Towards the end of last week, John pointed out the clueless sociopathy of Jay John Carney’s view of insider trading as a victimless crime. (Here, the string “Jay John Carney” should be read as “your liberal media at work”) [update: oops. Apologies to the distinguished White House press sect’y. And how do you spell “brain bubbles?”]
I just want to add that John’s reaction — that someone using private information to gain an advantage in a two-party trade has got a victim all lined up — is not merely obvious; it’s been studied.
That is: you can imagine a hand waving argument that because each party has their own reasons to enter a transaction, then even the “outsider” on an insider trade gains what he or she desires from the exchange, otherwise they wouldn’t make the deal. Since that motivation is untouched by the knowledge that the counterparty possesses and they do not, what’s the problem? That’s my rough approximation of the glibtard case, at least.*
The problems with this crayon-level argument are pretty plain, I’d say. The most glaring, to me, is that assumes that each choice exists only within the narrowest possible slice of time. Or, as an economist friend of mine put it in response to Carney’s “reasoning” (sic!):
The argument that trades are voluntary so everyone benefits is clearly only true ex ante – that is to say on the basis of the original biased information. The guy who gets stiffed clearly wouldn’t have made the trade if he’d had the same information as the insider. You might as well make this argument to justify dodgy second hand car sales or street trading swindles. The guy who buys a lemon from the dealer who has hidden its faults expected to make a gain but that doesn’t mean he actually does or that the dealer isn’t a crook.
Beyond any mere ridicule of the rich-people-can-do-no-wrong that defines the Village view, the point I think John was making is that insider trading has both individual victims — those who were cheated out of what they would have gained had there been full knowledge of what was going on for both parties to a trade — and systemic costs that we all bear.
Surprise! That turns out to be something people actually know something about
I’m not going to claim that the clutch of papers I turned up in a swift surf through the literature is anything remotely like an authoritative review of the current state of research on insider trading. But what struck me is how easy to come up with a bunch of different angles on the problems insider trading produces for markets as well as individual investors. Here’s an old analysis — it dates from 1991, which amounts to not much more than a mathematical formalization of a penetrating glimpse of the obvious:
In the absence of insider trading, and as long as managers’ salaries arepositively corelated with their firms results,managers will make such choices efficiently, and consequently such choices have previously received little attention, we show that, in the presence of insider trading, managers may make such choices inefficiently…More generally, the analysis of this paper suggests that the extent to which insiders may trade in their firm’s shares has considerable effects on the agency problem in corporations….
…ya think? Snark aside, the important point is that an insider’s actions don’t begin and end with the transaction. One set of victims in an insider trade are those who hold some share in whatever enterprise or instrument is being traded. It’s not just that insiders have more information than a counterparty, but that they have power to affect what their companies do — which means their incentives no longer align with everyone else connected to that enterprise. In other words: direct victims of insider trades include not just counterparties, but shareholders (or analogous parties-of-interest) in any given setting.
Then there’s this study from 2003. Here, Julan Du of the Chinese University of Hong Kong and Columbia’s Shang-Jin Wei report on the impact of insider trading on market volatility — basically how insider trades affect how fast (and how much) prices change on a market.
They conclude:
More insider trading is found to be associated a higher market volatility even after one controls for the volatility of the real output growth, volatility of monetary and fiscal policies, and maturity of the stock market. Moreover, the quantitative effect of insider trading on market volatility is also big when compared with the effect of the volatility of other fundamentals.
But who cares, or who should?
All of us. Wild changes in prices driven by insiders taking advantage of their privileged position undermine the entire purpose of capital markets. Du and Wei again:
Market volatility affects the incentive to save and to invest. In almost any model with a representative agent maximizing utility under uncertainty, the more volatile the asset market, holding the average return constant, the less the agent will save, and hence the less the investment will be. A certain degree of market volatility is unavoidable, even desirable, as one would like the stock price fluctuation to indicate changing values across economic activities so that resources can be better allocated. However, precisely because stock prices are supposed to serve as signals for resource allocation, excessive volatility that is not related to economic fundamentals would diminish the signaling function and impede resource allocation.
Or, to translate out of econ-geek speech: markets are supposed to allocate capital, sending investor cash to support productive investment. Mess with that, and the sorting function of the market, “the invisible hand,” to steal a phrase, starts to fail. Investment decisions are distorted and we end up with a less productive economy as a whole than we would have without the thumb on the scales applied by greedhead wealthy corporate insiders seeking yet more loot than they already possess.
__
All this is the long way ’round of saying that when our Galtian overlords f**k with market mechanisms in any of the splendid variety of ways they have schemed innovated, there are certainly individual losers involved. But the more consequential reality is that messing with the financial markets threatens the real economy — and that’s where all of us live. The foreclosure crisis begins as a financial disaster. It brings us to ruin because now 15 million actual homes are underwater in cities and towns across the United States…and that guts the whole damn country.
It’s not that eleven years in jail is too much for one misunderstood genius. Rather: just one financial felon behind bars is orders of magnitude too few.
*Here’s that case from the horse’s ass mouth — which would be Jay John Carney himself, from the piece to which John originally linked:
But are they [insider trader Raj Rajaratnam’s opposite numbers) really harmed? Of course not. No investor was ever induced by Rajaratnam to sell a stock. Stock market transactions take place impersonally, without regard to who is on the other side of a trade.
Saying that investors wouldn’t have sold if they had Rajaratnam’s information doesn’t make the sellers victims of Rajaratnam’s trading. Even if Rajaratnam hadn’t bought the stock, they still would have sold while being in a position of relative ignorance compared to him.
Oy.
Images: Francisco de Goya, Robbery, c. 1794
Jan Provoost, Death and the Miser, before 1529.
bourbaki
Uh John Carney, not Jay Carney.
I think you need to turn in your Obot card.
barath
John Carney, right? Not the WH press secretary…
cleek
glibertarian response: if you discover that someone has cheated you by using information you didn’t have access to, don’t trade with that person again.
i’ll bet 99.44% of all traders would laugh you out of the room for that. from the human view, markets are supposed to make money for the participants.
economics is not reality.
IMO, of course
Tom Oh Yeah I Remember Him Levenson
@bourbaki:
I’d say so. There goes my chances for a Politico slam, dammit.
Fixin as I type this.
ed drone
As through this world I’ve traveled,
I’ve seen lots of funny men.
Some will rob you with a six-gun,
And some with a fountain pen.
But as through this world you travel,
As through this world you roam,
You won’t ever see an outlaw
Drive a family from their home.
Woody said it best, sez I.
Ed
kindness
@cleek: Or you could hire someone to wack the guy.
Villago Delenda Est
Glibertarian faith in the market relies on something I like to call “perfect intelligence”, which is pretty much along the same lines as Smith’s “perfect liberty”: it’s a theoretical construct that is smashed to atoms in the real world, where efforts have to be made (as in, you know, REGULATIONS? LAWS? RULES?) to approach the “perfect” in which the system runs closest to it’s theoretical ideal.
Insider trading is inherently opposed to this; Smith points this out early, and often, in his book that fuckwits like Carney have never read, The Wealth of Nations, which is supposedly the bible of these people. Well, as with the Jeebusites, their holy book goes unread or is interpreted for them by parties with their own interests.
No wonder the Roman Catholic Church got really bent out of shape by the printing press…the damn masses MIGHT be able to read it themselves and discover they’ve been sold a bill of goods, or the holy book itself is rife with contradictions…although the Church did love the ease with which they could sell indulgences…their greed overtook them…
Chris T.
To put it even more simply (although to some extent this is “too simple” since it can no longer be quantified): abuse of trust leads to loss of trust.
The increased volatility of prices in various markets today is a direct result of the fact that nobody knows, any more, what things are worth, because now, none of the numbers used to compute relative valuations can be trusted.
Ochotona princeps
Great post.
Re Cleek: who cares what traders think? We support stock markets and banks because they (potentially) serve a useful role to society at large. The ideas and goals of individual players within the system aren’t particularly relevant to how we, collectively, should try to make the system work.
Straight vanilla loans and stock offerings are actually very useful to legitimate businesses; the problem is all the casino-flavored bullshit that was pushed on wall street in the past decade.
Tom Oh Yeah I Remember Him Levenson
@Chris T.: This is as clear as it gets. Thanks
Sentient Puddle
Y’know, I’m pretty sure that perfect information is one of the necessary conditions of this theoretical free market that libertarians claim to revere.
Chris T.
@Tom Oh Yeah I Remember Him Levenson: BTW, I meant to add that this also feeds into the famous IS-LM model that Krugman has to keep hammering into the thick skulls of everyone else out there. The preference for Liquidity-Money (versus Investment-Savings) rises when trust falls.
Davis X. Machina
A bad-information cascade is basically what destroyed the markets in 2007-8.
Bill Murray
That’s certainly what they tell the marks, rubes and other money sources. Econ-geeks have been given short shrift in the blame for the economic problems we face.
pete
The trouble with DFHs is that we were listening in civics class.
Another vote for Woody here, specifically:
Finally, have you heard Jackson Browne’s contribution to Note for Hope, the new album of old Woody lyrics?
BGinCHI
Tom, I hate to have to remind you that Marx was pretty clear in that fat book of his about how capitalism is organized theft while also being a productive system.
Or, shorter axiom: there is no such thing as a free market.
And one of the reasons there isn’t is that without regulation, human nature fucks things up. I mean, takes advantage to the detriment of the market.
Cap'n Magic
Of Course, the Koch Whores at CATO make the same case as Carney. To wit:
Roger Moore
Another way to think about this is in terms of fiduciary duty. If an employee of a company knows something important, he has a duty to let his boss know about it so the boss can take appropriate action. He isn’t supposed to run off and try to make money of that information personally at the expense of the company as a whole. That duty doesn’t stop when the employee is the CEO and the boss is the shareholders. Excusing insider trading is just another example of sucking up to the rich and powerful when they do the same things that would be rightly criticized if little people did them.
David Koch
I thought Art Carney was dead?
scav
@Chris T.: Well, to complicate things again, isn’t it also true that now there is at least a (increasingly significant?) part of the market that makes money off this short-term volatility and couldn’t be bothered to really care about the long-term trends or signal of value in the “traditional” market. So long as there are squiggly movements, they’re cool. They are, in fact, better off with the presence of that noise. It’s like the system has an auto-immune disease or something.
Culture of Truth
I just read the original Carney post.
Let me put respond this way:
Would bet on an NFL game with someone who knew both teams’ injuries and you didn’t?
Would you play poker with someone if they knew which cards were going to be dealt next?
Would play an Oscar pool with that accountant who stuffs the envelopes?
In short, would you gamble with someone who already knew the outcome in advance??
Anoniminous
@Cap’n Magic:
So CATO thinks Front Running:
is an acceptable business practice.
Personally, I can think of nothing that would drive stock trading out a stock exchange faster … but then I’m not a glibertarian.
Culture of Truth
What with FDIC insurance, bank robbery is really a victimless crime.
Culture of Truth
CBNC – the C is for “C No Evil”
kdaug
Dunno Doc, I think you’re over-thinking this.
If I go in and place a $1000 bet and lose, I’d expect to be out $1000.
If I place the bet and lose, and the security comes in and rustles everyone else in the house up to come up with $1000, and gives it to me so I can keep playing… this is a different ballgame.
maya
So a counterfeiter is just a party to a transaction who truly understands the principles of free market libertarianism.
Cap'n Magic
Anoniminous: As far as I’m concerned, the Gliberterians have the perfect place to put their beliefs into practice (Somaila), but refuse to do so on the grounds that their theories would be eviscerated in practice.
The Moar You Know
@maya: Truly. A counterfeiter is the ultimate expression of free-market libertarianism, one who literally earns every dollar he makes by the sweat of his brow.
Robert Waldmann
Excellent post. Thanks for translating from econgeek speak. The fact is that if it is good econ geekery it can be translated into English. I am paraphrasing Alfred Marshall who is the godfather of econgeeks.
I want to add two things (which I might have missed in your post).
First, I don’t see how anyone can claim that insider trading is victimless but embezzling isn’t. If shareholders hire a manager who takes money out of the corporations safe and puts it in his pocket, there is a voluntary exchange. The only problem is that someone is deceiving someone else about what is being exchanged just as in the case of insider trading. Rational people can avoid having their money embezzled by never hiring employees or buying shares of firms with employees. So they chose to put people in the position to pilfer their property. I know that hard line marxists want to eliminate the wage system, but I didn’t know that glibertarians were hard line Marxists (well actually I’ve noticed the similarities but I won’t bore people).
Second, the cost of crime is not all born by the victims.
Think of street crime. A very large part of the social cost is not born by the victims of armed robberies and muggings. The result of high street crime rates is that everyone who can afford to get out of the neighborhood does. The people who can’t afford to get out are isolated far from jobs and stores and everything and made much poorer. Also (this is sociological geek speak) it isn’t good for kids to grow up never seeing anyone with a decent job (as all such people escaped to lower crime areas).
The same is true of stealing from shareholders via insider trading or embezzlement (six of one half a dozen of the other). It may be true that rational people will not be victimized by insider trading, because they know it will happen. But that doesn’t mean it has no social costs. If shareholders are excessively screwed, no one will buy shares. the whole modern capitalist system is vulnerable to white collar crime. It is possible for large joint stock limited liability companies to fail to develop, because investors rationally avoid them.
I live in Italy. Most people here work for the public sector or for tiny firms (most people in the USA work for large firms). Large firms pay higher wages. Large firms sell goods for lower prices. They are often more efficient. But they can’t exist if managers are allowed to steal from shareholders. People can get away from the crime, but the social costs of flight from Wall Street are huge the same way that the social costs of flight from the South Bronx are huge.
Crime creates wasteland. In particular financial crime creates a financial wasteland.
eyelessgame
Why is it not just bloody obvious? Nothing new is produced by the insider trader – the insider making a trade does not increase efficiency of the market or add to GDP. As such, the insider ends up with more money. Someone else has to have less money.
It’s exactly the same as a bank teller getting access to the wrong password, and hacking into the bank’s account such that the bank suddenly has ten million dollars it didn’t have, and all of it is in the teller’s account. Who’s hurt by it? Same answer.
tkogrumpy
@Chris T.: This is gold.
Roger Moore
@maya:
Or, if you listen to the goldbugs, a counterfeiter is a freedom fighter showing the evil of fiat money.
Hoodie
Doesn’t this whole attitude have that “other people’s money” feel? This feels “victimless” to these sociopaths because they’re only thinking the victims are other traders like them, playing with other people’s cash. As others have pointed out, the real damage is the distortion of the economy caused by placing so much importance on the fate of financial and, particularly, equity markets that are rigged. But insider trading is just one more in a pantheon of other structural features that are causing this market distortion, or, in other words, there are a lot of other forms of “insider trading” than the blatant actions taken by Rajaratnam. Are we arguing about a marginal, angels-on-the-head-of-a-pin case, when the foundations underlying the idea of the market, i.e., the presence of a transparent and reliable pricing mechanism, have rotted away due to things like computerized micro-trading and barriers to access that effectively bar the vast majority from participating in the market in any fair way? It makes you wonder if you should say, “sure, go ahead and insider trade, that will finally convince enough people to relegate playing your fucking games to the equivalent of going to Vegas, and the economy can move on to doing something more productive.”
grumpy realist
You could also look at places that don’t have laws against insider trading and see how active their stock markets are…
If people have to allocate risk for some horrible putrid concealed info being the reason that the other side is trying to sell, they’re going to have a lower possible buying price. And not buy unless they actually have to. Result: less activity on stock market and lower prices for everything.
Is this really what the glibertarians really want?
Bill Arnold
@Roger Moore:
Whereas a counterfeiter who counterfeits gold coins, e.g. gold-plated Tungsten, is a criminal?
(Tungsten has the same density as gold to a few decimal places.)
Roger Moore
@eyelessgame:
The defenders of insider trading are trying to claim that it does increase market efficiency. There’s an interesting editorial in the LA Times where they talk about exactly this. Some idiots are claiming that insider trading makes the market more efficient by sending signals about the value of the stock. If they want that information to get out there, maybe it should be published explicitly.
Tom Return of the Pretentious Art Douche Levenson
@Anoniminous: Cato is impressive. Not good. But impressive.
@Robert Waldmann: Many thanks for this. I tried to shorthand the points you make: insider dealing screws those for whom insiders are fiduciaries; fuck with the market and you destroy a crucial social function, which makes us all suffer in exactly the way you describe in your excellent analogy.
genghisjon
I remember a time when”buyer beware”was the exception,not the rule.
r€nato
as usual, the libertarians are full of shit.
one of the reasons that the US stock market is a decent place for average citizens to invest their money, is due to government-enforced regulation of markets. The overall effect of the regulation is to *gasp* level the information playing field.
This is not so in other countries. Robert Waldmann mentions that he lives in Italy. I have some familiarity with Italy. The average Italian doesn’t bother with investing in stocks there; it’s a game for the elites who have inside information.
If libertarians want average Americans to enrich themselves by investing in securities, they have to also support an appropriate level of government regulation of those markets. But libertarianism is a lot closer to a religion than a political philosophy, and so you get absurdities like Cato claiming that insider training is a victimless crime.
Does anyone here want to have their Social Security funds privatized in a market that allows insider trading?
ThatLeftTurnInABQ
@Roger Moore:
Insider trading is a gateway drug for corporate looting, a practice which if tolerated on a small scale can be scaled up more or less indefinitely until it swallows our entire society. One of the commentors (sorry, I can remember who to hat-tip) a few days ago posted a link to an interesting academic study modeling deliberate looting via debt leverage and bankruptcy which seems apropos to this topic.
joes527
TRotPADL’s economist friend: Insider trading is like dodgy second hand car sales or street trading swindles.
Glibertarian: And that is bad how?
piratedan
OT: and my apologies for doing so….
I guess it really IS because we have a near in the WH, now the TeaParty is anti-Jobs:
http://www.teapartynation.com/profiles/blog/show?id=3355873%3ABlogPost%3A1566647&xgs=1&xg_source=msg_share_post
singfoom
@piratedan: Man, I wish I had the super secret progressive decoder ring, so I could join in on the Progressive Conspiracy those commenters on that link are talking about.
I love how calling out inequality in our country and how that messes up the proper function of our government by letting our politicians cater to the 1% is a Worldwide Socialist Conspiracy.
I mean, yes, there are socialists at the occupy movements, but it is not by any means a socialist movement.
Reregulating Wall Street and getting its tentacles out of our government != socialism.
Cheers!
khead
G-Fund.
I know the rest of y’all non-government folks can’t go there, but there’s a reason why I have allocated a decent chunk of $$$ there.
Mino
Just where do you think the market would be if 401Ks didn’t exist?
Ruckus
@scav:
They are, in fact, better off with the presence of that noise. It’s like the system has an auto-immune disease or something.
Xactly!
Unchecked growth is cancer, at some point it kills the host.
Auto-immune disease is just the host killing itself.
Ruckus
@Chris T.:
You must be a chief. You boiled this down to it’s essence, nothing extra, nothing missing.
Yutsano
@khead: There’s a reason why mine’s still parked there. And I’m relatively young.
goblue72
@Cap’n Magic: No surprise there – Prof. Manne was long one of those “Hayekian” libertarian true believers – who eventually wound up as Dean of the bought and paid for by the Koch family George Mason University Law School. Course, his argument was all conjecture with little empirical grounding(like everything else out of the Cato-style right wing think tank world). I think he’s currently hanging his shingle at the Dominoes Pizza School of Law.
Personally, I prefer my analysis of the efficacy of insider trading restrictions to have a bit more actual…data, as analyzed by a legal scholar with advanced training in economics:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=623481
(and in full disclosure, I’m a U. of Michigan Law School alum, so possibly a bit biased.)