A few weeks ago I wrote that market crashes are a form of feedback, but also a very inefficient one. I suggested that a more transparent financial marketplace where consumers could use technologies like the web to become more informed and involved would allow for less painful adjustments in asset prices, expectations, etc.
I’m now reading an essay by Paul Woolley titled “Why are financial markets so inefficient and exploitative – and a suggested remedy” which makes a similar case but, of course, does a much, much better job as its author actually knows a great deal about the topic:
The principals in this case are the end-investors and customers who subcontract financial tasks to agents such as banks, fund managers, brokers and other specialists. Delegation creates an incentive problem insofar as the agents have more and better information than their principals and because the interests of the two are rarely aligned…Since bubbles, crashes and rent capture are caused by principal/agent problems, the solution lies in having the principals change the way they contract and deal with agents.
(Or, as was said earlier by Bill Stensrud, it’s not the investment banks’ fault, it’s the investment bankers.)
Woolley’s essay is available for free and is part of the new anthology The Future of Finance and the theory that underpins it.