Michael Giberson
Thoughtful, useful, inadequate and wrong-headed. That’s my reaction upon completing Richard Bookstaber’s book, A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation.
As I mentioned last week (in The Perils of Financial Innovation, or Not), Bookstaber was among the MIT-trained economists lured from academia to Wall Street in the 1980s. In the book he gives an insider’s account of the development of financial innovations in the 80s and 90s, linking the innovations to the 1987 market crash, the failure of LTCM, and sundry less notable blow ups. For my taste, there was too much tracking of who did what where, and too little explanation of how various financial mechanisms were supposed to work, and why they sometimes went bad. About midway through the book, Bookstaber shifts emphasis from careers and organizations to his diagnosis of problems that underlie the system and a few ideas on how things could become better.
Overall, Bookstaber failed to convince me that “less complexity and looser coupling of markets” is a reform banner that I should be willing to march under. Bookstaber himself explains clearly the futility of hedge fund regulation, so it is less than clear what sort of public policy approach is warranted. (While last week I expressed concern that he might advocate reforms that simply shift risks back into the real economy, he avoids that temptation.) Individual investors, and particularly the firms that manage investments, may find some wisdom in Bookstaber’s hard won understanding of the limits of computational techniques – but this book is hardly the only place for finding these insights.
So the book is useful as a report on the financial innovations of the 80s and 90s, and inadequate and somewhat wrong-headed in his suggestions of a reform agenda. But my final reaction is in the word I led with: thoughtful. While I’m not convinced by Bookstaber’s talk of normal accidents and tight coupling, the book does offer a deeper understanding of working of financial markets and in particular of the contributions of hedge funds to “greasing the wheels of capital.” In a world where financial innovation continues to reshape markets and therefore the economy, deeper understanding of financial markets will prove invaluable to economists, business managers, and particularly policy makers.