By : Satyajit Das
October 17, 2008
Related Categories: Book Reviews
SourceLawrence E. Mitchell “The Speculation Economy” (2007) Berret-Koehler Publishers, Inc, San Francisco
Johan Van Overtveldt “The Chicago School” (2007) Agate Publishing, ChicagoA former American President observed that: “The business of America is business”. In the 20th century, the business of business became money. Stocks and the stock market evolved from a mechanism to raise finance for business to the raison d’être of business. Industry’s focus shifted from providing goods and services to the stock price. Business leaders became obsessed with the price of their stock and pursued strategies that optimised the market value of the company sometimes to the detriment of the underlying business. Financial engineering replaced real engineering.
The Speculation Economy traces events between 1899 and 1919 outlining how the Modern Corporation and stock markets evolved. The thesis is developed through a detailed history of the legal, financial and economic events that allowed financiers such as J.P. Morgan, Rockefeller and other to collect companies and create large firms for the primary purpose of creating stock and selling it. The book explores how legal and financial manipulation lay at the heart of the process by which these businessmen and their acolytes made money. This was the road that ultimately led to the current financial crisis via the pit stops of junk bonds, Enron and Worldcom.
The Chicago School lies at the other end of the century and the speculation economy. The Graduate School of Business at the University of Chicago provided much of the financial economics that facilitated the triumph of finance. The work of pioneers – Harry Markowitz, William Sharpe, Merton Miller, Eugene Fama, Robert Merton, Myron Scholes and Fischer Black – helped separate the value of financial obligations (stocks) further from the real underlying businesses.
Markowitz’s work that underlies much of financial economics developed the proposition that the risks of specific corporations could be diversified away. Therefore, corporations should compensate their shareholders for the general market risk of stock or risky assets generally and the stock’s risk with respect to the broad market (the stocks ? – beta). The profound conclusion that underlies this logic is that the specifics of the business matter less and less and the overall stock market more and more. There are other ancillary effects such as changing the fundamental concept of risk. Derivatives, which are the logical extension of this line of reasoning, further extends the thesis allowing investors to trade in stock price movements without actually owning the stock.
While the financial economics portion of The Chicago School is perhaps the most interesting, the book also covers the other theoretical developments at the University including monetary analysis (Friedman), economics of industrial organisation and regulation (Coase, Stigler, Telser) and the economics of the law (Posner).
Both authors are academics with a deep and profound understanding of their subjects. The level of detail and analysis is consistently strong. The Speculation Economy and The Chicago School provide fascinating historical perspectives into the nature of finance and the evolution of financial markets in the 20th century.
The events unfolding today flow directly from the events and philosophies outlined in these two economic histories. As Mark Twain observed: “History does not repeat but it rhymes.”