Category Economy

I Know You Have More Information Than Me

Danny Vinik 1 Comment

Matt Levine wrote a terrific piece at Bloomberg yesterday on New York Attorney General Eric Schneiderman’s attempts to crack down on high frequency traders getting information milliseconds before the rest of the market. This happened a couple of times over the past couple of months and Schneiderman is concerned about the “dumb money” on the other sides of those trades who are being ripped off. Levine doesn’t argue against that notion, but comments that it isn’t small investors who are the ones being ripped off. It’s the other high-frequency traders who aren’t receiving the market moving data milliseconds ahead of time. Levine’s main point is that ordinary investors should never try to compete with high-frequency traders, whether or not they get the data milliseconds in advance. Instead, they should look to compete on a longer time horizon.

That’s entirely good advice and Levine is right that it’s other high-frequency traders who are hurt by the ones getting the market moving data in advance. But I want to push back on one thing he said earlier in his post:

One way you can tell it’s bunk is umm there are markets and they are not essentially equal. This is a true story: Many banks employ analysts who write detailed research reports that include recommendations on whether you should Buy or Sell a stock, and they give those research reports to their paying clients and not to anyone else. Those clients are paying for an unfair advantage!** But it’s not just banks. The Wall Street Journal employs journalists who find news and then make that news available only to paying subscribers. Bloomberg employs journalists who find news and then make that news available to anyone on the Internet, shortly after making it available only to paying Bloomberg terminal users.

The “essential equity of the markets” is bunk because the essence of the markets is inequity. You trade because you have, or think you have, better information than someone else. If everyone had the same information, and believed that they had the same information, there would be no markets.

That’s true as well. But the difference is that small-time investors know that they don’t have the same information as banks and the clients of those banks. They are aware of the information asymmetry and believe they can beat the market anyways.

But when traders gain market moving data ahead of time, investors don’t know that they are playing on a tilted playing field. They believe they all are receiving the same information as everyone else at exactly the same time. They know they are competing against high-speed supercomputers and are at a disadvantage there. They don’t know that those supercomputers have a head start on them. As Levin notes, this doesn’t really make a difference for those investors because they can’t compete with the supercomputers anyways. It’s other supercomputer that aren’t privy to advance copies of the data who are the “dumb money.”

But just because there information asymmetries, that doesn’t mean that markets are unfair, in an equitable sense of the word (not a market failure sense). As long as you know that you face an uphill battle against investors with lots more resources and lots more information than you, you’re welcome to try to beat the market anyways. It’s when you don’t know that you’re facing an uphill battle that things really become problematic.

Rand Paul is Willing To Breach the Debt Ceiling

Danny Vinik 1 Comment

Republican Senator Rand Paul (R-KY) has been a rising star in the GOP the past couple of months, particularly after his drone filibuster. He’s been the leading libertarian voice, following in his father’s footsteps, but with a more populist tone that could give him a legitimate shot at the Republican nomination in 2016. However, he is very, very confused about how harmful breaching the debt ceiling would be. Here’s what Paul said on Glenn Beck’s radio show this afternoon:

With the debt ceiling, I’ve always been willing to go through the deadline. I’m willing to go a month, two months, three months, as long as it takes. And I think we could use that leverage to bring the Democrats to the negotiating table.

AHHHHHHH. I honestly don’t understand how Paul can think this. By all accounts, he’s a smart, hard-working guy who believes in what he says. But he can’t possibly think that breaching the debt ceiling for three months would be acceptable? That would be a disaster of unheard of proportions. Our interest rates would rise significantly, increasing the cost of our debt by trillions of dollars in the long-term. Vital government services that keep the country going would stop. Three months of that could lead to anarchy.

And this was all after Paul said that he doesn’t want a government shutdown, because it would be bad for the Republican Party. Undoubtedly, Paul understands that a government shutdown would be bad for the country as well. But does he really think that breaching the debt ceiling for 90 days is more acceptable than a government shutdown?

Maybe Paul is bluffing here so that Republicans will be in a better position to extort the President.  Maybe he is trying to shore up support from the base. I don’t know. But the casualness with which Paul speaks about breaching the debt ceiling and causing an international financial crisis is alarming. I truly hope he doesn’t believe what he’s saying.

Debt Ceiling Extortion

Danny Vinik 7 Comments

I have no doubt that Congress will raise the debt ceiling. Republicans simply have no choice, but to accept defeat and move on. The United States government pays its bills. Period.

Beyond that though, it’s remarkable how idiotic this argument has become.

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Republicans cannot hold the debt ceiling hostage.

In 2011, the last time debt ceiling brinksmanship almost caused an international financial crisis, Republicans were screaming that any debt ceiling increase must be offset by equal spending cuts. The entire goal was to reduce the deficit. While playing chicken with the debt ceiling was irresponsible then, there was at least a bit of logic in terms what Republicans were holding hostage and their ransom demands.

This time though, Republicans are holding the debt ceiling hostage while demanding a one-year delay in Obamacare. There is no connection between the two. Republicans are using the debt ceiling to extort the President. Worse, some Republicans seem ready to breach the debt ceiling if Obama does not back down and agrees to delay his signature legislative achievement. This is where things get absurd.

If we do breach the debt ceiling, it will likely have a significant, long-term negative impact on our debt. Rates on U.S. Treasury notes are lower than any other bond because investors are 100% confident that the U.S. will repay its creditors. The chance that a debtor doesn’t pay its creditor is called credit risk. Companies and countries close to bankruptcy have high credit risks. But the United States is never close to bankruptcy because the dollar is the world’s reserve currency and the U.S. can print its own money. It can always pay back its creditors. That’s why interest rates on Treasury bills are so low. But, if we breach the debt ceiling, that non-zero credit risk rises substantially. Suddenly, it becomes a very real possibility that the U.S. could not pay its creditors. Even if Treasury prioritizes bond payments so it does not technically default on its debts, the act of breaching the debt ceiling will likely shock investors and force them to increase the risk assessment of Treasury notes. That means considerably higher-interest rates for the U.S. in the long-term and thus higher interest payments.

In 2011, J.P. Morgan estimated that rates on Treasury Bills would rise 50 basis points if we breached the debt ceiling. They predicted that it in the long-term, that would add $75 billion per year to the deficit.  Compare that to the sequester, which was the result of the 2011 debt ceiling deal. It cut spending by $1.1 trillion over 10 years. Breaching the debt ceiling would effectively undo nearly three-quarters of those cuts in the form of increased interest payments.

So, in 2011, Republicans were so concerned about the deficit that they took the debt ceiling hostage to extract $1.1 trillion in spending cuts.
Now, Republicans are so concerned about Obamacare that they’ve taken the debt ceiling hostage and risked adding $750 billion to our long-term debt.

If Republicans were so worried our long-term debt two years ago, why are they willing to undo most of those spending cuts this time? Does that seem like Republicans actually care about our debt and are using the debt ceiling as a principle to get our fiscal house under control? Or does it seem more like an irresponsible, reckless party risking a global financial collapse in order to extort the President?

That’s why President Obama and Senate Democrats cannot and will not negotiate on the debt ceiling. There is nothing principled about Republican arguments here. The debt ceiling is simply a mechanism to hold the President hostage and force his hand. That’s unacceptable. Enough with debt-ceiling histrionics. Our democracy does not work that way.