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Guest Post: A Case For Legalized Insider Trading
Submitted by Martin Sibileau of A View From The Trenches,
Public securities, ceteris paribus, should trade at a discount to private securities, to compensate for the risk of lack of control and transparency.
In the past weeks, there has been a “revival” of news related to high-profile inside trading cases. And in an informal conversation at the Ludwig v. Mises Institute of Canada, one of our readers, coincidentally asked our view on insider trading. This left us feeling that it would perhaps be a good time to offer an “Austrian” (Hayekian) perspective on the subject in today’s letter. The topic, no doubt, could be included in the next edition of Walter Block’s must-read book “Defending the undefendable” (In this spirit, Mr. Block, please, accept our contribution to your list of undefendables!).
Insider trading is accurately pictured in that great movie called “Wall Street”, by a famous line of Gordon Gekko to Bud Fox. Gordon said: “If you’re not inside, you are outside”. Gordon was right. If only people understood that this is just a natural thing… It has nothing to do with ethics. It is neither good nor bad. It is only natural that those who are involved in the daily operations of a company will necessarily count with more information than those who are not. The reverse would be the odd thing. On the same basis, we must acknowledge that ambition is also a natural characteristic of human beings. It is only natural to expect that those with more information than the rest will use it to their own benefit.
Yes, we know that there is something in our argument that may not make sense to you…and we dare to guess that it is because you expect fairness when you invest your savings in a public security (i.e. a stock or a bond). But in all honesty…have you ever asked yourself why you expect fairness? You give your capital to a firm whose management you don’t know, where you don’t have voting rights unless your participation is significant, with the hope that someone else may later buy it from you at a higher price and that in the meantime, you cash a nice dividend… and you expect fairness? Really? Why would you do that to yourself?
We are not implying people should not trust those who issue or market these securities. But if they do, they should recognize that there is the risk that they may suffer a loss due to insider trading. It is a risk like any other one. How do you value it? The price of this risk would be measured in relative terms and, in this case, it would be measured versus private securities.
Public securities, ceteris paribus, should trade at a discount to private securities, to compensate for the risk of lack of control and transparency. Yet, today, the opposite applies: Private trades at a discount to public. And this, we think, is the crux of the matter, because it is certainly not fair to risk one’s capital to insiders, when one doesn’t receive a discount.
But…how did this distortion in the relative price of public vs. private debt or equity come about?
First, investors have a false sense of confidence and believe that insider trading is a “tail risk”, because governments make it illegal. Rather than allowing the price differential between public and private securities to signal investors the risk at stake, governments simply establish a cost to breaking the law. Of course, every time that the benefits of breaking the law surpass the associated costs (adjusted for the probability of getting caught), an insider will take a chance. Clearly, the likelihood of this happening increases considerably when the value of the capital of a company is subject to high volatility, because the benefits of inside trading increase while the associated costs (fines, penalties) remain unchanged.
It is this analysis of the suppression of an important signal, that led us to suggest at the start of the article, that this perspective is “Hayekian”. In Von Hayek’s view, Economics is the study of social cooperation, where prices signal important information. When governments ban insider trading, an important risk signal for the market is suppressed. If the spread (reflecting this risk) between public and private securities was not suppressed those issuing securities publicly would have a self interest in narrowing such spread. And we are sure they would act to reduce reputational risk to reasonable levels.
Having said this, we have to next ask ourselves why that spread between public and private securities is not allowed to exist. Why is insider trading suppressed? And its answer brings us to the second point…
Private securities today trade at a discount to public securities, ceteris paribus, mainly because public securities are more “liquid”. But as we wrote before in an unrelated letter, liquidity is not a characteristic intrinsic to a particular asset. Therefore, what makes these public securities more liquid than the private ones? It would seem that by definition, the fact that they are public should be enough to prove that they are more liquid. But we all count with an asset called “money” to have liquidity (i.e. a medium of indirect exchange) and nobody in his/her right mind would consider holding a public stock or a bond for liquidity purposes. What is meant by liquidity in public securities is the relative ease with which one can sell them either because an investment target has been met or because one wants to get out of them sooner rather than later. Volatility therefore plays a role in the appraisal of that liquidity, which also comes at a cost, in terms of a bid/ask spread.
Under these terms, that relative ease to get in or out of a public security is clearly facilitated by the fact that we have two additional government-induced distortions.
One distortion, present in most developed nations, is the existence of coerced collective savings, also known as pension plans. These are managed by people who naturally seek to gain economies of scale and demand large pools of assets to dump what they have forcefully taken from the contributors. To make their lives easier and under the flawed belief that in fiat currency systems sovereign debt is risk-free and one can effectively diversify across levered asset classes, they simply allocate funds based on defined mandates and portfolio allocation “theorems”. Public securities, packed with obsequent ratings, come in handy.
Another distortion is the existence of banking institutions that benefit from the leverage provided by reserve requirements below 100% and the backstop of lenders of last resorts (i.e. central banks), to make markets for the public securities. They do this in exchange of ancillary businesses: M&A, advisory, underwriting mandates, etc. These institutions, most often, first provide the future issuers of public securities with liquidity lines to gain their business and later to take them public. But think about this for a moment…have you ever seen a carpenter tell you that if you hire him to do your new kitchen cabinets, he will give you, as a perk, a $10,000 line of credit at Libor+100 bps? What would you think if he did? Then, why is nobody surprised when, on a daily basis, we see bankers approach a company to tell them that if their banks are hired to provide cash management or underwriting services, they will receive a 5-yr revolving line at L+100 bps. Evidently, liquidity is simply treated as a perk and this only happens because someone is supplying it at the expense of others (i.e. those holding the fiat currency as a store of value).
If insider trading was allowed and public securities traded at a premium vs. private ones, no company would see the benefit of paying underwriting or advisory fees to these banks, to access a more expensive market. Instead, banks would have to compete with private equity/debt funds to win the business of the issuers.
If coerced savings were forbidden and each one of us had to manage his/her own savings, we would demand more rigorous conditions and would do a better job diversifying them (caveat: at a macro level).
If banks did not count with leverage on a lender of last resort, they would not be out in the market giving away cheap revolving lines to private companies, with the intention of taking them public later.
And finally, we must never forget that even if insider trading was not illegal, we would still not be forced to buy public securities, while instead, we must always remember that we are indeed forced to use fiat currency and that its price is completely determined by insiders who meet every two months to decide its value. Yet only a few seem to note this.
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Grateful Dead "Passenger"
Firefly, can you see me?
Shine on, glowing, brief and brightly
Could you imagine? one summer day,
That same night be on your way
Do you remember? hearts were too cold
Seasons have frozen us into our souls
People were sayin the whole world is burning
Ashes have scattered too hard to turn
Upside out or inside down
False alarm, the only game in town
No mans land, the only game in town
Terrible, the only game in town
Passenger, dont you hear me?
Destination seen unclearly.
What is a man deep down inside,
What a raging beast with nothing to hide.
Upside out or inside down
False alarm, the only game in town
No mans land, the only game in town
Terrible, the only game in town
With all due respect.... Grateful They're Dead.
Since no gov't entity has displayed the least inclination or ability to actually pursue "insider" trading except in the most desultory manner, this article may be moot.
In fact, it's clear, to quote from some other film I can't remember: "Rules are for the little people." Legalizing insider trading wouldn't help anything, except maybe cutting off the tax-subsidized porn for some SEC and CFTC employees.
this article is totally retarded. Wall Street will never reveal "sources and methods" related to creating their trading strategies "on the inside" (of what exactly?) and therefore Washington DC will make it illegal to find out "what's really going on" with neither you nor me the wiser for it--nor with having even the notion of privacy protected by either side. it's as good as we can get...live with it Wall Street. Washington DC is NOT going away. "You (Wall Street) pry us, they (the Government) pry you (Wall Street)." Simple as that...
"Rarer still is your interest in Anacott Steel."
Funny thing is, printed money is more of a threat to free markets than insider info, at least nowadays. Why set up a system for insider info, that has very slight risk, when you can bludgeon and manipulate the market in any way you want, LEGALLY?
Rules, Rules, Rules. With out rules there would be no game/ players. All games need enforcement of the rules or the players vote with their feet.
State sponsored insider trading. Round up the usual suspects
Casablanca
The purpose of the SEC is to eliminate competition from the little and mid-level (hedge fund) inside traders so Goldman et al. get an easier playing field. They do it fairly well. My son proposed the idea of legalizing insider trading just yesterday and I found myself using shaky arguements trying to counter the idea. It is after all a very high form of what the market is about, information arbitrage. It will never happen because Goldman and JPM don't want more kids to play in their sandbox.
The "insiders" already get away with insider trading. In other words, the rats surrounding the biggest banks, SEC, Treasury, NY Fed, White House, Congress, etc.
Legalizing insider trading would prevent the law from being used as a hammer against political enemies and other scapegoats so that the SEC can parade them in front of us and tell us how darn well they are preventing insider trading.
And finally, we must never forget that even if insider trading was not illegal, we would still not be forced to buy public securities, while instead, we must always remember that we are indeed forced to use fiat currency and that its price is completely determined by insiders who meet every two months to decide its value. Yet only a few seem to note this.
It's sort of like sausage. Few want to see how it's made, but most everyone wants to eat it. Ignorance is bliss.
I am nearly convinced that most people expect and thus tolerate corruption and insider theft. It's the cost of doing business in America....even if that business is simply being a passive citizen. Most will tolerate it as long as it doesn't get too out of control. The problem is that once it does......there is no stopping it.
<I pledge allegiance to the banana republic of the Unites States of America....>
pink slime
... get too out of control.
The problem is that once it does
... there is no stopping it.
My opinion is that it is already too out of control, and so, there is no stopping it. However, most people do not know that, yet!
Bismark. Great quote.
Expecting Fairness? If the goods exchanged are actually as represented by the seller and the buyer pays the seller with sound money, that is fair. If the seller is deceitful, that is not fair but may be "legal". If the buyer pays with bogus money or bogus corresponding goods, that is not fair but he may be able to get away with it.
"LET THE BUYER BEWARE" AND OPERATE WITH AN ENFORCABLE CONTRACT. Then you have fairness.
Make it illegal for government regulators and legislators to go to work for ANY financial institution or lobby group for ten years after they leave their post.
Ummm...where have you been Mr. Sibileau? Who was the gangster who was given a tour of the exchange floor and after it was explained to him what the specialist did looked up and said "I'm workin for the wrong Mob"?
Sorry, this article lost me when it referred to Wall Street as a "great film". Anybody that can arrive at that conclusion does not deserve any serious attention on any matter whatsoever...Especially not film.
ahhh, yes...right-right. martin, you've reminded me that i have to finish reading the chicago plan...i'm about 37 pages in.
that's been the most frustrating thing about living here -- no office. i cannot devote my mind to things that require sustained and intense focus. it's enough to drive me mad. once upon a time, i could brew some coffee, roll some cigarettes, open a tome and spend anywhere from 8 to 12 hours 'in the zone'...lost, totally lost to the outside world. now i've got the wife poppin in every 13 seconds to update me on a bunch of meaningless bullshit; concerning withall, i couldn't give a squirt of piss. my kids causin one rukus after another right outside my door. and a cajun mother-in-law stompin about as she recovers from surgery. i won't go into it right now, but, suffice it to say, cajuns go out of their way to make sure you're aware that they're always there. loud and rambunctious people, the cajuns. i blame catholicism.
i have alot of brillant observations about that thing (the chicago plan) so far; and an hilarious few to braid in alongside the brillant stuff.
P.S. tell your colleagues in alabama that they should, in protest of alabama's rigid insistance to not only lay off the alabama stuff a little, but to aggrevate the condition by pressing forward with their plans to be even more 'alabama', yes, they should quit the state post-haste. short of that, they should even post-hastier go about severing ties with aurburn 'university'...seein how they're sort of a big-ole bull's eye for janus. i will have no mercy on all-barn.
and that's all i've got to say about that...
http://www.youtube.com/watch?v=WJ_yQ02xwsM
for now,
janus
No need to make a case .... it's called freedom ! I would rather have investors services keep us informed of insider trading than have the fucking corrupt government "protect us" and keep it all to themselves ? No patents .... no restrictions on trading .... all government < 10% of GNP ! NOW ! My Bitchez !
In a true free market there would be no rent-seeking licensure/SEC/FINRA requirements that are barrers to entry to what would otherwise be competing bourses. Reputation and integrity would be critical to trust from customers as far as their willingness to enter any given exchange. That includes whether one would be notorious for say insider trading. People would boycott it and the 'Tampa Bay Exchange' or what have you that does this would go out of business.
Insider trading itself would therefore be discounted as people wouldn't put up with it, and there would be ALTERNATIVE markets to enter, instead of the one size fits all 'market' that is the NYSE.
Isn't one of the tenants of a free market "the honest and fair exchange of goods"
Sorry,...where are these free markets you speak of?? Have I missed anything?
That was a delightful article, which tickled by macabre sense of humour!
... why ... expect fairness? ... Public securities ... should trade at a discount to private securities ... Yet, today, the opposite applies ...
My answer is that we have not gotten used to the runaway triumph of fraud taking over our society so completely, without any recourse. We were used to living in a society where there was the appearance of the rule of law. Events like the Savings and Loan, and Enron episodes still saw some people going to jail for their crimes.
We have not yet gotten used to the new social facts, (which really are only the exponentially fast development of what were always there, but which were not so painfully obvious before.)
TODAY, there are groups which have a plainly obvious impunity to commit murder, and to have there never be any proper investigations of those murders, and therefore, never any proper prosecutions.
TODAY, there are groups that have a plainly obvious impunity to commit frauds, and to probably not be prosecuted, or to only face token fines, which are a tiny fraction of the profits from their frauds.
The events of 9/11/2001 are examples of those events where some groups of people are effectively above the law, and have impunity to commit mass murders, because they dominate the government, and the mass media, and therefore, they can get away with blaming their mass murders upon other people, and are able to prevent any proper criminal investigation procedures from happening.
Both these kinds of events are flowing into each other faster, and faster, with an unbroken continuation, but with an obvious exponential growth, so that we suddenly notice, TODAY more than ever before, that they are runaways, and so, suddenly, we start asking questions that we never thought that we had to ask before. Thus, the events on 9/11/2001 became the pretext to allow the financial crises of 2008 to develop, as one crisis piles on top of another one! Although the same factors were always at work, behind the scenes, at least from 1913, in the USA, (if not always, throughout all human history) they were never so blatantly obvious as they are NOW.
Like I said, people finally went to jail for the Saving and Loan or Enron kinds of frauds. However, hardly anybody has been found responsible for the vastly greater frauds that made the 2008 crises happen, while, by and large, the only things that happen NOW are that large corporations pay token damages, as a kind of trivial license fee to continue to break the law. The fundamental principles of exemplary damages, or deterrence by the threat of imprisonment, are GONE.
Of course, I believe that those events are interconnected, especially at the top of the social pyramid system. Those pyramidion people, who can get away with mass murders, and use those false flag attacks to make more money, and engage in more mass murders, appear to be related to those who can engage in runaway financial frauds, with a similar kind of impunity.
That entire system is now so extremely bad, and mad, that it looks like it is heading towards severe psychotic social breakdowns. Some now refer to those pyramidion people as a "breakaway civilization!" That breakaway civilization appears to have an agenda which plans to start genocidal world wars, and impose democidal martial law. Therefore, it does NOT look like we are returning to the old-fashioned ideals about the rule of law, but rather are headed into mass murders beyond imagination, since the runaway financial frauds are now measured in insane notional units of quadrillions, which have no feasible ways to ever be resolved and brought back into any sane balance. The runaway Ponzi Scheme, pryamid system, of making money out of nothing, as debts, while having governments force everyone to accept that, was building at an exponential rate for decades, and yet, relatively suddenly, has reached a doubling rate where more and more people cannot fail to notice that, and begin to talk about it.
Those social facts were always there, and a handful of intellectuals were always aware of them. However, those social facts have been on an accelerating runaway trajectory, and have reached the point where people are being forced to notice them, and therefore, begin to talk about them, even in the mass media, to some extent.
This article brings this up, in a way that my well-honed macabre sense of humour found amusing, as a surprising kind of redirection of attention. Indeed, WHY do we expect that there will be respect for the rule of law, and that there should not be blatant insider trading, conducted with relatively impunity? WHY are we still cruising on the inertia of social habits, where we expect that there will be a rule of law, that is effectively enforced, to prevent blatant frauds in the financial markets?
The only answer appears to be that, in previous decades, or Centuries, there appeared to be more of that actually working through our social realities, while, suddenly, TODAY, that appears to be gone! There are now groups of trillionaire mass murders that have impunity to commit crimes, and to not be held accountable, because they effectively control the politicians, and public opinion, through dominating the mass media, etc.!!!
Of course, there were always those kinds of things going on before, certainly for as long as fractional reserve banking existed, through which there was privatized, legalized counterfeiting of money-as-debt, and income tax was enforced to make people pay for the interest on that money that was originally created out of nothing, by private banks, that had corrupted the government. Thus, there was always rampant runaway fraud. However, BEFORE, that was not so blatantly slap-in-the-face, blatantly obvious. NOW IT IS!
Therefore, NOW, stories like this can be written and published, in which people start looking through the looking glass of our Bizarro Mirror World ... and suddenly we start asking about WHY things are BACKWARDS!
The deeper answers to those questions are much more profound, since those answers are that the ways we think about everything are backwards! For several decades, I have been attempting to develop a radical philosophy that can cope with the systemic ways that everything else is happening in BACKWARDS, in a manner similar to like how this article touches upon. Indeed, it goes so deep as that our basic idea of the concept of entropy is BACKWARDS, so that our most fundamental concepts of energy laws were mistaken!
Basically, one way or another, sooner or later, the whole of the Neolithic style of civilization is being overthrown! This article discusses some of those "distortions" ... However, the magnitude of those distortions actually is going right off the scale of everything that we previously knew, and, I do not believe it is ever coming back ...
Radical Marijuana...We easily accept reality because in the end, we intuit that nothing is real.
Yeah, I love paradoxes!
My favourite collection of that kind of transcendental poetry was in the book called Perennial Philosophy, as an anthology edited by Aldous Huxley, of the poems of different mystics, from many different times and places.
And once insider trading is legalised (or not illegalised), how long until companies begin selling inside information to the highest payer... Maybe its a way to increase shareholder returns for both insiders and non insiders.
'...how long until companies begin selling inside information to the highest payer'... did you forget to /sarc that comment...?
No disrepect intended, just axing.
Actually I agree to certain point. If there is no expectation of fairness then trading of securities should be limited to insiders. That way there can be no "con game" on people who trust the untrustable.
If unfair trades were limited to insiders then my guess is that two markets would develop, one fair and one unfair ... and the unfair one would eventually die.
I'm FOR IT.
Yes, it is called market confidence, and if somebody lies or steals from me, they will get horswipped or shot. How's that for "fairness and "justice"? This author is a one of the Wall Street Psychopaths and Sociopath. That was the most bellacose bunch of bullshit I have ever read on ZH. I expect fairness and upfront honesty, otherwise YOU DON'T GET MY FUCKING MONEY to invest your fucking idiot! ANd if I find out you lost it, I M coming after you with a rusty knife, sand paper and some salt water, fucking idiot!
Bust the Deal Face the Wheel
http://www.hark.com/clips/csnjfrxldc-bust-a-deal-and-face-the-wheel
I'm confused...who's the psychopath here?
Idiots like you that stand on the train tracks, or those that do not evacuate when told to do so. Can you justify the "fairness" of Wall Streeters"? Really? Bite me ass.
What makes you think the author justifies fairness. He is simply asking...why YOU would expect fairness from Wall Street...hey, do you want to take a second read at the post?
Sure, and I should expect to be robbed when I walk the public streets, too, because, well, that's just the way it is, get over it.
We actually do expect that, which is why we pay for security services: public and private!
We are paying for law enforcement in the markets too, but we aren't getting any.
Can I make a case for legalizing hanging inside traders on meat hooks?
Anyone here who does not understand that the markets are one big con game?
Like thrift in today's welfare state, honesty has been discounted.
Honest joint stock managers would. Earn a premium.
Today everyone is honest thanks to government watch dogs so why pay more. Right? (/ sarc)
Sadly most people are too damn lazy to care. So this shit will continue to go on regardless of rules ... Until it doesn't.
Pitchfork justice will come, it's just a case of when.
So, let's see if I've got this, insider trading improves market efficiency by making public securities' price discovery more volatile than private securities. Hmmm, sounds contradictory to me but...
Since most "insiders" are management--aka, "hired hands"--then such insiders are using private/non-public material information for personal gain, which is akin to allowing management to raid petty cash to gas up their personal car, or to pay for their dry cleaning. IOW, it allows management to pilfer assets that do not rightly belong to them. So in a quest for improved price discovery, we sacrifice honesty and integrity on the altar of efficiency.
What about manager/owners? Such people are in a privileged position relative to other owners and so one could argue that their responsibilities as fiduciaries precede their rights as owners. Once private information is made public however, it's fair game for anyone.
You're right, except that you stop right there and do not analyze the dynamic consequences of the problem: If what you say happens, public equities die right there and from then on, the private capital markets take over. Personally, this later outcome is more efficient macroeconomically. But you may disagree...When I think of private equity, I think of companies like Ikea: If a russian town asks Ingvar Kamprad for a bribe to open an Ikea store, the man sends them fuck themselves, which he actually did. If Ikea was public and the country head of Ikea Russia had to make the decision, he would give the bribe, so he can show growth in his business and cash the bonus. So, there is even a higher morale standard to be enjoyed from private rather than public equity, not mentioned by the author here.
Pretty sure Facebook is the new model, strip it bare before any public trading. Insiders buy in at start, ramp up the hype and dump on IPO to muppets. Cash in on fees as you trade it on the way down while algos pick up the scraps.
Public security is more important than private security.we can give private security for leader who help to public.
pests of stored products
"...coerced collective savings, also known as pension plans. These are managed by people who naturally seek to gain economies of scale and demand large pools of assets to dump what they have forcefully taken from the contributors."
What? "Forcefully taken from...contributors."?
If I don't want a job with an attached pension plan because this is somehow "forcing" me to save, I don't take it.
This is some messed up thinking.
I think that, for instance, in many countries, this occurs, regardless of what job you take. Maybe you're taking a myopic view on this. In Canada, for instance, they have the Canada Pension Plan. Everybody contributes to it.
The government has a powerful interest in allowing banks, insiders, ponzi schemers, and banksters to rule the markets. This drives investors into government bonds.
Some have always been bigger, stronger, faster, more intelligent, luckier, prettier, or more socially adept than others, therefore stupid little laws just get in the way of the natural order of things.....
Original,
But the suggestion that this public securities premium would disappear when Insider trading would be allowed is preposterous to me.