Unexpected side-effects of floods

All of the spiders climb into trees (see #8).

Perfectly logical and yet utterly unanticipated; I feel like there is an allegory and/or warning related to systemic financial risk in there somewhere.

Update: It happens in Australia too:

Speculation is not manipulation

In the fine tradition of Thomas Malthus, famous Stanford finance professor Darrell Duffie has penned an op ed entitled "In Defense of Financial Speculation: It is not the same thing as market manipulation." He has a sharp mind and makes the case well.

First, speculators perform valuable market functions by taking risk and disseminating information (remember Enron?).

Speculators earn a profit by absorbing risk that others don't want. Without speculators, investors would find it difficult to quickly hedge or sell their positions.

Speculators also provide us with information about the fundamental values of investments. When the fundamentals appear favorable, they buy. Otherwise, they sell. If their forecasts are correct, they profit. This causes prices to more accurately forecast an investment's value, spreading useful information. For example, the clearest evidence that Greece has a serious debt problem was the run-up of the price for buying CDS protection against the country's default.

Is this sort of speculation wrong? I have not heard why.

The distinction between "speculation" and "manipulation" is important.

Those who call for stamping out speculation may be confused between speculation and market manipulation. Manipulation occurs when investors "attack'' a financial market in order to profit by changing the value of an investment. Profitable speculation occurs when investors accurately forecast an investment's fundamental strength or weakness.

Manipulation is much harder to pull off than making a simple directional bet.

Market manipulation for profit is not easily done... Simply driving up the price, as speculators are alleged to have done in the oil market in 2008, is not enough. To make a profit, a manipulator needs to obtain monopolistic control of the supply. Given the size of the oil market, that seems implausible, absent a major and sustained conspiracy.

As long as speculators do not crash and destabilize financial markets with them, they are not where regulatory attention should lie.

It would be better for our economy to enforce anti-manipulation laws, and require that speculators have enough capital to cover their risks, than to attempt to squash speculation.

Worth keeping in mind the next time someone starts ranting about "reckless speculation."

Emanuel Derman on financial sector returns

Here:

Last night I held a panel at Columbia about the economic system and the principles that should govern it. One interesting question raised but not answered by Prof Bhagwati was: Why are the returns to the finance industry so great? No one had a really good explanation but two reasonable ones were: the existence of cartels, and secondly, that financial firms' outsize returns are periodically wiped out by risks they weren't paying adequate insurance for. [emphasis mine]

Those both sound reasonable to me. More specifically, I find the cartel argument (or more broadly speaking, obstruction of competition) compelling for retail banking (e.g. through high switching costs and lack of transparency), traditional investment banking (e.g. M&A advisory, IPOs, debt issuance, etc.), and private equity (e.g. the emergence of mega-deals and club deals in the last boom). I find the high returns/tail risk argument compelling for trading operations, hedge funds, and private equity (e.g. the massive use of leverage that fueled the last boom).

Incidentally, I used to work in finance and at the time rather enjoyed Derman's My Life as a Quant.

Update: Felix Salmon looks at a similar question for credit cards:

It’s pretty clear from this chart that between them, the big credit card issuers absolutely have the ability to set prices. It’s also clear just by looking at their marketing materials that none of them is particularly interested in competing with the others by reducing the maximum interest rate that they charge.

In most contexts, a chart like the one above would I think bespeak a competitive market. But in credit cards, I’m not so sure.

Finance as rent-seeking

Finance in its modern American form is not productive. It is not conducive to further sustained economic growth. The GDP accruing from these activities is illusory – most of finance is simply a tax on what is done by more productive members of society and a diversion of talent away from genuinely productivity-enhancing activities.

The rise of China does not necessarily imply slowdown or demise for the United States. But if they specialize in making things and we specialize in finance, they will eat our lunch.

That's Simon Johnson at The Baseline Scenario on why finance is rent-seeking. I wouldn't go so far as "our most pressing national and international strategic priority", but I think his point is right.

Update: Here are some more quotes I liked:

China mostly invests in activities that raise productivity, raising the amount of goods and services that they can produce. This could be manufacturing or infrastructure or various kinds of services. Agriculture lags but continues to get some new investment. And of course they pour money into education.

I’m not a fan of the Chinese way of organizing their economy or their society. They no doubt have weaknesses that will catch up with them eventually (including waves of overinvestment in some sectors), and there’s good reason to think they will be the center of a big new “Asia Century” Bubble that is just now starting to emerge.

But contrast their pattern of investment in recent years with ours. What sector in our economy has expanded more than any other? Where should you work if you want both the highest wages on average, potentially very big bonuses, and quasi-retirement by age 40? Finance.

Of course, we need finance and an important part of modern economic development involves intermediating savings and investment. The US did this well, with some bumps in the road, and built a system that worked through the 1960s or 1970s.

But finance as a share of our activities (i.e., percent of GDP) has roughly doubled in the past 40 years. What has this really added in terms of productivity? The ATM and the credit card were great breakthroughs, but they are old.

I'm tempted to excerpt more, but I've already done so for about 30% of the post, so if you like it so far go read the whole thing.

Chart of the Day: Lehman income, bonuses

From The Economist:

This can't be good

Not only would record profits for Goldman look TERRIBLE on many levels, it is also hard to believe and even harder to know that they are not achieving them by taking on the type of systemic risks that nearly brought down the world financial system, oh, nine months ago.

Update: I take it back, I can think of at least one silver lining - if this signals higher profits in general for the financial sector, those could start to plug the massive holes in their balance sheets that everyone has more or less stopped worrying about of late.

2nd update: James Kwak at The Baseline Scenario draws out the optimistic and pessimistic interpretations.