Riffing off a post by John Kay, Felix Salmon points out that a big part of the problem with our financial system is the way that derivatives have corrupted aspects of banking that used to have an actual, concrete purpose:
Barclays’ Libor lies, for instance, started life as a way for its derivatives traders to make money: something which could never have happened when the banks reporting into the Libor system didn’t have derivatives desks.
A large part of the problem is the way in which financial tools which had a utilitarian purpose when initially designed have become primarily vehicles for financial speculation. Libor, for instance, was a way for banks to peg loan rates to their own funding costs, and thereby minimize their own risks while at the same time minimizing the amount that borrowers had to pay. Today, banks don’t fund on the interbank market any more, and Libor has become something else entirely: a number to be speculated on in the derivatives market, and, in times of crisis, an indication of how creditworthy banks are perceived to be.
Libor is no longer actually used to peg loan rates. Equity trading no longer bears much relationship to the actual value of companies. Asset-backed securities have little to do with making actual loans to actual people. As derviatives become more and more abstracted from their underlying instruments, they've morphed into independent entities to bet on, not ways to make the financial system run more smoothly:
Kay’s conclusion is sobering spot-on: the entire financial-services industry, he says, needs to be restructured so as to create the kind of institutions which thrive on increased trust, rather than on maximized arbitrage of anything from news to interest rates to regulations. In order for that to happen, we’re going to need to see today’s financial behemoths broken up into many small pieces — because at that point each small piece is going to have to earn the trust of the other small pieces which rely on it.
Felix is no more optimistic about that happening than I am. The financial crisis produced Dodd-Frank and Basel III, and that's pretty much it. Both are better than nothing, but neither comes close to addressing the fundamental problems with Finance 3.0. And I suppose we never will. The world had plenty of problems with a money economy, and plenty of problems with a credit economy, none of which were ever really fixed. So there's not much reason to think that we'll ever fix the problems with our shiny new derivatives economy either. I sort of wish we'd at least given it a serious try, though.