Financialization and information technology

1. Financialization and informationtechnology Ing. Tomasz Zieliński, PhD Department of Banking and Financial Markets University of Economics in Katowice POLAND

2. Finances in the economic system • The financial system and its functions in the economy • Is the profit generated on financial transactions a source of wealth? Is it a zero-sum, negative-sum game or a real growth according to WIN WIN strategy) • GDP as a measure of economic growth - contribution of the financial system to GDP • The dilemma of economic growth as a measure of well-being (happiness, imperfections of GDP)

3. Growing importance of finances in the economy • Dematerialization of money • Globalization • Economic deregulation • IT revolution (networking of the economy, e-commerce, e-banking, electronic payments) (*) • Dominance of shareholder paradigm over stakeholder paradigm • Securitization • The development of pension funds as a result of the inefficiency of the social security systems • Liberal monetary policy (low interest rates)

4. Financialization - premises of the phenomenon • The nature of the phenomenon, definitional dilemmas • The increase in the size of the financial system - the measures of financialization • Market dominance over interpersonal contracts (market as a key economic arbitrator, financialization of commodity markets) • Managerial, short-term style of business management • Increase in financial activity of non-financial companies • Growing indebtedness – increased leverage • Financial repression • Reintegration of investment and deposit-credit banking, • Shadow banking

5. Economic and systemic results of financialization • Loss of control over financial risk • Market speculative bubbles, • Economic crises • Crowding out effect - drainage of human and financial capital • An ambiguous relationship between the expansion of finance and economic growth

6. Ethical and social dilemmas of financialization • Commercialization of tangible and intangible values • The collapse of the ethos of work in favour of rentier attitudes • State involvement, privatization of profits vs. socialization of losses • Privatizing profits and socializing losses refers to the practice of treating firms' earnings as the rightful property of their shareholders, while treating losses as a responsibility that society as a whole must shoulder, for example through taxpayer-funded subsidies or bailouts. • Is still a bank an institution of public trust? • Social stratification, social inequality - Piketty Capital of the 21st century

7. Ways to reduce financialization • Regulations of the financial sector • Integration and internationalization of financial supervision • Demonopolization of the financial system, separation of commercial and investment banking • Limiting the protection of investors and depositors • Tax on financial transactions, capital resources tax • Education and informational disclosure - financial literacy • Whataboutinformationsociety?

8. Ethical and social dilemmas of financialization

9. Ethical and social dilemmas of financialization

10. Third wave In order to understand the full impact of the information age on our future, we need to step back and examine the profound effects of earlier historical transformations. The futurist Alvin Toffler popularized the concept by referring to three "waves" of technological development.

11. Pillars of New Economy

12. Pillars of Network Economy

13. „New Economy” vs. „New Economics” • Are the "old" economic rules enough to recalibrate, or we must to writethemanew? • D’Andrea Tyson, 1999 • Doestraditional economics have the appropriate analytical tools allowing to describe and explain new phenomena and relationships, or it isnecessary to develop a new economics? • A.Wojtyna, Nowa ekonomia i nowe prawa, „Gazeta Bankowa”, 29 styczeń 2001

14. Financialization and informationtechnology • Since the mid-1980s, the growth of computerization in financial markets has been significant. Technological advances have changed the finance and banking. • The relationship between financialization and information technology is underplayed, yet recognized as a significant factor in the development of global financial markets and institutions • Financialization studies present IT commonly from the perspective of global outsourcing - a policy decision of firms limiting labour costs by relocating their IT assets in countries with cheap labour and less regulation • In many ways, financialization and technological changes represent two sides of the same coin. • Financialization, looking through the telescope, observes the big picture of how financialization has shifted industrial capitalism to financial capitalism, with technology playing a large part in this process. • Financialization, looking through the microscope observes the social and organizational landscape to examine the adoption and deployment of information technology.

15. Askingabout IT and financialization • What role did information technology play in the global financial crisis? • How is information technology used to develop new financial products and services? • Does information technology change the nature of financial markets/trading? • To what extent is financial trading being ‘taken over’ by robot technologies? • How can regulators keep pace with information technology? • How do countries differ in support and governance of financial markets?

16. Domination of services overmanufacturing • 1. land 2. labour 3. capital -> 4. informationNew, the most effectivefactor of production? • Network economypromotes the development of those industries which involve as much as possible of information • Information nature of services contributed to theirdominance over the production

17. Services contribution in GDP The World Bank

18. Financial sector – the unlimitedgrowth • For last 20 years financial services became the biggest beneficiary of the information area • The information nature of finance met especialyconvinientcircumstaces

19. Whois to blame for crisis ? • "The banks exposed themselves too much, they took on too much risk .... It's their fault. There's no need to blame anyone else" • Warren Buffett • Subprime Debt Crisis, Reuters, Sunday, 25 May 2008 • Is it really that simple? • Is the list of blamers really so short? • Are new technology and information society the actors of the drama?

20. Dotcom crisis – NASDAQ index The most spectacular overestimation of the New Economy’s capabilities

21. Separation of financial markets from real economy • Financial markets = electronic markets • Financial markets stopped to serve real economy • Everything becomes subordinated to markets • Even commodity markets operate as financial markets • Markets feed itself, burdening the real economy with increasing costs • The young people represent the attitude of depreciating the importance of work. In their view, human wealth comes mainly from stock market speculation and financial transactions, rather than hard work.

22. Complexity of networks • Invention of personal computer was a symbolic beginning for decentralization of data processing. • The most significant impact on new economic and social order has been done by network technology and in particular by inventing Internet. • For that reason, nowadays, society of global information is characterized by increasing interdependency, interconnectivity and complexity. • For one hand, globalization, leveraged by network technology, enables exchange of people, goods, money, information, and ideas, which has produced many new opportunities, services and benefits for humanity. • At the same time, however, the underlying networks have created pathways along which dangerous and damaging events can spread rapidly and globally. This has increased threats of systemic risks.

23. Missing geography in finance • Networking and globalization of markets limited the impact of geographic location and distance • Investor stopped to trade something that has a certain intrinsic value and practical utility • It is difficult to consider usability in isolation from the physical location. • Is it true that capital has no nationality?

24. Speculation over real economy • In 1975, about 80% of foreign exchange transactions (where one national currency is exchanged for another) were to do business in the real economy. For instance, currencies change hands to import oil, export cars, buy corporations, invest in portfolios, or build factories. Real transactions actually produce or trade goods and services. • The remaining 20% of transactions in 1975 were speculative, which means that the only purpose was an expected profit from buying and selling currencies themselves, based on their changing values. So, even in the days when the real economy was dominant, some currency speculation was going on. • Today, the real economy in foreign exchange transactions is down to 2.5% and 97.5% is now speculative. The real economy has become just a small percentage of total financial currency activity. • From the real economy to the speculative (excerpts), Remarks by Bernard Lietaer at International Forum on Globalization (IFG) seminar

25. Financial innovation vs IT innovation Financial innovation involves creating and disseminating new financial instruments, including financial technologies, institutions and markets, as well as institutional, product and process innovation Technological innovations comprise new products and processes and significant technological changes of products and processes. An innovation has been implemented if it has been introduced on the market (product innovation)

26. CashlessSociety (1) • Sweden is expected to become the world's first cashless society by March 2023. By then, cash will not be accepted any longer as a means of payment in Sweden. • In 1661, Sweden was the first country in Europe to introduce banknotes. In 2023, Sweden is becoming the first cashless nation in the world, with an economy that goes 100 percent digital. • Both banks and government encourage citizens to adopt the cashless economy. Swish is close to becoming the Swedish standard for mobile payments. The application is used by way over half of the population in Sweden. Only 13 percent of the total population in Sweden rely on cash.

27. CashlessSociety (2) • Benefits • Lower crimebecausethere's no tangiblemoney to steal • Less moneylaunderingbecausethere'salways a papertrail • Time saving and limitingcostsassociated with handlingpapermoney as well as storing and depositingit • Easiercurrency exchange whiletravelinginternationally • Disadvantages • Exposesyourpersonalinformationto a possible data breach • Ifhackersdrainyour bank account, you'llhave no alternativesource of money • Technology problemscanleaveyou with no access to yourmoney • The poor and thosewithout bank accountswillhavedifficultypaying and receivingpayments • Somemayfinditharder to controlspendingwhentheydon'tseephysicalcashleavingtheirhands • Banks maychargefees to compensate for possiblenegativeinterestrates

28. Bitcoin - cryptocurrency, electronic cash (1) • Decentralized digital currency without a central bank or single administrator that can be sent from user to user on the peer-to-peer bitcoin network without the need for intermediaries • Transactions are verified by network nodes through cryptography and recorded in a public distributed ledger called a blockchain. • Bitcoin was invented by an unknown person or group of people using the name, Satoshi Nakamoto and released as open-source software in 2009. • Bitcoins are created as a reward for a process known as mining. They can be exchanged for other currencies, products, and services. • Bitcoin has been criticized for its use in illegal transactions, its high electricity consumption, price volatility, thefts from exchanges, and the possibility that bitcoin is an economic bubble. • Bitcoin has also been used as an investment, although several regulatory agencies have issued investor alerts about bitcoin

29. Bitcoin - cryptocurrency, electronic cash (2)

30. Bitcoin - cryptocurrency, electronic cash (3)

31. Financial innovation: the collateralized debt obligation (CDO) • Financial innovations such as derivatives were described as ‘financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal’ (Buffet, 2002). • A CDO is a structured financial product that combines cash flow-generating assets that are repackaged into discrete tranches and sold to investors. • Prior to the crisis, a single bank could pool together 5000 different mortgages into a CDO. An investor who purchased the CDO was paid the interest owed by the 5000 borrowers whose mortgages made up the CDO, but faced the risk that some borrowers may default on their loans. • The pooled assets (i.e. mortgages, bonds and loans) become debt obligations that made up the collateral for the CDO. • The tranches in a CDO varied in their risk profile, with senior tranches having first priority on the collateral in the event of default. The senior tranches of a CDO generally have a higher credit rating with lower coupon rates compared with junior tranches that offer higher coupon rates to compensate for their higher default risk (Investopedia, 2017).

32. Financial innovation: the collateralized debt obligation (CDO) - technology • Technology has played an important part in the CDO market, not only by facilitating interconnectivity across banks, but also by hidingcomplexities and constituent risks from regulators and investors. • CDOs were created and sold by most major banks (e.g. Goldman Sachs, Bank of America) over the counter, i.e. they were not traded on an exchange but were bought directly from the bank. • Duringthe crisis, the financial industry faced meltdown as banks had acquired a trillion dollars in worthless assets with about half this figure (US$503 billion) in CDOs • Once many banks experienced huge losses, the interbank lending market stagnated, as no bank would lend to another bank holding CDOs. • The banking crisis witnessed CitiGroup losing $34 billion on mortgage CDOs and Merrill Lynch losing $26 billion. The insurer AIG was seriously damaged due to selling $500 billion worth of Credit Default Swaps to insure against defaults on CDOs, since it was unable to meet such payments.

33. Algorithmization of the markets • „Computers have taken over the majority of trading on Wall Street and are threatening the very nature of the trading profession. • Robot traders are used by over 80 percent of trade markets, including the majority of investment banks and other big institutions, with retail trading remaining one of the only sectors still reliant on human brains. • In short, the conventional trader has almost completely died out, and with it the elements of risk-taking and intuition that defined the industry for hundreds of years.” Robots are killing off Wall Street’s traders By Laura French, Wednesday, October 29th, 2014

34. High-frequency trading HFT (1) • A major technological innovation in financial services in recent years has been high-frequency trading (HFT). • HFT is a subset of algorithmic trading which uses computer algorithms. • Increasingspeed of transactions – whatdoes „long term” mean? • High-frequency trading or HFT is a form of trading that uses powerful computer systems and complicated algorithms to execute high volume trades based on market conditions in a matter of seconds or less. • High frequency trading accounts for a large percentage of the entire volume of trading on the US markets. This percentage has been estimated to be around 50% since 2012, and was even higher in the several years prior.

35. High-frequency trading HFT (2) • Two forms of HFT. • Trading involves a large order executed via a computerized algorithm using a program designed to secure the best price. • HFT algorithms search for small trading opportunities in the market. • HFT is a highlycontroversialtopic. • A growing body HFT literature considers the positiveimpact of ‘speed technology’ on financial trading and market liquidity. • The oponents of HFT presentitas an illustration of the pathologies of contemporary financial markets.

36. Flash Crash – painfulllesson The May 6, 2010, Flash Crash - a United States trillion-dollar stock market crash, which started at 2:32 p.m. and lasted for approximately 36 minutes. Stock indices, such as the S&P 500, Dow Jones Industrial Average and Nasdaq Composite, collapsed and rebounded very rapidly. The Dow Jones Industrial Average had its biggest intraday point drop (from the opening) up to 9%, most within minutes, only to recover a large part of the loss. "22 criminal counts, including fraud and market manipulation against Navinder Singh Sarao, a trader. Among the charges included was the use of spoofing algorithms;

37. Difficulties with investigation • Isolating the variables for financial market and flash crashes is challenging. • Obtaining commercially sensitive quantitative and qualitative data on financial market tradingis problematic, not only because of the high cost of obtaining large datasets and the reluctance of financial technology (FinTech) companies, such as HFTs to allow third party scrutiny of their data. • These challenges make it difficult for researchers to ‘dig deep’ into the strategies and practices of computerized high-frequency and algorithmic trading firms to determine how and why human and/or computer interventions are implicated in adverse market events.

38. Information gap – complexity …. • “Markets are frozen because investors have no real idea ofwhat they are buying/have bought. Huge amounts of aggregationand the absence of the low-level data make the truevalues of these assets and pending losses very difficult todetermine,” • “Collateralized DebtObligation contracts - often the size of telephone books - need to be more mechanistic than legalistic. An openmathematical algorithm, or even published software, wouldfar better describe the waterfalls, and associated paymentstructures. Unless something dramatic changes, investors willabandon this class of instrument for a long time.” Hull J.C: cytza: Tapscott R., Tapscott D.: Overcoming the Current Financial Crisis and Restoring Stability and Prosperity with a New Perspective on Risk, Risk Management 2.0 (2008): 1-18. Web. 22 Sep. 2009.

39. Unlimited faith into analytical risk models (Black – Scholes 1973) • „The essential problem is that our models - both risk models and econometric models - as complex as they have become, are still too simple to capture the full array of governing variables that drive global economic reality. • A model, of necessity, is an abstraction from the full detail of the real world. In line with the time-honoured observation that diversification lowers risk, computers crunched reams of historical data in quest of negative correlations between prices of tradeable assets; correlations that could help insulate investment portfolios from the broad swings in an economy. • When such asset prices, rather than offsetting each other’s movements, fell in unison on and following August 9 last year, huge losses across virtually all risk-asset classes ensued.” • Greenspan A.: We will never have a perfect model of risk, “Financial Times”, March 16 2008

40. Media model of financial markets • Financial markets work as show-business • Information gap on financial markets created newidols– media and financial analysts • Rating agencies – within a day, can decide about the fate of company and even country • What about responsibility?

41. Concluding questions in the field of financialization and IT. • How might we characterize the technological frame of financialization? • What goals, problems, theories and artefacts group peoplethinking about information technology in finance? • To what extent does technological development contribute of the rise of the finance-led accumulation regime? • Can we compare and contrast the current financialization era with previous historical periods where technology reinforced the power of financial institutions and served the interests of the upper capitalist class? • To what extent does the deployment of IT in financial markets transform individual money holders into passive capitalists? • Does the development of technology in the finances affect human autonomy and intentionality? • To what extent does the deployment of ITcanjustify for the domination of financial interests and contribute to the rise of the homo-debtor? • Could information technology be used in order to roll back financialization and make the financial system work for the benefit of society?

42. At the end ..... • New technology offers new and very powerful opportunities, but used improperly could become the „weapon of mass destruction” rather then „the Golden Graal”