Questioning the “markets” – part 1

Over the past three and a half years, I have had a ring-side view of the finance industry. I have been involved in developing a market risk-management software product targeted at banks. This product has now morphed into a far more mundane corporate treasury management software. In the process, I have developed a great distaste for financial modeling and all the elaborate math that goes into modern finance. I have come to question the role of the finance industry and its foundations – the currency, equity, credit and derivative markets. Note that I am not questioning the role of the finance industry in the recent “crisis” or any such thing; I am questioning the very existence of the finance industry in its current form; I am questioning the role of the finance industry in the free market system as such.

What led me to ask such fundamental questions? Here are some observations/experiences in no particular order.

Banks vs Corporates:

  • It is a lot easier to make money in the finance industry by catering to banks.
  • Banks are a lot less concerned with the accuracy or soundness of the results produced by our software.
  • Banks are interested in far more complex analyses than corporates are. However, unlike the people at corporates, people at banks do not necessarily know what they are doing or how the analyses are to be interpreted.

Money:

  • There is far more money to be made in the finance industry as compared to other industries.
  • Many engineering graduates from IIT have some certification or the other related to finance (NCFM or some other acronyms that I don’t care to remember). These were unheard of when I graduated in 2006.

Math:

  •  Highly sophisticated math is required for any non-trivial analysis. Very few people have the capacity to understand the math.
  • A lot of the math is circular. Mathematical models are often calibrated to market prices of assets. The market is made by people who use mathematical models to price assets.
  • A lot of the math is essentially unfounded. Correlation trumps causality because the causality is too complex to model mathematically.

It is clear to me that the finance industry is sick. What made it sick? How long has it been sick? Can it be cured? If so, how? I will consider these questions in future posts. (I have a history of starting a post with part 1 in the title and failing to follow up. This time however, I am sure there will be more posts on this theme.)

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2 Responses

  1. Short answer: The regulatory framework has caused the finance industry to take the shape it has. Its the massive government intervention that’s at play here.

    Philosophy is also at play of course. Most economic and finance theories are the outgrowth of philosophic rationalism; ie pure Platonism as in the efficient market hypothesis. Keynsianism is also an example of this.

    This is completely unsustainable and it will eventually implode. My fear is though that when it does freedom and capitalism will get the blame and not interventionism.

  2. There is no doubt that interventionism has done a lot of damage, but is that all? Why is finance so heavily regulated? Is there something fundamentally wrong about the industry itself or its foundations – the markets for currencies, equities, credit etc?

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