Monday, August 03, 2009

I've Got A Secret

Kevin Drum talks about Paul Krugman talking about "speculation based on private information." It's easy to make a buck if you know the winning numbers for the lottery before you buy your ticket - unless everybody else does too. Krugman:

crashing the economy and fleecing the taxpayer aren’t Wall Street’s only sins. Even before the crisis and the bailouts, many financial-industry high-fliers made fortunes through activities that were worthless if not destructive from a social point of view.

And they’re still at it. Consider two recent news stories.

One involves the rise of high-speed trading: some institutions, including Goldman Sachs, have been using superfast computers to get the jump on other investors, buying or selling stocks a tiny fraction of a second before anyone else can react. Profits from high-frequency trading are one reason Goldman is earning record profits and likely to pay record bonuses.

On a seemingly different front, Sunday’s Times reported on the case of Andrew J. Hall, who leads an arm of Citigroup that speculates on oil and other commodities. His operation has made a lot of money recently, and according to his contract Mr. Hall is owed $100 million.

Asymmetric information explicitly breaks the efficient market hypothesis. When brokers take advantage of such information they cheat their customers and poison the possibility of markets operating efficiently. In the Market Magic version of reality, dishonest brokers are driven out of business by being out competed by honest brokers. No doubt something like this happens in the long run - but Bernie Madoff did manage to look good for quite some time. It's even better if the taxpayers pick up the tab for the cheaters mistakes.