Echoing arguments made for years by nutsy-crazy libertarian types who want there to be verifiable harm to someone's life, liberty, or property before people get tossed in jail, Dylan Matthews at the Wonkblog of the Washington Post today realizes that laws against insider trading are silly, don't do any good, and ignore most of what they purport to be preventing by not cracking down on the "crime" of insider non-trading.
Insider trading is actually an active good. Markets work best when goods are priced accurately, which in the context of stocks means that firms’ stock prices should accurately reflect their strengths and weaknesses. If a firm is involved in a giant Enron-style scam, the price should be correspondingly lower. But, of course, until the Enron fiasco was unearthed, its stock price decidedly did not reflect that it was cooking the books. That wouldn’t have happened if insider trading had been legal. The many Enron insiders who knew what was going on would have sold their shares, the price would have corrected itself and disaster might have been averted.
That’s the argument of Henry Mannes, an economist at George Mason University who’s advocated legal insider trading for decades now. Referring to the Enron and Global Crossing’s scandals, he says, “I don’t think the scandals would ever have erupted if we had allowed insider trading because there would be plenty of people in those companies who would know exactly what was going on, and who couldn’t resist the temptation to get rich by trading on the information, and the stock market would have reflected those problems months and months earlier than they did under this cockamamie regulatory system we have.” And that’s months and months where investors could have allocated money toward more promising investments, increasing market efficiency.
More formal economic models reach the same conclusion. Christopher Matthews at TIME — no relation — points to a study by researchers at the Atlanta Fed, who surveyed a wide array of models and found that insider trading makes stock prices more informationally efficient. Then again, it would deter some kinds of uninformed investors from participating — but again, that’s a feature, not a bug.
What’s more, insider trading bans don’t actually stamp out insider trading. Illegal trading remains, of course, and may actually be growing, which puts law-abiding investors at a disadvantage. But the bans also exempt some equivalent behavior. Let’s say that instead of hearing that The Post will post a loss, I hear that it’ll post a profit, and thus don’t sell any of my shares. That kind of “insider non-trading” is totally legal, but basically equivalent to insider trading. Allowing one and not the other is bizarre and inefficient.
I disagree with Matthews that we should as a matter of public policy want to discourage individual investors in particular companies, which he seems to think. But given the immense amount of informational non-asymmetry built into a world where time and attention are scarce, it is silly to create a potemkin law that pretends to solve that "problem" when it comes to stock market transactions--a problem inherently impossible to solve at any rate. Everyone always knows different things, at all times.
I was saying the same things here back in 2002, tried to use a real-world thought experiment to expose another side of how bad the laws are (as they might apply to enterprising journalism), as was Michael McMenamin in an October 2003 Reason cover feature.