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The Folks Who Sell Your Corn Flakes are Acting Like Goldman Sachs (newrepublic.com)
78 points by cs702 on Sept 13, 2013 | hide | past | web | favorite | 47 comments

I'm skeptical about the ban on insider trading in general. Now this author wants to extend it to a new sphere.

Basically, an oil company, which knows a lot about the oil market, shouldn't be allowed to speculate in oil.

Isn't this the mandated destruction of valuable market signals?

Should we also ban car mechanics from buying and selling used cars, because their special knowledge gives them an unfair advantage?

I'd never thought about this line of reasoning but it's an interesting hypothetical question. The Wikipedia article on insider trading is surprisingly informative on the counterarguments:

"Milton Friedman, laureate of the Nobel Memorial Prize in Economics, said: "You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that." Friedman did not believe that the trader should be required to make his trade known to the public, because the buying or selling pressure itself is information for the market"


"Legalization advocates also question why "trading" where one party has more information than the other is legal in other markets, such as real estate, but not in the stock market. For example, if a geologist knows there is a high likelihood of the discovery of petroleum under Farmer Smith's land, he may be entitled to make Smith an offer for the land, and buy it, without first telling Farmer Smith of the geological data.[2] Nevertheless, circumstances can occur when the geologist would be committing fraud if, because he owes a duty to the farmer, he did not disclose the information; for example, if he had been hired by Farmer Smith to assess the geology of the farm."


"There are very limited laws against "insider trading" in the commodities markets if, for no other reason than that the concept of an "insider" is not immediately analogous to commodities themselves (corn, wheat, steel, etc.). However, analogous activities such as front running are illegal under US commodity and futures trading laws. For example, a commodity broker can be charged with fraud by receiving a large purchase order from a client (one likely to affect the price of that commodity) and then purchasing that commodity before executing the client's order to benefit from the anticipated price increase."

It doesn't feel that contradictory for me to believe insider trading should be a illegal in equities but legal in commodities, if only because of the externalities involving trust in corporate governance, the conflicting incentives (if the CEO can short his own stock, that creates some perverse incentives). But there definitely a pro-market-signalling argument to be made WRT to the OP's article.

The thing with asymmetric information is that it quickly becomes a fraudulent behavior, i.e. 2008 mortgage crisis.

When you know something the other party doesnt, and specially if that party doesnt have access to that information, its hard to see that situation as not abusive.

The game doesnt require cunning to be profitable to all parties, and information asymmetry is a tool to profit from a zero-sum like mindset.

On the other hand, the stock market operates vastly on insider trading, because even though its a rule, its very hard to enforce.

There are a lot of disclosure laws in real estate, though. When you go to sell a house (in my state, anyway), it is against the law to say that the basement has never flooded if it has flooded.

I should hope that is illegal to lie during such a transaction. Real estate disclosure laws don't cover that, though. They cover information you are required to volunteer to serious buyers. In the absence of such laws, you would not need to say anything about the state of your basement unless the buyer specifically asked.

Exactly. And that's why we have those disclosure laws, to make it against the law to take advantage of the fact that a buyer didn't think to ask a particular question.

You should be able to buy a stock without having to ask the seller "Hey, did you just get a heads up from the CEO that this is going to tank?"

There are lies of commission, but also lies of omission.

"Milton Friedman, laureate of the Nobel Memorial Prize in Economics, said: "You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that." Friedman did not believe that the trader should be required to make his trade known to the public, because the buying or selling pressure itself is information for the market"

Friedman is full of crap.

Buying or selling pressure are indication that someone thinks the market will move in a certain direction. They do not indicate which someone, why they believe that, or how confident they are in their prediction.

Thus, even if we assume all market actors are perfectly rational with respect to the information they possess (which is never true), a mere short-term price shift due to buying or selling activity, even when the quantity of the activity (units bought/sold and at what prices) is made public, does not actually give us information about the beliefs and confidences of the person buying/selling.

If I want to treat sales as information and use them to assess where I think prices are going to go, I have to have all information available about the sales. I can't even estimate other people's beliefs about the sales without knowing about what transactions they make and what their portfolio looks like.

Unless someone's got some kind of super-Aumannian probability math for applying to imperfectly rational agents of whom we have imperfect knowledge, which we can use to make reliable estimates of probability and financial value despite all those levels of imperfection.

EDIT: OW, my brain hurts, and I feel like I need to go eat an advanced probability textbook.

I don't see your point. Friedman wasn't saying that the market would know that a specific executive was selling or buying stock, but rather, that the very act of anyone selling or buying stock by definition affects the price of the stock, and that it's better to allow people with the most information about a stock to influence the market.

This didn't stop the huge asset bubbles that formed due to the opaque markets of derivatives from forming.

Buying and selling pressure don't communicate things like size very well, but its often an extremely important point that we need to consider when thinking about the health of a market.

Allowing insider trading brings along with itself a whole slew of perverse incentives. The biggest by far is that most categories of 'insiders' are also in a position to materially impact the value of companies. Parties like tax auditors, advisory services around mergers & acquisitions, management consulting, that sort of thing. Insider trading is therefore partially a protection against conflict-of-interest.

What you are talking about broadly is Control Fraud[1]. One of the most startling things about mainstream (neoclassical) economic theories is that they implicitly make the assumption that control fraud doesn't exist[2]. Yet it has been the cause of many recent high profile crises [3][4][5]. So when you see people talking about how insider trading can't ever be bad, and how executive interests are always aligned with public good, keep in mind that those people are living in a fantasy world where Enron never happened.

[1] https://en.wikipedia.org/wiki/Control_fraud

[2] http://neweconomicperspectives.org/2013/07/discrediting-regu...

[3] https://en.wikipedia.org/wiki/Savings_and_Loan_Crisis

[4] https://en.wikipedia.org/wiki/Enron

[5] https://en.wikipedia.org/wiki/Worldcom

There's a huge difference between special knowledge and expertise and material non-public information that you know will move markets.

Martha Stewart didn't go to jail for having any specialized knowledge, she went to jail because someone tipped her off that a company she was invested in was about to go south. She sold those shares to someone who had no reasonable way of knowing what she knew which is essentially a type of fraud.

No. The reason that trading on insider information is illegal isn't that some third party is injured (if anything, martha's sales caused the third-party get a better price than he would have otherwise!) It's illegal because the officers of a company and the employees of a company are supposed to be doing the job of running a company for the benefit of the shareholders, and there's opportunity for some pretty massive conflicts of interest if they're also playing games trading stocks / stock-tips instead.

And also because people think it's "unfair", like the stock market's supposed to be a game or something rather than a place that you can buy and sell stock for a price which is well-correlated with the company's prospects. :P

That is the agency problem and bans on insider trading do not directly address that. The agency problem is addressed through bans short-selling and put options, as long as the officers and directors have along exposure to the share price, their interests are aligned.

The ban on inside information is intended to attract capital by ensuring that stock markets are fair and transparent. If the investing public believes that the stock market is nothing more than a con to take rubes' money capital will stay away, and keep capital from flowing to productive firms.

> If the investing public believes that the stock market is nothing more than a con to take rubes' money capital will stay away

No way - now 401ks are the only retirement savings vehicle aside from striking it rich through lottery or stocks. Guess how many people translate their investment in a mutual fund to the actual stock market shenanigans?

The point of the commodities market is to provide hedging instruments for commercial producers and consumers. It's difficult to imagine the commodities market being useful if you ban every potential customer and leave nothing but speculators.

Right. I was responding to the concept of insider trading in general, even after reading the article, I don't feel that I know nearly enough about the arcane commodities market to speak to that scenario.

She mostly went to jail for obstruction of an agency proceeding, and making false statements to federal investigators. She should have only said "I want my lawyer". Never talk to the police!

No, Martha Stewart went to jail for obstruction of justice because she lied to the investigators about someone giving her a stock tip. She likely would have been fine if she had just told the truth (or had just refused to talk).

That's splitting hairs, though. She lied because she knew that what she did was against the law. She was held up as an example not to dissuade people from lying to investigators as much as to dissuade people from insider trading.

That's not fraud.

Not that I agree with insider trading, but preventing it through legislative means strikes me as a "band-aid" solution.

The problem comes in a more specific case than that.

We know Twitter has filed for an IPO. Will it be good? Will it be bad? We don't know any of their financials. But insiders know.

Now, granted, they'll file paperwork to show them before people can buy, but that's (partially) due to the same thought process as 'insider trading is bad.'

Now, imagine a situation a year after Twitter IPOs: An all-hands meeting, where management tells everyone that they won't be getting their annual raises because finances are bad. Employees can exploit this knowledge, but those not in that (private) meeting cannot.

Any information asymmetry _will_ be gamed.

Here's why this exists:

Say I'm Kellogg's. I make Cornflakes. I pay $x/ton for corn and I sell Cornflakes for $3 a box. Now say that due to a drought, the price I pay for corn is now 2x. I have to raise the price of Cornflakes now. Consumers don't want to pay $5 for a box of Cornflakes, and my sales drop.

But if I buy corn futures when the price of corn is low, then when it goes up those become more valuable, canceling out some of my increased supply cost, therefore my business is less exposed to risk in price volatility of raw materials.

In other words, it's for hedging.

Now, there are various ways to exploit this unethically, for example if I as a commodity trading bank, actually have control over the prices of the commodities. We're right to be concerned about that. But commodities hedging itself is a good thing for the economy and we shouldn't spread FUD about it.

Correct, and to be clear, that is exactly what Kellogg's, General Mills, Coca-Cola, and other big food companies have been doing for years now. It's not uncommon whatsoever -- if anything, it's considered a best practice -- to hedge on commodities prices if your fundamental business depends on them.

In and of itself, that big food companies deal in commodities futures (call and/or put) is neither surprising nor irrational.

Things start to get scary when speculators dominate the markets for those commodities, and when commodities houses corner markets. The reverberations across various sectors of the economy would be frightening if anything went to shit at even one commodity shop.

What? People who use commodities to power their business are trading commodities futures on the futures exchanges??!?? Perish the thought!!!

The difference is whether they're using them for speculation or (real) hedging.

Actually that doesn't make a difference.

The entire point of the free market is to provide for speculation. People buying and selling goods for real dollars where they have real risk is called 'price discovery.' It incentivizes discovery of information relevant to the market and dissemination of that information to the market via price.

Lets take the example of corn flakes, I'll be a speculator, every day I watch the corn fields, one day I see a fire start on one of a field ostensibly representing half of that year's corn, I buy corn at any price knowing it will go up because the world's supply has just been cut in half. Next week I sell all that corn and take the profit as fruits of my labour.

People who trade Wal-Mart stock will often request satelite images of Wal-Mart parking lots to estimate sales. Just imagine the ingenious ways commodities traders use to discover information about supply and demand.

Farmers are completely free to sell their corn direct to consumers, but most prefer not to because that isn't an efficient or effective way of selling. Don't blame Cargill, blame farmer John down the street who wants the best price for his corn.

For big commodities like corn, that might not be a solution, but I'd like to build a startup that covers some huge market inneficiencies - for example, peppers grown 500 km from the city I live in are sold at U$ 1, while they cost U$ 4 at the supermarket.

Do you mean as in 500km from your city you can buy peppers for $1 and they cost $4 in the city?

Or did you mean that there is a $3 price discrepancy for peppers between the supermarket and the fruit stand?

I meant that in 500 km from my city you can buy peppers for $1 and they cost $4 in the city.

they're about $3 in the fruit stand and $4 in the supermarket.

Yeah. Thanks. But the point of the article is that is is surprising (regardless of it making a difference), that companies who you would expect to be using commodities primarily for hedging are using it much differently.

It's not a free market when the players get too big.

Isn't the title of this a bit misleading? Cargill doesn't sell corn flakes, it (possibly) sells physical grain to Kellogg's, or derivative products to hedge Kellogg's exposure.

I would say the title is an indication of how bad the article actually is. It is a shame they wrote such an information free article.

Cargill is a fairly interesting company and like all big and small grain companies, they hedge their inventory. Grain is a very low margin business and it is very important to protect both the company and the farmer from market volatility. This does tend to put these companies in the financial instruments business and they do tend to expand past agriculture.

disclaimer: worked for Cargill at one time and will not go into any depth other than to say the article is a bit information lite and the title is horrible, ill-informed dreck that I expect.

You clicked the link -> mission accomplished

If the point was to attract a more general audience to the subject matter I'd say the title was accurate enough.

Agreed. The folks who sell corn flakes could refer to either a) Grocery and general merchandise stores or b) Consumer packaged goods companies.

"Last year, the Global Financial Markets Association, a lobby group for banks, commissioned a study on whether trading houses are “too-big-to-fail.” Hoping it might convince officials to regulate these companies like banks, GFMA abandoned the study after Pirrong, its author, reached a different conclusion."

Seems like Pirrong was intellectually honest :)

I looked up some links on his study:

http://www.bloomberg.com/news/2013-05-15/commodity-trader- failure-seen-as-limited-economic-risk-in-study.html


Can we please stop it with the breathless conspiracy theory posts here? Especially from sources like the New Republic.

This was extremely difficult to read. Let's start with: Goldman has not just become a commodities trader. It has been one since 1981! And the article goes downhill from there.

And secondly, http://en.wikipedia.org/wiki/Futures_contract#Origin "The first futures exchange market was the Dōjima Rice Exchange in Japan in the 1730s"...

This article is dramatically light on specifics and historical context and heavy on innuendo and fearmongering.

As everyone else is saying, this article is spreading fear for no reason. Working with financial markets is a key technique for commodities companies and always has been, particularly to hedge. The net result is that food prices are lower and more stable.

The exception is onions. Onion futures were outlawed 50 years ago for "reasons" given in this article, and onions are more volatile than oil, which is the _most_ traded, speculated-on, and manipulated commodity.

In summary, the author of this article is calling for forcible action that would hurt peoples' lives, potentially even disrupting world food supplies.

I'd like to point out that this is a perfect example of how not to build mobile versions of a site. Due to changes in how iOS 7 Safari hides and shows the tool overlays when scrolling, they are now permanently displayed on this site. You never know when the browser interface will change like this.

Also, Apple has really screwed up with this feature change in Safari. There's so much to like about iOS 7 but not this. I've been working with the beta since it launched and have been hoping for this feature to be reverted but it looks like it's going to production now.

Meh, Chrome on iOS has had peekaboo interface elements for a long, long time. It works fine 99% of the time until you run across a site like this one.

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