What a weird question, you may think. But consider:
- In textbook markets, what is traded are products that are supposedly useful to customers. What is traded in many financial markets are highly artificial contractual arrangements that are several layers away from what happens in the real economy.
- In textbook markets, participants are liable to go bankrupt if they overspend. In financial markets, some market participants know that they are too big to fail, creating problems of “moral hazard.”
- In textbook markets, participants are expected to inform themselves about the products they trade. At least in some financial markets, what matters are not the “fundamentals” (e.g. the economic success of a company the shares of which are traded), but what other participants do. Many participants try to make profits by outrunning market movements or “sentiments”; this can lead to large swings, in disconnect from fundamentals
- In textbook markets, it is assumed that participants intend to hold property rights for a certain amount of time. In many financial markets, in contrast, traders (computers!) siphon off profits from small movements in prices, sometimes on a millisecond scale.
Why does this matter? If we call the arenas* in which financial products are traded “markets”, our attention is directed to certain features and distracted from others. Our view of what a just regulation of these arenas would be is also likely to be influenced by it. A widespread view of the relation between justice and markets is roughly as follows: Markets need to have fair rules that create a level playing field, and there needs to be regulation that prevents market failures, for example negative externalities. Apart from that minimal, procedural account of justice, market should be left free, not only because this strengthens individual freedom, but also in order to be maximally efficient. This efficiency, it is assumed, helps create a large “pie” that can then be redistributed, typically through taxation. And, it is assumed, that there is a trade-off to be made: between “efficiency” on the one hand and “equity” on the other.
But if financial “markets” lack many of the features that we typically associate with the term “market”, this model may not be appropriate. It may be futile to look for regulation that would “repair” financial “markets” so that they become more similar to markets for apples and oranges. We may not be “freer” as a society just because financial markets are less regulated.
Financial markets are made possible by the legal framework that undergirds them. This framework includes property rights, freedom of contracts, and myriads of more detailed rules. Instead of asking “how much much regulation?”, we should ask: what are the net effects of property rights, freedom of contract, and other regulation. We should ask whose interests they serve – cui bono? And we should remember that the assumption that we often have in mind concerning the regulation of markets – that more regulation comes at the cost of less freedom and lower efficiency – might simply not hold. Instead, we should ask more fundamental questions about the point and purpose of financial markets from a perspective of justice.
For example, what about the rules that define how one can run a bank – do they include a sufficient buffer to absorb losses that might otherwise have hugely negative effects on the whole society? As Admati and Hellwig, among others, have argued, the capital ratios of banks are still far too low.
Another question concerns the design of contracts if these can have externalities on the economy as a whole. We might want to ask how financial products for specific goods, e.g. home mortgages, should be designed such that they do not exacerbate social inequality.
And we might want to ask whether we really need “liquidity” on a nanosecond rhythm – or whether the allocation of capital could be sufficiently secured, with lower overall risks, by allowing only, say, one transaction per second – or, who knows, per minute, or per hour, or per day…
Talking about financial “markets” puts the burden of proof on those who raise such questions – but if we acknowledge that financial “markets” are, to put it mildly, rather atypical markets, we can remove the blinders and have an open debate. To be sure, alternative ways of regulating such arenas can be even worse than the very atypical markets they are – but it is not clear a priori that they are, and it is not clear that it makes sense, from a perspective of justice, to start from that assumption. We need to look at the details of different markets, the benefits they bring (to whom?) and the risks they create (for whom?), and then see which institutional framework makes sense for them – whether or not it resembles the “markets” we know from textbook models.**
*I use the term “arena” as a neutral term. I may have been influenced, however, by having seen a facebook comment that described the job market for philosophers (another “market” with somewhat atypical features) as a gladiator fight…
** Thanks to Tom Parr and Mark Reiff for comments on an academic text on these issues.