all day and on at home all night. My wife sat through dinners with CNBC. It was the noise my dogs slept to during the day. It was with me like a fever until the financial crisis began to abate.

CNBC was my first teacher, a statement which probably makes people who know a lot about economics and finance shudder. And yes, two years and much reading down the road I see severe limits to the network’s reporting: it has a very hard time seeing the forest for the trees because it plays to an audience of – and draws its interviews from – tree dwellers.

I’m still grateful. Starting with CNBC, with its tsunami of charts, graphs and arcane language, shaped my view of what’s happened in the last couple of years and which is the point of this note.

It’s commonly held that the function of free markets is to create and efficiently allocate wealth. Though I’m utterly unqualified to have an opinion, I disagree.

I think the prime function of free markets is to create reliable information, and because they do that job well they throw off wealth as their major side effect.

Skeptics might say it’s a little like arguing that the major purpose of a nuclear weapon is to create (very, very quickly) a vast new array of information about atoms, with the side effect of a transcendent boom, but I don’t think you have to stretch things that far. Even the mainstream of politics and Wall Street understands something has gone wrong on the information front; it’s why they talk about ‘transparency’ so much.

However, it’s hard to imagine transparency, however noble an idea, as a match for the baroque financial weapons wielded  by Wall Street. (Aside: here I think of the ‘Alien’ movies, with their ominous, organic-looking alien technology, plus, of course, the creatures themselves being utterly relentless and not even having the concept of remorse.) In other words, you can’t have a transparent derivative, if said derivative is a bet against someone who has bet on the performance of a group of groups of tranches of grade Z real estate. You’re just too far from your source material, the underlying deals.

All of which gets back to the point Mark Cuban makes in the essay linked below, that the original job of a market, to provide capital to a business to grow, has been lost.

My information idea is one step removed from Mr. Cuban, and it’s more semantics than anything else. If you invest in a business, you’re expressing a belief in that business’s potential. You’re offering an opinion which has a direct relationship to the thing itself.

As far as I understand the concept of “shorting,” it too seems likes it adds information. You’re saying “No, I don’t think this company will perform that well.” Those opinions offset the opinions of investors, and price discovery, as they call it, takes place.

But complicated financial instruments seems to have much less information value: if you’re betting against someone who is already at two or three removes from the deal itself (the mortgages that got bought, for instance) what kind of information are you adding? Who are you saying is wrong? The guy making the topmost bet? The underlying deals? Some intermediate stage? 

It seems to me that when you reach such a point, instead of your financial tools getting more subtle they get less so – now you’re just looking for direction and velocity and trying to do something with it.

If I ran the financial world, my goal would be to encourage dealing which produces a lot of information, and strongly discourage dealing that either adds little information or muddies the waters about the information you already have.

I have no idea how to do that, or who would be – to quote President Bush – the decider. I’m sure it’s hopelessly naive, silly, stupid, and proof of why journalists, especially the small town, over the hill type, shouldn’t even be thinking about such things. I’m over-stepping my station in life. But does anybody really believe the vast arrays of machinery and high-priced talent now deployed across the globe have a handle on things? They may know things we don’t – but as last Thursday demonstrates, what they don’t know is so much more important.

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