Trading in house price futures would stabilize house prices and increase households' welfare, according to new Bank of England research. This poses the question: why isn't there an active market in such instruments?

It's certainly not because their virtues are not known. Robert Shiller pointed out over 20 years ago that macro markets - assets whose prices were linked to GDP, house prices or industry or occupational incomes - could spread risk. And yet these markets barely exist at all. Why not?

One reason is bad incentives. The financial "services" industry has more incentive to sell overpriced rubbish such as complex credit derivatives, structured products and actively managed funds rather than good assets. As Akerlof and Shiller say: "competitive markets by their very nature spawn deception and trickery (p165)."

Also, there is a collective action problem in establishing new markets. A good market needs liquidity. But if people fear that liquidity will be weak or absent, they'll not participate in the market, so it will indeed fail to develop.

In his excellent book, An Engine Not A Camera (pdf) Donald MacKenzie describes how Leo Melamed, boss of the CME, overcame this problem in the early days of index futures by cajoling traders into trading them, thus creating the necessary liquidity:

A market, says Melamed, "is more than a bright idea. It takes planning, calculation, arm-twisting, and tenacity to get a market up and going. Even when it's chugging along, it has to be cranked and pushed." (p173)

Sadly, though, we often lack Melameds. When we do, we might need state intervention to solve the collective action problem. For example, the Bank of England could encourage the development of house price futures by giving them to households as part of its next quantitative easing policy - or, at least, it could provide easy credit facilities with which to buy them*.

You might find it odd that state intervention is necessary for the development of free, well-functioning markets. You shouldn't. As Karl Polanyi pointed out (ch 5 of this pdf), it was state intervention which drove the development of markets in the 15th and 16th centuries. David Graeber writes:

Despite the dogged liberal assumption...that the existence of states and markets are somehow opposed, the historical record implies that the exact opposite is the case. Stateless societies tend also to be without markets (Debt: the first 5000 years, p50)

All this poses the question. Why, then, haven't we seen state help to create what Robert Shiller has called financial democracy?

It's certainly not because of a commitment to laissez-faire: the massive implicit subsidy to banks tells us that the state is very happy to intervene in the financial system.

Instead, the answer was pointed out by Marx: the state serves the interests of capitalists, not the people. And financial capital would rather financial markets consisted of rent-seeking than of enhancing aggregate welfare. Crony capitalism has encouraged financialization (pdf), not financial democracy.

In this sense, a well-functioning market economy requires that the state be freed from the grip of capitalists. In some respects it is capitalism that is the enemy of a market economy, and Marxism that is its friend.

* This is just a variant on Andrew McNally's proposal to extend equity ownership.