Can finance be democratized?

Robert Shiller, who famously called the housing bubble, now calls for the democratization of Wall Street.  I’d like to believe that such a democratization is possible, but I suspect that it is not.

Shiller writes:

Finance is substantially about controlling risk. If risk management is suitably democratized, and if its sophisticated tools are better dispersed throughout society, it could help reduce social inequality. …

The essence of finance is that contracts should benefit all parties.

This last sentence hints at a fundamental aspect of finance that Shiller left out of his New York Times essay:  asymmetric information.  Financiers — in the process of gaining the information necessary to “manage risk” — have access to information that is essential to pricing assets that trade for millions — and even billions — of dollars every day.  You and I don’t.  If we want the financiers to do their jobs in the public interest — however we choose to define that — we will have to compensate them for not abusing their privileged position.  Even when banks acted mostly as utilities, the 3-6-3 banking rule was a clear indicator that bankers were well-compensated for behaving themselves.

What worries me about seeking to “democratize Wall Street” is that the goal of democratization has been pursued for decades.  And most of the laws passed with this goal seem to just make Wall Street richer.  There was a time (before most of us were born) when stock brokers earned incomes like bankers.  The charged a relatively high fee for every trade and mostly worked for a small well-to-do clientele.

In 1969 Time Magazine asked “Should brokerage firms be allowed to sell their own stock to the public, thereby letting the ordinary investor in on Wall Street’s enormously profitable business?”  And as we all know the answer was yes.  The NYSE let member firms go public.  Access to the vast capital of public markets allow newcomers to reduce the commissions paid on stock trade dramatically — this too democratized access to the markets.

More or less at the same time, the NYSE ended its unofficial policy of protecting the customers of member firms from losses due to a member firm bankruptcy.  (cf. Ira Haupt & Co. 1963 and Dupont-Homsey & Co. 1960).  The SIPC was founded in 1970, backed not only by member contributions, but also by a line of credit from the Treasury.  That is, hand-in-hand with “democratization” of stock trading came government insurance against tail risk.

Stocks are now cheap to trade and within the financial reach of many Americans.  But it’s far from clear that democratization of the gains from trading in the stock market have accompanied this change.  From the “spinning” of IPOs to the growth of hedge funds and the movement of significant financial activity to “over-the-counter” derivatives markets, the rich and connected still have better ways of making money from the markets than the rest of us.   And it’s far from clear that you can write a law that will prevent financiers with access to information the rest of us don’t have from reaping the gains of the information in one way or another.

Maybe we should give up trying to democratize finance and turn our focus to reining in its excesses — while recognizing that a good share of the profits from finance will always end up flowing to the financiers.


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