But it is worse than this. In October I attended the sold out Global ARC 2010 hedge fund conference in Boston. Stephen Harper was moderating a panel (no, not the Canadian Prime Minister but the talented CEO of Strathmore Asset Management, a Europe-centric fund of funds operating out of London, UK). During his session he made several references to the standard 2 and 20 fee that hedge funds charge. At the break after his session I challenged him on this assertion. After all if a fund of funds manager says it is the standard, it must be so, n’est-ce pas?

Finally, at a recent conference in London, UK, (reported in Opalesque) there was a session on hedge fund fees at which two senior fund of funds operators were commentators. They too had the working assumption that the standard hedge fund fee is 2 and 20.

Obviously I am going to disagree with this broadly held assumption. What I find so frustrating is that members of the hedge fund industry themselves believe this, thereby contributing to the myth and in the process creating an issue for the industry!

Ok, so what is the truth here?  In showing the actual fees for hedge funds I am relying on two surveys conducted by well known firms in the business-Preqin and TrimTabs.

Preqin observes in its April 2010 report, “Management fees for single manager funds are, on average, considerably lower than the perceived industry standard of 2%. The mean management fee is 1.65% with the median at 1.5%.” (see chart below)

The TrimTabs Report — Hedge Fund Flows dated January 2009, shows the time progression of hedge fund fees (see chart below). Only about 35% of single manager funds have a 2% management fee.  Certainly the movement has been upward until very recently. Many managers’ fees are in the 1-2% range. And of the managers that charge 2% or more, it has been my experience that this group is very over-weighted with CTAs (managed futures). Indeed, I do not know a CTA that charges under 2%, though I am sure some exist.

So I will make this noble supposition. Given that CTAs represent approximately 15% to 20% of the hedge fund industry and if we remove them from the sample, we can see that the rest of the industry has considerably lower management fees than 2%.

Finally, the data we are looking at represents managers’ posted fees. Any institutional investor with an allocation over $50 million can in most instances easily negotiate a fee discounted from the posted rate.

Two and 20 is not the standard!

(Click on charts to enlarge):

I will let the readers familiarize themselves with the Report.  There has been sufficient press coverage of it that most readers should have a good idea of the CFTC/SEC’s interpretation of events. The report is long, detailed and supported by pages of colourful charts similar to a physicist’s analysis of the aftershock of a major earthquake (a not unreasonable analogy).

But, according to one prominent real time market data feed firm, Nanex, the report did not have enough detail and because of that shortfall, failed to discover the real reasons for the flash crash. Their analysis makes very interesting reading. It feeds into the major point of several of my previous blogs.

Early on Nanex contacted the investigating staff committee and offered its services and its software to help it understand events. The staffers took them up on this offer. Subsequently, the Nanex website logged more visits from the SEC than from any other source. However, in their ensuing analysis, the staffers elected to use one-minute data increments. The real action according to Nanex was occurring in millisecond increments!

This is a massive difference. Let’s rebase this difference to make the context apparent. Looking at trade data in minutes when the action is in milliseconds is like looking at two month intervals if the action is in minutes. We all know a lot of trees would be missed in the woods under that level of scrutiny!

Reading their analysis left me breathless. I come from the old school of trading that prevailed until about a decade ago (and yes, I do remember ticker tape). The world of high frequency trading (HFT) is somewhere out in the cosmos as far as I am concerned.

Important for this discussion is to understand two oft-used concepts in HFT–latency and co-location. Latency is the lag taken to transmit an order to the exchange’s computer and get a response. Latency is bad in this competitive world, so HFTs do anything possible to reduce it. Reductions are measured in 50 millisecond moments or less. One popular means of doing so is through co-location, which means that HFTs set up their computers as close to the exchange computer as possible. However, this presents one problem: there are nine exchanges on which these trades can occur and co-location can only occur in one place. So at which exchange would you co-locate your computer? Naturally the largest, the NYSE.

What did Nanex find when it reduced the time slices from minutes to milliseconds? A very curious phenomenon was occurring in the 50 millisecond interval. The NYSE trades were consistently occurring at slightly higher prices than other exchanges, which upon further analysis, was a result of its order time stamps being ever so slightly delayed.

The effect of this was to cause a rush of sell orders to flow towards the NYSE and buy orders to flow to all the other exchanges where prices were ever so slightly lower but correct in real time. This caused liquidity to flow away from all these exchanges towards the NYSE, quickly choking up the system.

What was causing this delay? Further analysis down at the millisecond level showed massive order bursts were hitting the NYSE at the bid (certain to be executed). These bursts were so large that they slowed down the exchange’s processing times. Several HFTs reported time delays causing them to cease trading which further drained liquidity.

Eric Hunsader, the founder of Nanex, has proposed a disturbing scenario. It is his view that certain HFTs are ‘order stuffing’ for the sole purpose of slowing the NYSE down thereby giving them the opportunity to do profitable arbitrages on the smaller exchanges. This is not simply a theory as he has the analytic evidence and data to back up his statements, all of which can be found on the aforementioned website. In fact, he outlines a number of toxic strategies that certain HFTs engage in to gain an advantage over their competitors. No doubt some of these algorithmic traders are pursuing these strategies to make up for their relatively high latency rates.

Hunsader points out there have been several instances of the effects of the flash crash occurring in the past. Luckily the environment they occurred in was not as volatile as the market was on May 6^th. That is not to say they won’t reoccur in the future.

It is necessary to understand that HFT is a product of the regulators. It is unlikely to have occurred without their apparently overzealous rush to reduce dark trading (see earlier blogs). Now a whole series of new problems have cropped up. And unfortunately it certainly reinforces the theme that Wunsch and Bookstaber speak to in my previous four blogs.

It’s no wonder that noble objective of “ethics on Wall Street” has become an oxymoron!

The final point Steven Wunsch makes in his submission to the SEC is a profound one. He asserts that blind regulation to promote transparency on the altar of market efficiency, price discovery and capital formation has destroyed the very institutional fabric that bound Wall Street and other similar dealer communities. This fabric was woven from the rubric of Dictum Meum Pactum (my word is my bond).

The process of atomizing competition through essentially demutualizating stock exchanges and any other forms of member organizations in favour of ECNs (Electronic Communication Networks) and ECN-like exchanges fighting over high frequency trading with ever faster order matching engines has made the trader’s world an anonymous void filled with distant winking lights. There is no human interaction upon which to build a culture of ethics.

Wunsch laments that this has created a different culture on Wall Street that is not client focused. Instead of a self-policing ethic whereby participants who practice front running, for example, are quickly shunned by their street colleagues and in turn by clients looking for and relying on high moral standards, the modern Wall Street world has degenerated into one of making profits no matter what to enhance bonuses and personal power. Bonuses have become based on speculative activities rather than sound service. The old question, “where are the customers’ yachts?” comes to mind.

Quoting Wunsch:

“…substituting NMS and regulatory police for Dictum Meum Pactum was a bad trade….It is also causing a weird indecipherable quantity-based approach to transparency to replace an understandable quality-based approach. It is causing investment banks to drop away from capital raising in order to focus on speculation, creating systemic risk and too-big-to-fail problems for the economy…A bad trade, indeed. Not only are markets far less safe now, but the most important functions that markets used to serve are being abandoned, as the temptation to speculate has been cut loose from the ethical prudence that heretofore restrained it.”

Isn’t there an echo here? Go back a few months and read my blog entitled “Bookstaber’s Law” published here on June 28. This was written without having any knowledge of the point Wunsch has made. Bookstaber’s Law, as I dubbed his aphorism was, “imprudence drives out prudence”. When I read the Wunsch quote above, I was hit right between the eyes again of the import of what both these gentlemen are saying. Wunsch has provided another very important linkage.

To be fair, no one can say the investor has not accreted some value from NMS’ activities. Certainly we have seen a substantial drop in transaction costs, whereby the dealers are the losers and investors are the winners. But one does have to question the value of the benefit in the collective sense rather than the individual one, if getting inside quarter, dime, nickel and penny spreads has aided and abetted the near total collapse of the modern financial system and with it, the global economy.

I hope my readers will take the time to read the full text of Wunsch’s submission to the SEC. I have only lifted a corner on the many fascinating and challenging points that he has made. It is definitely worth the time to read. And one cannot really deny his admonition to the SEC as restated by Alexander Pope: “A little learning is a dangerous thing; drink deep, or taste not the Pierian spring: there shallow draughts intoxicate the brain, and drinking largely sobers us again.”

Against this backdrop, if it has resonance with you, it is not difficult to see how the most recent events in the market like the flash crash could very well trace their origin to well intentioned though misguided policies.

Think about it–proponents would argue that in a fully transparent market, every trade ticket printed is at the correct price…  how could this be?  We all know that prices can be incorrect for extended periods of time. Is the SEC attempting to mandate through the NMS, the removal of alpha, because that is what precisely correct prices at every trade means. Further, it also removes arbitrage as a means of correcting prices because, theoretically, they will not need correction.

Frankly I think the price discovery argument is a bit bogus when applied to mandating transparency. As we have seen in Wunsch’s argument, today’s market is less transparent than ever. He further posits that other actions in the name of transparency may in fact have contributed to or even caused the market collapse.

For example, the removal of the uptick rule (cannot short on a downtick, only on an uptick), the marking to market of financial firms’ securities and derivatives positions and the switchover of the NYSE to full electronic trading were such profound and dramatic changes that they constituted what he calls a perfect storm, particularly to financial stocks. Their slide started in late 2007 and continued through to March 2009.

In his words:

“It just may be that the suddenly electronic NYSE, stripped of its uptick rule, faced more efficiency than it could handle. In this unfamiliar and volatile environment, what if you could artificially push a bank’s stock down to say half of what it was really worth, perhaps using aggressive short sales coupled with the steady purchase of CDS insurance against the bank’s bonds, the rising price of which would signal the bank was in trouble, and then deliver the knockout punch by floating rumors that the bank’s hedge fund clients were fleeing or that its counterparties were demanding more collateral? (This scenario closely parallels what the heads of the biggest investment banks reportedly alleged in emergency calls to the SEC in the fall of 2008 as they begged for short-selling bans, which were, in the end, granted.)”

Consider how flawed the whole concept of price discovery is. Are its proponents really suggesting that prices are correct in either of the extremes of bubbles or crashes? Yet they point at the printed price of the last trade as being correct. This is ludicrous.

It seems regulators are muddling up the notions of “correct” pricing and “market clearing” pricing. Transparency may help determine the price that will clear the market at any point in time, but it definitely does not have to be the correct price. Any experienced investor knows that when markets reach extremes, emotion, not logic runs the show.

Consequently, Wunsch’s arguments have some resonance in this quarter.  He would like to see the continuing evolution of regulations to promote transparency take a rest to reflect on whether they are effective in achieving their core objectives.

In my next installment I shall look at the most profound and, indeed alarming, assertion that he makes; namely, the overzealous promulgation of transparency regulation is killing Wall Street making it a dangerous place to do any sort of transactions.

]]> http://www.investmentreview.com/news/removal-of-uptick-rule-perfect-storm-4775/feed 0 http://www.investmentreview.com/expert-opinion/the-transparency-fallacy-4756 http://www.investmentreview.com/expert-opinion/the-transparency-fallacy-4756#comments Mon, 20 Sep 2010 13:06:41 +0000 caroline.cakebread@rogers.com http://www.investmentreview.com/?p=4756 Part two on how the SEC caused the flash crash….click here for Part one.

There is a lot of background to the storyline of this blog which I will attempt to fill in as best I can as I go along. The SEC lobbied Congress in 1975 to allow it to grant the National Market System (NMS) the authority to operate, which it did. Wunsch contends that its foundation was based on an inherent, but wholly untested theory by both academics and practitioners, that transparency is good. It was supported by the belief that increased transparency leads to better trading efficiency through lower trading costs, improved price discovery, more beneficial exchange organization and enhanced capital formation.

The first target of NMS was block trading because politicians thought it was a world reserved for the big guys and the little guys (retail) would always be the loser. Wunsch cogently contends that this is not the case and in fact the reverse is true. Block trading is not necessarily transparent and therefore it qualifies as a “dark pool”, at least in the minds of politicians. As such they feel it ran counter to the Exchange Act goals of “transparency, fairness and efficiency”.

The NMS is attempting, by curtailing block trading and upstairs trading through forcing all trades onto public screens showing all order flow, to create one gigantic “lit” market. I suppose this is a noble cause indeed, if the underlying assumptions are correct. Wunsch reasons they are not by pointing to the unintended consequences of the policies:

“By reining in dark pools, the proposed rules would hasten the ongoing transformation of the lit market into what is effectively becoming a giant, highly fragmented dark pool, characterized primarily by algorithmically shredded institutional blocks and high frequency market making.”

This is accomplished Wunsch contends by algorithmic order shredding, whereby an order is disassembled into hundreds, perhaps thousands of tiny orders executed in a multiplicity of dispersed venues. Their real purpose is to obfuscate not create transparency as none of the mini-trades mean anything individually and even less so in aggregate simply because of the volume and speed by which they are executed. If anyone thinks the public (read small investor) is any better informed under this regime, think again.

To me this is a hugely compelling point. I have always known that if you want to hide something, one can do so by providing too much information under the guise of being totally transparent.

But the meat of Wunsch’s assertion lies in the nature of the market structure itself.  He learned with his own the exchange, the AZX, that the only way to accommodate full transparency was through what is known as a “call market”. Defined, a call market or single price auction is one where buyers and sellers meet at discrete points in time and reveal their order book to one another and determine a clearing price through auction. Even then many conditions must be satisfied to make it work.

The market structure we have is known as a continuous market which means that order flow can arrive anytime. If buyers and sellers cannot be matched, specialists or market makers provide temporary liquidity to ensure an orderly market.

The problem is that transparency is a non-starter in a continuous market, either as a trading strategy or market structure. This is not hard to figure out. Being the first discloser, that is the transparent one, simply invites the competition to pick you off. You will always be at a disadvantage. Consequently larger traders will do what they have to obscure the size of their order. No matter what regulations are instituted to promote transparency in a continuous market environment, large traders will find a way to obscure their order flow. What is important are the unintended consequences of these regulations.

More on that in the next installment.

I have recently read two very, very profound pieces by an old acquaintance of mine, Steven Wunsch. He boldly asserts that the SEC is responsible for the flash crash of May 6^th, 2010 and furthermore, it has no interest in finding the real cause of the event, except to use it as a means to enhance its position to further regulate markets.

The article which caught my attention was published in the TabbFORUM entitled, “Be Afraid, Be Very Afraid: The SEC and the Flash Crash”. It was a short piece but it lead me to seek more. The most interesting read was Wunsch’s submission to the SEC written on January 14, 2010 entitled “Dark Pool Comment Letter”. This letter is a well articulated alternative view of the trading universe and I have to tell you, it is well worth the read-all 23 pages of it.

We should quickly review Wunsch’s credentials in order to establish his pedigree because, without knowing them, it would be far too easy to dismiss him as a crank.

When I first encountered him he had just left Kidder, Peabody and was in the process of establishing Wunsch Auction Systems, a call market system for trading stocks. Eventually, it became the Arizona Stock Exchange. It was a pioneering effort to allow natural buyers and sellers of equities to trade directly with one another without intermediation by a broker or dealer. The AZX sought to reduce transaction costs for its participants, remove volatility from the market and determine more robust and fair pricing for equities traded. It was the predecessor of Electronic Communication Networks (ECNs).

It was ultimately wound up for lack of volume and Wunsch is now working with the International Securities Exchange, a large global options exchange headquartered in New York. Suffice it to say, Wunsch has had enough experience with exchanges and their operation to make credible comments about the trading regulations promulgated by the SEC and its step child, the National Market System (NMS).

This blog will come in a number of installments and I guarantee they will be interesting! And by the way, how did the SEC create the flash crash?  In Wunsch’s succinct words, “it was a foreseeable concatenation of only a few elements: market orders triggered by stop loss orders hitting stub quotes after high frequency traders pulled out while  the NYSE was replenishing liquidity manually”.  I heard an advisor to the SEC basically say the same thing not too long ago.

Stay tuned for an explanation in the next installments.

Shadwick’s point is that mathematical finance has developed by trying to emulate the theoretical precision of the hard sciences although it is impossible to do so with events that capture the actions of humans. His view is that mathematical finance has gotten it horribly wrong by answering all the wrong questions. In a lovely quote from Keynes he makes his point:

“We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine the working of which we do not understand.”

He makes his point early. VaR (Value at Risk) at 99% answers the question “what is the worst loss we should expect in 99 days of 100?” — or, stated in reverse, “what is the least we should expect to lose one day in 100?” He contends this is the wrong question; rather we should ask, “what should we expect to lose in that one day in 100?”

He contends that statisticians know the answer. They call it Expected Shortfall (ES). Further, the calculation of VaR relies on the normal distribution, an assumption that is hopelessly out of sync with financial data. He cited the work of innumerable well-known mathematicians, which show that financial data is far too prone to fat tails to be normal.

ES would suffer from the same problem, except that the technological developments to make it robust occurred before the crash of 1929! It is called Extreme Value Theory (EVT) and -get this – it has been in widespread use in the insurance industry for decades. It has almost been totally ignored by finance.

Shadwick took us through a brief history of mathematics in finance briefly citing the contributions from Bachelier, Fisher and Tippett, Cowles and Gnedenko all prominent mathematicians. When he got to the founder of Modern Portfolio Theory, Harry Markowitz, he made an essential point: Markowitz explicitly brought risk, measured by standard deviation into the discussion for the first time, which inadvertently sent modern finance theory headlong into the two moment world of mean-variance – and it has been paying dearly ever since. Shadwick very appropriately noted that the normality assumption was not made by Markowitz, and indeed, I have heard Markowitz say this on two occasions.

It is this assumption that is the killer in finance theory and it is an underlying factor in VaR, which was globally promulgated by shortsighted regulators at the BIS in Basel I as the metric banks must use to calculate risk.  We now know what folly that was!

Now comes the part missing in Shadwick’s presentation. In his unseen tables (they are available) he shows by employing EVT, the coming collapse was clearly showing up well ahead of its occurrence. His first set of tables analyzes the Dow Jones Index in the months leading up to the 1929 crash. Relying on the probabilities derived from a normal distribution was hopelessly wrong, but EVT was giving the signals well before the main event.

He then shows the ES with Citigroup’s stock. As early as the 27 of February 2007 the first breach showed the ES increasing from 3.93% to 5.92% (daily) and then steadily increasing from then until it went over 60%. The first really big losses in Citigroup’s stock occurred over mid to late September 2008 (!) at over 10% each day, growing to 18%, 23%, 26% and ending with a 39% one day loss.

Shadwick laments’ “we have the technology, why aren’t we using it?”  Indeed.

The first was by a senior adviser to the SEC, Dr. Richard Bookstaber.  Some of you might know him as the author of the excellent, best selling book A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation. Rick comes with a wealth of experience (as did all the speakers). He has worked on both the sell- and buy- side of Wall Street.  He has been an academic, a head of risk management, a head of trading, run a hedge fund and been a quant manager at many of the most prestigious firms in the US. He has consulted to the CPPIB on its risk management culture. So when he speaks, I listen.

Rick made an unusual reference to Gresham’s Law and proposed a corollary.  Gresham’s Law (not really a law) suggests that good money is driven out by bad.  For example, when the Canadian Mint stopped minting silver Quarters because the silver ones had become worth more than 25 cents due to the escalating price of silver and started issuing nickel and copper ones instead, silver quarters quickly disappeared from Canadian change as people started hoarding them.

Rick restated Gresham’s Law to say imprudence drives out prudence. He was referring to the paradox that while everyone on Wall Street knew that synthetic CDOs for example, were destined to implode; no one could refuse to deal in them because there were always some investment banks that would. Therefore, not to deal meant passing up significant profits and thereby giving competitors an economic advantage.

Bookstaber’s Law as I shall name this insight, gives us a means to judge the new regulation that is being proposed in the US Congress. The Obama administration is crowing that this is the most significant overhaul of Wall Street since the 1930s. I am not so sure.

Take the Volker Rule which I wrote about in an earlier blog entitled “Hedge Fund Managers High Five Obama”. The rules proposed by Volker were emasculated by the Senate negotiators. As well, regulators have been effectively removed from writing the language of the Bill, thereby leaving it up to conflicted politicians.

Clearly the powerful investment banks have been spending huge lobbying dollars to kill any effective regulation. The same phenomenon is occurring in Europe. The banks are calling the tune.

Bookstaber’s Law is in effect.  Everyone knows it’s destined to fail, but no one is willing to potentially lose an advantage. Therefore they will continue to play the imprudent game.

As a sidebar, the one part of the reform package that does look meaningful is the establishment of the Financial Stability Oversight Council, a super-regulator that will monitor Wall Street’s largest firms and other market participants to spot and respond to emerging systemic risks. The Treasury Department will lead the panel, which includes regulators from other agencies. In his remarks at the Niagara Dialogue, Bookstaber seemed to favour this council perhaps because it gave the power to the Fed and other more independent agencies.

With a two-thirds vote, the council can impose higher capital requirements on lenders or place broker-dealers and hedge funds under the authority of the Fed. The council also will have authority to force companies to divest holdings if their structure poses a “grave threat” to U.S. financial stability.

It remains to be seen what actually becomes law with this Bill and how much meaningful reform is actually achieved. But I thought Bookstaber’s insight was a wonderful nugget to take away from this symposium.

More to come…

Last week I had the privilege of attending an excellent hedge fund breakfast discussion hosted by CIBC Mellon at the National Club. Moderated by none other than our highly literate editor, Dr. Caroline Cakebread, the exceptional panel spoke to a sellout house.  What made the panel and the session exceptional was the highly knowledgeable and experienced speaker roster, all of whom were refreshingly articulate. Gary Ostoich, Spartan Funds Managment; Chris Addy, Castle Hall Alternatives, and Peter Hayes, KPMG did a superb job.

Only one question, including those from the floor, did not get the treatment I expected: “Is there still such a thing as hedge fund alpha?” It is an interesting one indeed.

To be fair to the panelists, the question was not well defined so they had different directions they could go in. Focusing on the modifier “still”, one could interpret the question to mean that there have been a lot of hedge fund replicants appearing in the last few years who claim to be able to create the properties of hedge funds without actually owning one. They do this in one of three ways: 1) replication of the return distribution and its properties; 2) creating passive exposures with various statistical factors which capture hedge fund properties; or 3) passively mimicking hedge fund trading strategies.

What is appealing about these replicants is that they are cheaper, liquid, transparent, and mechanical — but are they alpha? Decidedly not! However, the point is that a lot of so-called hedge fund alpha is actually beta and exotic beta. So, of course this begs the essential question–what is alpha?

I like to think of alpha as the dark matter of investing. Physicists and astronomers who try to calculate the matter/energy inventory of the universe add up what they know and subtract that from the total and the residual which is very large, they call dark matter. Similarly, financial mathematicians add up what they know (return to betas), subtract it from the observed return and what is left over is called alpha.

Unfortunately, this is a haphazard process because not all the beta variables get included.  In fact, usually the S&P500 beta is the only one included. This artificially enlarges alpha. As implied earlier, the more betas that are included, the return assigned to alpha will decline. Hence the moderator’s question.

However, there is another interpretation of this question. With the turmoil in the markets of 2008 and 2009, hedge fund alpha either disappeared or became negative. So are we seeing the return of alpha?

Like all questions on this subject, there are many subtleties, so I ask forgiveness from my readers for not delving into them in this short blog post. My answer is, yes, absolutely, it is back and it will come back in spades. Volatility creates opportunity to earn alpha. The general removal of bans on short selling (except the Germans), reduced assets chasing the same trades allows a greater share of the alpha pie among those remaining and the Volker Rule, which looks like it may be implemented, will remove bank prop desks from the alpha hunt. All of these factors make me optimistic that we are in a sunny period for alpha generation among hedge funds.

We have known for some time that the ability to earn alpha ebbs and flows. This is evident in many of the studies that academics undertake. What we all must keep in mind however is the alpha distribution (before fees and transaction costs), which has a zero mean. Therefore for every alpha winner, there is a loser meaning that if hedge funds are going to be like the above-average denizens of Woebegone Lake, they must as a group be taking if from some other group. Who do you think that might be?

Subsequent to his remarks, I am sure that he was appalled at Germany’s irritating unilateral moves of banning short positions in financial stocks (naked or not) and naked positions in CDSs on sovereign bonds and large German banks.  The Germans just do not seem to get it.  Predictably rather than reducing volatility, the measure enhanced it just as their actions did in 2009. And it is these short-sighted and largely uninformed regulators who are leading the charge on taxing financial transactions rather than simply raising bank reserve requirements.

Richard Werner waded in with a controversial message.  He reminded us that it is not central banks that create capital but the banking system itself. As such, a very simple solution to the serial bank-created bubbles is to limit the means whereby commercial banks create capital. Rather than let banks lend however they wish, controls should be placed on the credit creation process with respect to financial transactions. In a way this is similar to Volker’s proposal of banning banks from engaging in proprietary trading and other risky activities, which are at the heart of what Werner is talking about.

It became controversial when Werner accused the ECB of not wanting to control bank capital because they indeed wished to precipitate crises to meet their longer term objective of a centralized fiscal agency. Further, it has purposefully created every crisis to date!  Its goal is to create the United States of Europe. Professor Wade, while supporting further integration of Europe economically, did not see events heretofore as the product of a conspiracy.

Professor Stiglitz was mindful of these themes and added further colour to them. But his view is that Europe will muddle through again and patch the system through compromise as it always has. He sees no hope for the southern European nations other than default, but they are a sidebar to the main action. In fact the UK, Japan and the US are in worse fiscal shape than any of these countries and this is the problem. Further, countries which create large trade surpluses without letting their currencies adjust are creating deadly imbalances in the global economic order.

Clearly all the speakers were very concerned about the events unfolding in Europe but none could clearly articulate a solution or even see a way out of it that was politically feasible.