Monday, June 01, 2009

The Chicago School of Economics Goes Belly-Up

Read Brad DeLong. He pulls apart the attempt by Richard Posner, "leader of the Chicago School of Economics and Fourth Circuit Court of Appeals judge to rescue the Chicago School’s foundational assumption that the economy behaves as if all economic agents and actors are rational, far-sighted calculators."

Fun though that is, I'm making this entry to save this quote:

Start with the observation that financial markets have six useful purposes:

* to aggregate the money of people who ought to be savers into pools large enough to finance large-scale enterprises.

* to channel the money of people who ought to be savers to institutions and people who ought to be borrowers.

* to spread risks so that no one individual finds herself ruined by the failure of any one investment or the bankruptcy of any one company or the slow growth of any one region.

* to keep managements efficient by upsetting and replacing teams and organizations that have outlived their usefulness.

* to encourage savings by creating liquidity—the marvelous fact that one can own a piece of an extremely illiquid and durable piece of social capital (an oil refinery, say) and yet get your money out quickly and cheaply should you suddenly have an unexpected need for it.

* to take the money of rich people who like to gamble and, by providing some excitement for them as they watch their gains and losses, use it to buy capital equipment that raises the wages of the rest of us (at the price of paying a 20 percent cut to the Princes of Wall Street). This is a superior use for the rich—and for the rest of us—than, say, taking their wealth to the crap tables of Vegas.

Wall Street innovations and practices are useful only insofar as they promote these six useful purposes. Call them aggregation, accumulation, diversification, efficientization, liquiditization, and casinoization.