Insiders, Rents, and Reuters

Update: Just realized Neil Irwin considers a somewhat-similar idea here, though I think they’re ultimately quite different in design, I discuss it more at the end.

Earlier this week, we learned that the University of Michigan sells its popular consumer sentiment figures to Thompson-Reuters which delivers the elite customers the information 5 minutes before it is made public, and the super-elite 2 seconds earlier still. As you might imagine, the liberal blogosphere is up in arms. “Insider trading” is trending, at least on my timeline.

But this is a blessing and opportunity in disguise. So long as traders are just rational and not super-rational (also known as renormalized rationality; no one thinks they are) the prisoner’s dilemma will trap them in a brilliant bind. The United States government through the Bureau of Labor Statistics, Federal Reserve, and deep network of public universities frequently and freely releases rich and extremely valuable information. Take the payroll report that is released the first friday of every month, and available to all free of charge. As a rational human being, it is almost worthless to me. However, for a trader on Wall Street, the report conveys crucial information on aggregate demand and forms expectations on Federal Reserve action.

This asymmetrical response generates significant rent, in the form of incredible consumer surplus to the financial services, especially high-frequency traders. How much would you pay for the unemployment figures? I’d pay no more than $5 a month, and that’s for personal interest. For a trader, on the other hand, the value is far greater – and more so the earlier he receives it relative to his fellow traders.

One ought to wonder why the public purse is used for information gathering which creates surplus for a small segment of society. The government stands to make deep profit which can finance progressive redistribution and increase both private and social welfare. But it requires an abdication of our gut aversion towards “financialization” or “insider trading” as if that’s something yucky.

Rather, I suggest a process that will work thusly:

  1. Some practical time period, t, before an important government report is released an electronic auction house opens. The SEC (secretly) decides how many “early” permits auctioned would maximize revenue. =
  2. The SEC further runs an auction selling “milliseconds”. You can buy as many “milliseconds” as you want, from the regulated auction market. The SEC does not disclose how many such segments are being auctioned.
  3. Key: The “milliseconds” auction starts before the primary “early permit” auction.

So, the secondary auction starts and a bunch of traders buy their fancy little milliseconds. Mechanism design tactics must be employed to prevent collusion, and the SEC will hire Al Roth to figure something out. A millisecond is rivalrous (not technically, but in principle), that is if I know information one second earlier, it becomes less valuable if you do as well. But no one knows how many total milliseconds there are, and hence will buy what the expect will maximize revenue.

Then the primary auction for “early” permit starts, without which milliseconds are useless. Because many traders have purchased milliseconds, the government has created a captive demand for “early” permits, increasing demand and revenue thereof (and also decreasing rent).

Traders cannot opt to wait for the public information arrival because they know their competitors will just buy it up front. It would be most profitable if they all just waited for the public announcement, but since they all stand a huge benefit from defecting, they will all default. Therefore, their rents are lost because of their own rationality.

I suggest all important economic reports are auctioned this way, like:

  • FOMC minutes,
  • The Beige Book,
  • News of Osama Bin Laden’s death
  • Income reports,
  • Anything and everything markets will like, including,
  • Election results.

just realized Neil Irwin suggests a similar idea, but I ultimately feel they’re quite different. Mine is designed in a way to snare rentiers into a prisoner’s dilemma into a captive demand of information, rather than nice auctions, per se. Irwin ultimately thinks this violates the responsibility of a government; but I think all this data collection is useless for the whopping 99.9% of us that don’t look at trading terminals all day. And yet our tax dollars finance this boring nonsense, creating rents for a small minority. I like Jeremy Bentham a lot, and he’s always inspired my tax philosophy. I say, when in need of revenues, just create artificially new property rights and auction them to the highest bidder.

P.S. Some have responded that traders do indeed collude, as in Libor. This is a failure of SEC criminal (= jail) enforcement. Anyway, mechanisms like this where defecting is so probably is unlikely to create a collusive equilibrium. Trust between traders would need to be too significant. If demand for permits crashed, someone would buy many for a pittance to make a huge profit. Collusion is not stable.

But say they all did collude not to buy until the public disclosure. Well, that’s not too different from today…

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