Archive for October 2011

Pretty Boy Floyd Had Nothing On These Guys

October 18, 2011

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.  How do you spell brain bubbles, anyone?]

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.


Images:  Francisco de Goya, Robbery, c. 1794

Jan Provoost, Death and the Miser, before 1529.

“Precedent? Megan McArdle keeps using that word …”

October 15, 2011

Jim Bales here, and my thanks to Tom for the loan of the soap box!

Ms McArdle has a piece in which she claims that the Republican obstructionism in Congress to the Obama Administration has a precedent in Democratic obstructionism in Congress to the Hoover Administration.

Sadly, Ms McArdle presents no evidence to support her assertion.

The closest she comes to evidence is quoting Prof. David Kennedy, of Stanford’s History Department, as saying:

“Hoover also faced a very obstructionist Democratic Congress–they understood, as these guys do today, that if they just go in the middle of the road and refused to move, that would benefit them at the next election.  And it paid off.”

Unfortunately, Ms McArdle gives us no information as to how Prof. Kennedy knows that the motives of the Democrats in the 71st and 72nd Congresses (1929-1933) were the same as the motives set forth by Republican Mitch McConnell:

The single most important thing we want to achieve is for President Obama to be a one-term president”

Think about it. Retaking the White House is more important to the Senate’s most senior Republican than, say, reducing unemployment, feeding the hungry, healing the sick, clothing the in needy, etc. All pale in comparison to putting a Republican in the White House, and so Mr. McConnell has obstructed them all.

Now, is the good Senate Minority Leader true to his word? Well, since Ms McArdle couldn’t take the time to substantiate her assertions (or tell us how Prof. Kennedy substantiates of his assertions), we will have to do a bit of her homework for her.

A simple measure of obstructionism in the Senate is the number of cloture motions introduced over the two years of a particular Congress. (If one does not consider this a measure of obstructionism, then one needs to explain how filibustering is not obstruction.)

As the Republican leader in the Senate, McConnell’s obstructionism in the 111th Congress (2009-10) led to a mere 136 cloture motions. So far (as of Oct. 12) the 112th Congress has had 32 cloture motions.

This level of obstructionism is, according to Ms McArdle, “quite precedented“. In fact, she claims that the precedent can be found in the 71st and 72nd Congresses (1929-31 and 1931-33).

Just how obstructionist were those anti-Hoover Democrats? In the 71st Congress there was precisely one (1) motion for cloture. Such motions skyrocketed in the 72nd Congress, when those dastardly Democrats forced two (2) of them.

If precedent means what the rest of us think it means*, Ms McArdle is claiming that forcing a motion for cloture three times over four years is precedent for forcing 136 such motions over two years (and 168 such motions in less than three). On the other hand, maybe precedent actually means whatever it is she thinks it means.

Vizzini Lives!

[*] Precedent (n): ” An act in the past which may be used as an example to help decide the outcome of similar instances in the future.” Source: Wiktionary

Image:  Jane Sutherland, The Obstruction on Box Hill, 1883.

You Don’t Need A Weatherman…

October 13, 2011

…to tell which which way the wind blows.  Not when even Marty Feldstein marches in with a more aggressive mortgage forgiveness plan than we’ve seen out of either Congress or the administration.

I don’t love the plan as offered, to the extent that an 800 word op-ed. offers much in the way of a fine-grained proposal.  Feldstein, Ronald Reagan’s head of the Council of Economic Advisors, calls for forgiving out-of-the-money mortgages down to 110% of the homes’ value — a threshold that would touch 11 million out of the 15 million  homes in the United States.  Lenders would absorb half the loss and the government would cover the other half, at a cost Feldstein asserts would be less than $350 billion.

I don’t have much to say about that part of the plan.  Why 110%?  Is there any data that suggests that’s the number to encourage underwater mortgagees to stick with the loan?

Or…how much of the current foreclosure crisis is driven by unemployment, and hence at this moment is unlikely to be touched by a payment reduction that still leaves the house underwater?

No clue, here (and no expertise to justify a guess), but these are empirical questions that could be answered…and in any event Feldstein — now at Harvard — is at least trying to come to grips with that insane number of 15 million houses that embody enormous financial loss.

The part of the this proposal that I think is almost certainly a bad deal is the price homeowners would pay to get their mortgage reduction:  Feldstein would transform these loans from non-recourse status —  in which the lender can claim the collateral, the house, but no other assets if the borrower defaults — into an instrument that puts all the borrowers assets are at risk.  To me, taking financially vulnerable people in the midst of  a bad economy and placing them at still greater economic risk seems to me both cruel and stupid.

Much better, in my view, are the proposals that place the government — the taxpayer, you and me, baby — into financial partnership with both the borrower and lender.  In these approaches, the borrower who gets mortgage relief has to share with the lender (and/or the Feds) any gain made from an ultimate sale of the property.  Everybody’s incentives align, and the borrower is not one layoff away from utter ruin, as he or she would be in the Feldstein scheme.

But what really stood out for me is not that Feldstein has come up with the least middle-class-friendly version of mortgage relief out there — that’s how he rolls — but that even such an old Reagan hand has driven to the core of the matter:

…As costly as it will be to permanently write down mortgages, it will be even costlier to do nothing and run the risk of another recession.

Yup, Dorothy, we’re not in Kansas anymore — or perhaps, pace  Thomas Frank, even in Kansas they’ve starting to grasp the most brutish of brute fact.

Yes, it sucks that the taxpayer must bail out over-extended borrowers and the reckless (criminal) financial institutions that placed those loans.  But life does blow sometimes — as most actual grown-ups understand.  Increasingly, those able to recognize the difference between ought and is accept that it’s better to deal with that fact than to watch the entire fiscal structure of our economy swirl down the toilet of whinging infant Congressional Republican orthodoxy.

Feldstein concludes by restating that same message.  Better the nation take its medicine than seek to extract the pleasure of righteousness amidst the rubble:

I cannot agree with those who say we should just let house prices continue to fall until they stop by themselves. Although some forest fires are allowed to burn out naturally, no one lets those fires continue to burn when they threaten residential neighborhoods. The fall in house prices is not just a decline in wealth but a decline that depresses consumer spending, making the economy weaker and the loss of jobs much greater. We all have a stake in preventing that.

That’s DFH talk, of course.  Without quite saying it out loud Feldstein here offers the suggestion that society has both values and obligations that trump the every-man-a-wolf-to-his-fellow-man cult of the individual that passes for  contemporary GOP “thought” on the social compact.

When you’ve lost Marty…

Image:  John Constable, The Hay Wain, 1821