Topic: Finance, Banking & Monetary Policy

Court Denies Insider Trading Appeal

This week the New York Times reports that the Supreme Court has refused to review the ruling of the Second Circuit Court of Appeals in the case United States v Newman. The Second Circuit, in December, overturned the insider trading conviction of a pair of hedge fund managers because nothing of value was exchanged in return for the information and thus the managers could not have known that the information they received was improperly disclosed to them by the information source.  The Supreme Court decision would seem to block insider trading prosecutions in the absence of clear financial gains to those who leak the information.

This, in turn, has energized some members of Congress to introduce legislation to make it illegal to trade on insider information regardless of how one obtains it. This standard would define insider trading far more broadly than the standard laid out in Newman, or, for that matter, even before Newman based on the precedent in Dirks v SEC.

In his article in the current issue of Regulation, Villanova University law professor Richard Booth explores the Newman ruling.  He argues that ordinary diversified investors neither lose nor gain from insider trading because they own all stocks and don’t trade very often.  The only investors who have an interest in the prosecution of insider trading are “activist investors – hedge funds and corporate raiders – who stand to benefit from slower reaction times as they buy up as many shares as possible before anyone notices.”  “… [H]edge fund managers have a distinct interest in seeing other hedge fund managers prosecuted for insider trading.”  They rather than ordinary investors are the beneficiaries of insider-trading prosecutions.  Thus ordinary investors should applaud the Newman ruling and oppose the attempts by Congress to adopt a European-style law against all insider trading.

For more Cato work on insider trading, see these links.

Research assistant Nick Zaiac contributed to this post.


Bitcoin Air-Kisses the Euro

Volatility is a well-recognized impediment to the success of Bitcoin as a currency. An example of the argument for volatility-based caution about Bitcoin, chosen at random, appears in Professor David Yermack’s December 2013 NBER working paper, “Is Bitcoin a Real Currency? An Economic Appraisal.” Wide swings in the price of bitcoins vis á vis other things will obviously tend to suppress its utility as a store of value or unit of account. Nobody wants to deal with recalculating prices denominated in Bitcoin day over day or hour over hour.

But I’ve long felt the volatility knock on Bitcoin to be slightly unfair. My favorite response line has been to say that judging Bitcoin based on its current volatility is like declaring a 10-year-old unfit to play in the NBA because he’s too short.

As a new asset class (or very different member of the “cash or cash equivalent” asset class), Bitcoin has yet to find its place in the world. The uses to which it is put will ultimately translate into a dollar price based on a recognized, relatively steady level of demand. Right now, speculation about where demand for Bitcoin will end up takes place in thinly traded markets. Just those two ingredients — uncertain future use and thin markets — are recipe enough for plentiful volatility.

But there’s every reason to believe that the market for Bitcoin will deepen and grow in sophistication, tempering its volatility. The capacity of the Bitcoin protocol to transfer and store value in exciting new ways will produce transaction demand — supplanting speculative demand, which today dominates because of anticipated price appreciation. Transaction or “use” demand will also increase because of Bitcoin’s capacity to administer countless economic and social functions beyond value transfer, including messaging, proof of authorship, land and title registry, and identity/naming. This will drive volatility down, I believe, both because it will shift bitcoins out of speculation and because it will give the markets more concrete information about what use demand is and will be.

End the Fed’s Guessing Game

The FOMC decided last week against raising interest rates given its concerns about the global economy and financial conditions. While these concerns are reasonable, the FOMC’s decision highlights a growing problem that has increasingly plagued the Fed since the crisis erupted: its incredibly ad-hoc approach to monetary policy.

Just a few months ago the FOMC was signaling it would almost certainly raise interest rates, but now it has changed its mind. This change would not be so bad if it were predictable, but it was not so. No one expects the Fed to perfectly forecast the economy, but we should expect the Fed to make clear how it would respond to differing states of the economy. This simply has not happened. From the QE programs to forward guidance to lifting interest rates from zero, Fed policy has been made up on the fly. This unpredictable behavior has meant that no one, including Fed officials, knows for sure what will happen from one FOMC meeting to the next.

As a result, markets have become more and more obsessed with every word coming from the mouths of Fed officials. Post-FOMC press conferences like the one last Thursday became must-watch TV for anyone concerned about investments. Ironically, then, the Fed’s attempt to calm markets through these ad-hoc measures has only made them more fragile.

It would be far better for the Fed to focus on a narrow mandate in a rule-like manner that makes conditional forecasts possible. For example, if the Fed were to target a stable growth path for total dollar spending and adjust policy as needed to hit it there would be far less of the Fed’s current guessing game. The FOMC’s decision last week highlights how sorely this change is needed.

[Cross-posted from]

New Policy On White Collar Prosecution Risks Scapegoating

Last week, the Department of Justice announced a new policy regarding its approach to corporate criminal investigations.  Instead of focusing first on the company and, having resolved that portion of the investigation, turning to the task of identifying potential individual criminal suspects, prosecutors are now directed to build their cases against individual wrong doers from the start.  Media coverage of this policy statement has focused on criticism levied against the administration for being too soft on Wall Street and too cozy with corporate donors.  The New York Times trotted out the old complaint that no one went to jail in the wake of the financial crisis (even though, to my knowledge, no one has ever identified a criminal law the violation of which caused any part of the crisis).  While the administration’s rhetoric about equal justice before the law is admirable, the policy memo and its surrounding coverage have a distressing whiff of scapegoating about them. 

Reforming the Federal Reserve’s Rescue Authority: Warren and Vitter Come to Cato

For all the ink spilled on TARP — the bailout package authorizing the Treasury to purchase or insure up to $700 billion of “troubled assets” during the financial crisis — that program is dwarfed by another market intervention that occurred around the same time. In fact, the Government Accountability Office estimates that the Federal Reserve lent more than $16 trillion to financial firms between December 2007 and July 2010 — a figure that comes close to matching the entire, annual gross domestic product of the United States.

On Wednesday, Cato’s Center for Monetary and Financial Alternatives hosted a two-part discussion of the Federal Reserve’s emergency lending power, and the legislative efforts underway to reform it. The first panel saw the Washington Post’s Ylan Mui interview Phillip Swagel, a former Treasury official turned University of Maryland professor, Marcus Stanley, the policy director at Americans for Financial Reform, and Mark Calabria, Cato’s own director of financial regulation studies. United States Senators Elizabeth Warren (D-MA) and Richard Vitter (R-LA) joined us for the second panel, during which they outlined their proposed “Bailout Prevention Act of 2015,” as well as their broader, bipartisan quest to end “too big to fail.”

Warren and Vitter on “Too Big to Fail”

Senator Elizabeth Warren (D-MA) and Sen. David Vitter (R-LA) came to the Cato Institute on Wednesday to call for stricter limits on the Federal Reserve’s ability to prop up large financial institutions with loans guaranteed by taxpayer dollars—which Warren characterized as “shoveling money out the back door.”

Warren noted that, during the financial crisis, most of the focus fell on TARP. “But what a lot fewer people were talking about was how the Fed was shoveling money out the back door in a very quiet way, not to support the financial system overall, but to support very targeted financial institutions. $9 trillion—your money, tax dollars, went out the door, to just three financial institutions.” 

Vitter joked that he and Warren are “the Odd Couple” of Congress, but added, “I think the fact that we’re here working on this together illustrates how broad and legitimate the concern across America is with ‘too big to fail,’ and the fact that it is, unfortunately, alive and well.”

“Left right and middle, I think it’s a very broad concern,” he said. The senators have proposed a bill that would forbid the Fed from lending money to insolvent institutions, and would place a high interest rate on the loans.

Warren mocked the Fed’s current standard of “insolvency” for financial institutions, which they define as not yet having filed for bankruptcy. “The way I read that, they said ‘What we’re going to do is set up a little cart, right in front of the bankruptcy courthouse, and when institutions come to file their papers…we’ll just intercept and say, ‘Would you like a trillion dollars from us instead?’”

Warren argued that giving large institutions a free government guarantee unfairly pushes smaller institutions out of the market.

“The question is, will the insiders control the game—those who’ve got the lobbyists, those who’ve got a lot of money on the table, but a very small, insular group, that, frankly, wants to enhance its profits at the expense of the public,” she said. “You’re driving one set of competitors out of business, and advantaging another set of competitors.” 

“’Too big to fail’ is not over,” she said, “And it is our responsibility in the United States Senate and the United States House of Representatives to do everything we can to turn the rules in the direction of taking away the advantages that the ‘too big to fail’ banks enjoy in this marketplace and in this political system.”

Free Banking Theory versus the Real Bills Doctrine

The “real-bills doctrine” was roundly rejected by postwar monetary theorists of both the Chicagoan and the Austrian perspectives (Lloyd Mints 1945, Ludwig von Mises 1949). But George Selgin (1989) was right to warn us that “it would be a mistake to think of the real-bills doctrine as a ‘dead horse’” because “dead horses of economic theory have a habit of suddenly springing back to life again.”

In recent years no less prominent an economist than Thomas Sargent (2011) has declared that in the debate over alternative monetary regimes, “The real bills doctrine is alive and well today.” Most recently the leading young Spanish economist Juan Ramón Rallo of the OMMA business school and the Juan de Mariana Institute in Madrid has defended propositions that he identifies with the real-bills doctrine. Rallo draws on the writings of Antal Fekete, who has been advancing what he calls “Adam Smith’s real bills doctrine” for more than 20 years. I had the pleasure of an on-stage dialogue with Professor Rallo in Madrid this summer, where we discussed aspects of the doctrine. Fortunately, what Rallo actually defends is mostly free of the shortcomings of the usual versions of the real-bills doctrine.