Regulation and Market Efficiency

Back to Basics Series (1)

(Picture : Léon Walras 1834 - 1910)

"PARIS -(Dow Jones)- French Prime Minister Francois Fillon said Friday (January 9th, 2009) the next G20 summit on financial regulation must yield concrete measures and that no market segment or entity should escape regulation in the future."

"Financial markets must be regulated!"; behind this current unanimity and dominant thought, can't we recognize the troubling signature of "The Market" itself? Isn't it another expression of its powerful strength to make opinions converge as well as to erase discordant or more complex statements?

As John Maynard Keynes used to say : "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally". A majority of market actors wanted to access the high-with-apparent-low-risk subprimes returns. When everything goes wrong the same majority is calling for more regulation.

Regulation or deregulation: what does it mean?

It is not true that "deregulation" means "absence of rules". Indeed from the very beginning of modern stock exchanges in Amsterdam and London in the XVIIth century [1], precise rules and conventions have been organizing exchanges between market actors. Since then and in particular with the marginal revolution of the 1870's, with Carl Menger in Austria, William Stanley Jevons in England, and Leon Walras in Switzerland , these rules have even been highly systematized and even mathematized.

Rules of deregulation have been organized by the "neoclassical finance" to try to reach some specific market conditions, such as pure competition and create an environment where an important assumption, called more recently by Professor Eugene Fama at the University of Chicago Booth School of Business, the Efficient Market Hypothesis (EMH) holds. This assumption is the starting point of very strong and consistent political, economical and intellectual statements. Any contradiction or proposal of improvement of the "deregulated" point of view must take into account this complexity.

For example, in this consistent theoretical framework, not only "speculation" (which is not always easy to define) is not "bad" but it plays a positive role: it enables the conversion of information into prices.

[1] Walker, Gordon,Securities Regulation, Efficient Markets and Behavioural Finance:Reclaiming the Legal Genealogy. Hong Kong Law Journal, Vol. 36, No. 3, 2006; Latrobe Law School Legal Studies Research Paper Series No. 2008-03. Available at SSRN: http://ssrn.com/abstract=1099512