In his remarks he says "There are many confusions here, so it is tough to know where to start", "D'uh!", and "Unconvincing!"
David, I respect your opinions, and if you ever want to guest blog here, send me an email and I'll post it for my readers :-) Since I'm a truth-seeking idealist, I'm displaying your comments where they can be seen.
A couple of thoughts:
1) No disagreement that the market works through the self-interested actions of participants. But I don't see how this contradicts my original comment that "not all financial games that make money for a hedge fund necessarily lead to more efficient resource allocation in the overall economy." Although selfishness is crucial to the operation of markets, let us not mistake selfishness for altruism :-)
2) Of course it's based on an unscientific sample (i.e., people I know), but yes, I would say that people who join startups tend to be more idealistic than people who join hedge funds. Would anyone differ if I replaced the word "startups" with "the Peace Corps" or something similar (like "academic science" ;-)? There are generalizations about groups that are statistically true.
A lot of people are in startups as much for the chance to "do something cool" or improve the world, as for the stock option lottery ticket. I can't think of a single person I know who is in finance primarily because of the good it does in the world. Perhaps, as David mentions, they are looking ahead to their future days as a philanthropist, but I think that consideration is dominated by near term remuneration.
Comment 1: I was the original commentator but forgot to sign. There are many confusions here, so it is tough to know where to start.
1) You write:
"For example, many people in startups are idealistic, and part of the attraction of their work is that they are changing the world for the better. The same goes for academic scientists."
Do you have any, you know, evidence that the average person in a start-up is more idealistic than the average person in a hedge fund? (By the way, is it useful to compare hedge funds as a class, including big ones and small ones, against start-ups? You think everyone at Cisco and Microsoft is an idealist? A more fair comparison would be tech start ups (like the firm you started) with hedge fund start ups (like the firm that I started). What makes you think that you (and your buddies) are more idealistic than me and my buddy?
2) The purpose of a hedge fund is not to allocate capital more efficiently. D'uh. But that is the effect of a hedge fund's activities. We can go into specific examples, if you like, but every time I short a stock it is because I think it's price will go down. But, by shorting it, I drive the price down a bit and therefore bring closer the day when it is accurately valued.
3) "Although financial activities play an important role in the economy, as I have emphasized, I suspect the prime motivation for finance as a career choice is maximization of remuneration, not altruism :-)"
And you start a tech company because, what, you are an altruist? I assume that this is a joke. All of us make career decisions for a variety of reasons. Salary, security, people, intrinsic interest all play a part. How much time would you spend on your current start up if you were certain that the financial reward to you would be zero?
Comment 2: I asked you for a specific example and the best that you can do is some ramble about the tech bubble? Unimpressive!
1) What should a hedge fund have done in 1998 with Yahoo at $4 (split-adjusted)? Is this a "bubble," so you should short it? Or is it too low, so you should buy it?
That was a really hard question in 1998 and --- guess what? --- it is an equally hard question today with YHOO at $25. It is a fantasy to think that you (or anyone) knew in 1998 or 2006 or any other specific time what a fair price of YHOO should be, or what the price of YHOO will be in 6 months.
You mention some hedgies or traders who "knew" that it was a bubble (YHOO goes lower in 6 months) or "knew" that the bubble was going on (YHOO goes higher in 6 months) without any sense of how this identifies a class of strategies widely used by hedge funds that fails in increase economic efficiency.
The economy is more efficient of capital is better allocated, relative not to some utopian ideal of perfect allocation, but compared to some other plausible world. All the equity trading done by hedge funds as a class makes the price of YHOO go more quickly to its real stable value, relative to what the price would have done in the absence of that hedge fund activity.
Can you imagine what the bubble would have looked like were it not for the billions of dollars of shorts done by hedge funds?
Comment 3: You write:
"I know from personal contacts that hedge funds actually behaved this way, and it is supported by subsequent academic studies."
Baloney! If you can site these "studies" then please do so! The one you do (in the linked post) is not worth more than the 5 minutes I spent with it. The authors have no information on short positions, so how can they know what was going on?
Who do you think made all that money shorting stocks in 2000-2003? Some old lady in Des Moines?
There is no evidence that the bubble would have been less severe in the absence of hedge funds. Indeed, since the S&P is at about the same level that it was in 1999, just how much of a bubble was there?
