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The Wild West Of Finance

Filed by KOSU News in Business.
December 7, 2011

Below is an excerpt from Adam Davidson’s latest column in the New York Times Magazine, “The Wild West of Finance.”

Also, see last week’s column, “Europe’s Financial Crisis, in Plain English.”

Day trading is part of the often demonized Wild West of investment. It’s a world of online brokers, boutique money-management firms, private-equity companies and others — a gold-rush universe where anybody can sell almost anything as long as you don’t (technically) tell any lies. It isn’t a glamorous life. Day traders, for instance, stare at computer screens all day buying shares, only to sell them seconds or minutes later. Their hope is that if they buy low and sell a tiny bit less low enough times in a day, they can add up some real profit. Surveys indicate that most lose money and give up fairly quickly.

Hedge funds, which allow rich people and institutions to outsource their financial gambling, are the major players in the Wild West. And, contrary to public belief, they are no more likely to succeed than independent day traders. The handful of firms that have made huge and consistent profits hide a remarkable secret: study after study shows that most hedge funds either lose money or make tepid returns. Many — and, some argue, most — actually shut down after a few years.

What’s to celebrate here? The Wild West represents something akin to a normal, thriving market. It is largely overseen by the S.E.C., which takes a forgiving approach to firms that sell products to active investors. The downsides to this lax regulation are well known, but it is not without its benefits. Entrepreneurs with nothing more than a good idea can enter the market relatively quickly and compete against established firms. If they can offer better products than their competitors, they’ll succeed; if not, they go bust (hopefully before they almost blow up the world). One major sales pitch for capitalism is that constant competition makes us all better off. If FAZ — or a hedge fund, for that matter — doesn’t appeal to enough people, it will eventually collapse. And there is nothing wrong with that. Failure is as important to healthy capitalism as success.

The nation’s handful of huge banks, however, are spared the indignity of failure. (Ignore Bear Stearns and Lehman — they were puny compared with the true giants.) Citi and Goldman Sachs both bet against the interests of some of their largest clients and created products designed to fail. It’s extremely likely that all of the nation’s largest banks would have collapsed over the past three years without enormous help from the Federal Reserve. In any normally functioning market, they would have subsequently had trouble making huge profits. Instead, they’ve gotten bigger and richer.

Read the full column here. [Copyright 2011 National Public Radio]

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