01 April 2012

(In)Efficiency of Financial Knowledge Market

Recently I was asked about what I consider as the biggest risk for our new venture FRXmarket.com.* (For those who haven’t heard about it: it’s going to be the P2P online market for finding, buying or selling independent professional financial and economic knowledge.) The short answer is: “The venture gets ruined by big money – literally.” The sorriest thing by that would be the continuing inefficiency of the financial knowledge market; indeed, far too many “little guys” would continue to get “ripped off” by the “market behemoths”.

I cannot otherwise than wonder how people (including myself when I’m not in the mood of asking questions) do not recognise the facts that are very obvious – perhaps because these facts are blindingly obvious. This is especially true when it comes to the money and finance. For example, everyone knows that Wall Street is corrupt, and has been since at least 1980s. There are enough reality stories available, read for example the recent article by Greg Smith in the New York Times entitled “Why I Am Leaving Goldman Sachs,” or some of the books by Michael Lewis such as “Liar's Poker” and “The Big Short: Inside the Doomsday Machine”. Yet most of the people are still relying to the “free” sell-side financial advice and analyses.

Testimonials like this (Source: “Why I Am Leaving Goldman Sachs” by Greg Smith in the New York Times, and the readers’ comments to this article.) haven’t changed much:
* “To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. [...] I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work. [...] It makes me ill how callously people talk about ripping their clients off."
* “I have been in the securities business for 30 years and Mr. Smith's comments unfortunately ring true, not only of Goldman Sachs, but of much of the rest of the brokerage/ "financial adviser" community. [...] More recently when I questioned the push to sell illiquid, ultra-high commission, non-transparent "alternative investments" I was told in no uncertain terms to stop questioning as these were "profit centres" and the key to retaining "high-producing" sales groups in the company.”
* “In 2008, I worked for JPMorgan Chase, albeit at a lower level than Mr. Smith. I spent a year trying to tell managers that there were all kinds of abuses going on with respect to disclosures about mortgages and home equity loans. All paid me nothing more than lip service. They couldn't have cared less about the client; it was all about their bottom line...”
While these may reflect somewhat biased personal viewpoints, there is no reason to think that they are lies.

As David Callaway puts it in his article (published on 22 March 2012 in MarketWatch) Ben and the Muppets’ European adventure Commentary: Few warnings get taken seriously in a bull market: Wall Street corruption is such an acceptable view that nobody wants to hear it anymore. In the very same article he continues with commenting the above referred Greg Smith’s article: “When will they listen? When a large Goldman client publicly bolts. Watch for it.” This however may not happen in the foreseeable future; ultimately “big money” is in the same boat, no matter if Wall Street or large corporations from the Main Street. So the “little guys” / “small players” have to take care by themselves.

What usually happens is that the voices of “little guys” (including the Occupy Wall Street movement as well as the few brave former Wall Street insiders) are being marginalized by the marketing machines of the “big guys” / “large players”. In other words, “large players” are able to produce this much noise that this noise becomes to the main stream knowledge, i.e. it sets the tone in financial media, guides what one needs to know to receive a professional qualification in finance etc. The trick is that the “big guys” are not lying – they are simply presenting things in the light suitable for a specific situation. This is something that “little guys” most often cannot afford – they simply run out of money before. Professional services such as communication specialists, legal advisors and others are generally way too expensive.

Who are not happy with the prevailing situation, are being suggested to get “a high enough job in bank,” or something along these lines – in other words become corrupted by themselves. This may solve one’s financial problems (and that’s why well-paid jobs are still being sought even though they may have very little if anything to do with creating real value for the society), but bankrupt him/her morally. That’s why there are those who knowledgeably say “no” to this kind of suggestions.

Is this a hopeless situation? I don’t think so. What we need, are viable alternative solutions. Technically these are not that difficult to implement or understand. Apparently, clients can be “ripped off” only if they have too little information and/or their knowledge is insufficient. Multiple layers of middlemen, “censoring” layers and conflicting interests are obvious reasons for the asymmetric information in the financial knowledge market. These can be solved with a transparent person-to-person approach. The key challenge is to get around all the “noise” generated by the marketing machines of the “big money” which is becoming easier thanks to the growing social networks. In the end, also large corporations consist of people many of which most probably are questioning dubious practices such as those cited above. So let’s be positive about the future :)

* The link starts working in a few days after publishing the post.

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