Insider Trading and Central Banks
By Staff News & Analysis - October 05, 2010

Are former Fed officials gaining access to secret information? … In its story about the problem of former Federal Reserve officials gaining access to secret market-moving information at the central bank, Reuters has found a really good solution: Ben Bernanke should come out and give a press conference after each meeting of the Federal Open Markets Committee, which sets monetary policy. The European Central Bank holds a press conference after its key meetings that gives its president, Jean-Claude Trichet, a chance to explain the reasoning behind its actions in a public forum. "If Bernanke can't stop the leaks he ought to have a full press conference after the meeting. It's inappropriate for certain people to gain an advantage on information from the Fed," said Ernest Patrikis, a former No. 2 official at the Federal Reserve Bank of New York and now a partner at law firm White & Case. The story notes how some former Fed officials, like former Fed governor Larry Meyer, are talking to people at the Fed about the confidential internal discussions leading up policy decisions. Then, Meyer and other former Fed officials (and other people who haven't worked at the central bank but are close to its officials) write notes to their clients summarizing what they found out. For this, they get paid millions. – Market Watch

Dominant Social Theme: If you know too much, sit down!

Free-Market Analysis: We've written about the insanity of insider-trading laws before but this article brings it all back to us. Many laws and regulations these days are written as a kind of pre-emptive propaganda and insider-trading regulations are among the most pernicious in this regard. The powers-that-be have wanted to make sure that average investors would not entertain any doubts that the stock market (where enormous profits are made) placed him or her on a level playing field with the "big boys.

Sub-dominant social theme: "If we catch any of these Wall Street types taking so much as a finger's worth of advantage over YOU sir, they're going to see the inside of the Big House!"

This is morally repugnant to us because it reminds us of ancient South American rituals – the ones where they ripped out the hearts of victims to ensure precipitation. Every once in a while, with great fanfare a human life is destroyed (with 10 or 20 years of jail) for the singular crime of trading on "information." People, in aggregate, are then supposed to sit back, satisfied that the stock markets are "fair."

Just today in fact, we have another example of this sort of pursuit from France. reports, "A Paris court has convicted former trader Jerome Kerviel guilty of all charges in one of history's biggest trading frauds, sentencing him to three years in prison and ordering him to repay Societe Generale SA the staggering euro4.9 billion ($6.72 billion) that the bank lost." The issue of how and why Kerviel was able to bet over 50 billion euros during a single year is not something the court is apparently addressing, only the losses that Kerviel cannot possible pay back in a dozen lifetimes.

The system itself, were it a person, would likely be declared clinically insane. The idea that the Kerviels of the world (despite his failures) trade on an even footing with the rest of us is questionable in the extreme. Never mind that everyone trades on information. The "information" that people are put in jail for is very specific and peculiar. In fact, insider trading has only been a "crime" for about 30 years. Like most white-collar crimes, it is a moving target, having more to do (reality) with the power elite's intention to criminalize any financial function that it does not entirely control and mandate for its chosen players.

There are other problems with insider trading regs. They are kept purposefully vague so that the SEC (in America) can utilize them whenever its attorneys wish to and apply them "creatively" (for whatever purpose.) All this does, in fact, is reinforce the inequities that surround insider trading laws and ensure that they remain what they really are, a fear-based promotion designed to inflict maximum pain on a few "outsiders."

What is so repugnant about these sorts of manipulations is that the stock market is neither fair nor equitable and it takes a certain kind of personality to "invest" in it. Most people know instinctively that there is something strange about the evolution of Western-style equity marts but combine a raging bull market with endless streams of media promotion featuring individual stocks and many people are apt to succumb to the blandishments of "trading" – at least with a little bit of their income.

In fact, as we have pointed out on numerous occasions, the modern stock-market (US style) has been in existence about 100 years. It really found its legs once a central banking beachhead (the Federal Reserve) was established in the US. The Fed inflated wildly (and illegally) in the 1920s (the Roaring 20s) and "investing" as a national pastime was off and running.

Of course, the 1930s severely dented the mania for stocks and it was not until the 1950s road shows were conducted by the New York Stock exchange that people were able to put aside their reluctance to begin to buy stocks again. After the 1950s, the modern stock exchange (especially in America which was the most consumer oriented) made steady progress until the 1970s.

The 1970s were not kind to stocks but the 1980s and 1990s (with ups and downs) saw steady progress for many equity investors. It was not until the middle of the first decade of the 2000s that the wheels really began to come off. And now, in our view, the American model of stock investing is dying. Of course it is still being flogged but the Baby Boomers (its primary target) have been scarred by all that has happened in the past few years and we question whether its animal spirits will ever be fully resuscitated.

Nonetheless, of course, the insider trading meme continues to be promoted. One of the first big cases featured a couple of printers who were reading Business Week and trading on the information before it was published. But is it really so simple? Wall Street has access to the best mathematical minds in the business and the best computers. We remember one big firm in the 1980s that practiced aggressive pairs trading using ratios between similar stocks and running those ratios through huge computers at night, then making bets on the ratios during the night before traders readjusted them the next day. How did this differ from insider trading? The firm had access to information and technology that Mr. Joe Public could not have accumulated in his entire lifetime.

What about Big Board "specialists" who apparently used to set NYSE stock prices too high or too low at the beginning of the day and then make a killing as the stocks gradually drifted down to where they should have been all along – based on the proprietary supply-and-demand of their "book." It was perfectly legal – the specialists were just trying to make a market and ensure "orderly trading." We could go on and on. The idea that stock markets are fair or that everyone gets decent information about stocks at the same time is a farcical one – and the saddest farce of all is that people are in jail over "insider trading." Without information markets simply don't function.

And here's one more example for you. How about the OTC market makers in the US who are granted the legal right to "short" a "reasonable" amount of shares in order to facilitate orderly market making. Sounds great until they start acting in concert with illegal crime syndicates comprised of wealthy naked short sellers who act in concert to destroy companies and their underlying value. The market makers in unison hammer the bid side of a market with coordinated short sales, all in the name of "reasonable" market making. Meanwhile, their buddies who hide behind offshore structures – although they tend to live primarily in Brooklyn, Boca Raton and southern California – make a killing by scaring retail investors and purposefully destroying companies.

And here is where regulators once again ASSIST with the process… yellow journalism rises to the occasion to support the "short attack" with all kinds of defamatory and often crude statements. No name journalists come out with outlandish reports AFTER the shorts are in position to provide regulators with the necessary "whining" required to bring their naïve investigators into the equation and on and on it goes.

In the last example above, the only people who are not part of the knowledge pool are the average mom and pops who invest in the companies. The short syndicates and their accomplices, which often includes the regulators (knowingly or otherwise) walk away with millions every day from their inside "creation" of information. Once again, the whole notion of regulators being able to police "insider trading" is farcical.

Those at and around the Federal Reserve – and central banks generally – know this of course. Information is the currency of the Fed and while there is no indication that Fed officers directly trade on such information, the lines certainly become blurry the farther out you get from official central banking personages themselves.

If one is acting on information derived over time about where certain central banking decisions are headed, then isn't that a form of insider trading by anyone's definition? But it gets even worse. If one is SELLING one's information and access then isn't one "soft dollaring" the information that one has access to. One is "monetizing" one's access. Isn't that a form of insider trading? What about Alan Greenspan? He gets paid hundreds of thousands of dollars for his insights. Isn't he monetizing his access to the central banking mechanism generally? is that "fair?"

Life is unfair. Securities regulations generally are not about protecting the "little guy" but about setting up barriers to entry to make sure the established players have no competition. (It's called regulatory capture). There is probably not a single regulation that works as advertised or does not have other adverse consequences that reduce "fairness." The monetary inflation provided by central bank overprinting is itself unfair, giving people the idea that stock markets are going up due to economic circumstances rather than monetary ones.

After Thoughts

In fact, financial regulation itself is futile. After 100 years of ever-increasing regulation, law shelves groan and all that has been accomplished is the centralization of power and privilege and the further reduction of any real opportunity for individuals to participate on an even playing field. But then again that's probably the point.

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