Continuous Growth Happens Only in Cancer
In a way, today’s off the record roundtable on “The Economics and Psychology of Building Sustainable Finance” reminded me of yesterday’s spectacular quote by Eurogroup President Jean-Claude Juncker, as mentioned in the opening plenary of the GES2011 by Ali Babacan, Deputy Prime Minister of Turkey: “we know what to do, but we don’t know how to do it and get re-elected”. In my opinion, had we correctly deployed our existing regulatory and supervision tools, we could have foreseen the financial crisis triggered by the US housing bubble, despite its extraordinary “black swan”-ish character. Regulators did not do that, for fear of upsetting traders, bankers, shareholders and ultimately the consumption-driven general public.
From the session today, I see that academics, traders and politicians alike have come to acknowledge, more or less publicly, that the efficient market hypothesis has failed us. In addition, as one panelist in the roundtable correctly said, “it is sick to imagine continuous growth; continuous growth happens only in cancer”. Perhaps the grand, perfect mechanistic model that can replace the efficient market hypothesis has not been discovered yet. Nonetheless, out-of-the box interdisciplinary solutions can be envisioned, which could ultimately aid in building “sustainable finance”.
While no consensus over a definition of the concept “sustainable finance” is imaginable – though I appreciated the proposition of the one of the panelists that it refers to getting finance back to its original mission, i.e. to collect savings and give people the best possible return on their savings by allocating capital efficiently – disciplines such as psychology can bring us some surprisingly feasible solutions for making finance work again.
Training the Minds of Traders
If we accept the proposition contained in David Tuckett’s recently published book that financial assets stimulate both great excitement AND great anxiety (because they are abstract pieces of paper whose value is determined by expectations about the future), then we also accept that our financial systems displays a flawed functional setup: not everybody can be a winner in this league! In such a “divided” state of mind, emotions foster exciting stories about new investing opportunities, and they alter perceptions of risk. As a solution, regulators could come up with a financial research public body aimed at increasing transparency and generating anxiety and reflection when trading gets out of its normal patterns. Let’s fool the market with its own psychological weapons, so to speak!
Participants in “Proposals GES2011” had to vote on the possibility of going even further: should we have macroprudential supervisors (i.e. the European Systemic Risk Board) control a macro-prudential investment fund, which would take contrarian positions when supervisors detect market dislocations? We could fight herd behaviour from within the system! Other solutions seem more realistic: less leverage and more equity participation in the financial sector, or limits on cross exposure between financial firms.
Psychology matters. Dear regulators, please acknowledge that the cake is not getting bigger! And please use some bold tools to get markets off their dopamine kick!