Paul Krugman’s piece linked above is nice bit of political economy, both for its succinct description of the layout of interest groups in our politics and for its warning about how the financial industry is trying to weaken the guardrails against the financial instability that could lead to future bailouts. Given its recent track record, the financial industry should not be trusted to write its own regulations, but it has enough money to buy many legislators.
On this theme, in “Odious Wealth: The Outrage is Not So Much Over Inequality but All the Dubious Ways the Rich Got Richer” I write in praise of vulture capitalism, but what the financial industry wants is another matter:
Among excessive rewards caused by the government, bailouts without increases in equity requirements big enough to prevent future bailouts are especially unfair. But actions by the government to protect the profits and business models of firms already in place by standing in the way of firms doing new things in new ways can in the long run be just as damaging. And in the digital age, copyright law is long overdue for reevaluation.
In academic finance, concerns about high-frequency trading go under the heading of “market microstructure” issues. There are other bigger problems in finance at the macroeconomic level that I have talked about more than once. The best reason to fix unfairness—or even perceived unfairness—in market microstructure is so people aren’t distracted from noticing how those in the financial industry use low levels of equity financing (often misleadingly called capital) to shift risks onto the backs of taxpayers and rewards into their own pockets. In quantum mechanics, electrons can “tunnel” from one side of a barrier to another. Using massive borrowing to ensure later government bailouts, the financial industry has perfected an even more amazing form of tunneling: the art of tunneling money from the government so that the profits appear on their balance sheets and in their pockets long before the money disappears from the US Treasury in bailouts. By comparison with this financial quantum tunneling of money from the US taxpayer that has been a mainstay of the financial industry, high-frequency trading profits of a few billion dollars a year are small change.
Of course, the real authorities on these issues are Anat Admati and Martin Hellwig, who wrote The Bankers’ New Clothes. They are the ones who should be writing regulations for the financial industry, not the industry itself. You can see a brief summary of their argument in “Anat Admati, Martin Hellwig and John Cochrane on Bank Capital Requirements.”