Market tantrums should be tamed

July 4, 2012

The headline could have come from a hundred places any time in the last hundred years. “Market has gone wild”, it read. The accompanying news report explains that the price of a crucial financial asset is in “free fall”. Traders and businessmen are calling on the government to step in.

The asset in question could be peripheral euro zone government debt today, global equity markets in early 2009. The wild market could have been soaring rather than falling: the stocks of 1929 and 1999, the house prices in Florida or London in the 2000s, or the supposedly safe government bonds today.

The actual headline comes from a Hong Kong newspaper in 1983, when investors in the then British colony began to fear the worst from a Chinese takeover. The UK’s Minister of State told the locals to “have confidence in yourselves”, but, as today’s Spanish and Italian politicians can ruefully confirm, such rhetoric is not enough to stop an investor stampede. A few weeks later, the Hong Kong authorities did indeed take the matter out of traders’ hands – they fixed the exchange rate between Hong Kong and U.S. dollars.

Under the leadership of Alan Greenspan, the U.S. Federal Reserve took the opposite approach. With a few dramatic exceptions, it trusted the ultimate wisdom of markets. That laissez faire faith was a mistake. If the Fed had intervened to limit house price increases a decade ago, the current economic malaise might well have been avoided.

Interventions are helpful because wild financial markets are one of the worst aspects of the modern economy. Financial asset prices can move fast for no good reason. When they rise too high, they provide misleading signals, which misdirect the flow of investment. When prices fall too far, the damage to the real economy of goods and services can be severe and long lasting. Damage to factories and roads is relatively easy to repair; it only took a few months for the global supply chain to recover from 2011’s severe Japanese earthquake. The damage from the financial crisis of 2008 still lingers.

The financial sector is more fragile than the real economy for two reasons. The first is an unavoidable difference between financial assets and other purchased goods. The perceived value of stocks, bonds and the like depends on the buyers’ dreams and hopes. Dreams often exaggerate reality, for better or worse, and hopes once dashed, are not easily restored. It is much harder to get carried away in the rest of the economy, which deals primarily in actual products in the here and now.

The second reason is an intellectual mistake: an unjustified respect for the wisdom, efficiency and utility of financial markets.  Regulators, economists and much of the general public treat the market prices of shares, bonds and oil like the utterances of an infallible oracle, even when these prices are more like the random demands of an overtired two-year old.

If the financial toddler is not stopped, the tantrum can end in the economic equivalent of broken toys and hysterical tears. A calm parent is needed to calm financial frenzy. The authorities should restrain financial dreams and moderate financial hopes. In other words, they should be bold enough to just say no to markets.

For all the post-crisis talk of financial stability, central bankers and regulators remain shy about using their powers. The European Central Bank, for example, objects on principle to the obvious response to investors’ hysterical flight from some euro zone members’ government bonds: buy the unpopular instruments. The ECB’s hesitation could lead to the demise of the single currency. The right principle is that whenever financial asset prices are moving too fast in either direction, bank regulators and central bankers should feel free to intervene directly in markets, set new requirements for bank capital and loan collateral or print or destroy money.

Such an activist agenda infuriates enthusiasts of free markets, but they should recognise that freedom is often best protected by restraint. In the real economy, the freedom of airlines, food producers and the like is limited by detailed regulations on everything from product safety and labelling to labour practices and environmental impact. The constraints maintain competition that is helpful to society. More restraints on financial markets would make them more capable of doing their real job – allocating capital and setting prices in normal times.

Like parents, financial market overseers will not always get it right. The experts will sometimes exert too little discipline and sometimes too much. But just as toddlers are less trustworthy than fallible parents, overexcited traders deserve less respect than a group of intelligent people with a simple goal – to avoid financial excess.

Dramatic headlines may get most of the attention, but the economy would benefit from more dull ones, along the lines of “Tantrum averted”.


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This is one of the most muddled articles with respect to regulation of free markets ever written. Even the hint that any regulators could respond to volatility in a meaningful manner is ludicrous, someone’s misguided dream of utopia.

If volatility over periods of minutes are an issue, there may be ways to slow down trading, but if anything, financial trading is headed the other way.

What about the long climb in prices of whatever such as housing. How are regulators to control that?

Now, let’s get real. Can the regulators do their job of limiting gambling? Apparently, the answer to that is no.

Can we stop investors from panicking?

So, volatility is here to stay. Get over it.

Posted by ptiffany | Report as abusive

[…] Market tantrums should be tamed (Reuters) […]

Posted by Around The Net In Ten Posts – Wednesday July 4, 2012 | Market Remarks | Report as abusive

I guess, it’s not a tantrum. It’s a melt down, as our “financial experts” do not consider their own or others economical safety, any more.

Posted by MartingaleBias | Report as abusive

Speaking of muddled, a “long climb in prices of whatever” is not the subject of the article, which seems crystal clear and rational. “Can we stop investors from panicking?” Maybe not, but regulators can briefly halt trading. Sometimes a five minute break is all traders – not to be confused with investors – need to alter their mood for the better.

Posted by TobyONottoby | Report as abusive

Yes, you are right of course Edward – no one should ever lose, and we should always eat chocolate cake. People like yourself, Barrack, and Ben know what is best for us common folk, and we should be happy with the lot in life that you choose for us. Great article.

Posted by potatohead | Report as abusive

Well written.

Thatcher’s dictum that you ‘can’t buck the markets’, along with Reagan’s like-minded attitude, sowed the seeds of the 2008 calamity, now running at a finance house near you as an ongoing fiasco.

The ‘markets’ can not only be bucked, they need to be whipped into line. The obscene profits being raked in by investment banks and hedge funds out of the current turmoil is being paid for by the masses in the form of unemployment, higher levies and cutbacks in public services.

The family that eats in the burger joint is picking up the tab for the champagne-quaffing oyster-eaters in the four-star Michelin restaurant.

It’s time to put wrongs to right. The ‘markets’ are a brainless herd of wildebeest. The guy in front turns left, followed by the ten thousand behind him. A right turn produces the same effect.

It’s way past time for governments world-wide to grow a pair and take on the manipulators and circus-jugglers who profit from the kind of volatility they themselves are often responsible for.

You can include the rating agencies in that.

Posted by Hewson | Report as abusive

A few questions: exactly when did it become the role of government to sheperd markets? How is normal price discovery ever to reassert itself if governments constantly seek to intervene? What qualifies a government to set prices?

Did the earth start turning backwards on it axis at some point and I didn’t get the memo?

Posted by HumanityRenewal | Report as abusive

I especially like the part about destroying money…

Posted by the_italian_guy | Report as abusive

This article is so funny.
“No you can’t sell your house for one million dollars! You only paid half a million for two years ago! You can only sell it for six hundred thousand!”
“No you can’t sell shares in that company for five dollars! I don’t care if you need the money, they were six dollars yesterday so you’ll have to wait a year to sell them at five! No one wants to buy them at the allowable $5.95? Too bad!”
I love the photo of the columnist. He looks so confident and knowledgeable.

Posted by RandomName2nd | Report as abusive

The author is claiming that governments should somehow have kept housing prices from rising? Nonsense. Sound financial loans would have averted the entire disaster – and kept prices in line because only those who could afford houses would have been buying houses, preventing the bubble that occurred.

This entire mess originated in the CRA of the late 1970’s, and accelerated when the Clinton administration forced banks to make bad loans in order to do business. It just took 10 years for those loans to catch up.

The last thing we need is the government trying to regulate every aspect of life. We’ve already seen how that turned out in Soviet Russia.

Posted by stevedebi | Report as abusive

To many of us individual investors the markets appear to be schizophrenic, perhaps even psychotic. Subject to daily emotional whims rather than hard data. Up one day on optimism regarding Europe. Down the next day on fears regarding Europe. Ad nauseum. Business results seem to have little impact except momentarily.

Posted by explorer08 | Report as abusive

Everything has alreday been said. Now it’s my turn: Sheer stupidity and arrogance.

Posted by calexandre | Report as abusive

Why would anyone in the world ever trust Wall Street or a bank? You can only trust gold. Buy it and keep it.

Posted by urownexperience | Report as abusive