Airs – Ian Lance Taylor

Market Complexity

The stock market gyrations last Thursday may be a nice example of the issue of complexity I’ve discussed in the past. When the financial markets are too hard to understand, failure modes become unpredictable.

Because there is profit in complexity, or at least the chance of profit, we can expect more of this going forward. History suggests that there will be a slow and intermittent increase in complexity and volatility, up to some limit where ordinary investors are no longer willing to tolerate it. The government will increasingly try to guarantee the behaviour of the financial instruments used by ordinary people: bank accounts and 401k plans. High finance will increasingly separate from ordinary finance, as indeed was the case in the past.

My guess is that we’re headed for a cycle of booms and busts more like the ones in the last 19th century. The money that comes from complexity has a lot of influence over the political system, and people are working hard to avoid regulations which smooth things out while lowering profits. At the same time the government may increasingly intervene to keep finances stable for most people. E.g., although Fannie Mae and Freddie Mac will most likely disappear, there will be some new mechanism for controlling home mortgage interest rates.

Hard to say how it will all work out, but whatever happens you heard it here first.

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Ian Lance Taylor

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2 responses to “Market Complexity”

  1. jldugger Avatar
    jldugger

    Here’s the failure mode of the stock market: you continue to own the stocks you own, and they continue to pay dividends and grow. The recent trend towards no-dividend stocks is odd to me, and is clearly dependent on a functioning market for owners to receive any profits.

    The other thing that’s becoming apparent from the market hiccup on Thursday is that we may rely too much on people. The NYSE is the last remaining market of specialists. In theory specialists are a trader of last resort, but we saw them balk when the market was sell heavy, and the auction they held seems to have been counterproductive, where the NYSE auction results in one value and Nasdaq trades at a value 20 dollars cheaper. Whoops. Guess which number people thought was more reliable.

  2. Ian Lance Taylor Avatar
    Ian Lance Taylor

    The last time I looked, most dividend paying stocks were overpriced compared to the income stream. You could do better for your money by investing in treasury bonds. Even with dividend paying stocks, you only make your money back when you sell the shares.

    I’m not sure I agree that relying on people is the problem. Complex computer programs can head off in strange directions very quickly. At least people take a comparatively long time to do anything, and in disconnected groups they tend to balk at the really odd. People can serve as an important brake on the financial system.

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