Insider Trading On The Universe

Here are some things that are happening:

– Oooh correlation is one oooh.

– The SEC has proposed rules that would ban banks from “betting against” securitizations that they create for one year after marketing them, a sort of anti-Abacus rule.

– The SEC is also investigating whether people traded on inside information ahead of the S&P’s downgrade of the U.S. Amusingly:

It isn’t clear if securities regulators also are looking at trading of U.S. Treasurys. Inside information might not have been a blessing with these securities. Investors who bet against U.S. government debt suffered losses immediately after S&P’s downgrade because rattled stock investors retreated into Treasurys as a safe haven. Such losses wouldn’t be a defense against accusations of insider trading, lawyers said.

– Raj Rajaratnam may be going to jail for a million billion years for talking to some people about some stuff and then buying and selling some stocks. The Times is seeing him off with this bizarre quote:

The question is whether such a sentence — longer than the average federal prison term for murder — is appropriate. “Given the magnitude of the crimes, it’s hard to feel any pity for him,” said Harlan J. Protass, a defense lawyer …

These things seem puzzling – with the puzzle being, what do we want out of our capital markets?

Some smart people believe that insider trading should be legal and find it puzzling that our legal system considers it worse than murder. But if you are going to make insider trading a crime, you probably do so on some sort of theory of fairness: the little guy reading 10Ks and watching Jim Cramer should have just as good a chance of making money as the big mustachioed guy who gets calls from corporate directors as soon as they get out of board meetings. This is kind of a nutty theory but we seem to like it. It may be related to our theory that all Americans should have the same opportunity to invest their own retirement funds or make their own decisions about future healthcare needs.

But that theory gets murkier when you talk about shorting broad indices because you think that someone is going to say something negative about USTs which, by the way, will go up on the news. Here there’s no “real” corporate event that will make earnings go up or down – there’s just a self-interested, conflicted, quasi-competent market participant saying some words about a debt issuer, which apparently people used to make money trading securities of different issuers.

Similarly, the public perception of the anti-Abacus rule is kind of hard to argue against – OMG, you BUILT A SECURITY TO FAIL, then you BET AGAINST IT – but the reasoning is sort of puzzling to me. Let’s grant that banks shouldn’t be able to stuff a CDO with mortgages chosen for their poor underwriting and general dodginess, sell them to clients, and buy naked protection on them. But what if you built a securitization of, like, every subprime mortgage? Or maybe only the top 10% best-underwritten subprime mortgages? And then you bet against it – because you believed that all subprime mortgages were going to get whacked by house price declines and rising unemployment? That would have been more or less a winning strategy.

Is that a conflict of interest? Well, yeah, sure. You had clients who bought something on macro thesis X (no one bought Abacus because they especially liked the underwriting of its loans), and you sold it/bought protection on it based on macro thesis Opposite Of X. If you were their fiduciary they’d be all “WTF, you told me macro thesis X, and you didn’t believe it?” But you’re not. You’re just selling stuff. They can take their own counsel on the world economy. It’s no different than betting that gold or the Swiss franc or interest rates will go up, or down. Some people will take the other side, and that’s their business. You may have better insights than them – in hindsight, I guess, someone will always turn out to have had better insights – but it’s hard to imagine how you could be an insider on a macro bet. Or why your conflict of interest – your taking the opposite position from your customers on a macro question – should prevent you from making the trade.

I worry that the regulatory-and-political response to the financial crisis too easily conflates the micro and the macro – and that the everything-is-correlated effect makes it easier to do that. The packaging of Abacus seems to have been shady – investors were apparently misled about the roles of Paulson and others in picking mortgages to put into the CDO, and those mortgages seem to have been cleverly selected for dodginess – but basically the long investors in that trade lost money because the mortgage market went to shit, not because of the selection of the loans. People made money after the S&P downgrade not because the S&P is correct about the declining credit quality of Treasuries – it would be weird if that were true since rates went down on the downgrade – but because there continues to be a lot of uncertainty in the global economy and the S&P downgrade was one small symptom of that.

Banning “betting against clients” and investigating “insider trading” on the S&P downgrade suggests a mindset that no one should have an unfair advantage not only in corporate/earnings/M&A news, but also in having macro knowledge about the universe. And that seems like a hard thing to regulate.

And poor Raj. He seems to have made money mostly by doing a lot of research and making good bets on stocks. Some of that research – his lawyers say less than 1% – involved calling up directors and saying “hey, got any inside information for me?” So, not good. But in an all-correlations-to-one world, anyone arrested for garden-variety shenanigans like that becomes a symbol of Wall Street Evil and you-stole-grandma’s-house. Which is not great for sentencing.

(hidden for your protection)
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85 Responses to “Insider Trading On The Universe”

  1. HAM05 says:

    may have missed the take-away of the post, but that tubby tiger makes me smile – look how happy he is!

  2. pazzo83 says:

    best-underwritten subprime mortgages : subprime mortgages :: curvy woman : fat chick

  3. NowOnePerson says:

    I was getting prepared to answer the question: "what do we want from our capital markets?"… shoulda known that there was a 32-paragraph answer to the question waiting on the other side of that link. Ooooh Tricked me ooooh!

    -Guy who's now going to go back and read it all because he secretly enjoys these posts, despite his poking fun at Matt.

  4. Paycheck update says:

    You don't work for Goldman any more, Matt.

  5. spanishmoon says:

    Matt – you seem like a nice kid. But now, a few facts:

    1) Raj ran a criminal enterprise.

    2) He was never any good – he got his start in the business front-running customer orders (including mine) on the Needham desk to build his track record and continued his criminal ways at Galleon.

    3) He got caught on about 1% of the crimes he committed, not vice-versa as you suggest.

    4) We are all going to lose our jobs in this industry unless it cleans up its act.

    Sorry to be a buzzkill…but we need to keep it real as most of us face no bonuses this year and the certainty of many of our friends losing their jobs this winter.

    Your sympathy for this fat, criminal fuck is grossly misplaced.

    The judge should give him 10 extra years for that shirt alone.

  6. PMCO_sucks says:

    This was a seriously good post.

    -beginning to question why I dismissed all of the other TMLDR posts / examining motives

  7. SEC says:


    You seem to have a slight obsession with insider trading. Got something to share???

  8. Guest says:

    Matt just likes to drink Raj's curry. What's wrong with that?

  9. Hm. says:

    Add 5 more years for having your pinky extended while drinking.

  10. Roomy Khan says:

    Rajratnam & Wollensky

  11. C. Gasparino says:

    I buy extra-small naked protection.

  12. Guest says:

    Wait, when did EP come back?

    -guy who actually likes these posts and is mostly kidding

  13. early_hominid says:

    Plus campaign season's coming up. Timberwolf may have been one shitty deal, but it might smell pretty sweet next to what Washington can come up with in an election year.

  14. winning! says:

    So, if I hire those lawyers, and 99% of my trades make -0.1% combined, but ~1% of them make 50-500%, and they're the largest trades in my book, it's all okay? Suh-weet.

  15. The Wolf says:

    Matt, please go look up a few of Bess's posts. Now make your posts look like hers so they can actually be readable. Ugh!

    Bravo on the comment authors!!!!! You guys save Matt's ass on each and every post!

  16. Cilantro Fund says:

    I applaud your use (and spelling) of the word "mustachioed"

    Bravo, Matt, indeed

  17. Guest says:

    Did you just compare being upset about buying Abacus to taking a bad currency position? That's sort of like blaming the convenience store guy for selling me cigarettes even though he's pretty sure they are bad for me, right? Well except for this particular shop keep put cyanide in the cigarettes, grossly overpaid someone to lie and say they not only aren't bad for you but certainly don't contain any cyanide, took a life insurance policy out on me and waited for me to die. All I wanted was to make friends outside bars but serves me right for not having the right macro hypothesis.

  18. Touch Base Later says:

    Is Raj resting the wine glass on his stomach? I need to learn to do that.

  19. FLOTUS says:

    I wish Barry would smoke some of those cigarettes…talk about getting your 'macro' views wrong.

  20. veleno says:

    I would send all the bond traders on wall street to jail for what they did with CDOs and CMOs before I send Raj for what he did, which really did not hurt anyone. And you want to send him to jail for 20 years? When murders and rapists get less? GIve me a break!

    Let me tell you, spanishmoon, if you work in the financial industry, the fact that you don't make a bonus this year pleases me to no end. You should not have made a bonus for the past 10 years!

  21. Citicorp Shareholder says:

    I suggest that you save your posting. Then, ten or so years from now, when you have grown up, and gotten your head out of your ass, re-read it. Your next step should be to apologize to the entire world for your having been such a douchebag.

  22. Special guest says:

    I swear I'm going to crush whoever snapped that fucking picture.


  23. 복마크 says:

    Matt…great comment! But where's the post on "insider trading"?

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