Kevin Drum - June 2013

How Wall Street Takes Ordinary Schlubs to the Cleaners

| Wed Jun. 12, 2013 5:00 PM EDT

In my previous post I wrote about the disclosure that, for a price, investors can get access to the University of Michigan consumer confidence index a few minutes before the usual 10 am release time. In fact, high-speed traders pay to get access just two seconds earlier than everyone else. I concluded that instead of having to work harder or risk breaking the law to get early information, as in the past, "now you just have to pay a fee in order to guarantee that you can take all the ordinary schlubs to the cleaners." Felix Salmon, ever the contrarian when it comes to little guys getting screwed by Wall Street, tweeted back:

Dear @kdrum, how exactly are ordinary schlubs being taken to the cleaners here?

Well, here's my case, in convenient list form:

  1. Wall Street traders are paying for this early information.
  2. They aren't idiots. They'd only do this if they could make trading profits based on their insider knowledge.
  3. No new money is created by making this information available to a few well-heeled traders a few minutes before everyone else. It's a zero-sum game.
  4. Thus, someone is getting the short end of these trades.
  5. That someone must be the people who aren't paying for early access. There's no one else these traders could be taking advantage of.
  6. And who are these folks? I don't know. But almost by definition, once the snowball rolls all the way downhill the answer has to be people who aren't plugged in and don't have the money to buy early access. In other words, ordinary schlubs.

I'll grant that this argument isn't 100% watertight. It's possible that the early-access crowd all spend a few minutes fighting with each other, and by the time 10 am rolls around the market is exactly where it would have been otherwise. It's also possible that Wall Street's sharpest traders pay for this information in order to get better returns for the widows and orphans funds they run. But I don't believe in the tooth fairy and I don't believe in either of these things either.

Bottom line: the release of financial information moves markets. If you have early access to this information, it means you have privileged insight into how the market is going to move five minutes from now. That's a moneymaker, and the money is made from all the people who trade with you during the period when you know more than they do.

Wall Street pros, of course, have always known more than most of us. They work harder, they have more training, they have Bloomberg terminals, etc. That's produced a skyrocketing amount of unproductive financial activity over the past few decades, but usually in ways that are at least marginally defensible. This latest disclosure, however, is almost a parody of unproductive financial activity. Not only is it obviously socially useless, but there's just something a lot rawer about providing an early release of supposedly public financial information to a chosen few who are willing to fork over a bit of squeeze. Welcome to the schlubocracy.

UPDATE: Karl Smith provides a more macro version of this argument here. It's worth a read.

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The Financialization of America: A Wee Example

| Wed Jun. 12, 2013 12:47 PM EDT

Once a month, at 10 am, the University of Michigan releases its consumer confidence index. But not everyone gets it at the same time. Thomson Reuters pays Michigan a million dollars a year for early access:

Five minutes before that, at 9:55 a.m., the data is distributed on a conference call for Thomson Reuters' paying clients, who are given certain headline numbers.

But the contract carves out an even more elite group of clients, who subscribe to the "ultra-low latency distribution platform," or high-speed data feed, offered by Thomson Reuters. Those most elite clients receive the information in a specialized format tailor-made for computer-driven algorithmic trading at 9:54:58.000, according to the terms of the contract. On occasion, they could get the data even earlier—the contract allows for a plus or minus 500 milliseconds margin of error.

Read the whole story for more, but in the meantime just sit back and be amazed at how high-speed trading has changed things. Getting early access to economic information has been important for centuries, and people have always been willing to pay for that early access. In the past, though, getting early access has always required either putting in extra work—for example, paying lookouts for early reports of ships coming into port—or else outright fraud—think Trading Places. But not anymore! This isn't exactly something that either Michigan or Reuters advertises, but now you just have to pay a fee in order to guarantee that you can take all the ordinary schlubs to the cleaners.

This is a small example of the financialization of America that I posted about yesterday. It has no possible social value, and it doesn't make credit markets more efficient in any way. It's just a purely artificial way for the rich to hoover up economic rents, and it's fully institutionalized and above board. Lovely, isn't it?

Chart of the Day: The Great Gatsby Curve

| Wed Jun. 12, 2013 12:11 PM EDT

Via Counterparties, I see that the White House has released an animated version of a chart created recently by Alan Krueger, Chairman of the Council of Economic Advisers:

The Great Gatsby Curve illustrates the connection between concentration of wealth in one generation and the ability of those in the next generation to move up the economic ladder compared to their parents....The curve shows that children from poor families are less likely to improve their economic status as adults in countries where income inequality was higher — meaning wealth was concentrated in fewer hands — around the time those children were growing up.

In a nutshell, children of poor families have a hard time moving up in the world in countries with lots of income inequality:

So why does this matter for the United States? The U.S. has had a sharp rise in inequality since the 1980s. In fact, on the eve of the Great Recession, income inequality in the U.S. was as sharp as it had been at any period since the time of "The Great Gatsby."

I know I've declared jihad on animated GIFs, but this one is actually sort of useful. It only takes a minute to unfold, and it demonstrates the problem pretty dramatically. Krueger's full speech from last year is here.

Quote of the Day: Darrell Issa Wins the Chutzpah Award for June

| Wed Jun. 12, 2013 11:06 AM EDT

From Republican attack dog Darrell Issa, responding to a request from Rep. Elijah Cummings (D-Md.) that he release full transcripts of interviews with IRS workers, not just cherry-picked excerpts:

Your push to release entire transcripts from witness interviews while the investigation remains active was reckless and threatened to undermine the integrity of the Committee's investigation.

Once again, there's a little piece of me that admires such naked chutzpah. Issa is basically saying that it's OK to release little pieces of the interviews that are ripped out of context to create a false impression of White House involvement, but it would be reckless to release full transcripts that pretty clearly shows the White House had nothing to do with any of this.

Who thinks up this stuff? It might occur to me to mumble something about an ongoing investigation and then duck back into my office, but to go on the offense and explicitly suggest that releasing full transcripts would be reckless? It takes a special kind of mind to think you can get away with that.

Housing Prices Are Up, Up, Up in Southern California

| Wed Jun. 12, 2013 10:25 AM EDT

Housing prices nationwide are up, but in most areas we haven't seen scary kinds of increases. It's a different story here in Southern California, though, where home prices have risen 25 percent in the past year:

"We're deep into uncharted territory," DataQuick President John Walsh said, citing "razor-thin" inventory, pent-up demand, low interest rates and all-cash purchases by investors and wealthy individuals. "How this all plays out is educated guesswork at this point."

....Extremely low inventory and mortgage rates have ignited those bidding wars and helped turn the housing market into an economic bright spot — both in the Southland and nationwide. Investors have also played a major role in the recovery that began last year, buying run-down, lower-cost properties to fix up and rent out.

Is this a bellwether for the future—and for the rest of the country? Maybe not. Richard Green, director of USC's Lusk Center for Real Estate, thinks prices will ease later in the year for a simple reason: "Ultimately, people don't have the income," he says. That's cheery news, isn't it?

Watching the Watchmen, NSA Edition

| Wed Jun. 12, 2013 9:35 AM EDT

Dan Drezner has a generally good take today on the NSA surveillance programs that have dominated the news for the past week. It's worth a read. In particular, here's his response to Tom Friedman's conclusion that the programs don't "appear" to have been abused:

Friedman allows that these surveillance programs are vulnerable to abuse but says that, "so far, [it] does not appear to have happened." Here's my question: how the f**k would Friedman know if abuse did occur? We're dealing with super-secret programs here. Exactly what investigative or oversight body would detect such abuse? What I worry about is that we have no idea whether national security bureaucracies abuse their privilege.

The last time I trusted intelligence bureaucracies and political leaders that the system was working was the run-up to the Iraq war. Never again.

The traditional method of oversight is via congressional committees and the court system. But even if you assume that intelligence organizations are reporting their activities honestly, those don't really work anymore. Once a program is in place, courts end up rubber stamping virtually every application and congressional committees do pretty much the same. They simply become too accustomed to what's going on to truly pay attention. And in the case of Congress, even if some members do have issues, they're all but gagged from speaking out about them.

In some way, it strikes me that the answer needs to lie somewhere else. Someplace where the faces change more often and there's less institutional pressure to automatically approve of whatever's going on. Someplace that has, at the very least, a certain amount of authority to explain publicly the broad outlines of what the surveillance state is doing. But where?

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Maybe America Doesn't Like the NSA Phone Surveillance Program After All

| Tue Jun. 11, 2013 6:07 PM EDT

This is from the AP today:

A leading Republican senator on Tuesday described controversial U.S. spy programs as looking far deeper into Americans' phone records than the Obama administration has been willing to admit, fueling new privacy concerns as Congress sought to defend the surveillance systems.

Sen. Lindsey Graham, R-SC., says the U.S. intelligence surveillance of phone records allows analysts to monitor U.S. phone records for a pattern of calls, even if those numbers have no known connection to terrorism. Graham says the National Security Agency then matches phone numbers against known terrorists. Graham helped draft the surveillance law that governs the surveillance program.

Technically, I guess this is true, since the Obama administration hasn't been willing to say anything about the NSA phone surveillance program. But aside from that, this is what everyone in the world has been talking about for days, ever since the Verizon warrant was first revealed: pattern matching, link analysis, and data mining in general. So this is hardly a fresh bombshell. Still, in a way I guess it's the first official-ish acknowledgement that this is what NSA is doing, so that makes it news.

Elsewhere, CBS News reports that 58 percent of Americans disapprove of the government collecting the phone records of ordinary Americans. Yesterday, Pew reported that 56 percent of Americans approved. Obviously, question wording is going to be a real headache on this issue.

So Far, We Haven't Learned Much From the NSA Leaks

| Tue Jun. 11, 2013 2:02 PM EDT

Sam Stein reports that the Obama White House briefed members of Congress on the PRISM program 22 times between October 2011 and December 2012. However:

The fact that 22 meetings and briefings were held for members of Congress does help the administration argue its case that this wasn't simply an example of executive overreach. That said, it's impossible to know — without receiving notes from the meeting — whether or not the PRISM program was discussed during the sessions, or whether the meetings were more broadly about Section 702.

This gets to one of the reasons that I remain conflicted about all this. The PRISM program itself, as near as I can tell, is mostly a technical means of transmitting data and making it available to analysts. I'd like to understand it better, but the truth is, unless you're a bit of a geek you probably shouldn't care about it much. It's hardly a revelation that the intelligence community uses software to manage its huge masses of data, after all.

What you should care about is Section 702 of the FISA Amendments Act and how it's being interpreted. In other words, you should care about what data NSA has, not what software they use to manage it. So far, though, all the leaks about PRISM haven't really given us any insight into that. We've known for a long time that various agencies have ramped up their use of warrants and National Security Letters to demand data from tech companies, and we've been suspicious for a long time about just how broad this data collection is. Today, in the wake of all the PRISM leaks, we're even more suspicious—but we don't know anything more than we used to. What I'd like to see are the warrants themselves and the minimization procedures attached to them, but so far nobody's leaked any of those.

I feel the same way about the NSA phone surveillance program. When Glenn Greenwald first broke the story, I was a little puzzled, and I still am. This program began in 2002. It was exposed in 2005 and created enormous controversy. In 2007 and 2008, Congress gave it a legal basis. There has never been any suggestion that it was shut down, and I can't figure out why anyone would have thought it ever was. I sort of feel like this was a fight we lost years ago.

Bottom line: I'm happy that this is getting another round of scrutiny, but I'm still not sure what I've learned that I didn't already know. That will require either different leaks or else a decision by the White House to produce a serious white paper about our nation's surveillance programs—something I'll bet they could do without seriously endangering any of them. Unfortunately, the presidential candidate who campaigned on his commitment to more transparency in these programs doesn't seem inclined to do that now that he's sitting in the Oval Office. So I guess we'll have to rely on more leaks instead.

UPDATE: Alternatively, a bill to declassify key FISA court rulings might be a good start. More here.

Barack Obama and the Anti-Neustadt Presidency

| Tue Jun. 11, 2013 1:17 PM EDT

Jamelle Bouie is dismayed that President Obama decided this morning to announce that he supports the Gang of Eight immigration bill:

In no way is it an exaggeration to say that President Obama’s speech came at the worst possible time. Later this afternoon, the Senate will take a procedural vote that will determine whether or not chamber decides to begin debate on the Gang of Eight bill.

Insofar that Rubio, Jeff Flake, Lindsay Graham and others were having a hard time bringing conservatives to their side, it’s now even more difficult. And if House Republicans take this as a cue to reflexively oppose reform, it puts Boehner in a tight spot—does he try to build a GOP majority for the bill? Does he abandon the “Hastert rule” and pass a bill with Democratic support! Or does he leave the effort altogether?

If this sounds dramatic, then you are drastically underestimating the anti-Obama furor of the Republican base, which has ended political careers for the sin of being friendly with the president. If Obama wants comprehensive immigration reform to pass, he needs to stay completely out of the way. If he wants to claim some credit, he can do so at the signing.

I don't disagree with Bouie, quite. It's not that. But his post made me wonder if this has now congealed into firm conventional wisdom on both sides: Obama needs to stay aloof from any issue he actually cares about, because his public support is always and everywhere unhelpful. Democrats don't care and Republicans will go running for the exits at the mere prospect of being insufficiently hostile to him.

Is that what we've come to? I guess so, but I still can hardly believe it when I see it actually set down in black and white.

The Financialization of America (and the World)

| Tue Jun. 11, 2013 10:55 AM EDT

Bruce Bartlett writes today about the relentless financialization of the American economy and the danger it poses:

Ozgur Orhangazi of Roosevelt University has found that investment in the real sector of the economy falls when financialization rises....Adair Turner, formerly Britain’s top financial regulator, [suggests] that the financial sector’s gains have been more in the form of economic rents — basically something for nothing — than the return to greater economic value.

Another way that the financial sector leeches growth from other sectors is by attracting a rising share of the nation’s “best and brightest” workers, depriving other sectors like manufacturing of their skills.

The rising share of income going to financial assets also contributes to labor’s falling share....This phenomenon is a major cause of rising income inequality, which itself is an important reason for inadequate growth.

The dangers of runaway financialization are pretty well known and pretty well accepted. Given that, the key question you should ask is: Why? It's not inevitable, after all. The finance industry doesn't grow because some fundamental feature of the modern economy demands it. In fact, it's really more mysterious than it seems. After all, we know why, say, the car industry grew during the 20th century: because more people wanted cars. Likewise, we know why the tech industry is growing now: because more people want to surf the net and play video games.

So why has finance grown? Because the world needs more finance? Up to a point, sure: availability of capital is a key requirement for economic growth in a modern mixed economy. But we passed that point quite a while ago. Capital has been freely and easily available in America and most of the developed world for decades. So again: Why the continued growth? It doesn't seem to be demand driven, so there must be some other reason. Anyone care to guess in comments? No prizes for the right answer, I'm afraid.