At universities, the reality of the financial casino is taboo

Computerized high-frequency trading on the stock exchange can manipulate prices within milliseconds: A casino with no economic benefit.

by Urs P. Gasche

In the financial crises of 2008 and 2023, financial science also failed, says finance professor Marc Chesney, of all people.

[This article posted on 4/18/2023 is translated from the German on the Internet, An Universitäten ist die Realität des Finanzcasinos tabu - infosperber.]

https://www.infosperber.ch/wirtschaft/kapitalmarkt/an-universitaeten-ist-die-realitaet-des-finanzcasinos-tabu/

Chesney, together with a group of professors and researchers from Swiss universities, had already criticized in 2018 that even ten years after the outbreak of the financial crisis in 2007/08, old, outdated economic theories are still being taught at universities.

If one follows many curricula and textbooks at highly respected universities in North America[1] and Europe, one learns at most marginally about the fact that a financial crisis took place in 2007/2008. The eminent role of speculative derivative products remained mostly a marginal note (see: "Economics and finance: the monopoly of prevailing thought," Marc Chesney 2019). The financial academic world had become detached from the needs and realities of the economy and society.

Finance professor Marc Chesney challenges, among others, the following three paradigms that dominant economic theory still takes for granted:

1st paradigm

"Financial markets are efficient and perfect in principle, and speculation is not really problematic. It brings liquidity to the stock market and therefore basically plays a positive role."

This way of thinking is not accurate, says Marc Chesney: "Like a bet, speculation in the financial markets can be positive, neutral or negative." For example, he says, if someone bets on bad weather, it has no effect on the number of hours of sunshine or rain the next day. However, when hedge funds and other financial investors speculated on the collapse of Lehman Brothers with credit default swaps CDS or short selling, it accelerated the bank's demise, he said. As a result, 30 million people worldwide would have lost their jobs.

At CS, too, bearish speculators accelerated or even brought about the downfall. The stock market price of the corresponding CDSs skyrocketed.

Instead of being efficient most of the time, financial markets are in reality very often manipulated. And when too many derivatives are in circulation, uncontrollable systemic risks arise.

But all too many standard textbooks would neglect or even ignore the role of derivatives in the 2008 financial crisis. This would have consequences if today's students were to work in the management of a major bank tomorrow.

2nd paradigm

"Speculating on stock exchanges always reflects real changes in the real economy and serves the good functioning of financial markets."

This paradigm is wrong, he said, because in high-frequency trading one can manipulate prices: Within moments, one can trigger and cancel purchase contracts, driving up the price to profit. In North America and Europe, at least 50 percent of all stock market transactions are now carried out using high-frequency trading. The orders are executed fully automatically by computer.

Algorithms exploit minimal price fluctuations. A measly return becomes a big return with a large capital investment. When buying or selling, high-speed trading can bring profits a few milliseconds or microseconds ahead of other high-speed trading bidders. These speculative trades have nothing to do with the good functioning of the financial markets. On the contrary, prices can be manipulated. In any case, these betting transactions have no economic benefit whatsoever. "You might as well go to the casino," wrote financial journalist Werner Grundlehner in the NZZ.

Eleven years ago, NZZ editor Christof Leisinger already commented: "Securities trading has in many cases become a pure end in itself. The most extreme variant is high-frequency trading. The goal is to achieve the highest possible profits, regardless of other circumstances." Dirk Müller, stockbroker, fund manager and book author, argued for a ban on high-frequency or algorithm trading as early as 2013: "Such trades used to be considered price manipulation."

A ban would have to be enacted by the legislature, the Swiss regulator Finma told the NZZ. It had "no consumer protection competence."

For once, the EU Parliament wanted to be brave and introduce the rule that stock exchange orders may not be cancelled or modified for at least 0.5 seconds. Reason: The permanent placement and cancellation of orders could manipulatively increase the price without purchases and sales taking place. But the umbrella organization of exchange trading firms, FIA-EPTA, was against it, and subsequently so was the EU Council of Ministers.

The problem of these pure betting transactions, which today make up a large part of stock exchange transactions, has been known for a long time. But it is not really critically discussed at the universities and the parliaments did not regulate it.

3rd paradigm

"Government bonds are assets without risk"

This paradigm is also wrong, says Chesney. If banks in the EU or Switzerland, for example, hold government bonds in dollars, reals or rupees, there is a risk of a deteriorating exchange rate. The level of future inflation can play a big role.

But because government bonds are considered securities without any risk under current banking regulations, banks do not have to set aside reserves for them. This also applies to euro-denominated government bonds issued by risky countries such as Greece or Italy.

Proximity to big banks

Most university curricula adhere to the above paradigms and others as well. Perhaps university financial institutions are too close to big banks. This impression can arise because many university institutes and professors receive financial benefits from the financial sector. Some institutes even exist only thanks to sponsoring by banks.

Coming soon on Infosperber

A micro tax on all electronic financial transactions as an elegant and unbureaucratic means to reduce excesses and large risks on the financial markets.

FOOTNOTE

[1] For example, at Berkeley, the program for the 2009 undergraduate Introduction to Finance course did not include the financial crisis and related issues such as financial instability. The same is true for the 2016 MBA course "Core Finance". At the Ross School of Business at the University of Michigan, the 2009 undergraduate course program "Financial Management" lists the topic "Special lecture on the financial crisis". This is to be applauded, although it is only one of 28 courses in that semester. In the same course held two years later, the topic had disappeared.