Almost always it is possible to reduce an economic problem along with a solution down to one sentence. Most people sense that there are negative issues with Wall Street and the rest of the financial sector that are starting to emerge.
Is there anything wrong with the way things are done on Wall Street that might cause economic hardships to the rest of the country? The answer of course is a resounding yes.
In its current form, Wall Street has no utility to society. Derivatives trading produce negative externalities to society. How is that? Derivatives derive their value from the underlying security on which a derivative is based. The percentage change in the price of a derivative is always much greater than the percentage change in price the underlying security. Any problem here? As a matter of fact yes there is a huge problem but not one that is likely to be seen with a casual glance.
Derivatives trading creates an incentive to buy derivatives and then manipulate the price of the underlying security. Unless there is a counterforce to prevent it, people act on any incentive they have. Stop enforcing securities laws and all stock trading becomes focused on manipulating stock prices. This is the exact situation that exists on Wall Street today.
This activity actually is a huge problem for Main Street because it interferes with the necessary process of putting capital to its highest and best use. Any less than efficient allocation of resources over a long period of time will destroy an economy.
Lets define the problem in one sentence and then provide a one sentence solution .
Problem: Manipulating securities prices is causing an inefficient allocation of capital and is causing economic hardships. (Inefficient allocation of resources is actually a major cause of unemployment.)
Solution: Since the existence of derivatives creates an incentive to manipulate securities prices, ban derivatives trading.
Is that simple enough? No, even if banning derivatives is the only solution to saving the world, it won’t happen. The solution is not popular so it will get dismissed and called unrealistic or something.
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