Wall Street trading titan Jane Street was last week banned from trading in India, having made a $5.2 billion profit from options trading apparently mostly at the expense of Indian retail investors, according to a Financial Times report. Jane Street, a trading house with $20.5 billion of net trading revenues in 2024, is an extreme example of the “financialization” that has overtaken the global economy since the 1980s. Just as globalization produced pathologies and is now being reversed, so too has financialization; it needs to be put back in its box.

The Indian market is just one where financialization has gone too far. That stock market is fairly illiquid, even in the larger names, but as in many markets, options trading volume in Indian stock indices is a vast multiple of trading volume in the underlying stocks. There is a large universe of Indian private investors who are eager to gamble on the movements in stock prices and there is not much sober domestic institutional money providing depth and countering the follies of retail investors, mostly very unsophisticated.

With the Indian stock market’s direction having been generally upwards, those private investors are as risk-seeking as the GameStop “bros” of 2021. Genuine growth prospects are not necessary; the GameStop crowd were irrationally exuberant when Joe Biden had just become President, so the outlook for the U.S. economy was an exceptionally gloomy mix of over-regulation and inflation. Their Indian cousins are thus an easy mark for the likes of Jane Street, providing excess exuberance in the options market against which Jane Street can successfully trade.

Jane Street’s normal trading strategy in India appears to have been an intra-day manipulative arbitrage between stock and futures markets. They would buy stocks early in the day, sending prices up, then sell a much larger volume of options (or buy put options) at the higher prices that ruled around midday. Then within the last half-hour of trading, they would sell the stocks they had previously bought, thus triggering a stock price decline and a much larger move in the options markets (because of their leverage) by which they would make more profit than they lost on the stocks. The strategy works because the stocks are thinly traded, producing a large price movement with sudden selling, whereas the options markets are much deeper, allowing a higher volume of trades to be carried out while moving the market less.

Jane Street’s strategy, if that was it, was manipulative only to the extent that local regulators could define it as such post facto. (By definition, regulators cannot define all manipulative strategies up front, because it is always possible to invent new ones). Jane Street itself is an inevitable outgrowth of a highly financialized world, although as Sam Bankman-Fried got his start there, the damage it has done has spread well beyond its own operations. The solution is to correct the markets so that options trading volumes do not vastly exceed the volumes in the underlying stocks. This can be done by draconian regulation, but it is better if possible to do it by economic means, for example by raising interest rates to lower asset prices and eliminate inflation, de-financializing the markets, so that options gambling by retail investors becomes unattractive.

In today’s world, the enthusiasm of Indian investors and the GameStop “bros” to gamble in the options market is merely an extension of the excessive risk appetite of the unsophisticated, one current manifestation of which is the fashion for Internet sports betting. Excessive risk appetite by the lower orders leads a high proportion of them to bankruptcy, financial misery and destroying themselves through Fentanyl or otherwise; it should thus be severely discouraged.

Lord Liverpool in 1824 addressed this problem when he abolished state lotteries and tontines. The loathsome Harold Macmillan and John Major, resurrecting them through Premium Bonds and the National Lottery, both deterrents to sound investment, have a great deal to answer for in terms of ruined lives. Internet sports betting is yet a further and more pernicious conduit for this tendency; if it cannot be banned altogether, it should at least be prevented from offering its revolting services at ballgames, either live or televised.

The first burst of financialization came in the 1710s, with the lead-up to the South Sea Bubble in Britain and the Mississippi Scheme in France. With the explosion of public debt and money supply creation by both sides in the War of the Spanish Succession, followed by a decline in interest rates that gave bondholders big capital gains, innumerable wholly unregulated banks and brokerages appeared, as did the beginnings of stock markets. Most of this activity ended in failure, but one financing should be highlighted, immensely important for the future Industrial Revolution: £20,000 raised by the Sword Blade “bank” in 1715 for the company owning the rights to Thomas Newcomen’s steam engine. Anyway, in 1720 it all went crash in both countries, with a partial bailout in Britain, after which there was no noticeable financialization in either country for over a century.

The next burst of financialization, much more gradual, came in Britain and France after 1870. By that date, both countries had well-established banking systems, which had been willing to finance industrialization, although railroad bonds were preferred. The Overend and Gurney crash of 1866 and the extraordinary decision by Disraeli in 1868 to nationalize the tech sector, in the form of the Electric and International Telegraph Company, of which I wrote previously, sent several British banks bust and changed others’ orientation (and that of the major French banks such as Credit Lyonnais, in 1900 the largest bank in the world) to financing foreign governments rather than domestic industry.

The result was a huge surge in British and French foreign investments and a sharp and prolonged decline in British economic growth, both of which lasted until 1914. One aspect of financialization was the mad bubbles in South African and Australian gold mining stocks, mostly sponsored by crooks such as Cecil Rhodes – since the world was on the gold standard, a gold mine was simply a license to print money, no more, no less.

Since the late 1980s, the financial sector has grown and stock prices have risen sharply and consistently, as a percentage of GDP. That is similar if not exactly analogous to the trend in Britain in 1870-1914; in both cases productivity growth and industrial innovation have declined. To reverse these unpleasant trends, several political and economic actions must be taken. One of these actions would be to reverse the pernicious trends towards globalization and government control, which have distorted capital markets and produced a tsunami of malinvestment in climate change remedies and other intellectually fashionable rubbish. However, further actions are needed.

First, asset prices must be returned to their 1980s levels, in terms of GDP and ordinary incomes. The rise in house prices since the 1980s has made owning a home impossible for most people before the age of around 40. This has hugely pernicious economic and social effects. It prevents family formation, meaning that only the underclass reproduces itself – with dysgenic effects brilliantly portrayed in Mike Judge’s 2006 movie “Idiocracy.” It discourages capitalism, because accumulating assets appears to have no useful effect. This encourages big city support for the idiotic Islamic socialism of candidates like Zohran Mamdani as well as leading to frivolous overspending on mindless international vacations that pollute beauty spots and lead to no lasting benefits for the vacationers. It encourages economically damaging gambling, in the hope of “striking it rich” through the lottery, through options and “meme” stock markets and through Internet sports betting as discussed above.

High interest rates and tight money, anathema to the casino developer Donald Trump, will be enormously beneficial in reducing asset prices. Another reform that will discourage exploitative short-term trading as undertaken by Jane Street is a Tobin tax, at a low level such as 0.01% of value traded. Such a tax will make it inordinately expensive to speculate on short-term gains, without significantly affecting ordinary market liquidity. Britain in my youth had a Stamp Duty, levied at a much higher rate of 0.5%, which was highly beneficial in keeping markets approximately honest and dominated by genuine investors. In an era of gigantic budget deficits, which will be worsened by higher interest rates, the Tobin Tax will also yield very useful state revenue, almost none of it from ordinary people.

Lower asset prices will naturally produce a shake-out among the current overstuffed and over-large financial sector, as in 2007-08. This time, there must be no bailouts. It would be highly beneficial if the great majority of hedge funds and many overleveraged private equity funds went bust, taking with them the behemoth Big Four banks and the big investment banks. That would leave a financial sector dominated by medium-sized regional banks, much more suited to finance local entrepreneurial businesses, while starving the overleveraged Big Business of capital. Preventing the Fed from paying interest on its $3.2 trillion of bank deposit “reserves” would also be helpful, forcing the banks owning those assets to run down those balances and do something useful with the money.

In an ideal world, the U.S. financial system would resemble that of Britain in 1820, dominated by local “country banks” with just a few modestly sized brokers in financial centers to take care of an equally modest volume of foreign or financially sophisticated business. In such an environment, true entrepreneurism would finally flourish, to the great benefit of productivity growth and everybody’s living standards.

-0-

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)