BrianGarst.com

The government got their man! An evil Wall Street hedge-fund titan will be locked away for up to 205 years(!) for his horrible crime of…bringing more information to the market so it can run more efficiently. Well, that’s not what the government calls it – they call it “insider trading” – but that is in fact what he did.

Insider trading is not harmful and should not be a crime.

But before I get into that, here’s the news:

The widely followed trial exposed the behind-the-scenes dealings of a once-prestigious hedge fund that gained access to highly sensitive information about, among other companies, Goldman Sachs Group Inc. at the height of the financial crisis.

…The counts Mr. Rajaratnam was convicted of carry a total of up to 205 years in prison time, but under federal sentencing guidelines, he is likely to receive 15 ½ to 19 ½ years, according to prosecutors.

…In a statement, Manhattan U.S. Attorney Preet Bharara said: “Unlawful insider trading should be offensive to everyone who believes in, and relies on, the market. It cheats the ordinary investor.… We will continue to pursue and prosecute those who believe they are both above the law and too smart to get caught.”

Preet Bharara, the same thug behind the online poker busts known as black Friday, shouldn’t talk about things he does not understand, and economics is clearly one of those things.

First, let’s address his argument of cheating the “ordinary investor,” which is the typical argument from fairness against so-called insider trading. In this view, it is “unfair” for trades with information that is not public (or “inside”) to profit from it, when others without the information cannot.

The problem with this argument is that it is the very nature of the market economy that experts can profit from their specialized knowledge. As Don Boudreaux explains, ” If I embark upon an occupation that I know nothing about — say, running a restaurant — I am likely to suffer substantial losses. These losses would result from the competition of other restaurants run by people who possess more knowledge about the restaurant business than I do. No one thinks that the industry-specific knowledge possessed by experienced restaurateurs gives them any advantage that is unfair.”

But what really makes clear the case for legalizing insider trading is considering its impact on the market itself. Prices, at their core, are information. They tell people something important about whatever product they represent, whether it be a good at a store or a corporate stock share. The market relies on these prices to accurately reflect all the relevant information, and most of the time they do – or at least do so better than every other possible system – because they harness the collective knowledge of society, knowledge that could never be held by any single person or group of people, through the billions of individual economic decisions made every day.

This system only works, however, if prices carry all the necessary information. Witness what happens when government institutes price controls. By keeping the price of a good artificially low, the government signals the market that less of that good is actually needed than the market demands. This creates shortages.

But sometimes information is not easily available in the market. Individuals might want to protect certain knowledge if its release would harm their economic position. Many Enron insiders knew, for instance, that their company’s share price did not reflect its real market value, because Enron was lying. This eventually caused considerable harm to Enron investors, which consisted of ordinary Americans, many of whom were no doubt saving for their retirement.

Now imagine some of these insiders had acted on their knowledge, as they surely would have been more likely to do were it not illegal, by selling their Enron shares, or taking a short position. This would have been a big signal to the market that something is wrong here. Others would have seen this and investigated themselves and found that yes, something is wrong at Enron.

But letting the market get wind of this fact sooner than they otherwise would, and did in the case of Enron, is illegal – out of “fairness,” of course.

The final argument against the illegality of insider trading is that it meets all the criteria of a bad law; it is arbitrary, vague and unenforceable. It’s arbitrary because no two partners in a trade ever have exactly equal knowledge, so whether something is public doesn’t even address their own issue of fairness. It’s vague because “public” is debatable. Is something public if you have to spend 100+ hours researching in a library to find it, even though that is unrealistic for most investors, thus leaving that knowledge just as inaccessible as “inside” knowledge? And, finally, it’s unenforceable (or only partially enforceable) because an entire category of decisions based upon insider information can never be discovered. That is, people can refrain from buying based on inside information, and there is no way to catch these pernicious criminals, who otherwise would have engaged in a trade with willing sellers (and thus harming them, by the logic of the Preet Bharara’s).

The economics of this prosecution are simple: Raj Rajaratnam is being sent to prison for giving the market more information, and thus allowing it to function more efficiently, than it otherwise would possess and otherwise would be able. The politics of this prosecution are also simple: “Wall Street” is seen to have done something bad (never mind that it was partly coerced into doing so), and therefore must be punished. Raj Rajaratnam works in “Wall Street,” and therefore is also bad and should be punished.  In this case I find both the economics and the politics to be absolutely revolting.

insider trading thuggery