Markets are efficient at sorting out goods prices, but less so at uncovering snake oil in financial investments
Gary Cohn wants to overturn the US Department of Labor’s fiduciary rule that pension sellers’ primary duty is to their customers. Cohn, formerly Goldman Sachs president but now US President Trump’s National Economic Council director, complained that it was ‘like putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn’t eat it because you might die younger.’
In fact, it is more like saying you should not put melamine in baby milk, or sell thalidomide to expectant mothers. Indeed, the call from the ‘industry’ to rescind the rule is like the burglars’ lobby calling for a ban on locks. I suspect that Cohn’s words will epitomize this age the way Marie Antoinette’s recommendation of cake to the starving poor represented the French monarchy.
Within weeks, the Trump administration is building a bonfire of the regulations that were designed to stop an action replay of 2008, and it is all the more worrying that so many nominees have gold on their hands from the crash. Lobbyists had previously attenuated Dodd-Frank so much in drafting that it was already the Maginot Line of financial regulation. But filling in the holes would be much more effective than demolishing the partial defense it represents against the Barbarians looting at the gaps, so it is disturbing how much enthusiasm Trump has for tearing down this wall, even as he demands a new wall against the US’ neighbor and trading partner Mexico.
The market fundamentalists now in office consider it axiomatic that lead in gasoline, paint and water, asbestos insulation, unrestrained pollution and BSE in beef notwithstanding, markets are better than regulation and governments. In fact, that is murder by metaphor: when physicists studied how gases expand, they derived laws based on aggregate results of individual gas molecules that bounce about in what some happy scientist called the Drunkard’s Walk as they ricochet from their equivalent of lamp post to street sign. Taken together, however, as energy levels rise, the random molecular wobbles average out and the gas expands predictably. Fundamentalists make a metaphor into a model and compare the behavior of molecules to humans, extrapolating that a host of individual economic decisions will coalesce to form a predictable and benign hidden hand.
If you tried to parallel the expanding gas experiment with a square full of actual drunks, however, it would not compute: people are not molecules. Some of them would pass out, some would make out, some would fight it out and yet others would try to rob the more incapacitated. Investors act on sentiment and prejudice, they listen to each other – and they often make irrational decisions, or make rational decisions based on ‘alternative facts’. Some are contrarian, although the history of the markets suggests that most suffer from lemming syndrome and follow the crowd wherever it leads. Markets can indeed be efficient at sorting out the prices of tangible goods, but are much less so at evaluating the percentage proof of snake oil in financial investments.
We have expert evidence to reinforce our suspicions about the economic strategy. President Trump’s connection with casinos brings to mind the gambling inherent in investment strategies, but those of us without chips to place can watch and learn from the experienced punters at play. So we should draw lessons from the big bank executives who, the Wall Street Journal reported in January, were dumping more of their own stocks after the election than at any time over the last 10 years.
The implication is that they knew the market would rise on Trump’s inauguration because of ‘animal spirits’, like a cobra charmed by the mantra of tax cuts and deregulation. But they were also sure that stock prices would reflect the real economy and face a high risk of falling as soon as he began actually administering.
So how can actual business flourish in an economy run by an administration of the impenitent wild things who gave you 2008 and are now declaring tariff wars with every major trading partner, not to mention getting close to declaring actual war on many others? In fact, while the presidential decrees might augur a business collapse for us professional Cassandras, some boats will float high regardless of the receding waters.
Look on the bright side: there will be plenty of opportunities for IROs who feel the feral spirits of the age. There will be a lot of penny stocks to be pumped and dumped along with exotic financial instruments reflecting the outburst of predatory ingenuity that awaits us.