The Market for Rents

“There are rents. Look around.” would inaugurate my ideal essay. Since I learned about the economic definition of supernormal profit, I’ve been fascinated by the idea of rentiers. This informs my admiration for David Ricardo and Henry George, as well as my broad disdain towards aspects of Wall Street. When I recently heard that Thompson Reuters sells its report early to elite traders, where Paul Krugman and Kevin Drum see a vindication of wasteful finance, I see the model for an extremely effective tax on rents. I want markets to work, and I see this as a robust financial transactions tax. I’m excited! 

My previous post, arguing for the sale of government information as a tax on rents has received some attention. I left the idea half-baked, and I want to clarify specifically why this would be socially beneficial. Roughly, I want firms to “buy” their rents. Think about a government-issued permit sold for $p that promised you $n in risk-adjusted profit. By definition, (p-n) is your rent. If the permit provides access to early information, an increased demand for the permit does two things, increases p (because other things equal, an upward shift in demand raises the market price) and decreases (because other things equal, if someone else has access to early information, your access is that much less valuable).

If somehow, the demand for such permits was a positive feedback loop – that is, increased demand induced a further increase in demand – then a competitive market would clear at a point where p = n, eliminating all rents from the information. However, there are two components of profit from a government-issued report:

  1. The value of the information itself – perhaps the implication of a payroll jobs report on the state of aggregate demand.
  2. The value of knowing the information before the market. We know that for the University of Michigan consumer sentiment report, this is at least in the millions.

It’s curious that people think (2) is more morally questionable than (1). Actually (2) is just firms eating each others profit in a way that doesn’t really hurt or help society. (If J.P. Morgan pays off Barack Obama to learn who the next Fed chair will be, this will just increase their relative profits to Goldman Sachs). On the other hand, (1) allows highly-scaled trading firms – with access to cutting, proprietary algorithmic and technological edge – to earn a profit on publicly financed information.

Think about the jobs report, which costs money, and scares some Republicans about privacy and individual rights. The value of its publication is quite minuscule to the average American. But it is highly valuable to Wall Street which will then bet on things like overall market health or chances of a QE taper. It’s a classic example of Mancur Olson’s “dispersed costs and concentrated benefits”.

What if we can design a mechanism that uses (2) to capture the rents from (1). Enter the following information auction:

  1. The SEC will run two auctions on the open market. One for permits granting the right to early information, and the other for the extent by which each permit-holder will be granted said early information.
  2. Call the second auction the “market for milliseconds”. The SEC secretly sets the maximum number of “milliseconds” by which someone can access information before the public release. Traders then compete to buy the number of milliseconds that maximizes expected profit.
  3. Then the SEC auctions a limited number of permits, for which there is a captive demand as milliseconds are useless without at least one permit. (Rents from the rentiers).
  4. The difference between this and a classic auction as (somewhat sarcastically) supposed by Neil Irwin is the ability to buy the precise extent of information expedition. This is critical in automatic rent elimination.

While the dual-auction may seem like an unnecessary complexity, it both increases revenues and is required to bind profit from information to profit from early information, which is in some way rivalrous, though not technically (the value of my time premium is inversely proportional to the extent of yours). It “discretizes” the market into “buy” and “don’t buy” rather than “buy a little”, as if you bought just one millisecond you would then realize it is not worth it to buy a whole permit. But, if you buy a millisecond at the margin, it is ceteris paribus more worthwhile for me to follow-suit. This is the necessary positive feedback loop. Firms will now keep buying milliseconds until the profit of the information itself is lost. But between “buy” and “not buy”, the former will be the dominant strategy.

This is a prisoner’s dilemma for traders. Ideally, they would all collude to ignore the auction altogether, waiting for the public release of information. But if everyone else colludes, it’s extremely lucrative for me to buy many milliseconds and just one permit. They will all “defect”, creating a competitive market for early information.

The government can do this for the release of every bit of market-important information:

  • Job numbers
  • Barack Obama’s nomination for Treasury Secretary
  • Who will replace Ben Bernanke?
  • Would Obama have signed Obamacare? Dodd-Frank?

I don’t think the market should earn profits from government reports or policy decisions. You can think of this as an automatically-tuned financial transactions tax. This would ideally be very low during most times, but whenever the government releases information, all trades induced by said release should be taxed at a firm’s Bayesian prior that it is accurate. (From the government, this would naturally be certain). The dual auction accomplishes precisely this.

The maximum time period by which the information can be expedited is the total milliseconds on the open market. But it will always be less than that unless one person purchases the whole market. In this case, the government can still capture all rents. On the second market for the permit to use that information, the SEC should just keep purchasing permits from itself driving the market price to the point where the buyer is indifferent. (The structure of an auction makes it quite possible to determine the reservation price). Of course, this is highly unlikely to happen, but is a good illustration of the reason why two markets are required.

It is natural that the government should command the quantity, and not the price, of information. Given a certain price, the government cannot limit the maximum time by which information can be expedited, which is not a desirable uncertainty. Further, auctions in this case better lend themselves to market-controlled rent elimination.

I hope this clarifies the process, and I’m eager to see where else a similar methodology can be used to cancel rents.

  1. First, I’m very impressed by your work. If you’re in the East Coast area come August, perhaps we will even have an occasion to meet.

    Two comments. First, although your focus is on government information, but I think it should be mentioned that your arguments generalize to private sector too. In particular, Thomson Reuters could feasibly use this mechanism to extract more surplus from their clients. This would effectively become a form of first degree price discrimination as you charge each person their full valuation.

    Second, I had a hard time parsing and justifying the two stages of the auction. It seems that you’re dealing with a problem involving auctioning different products (1 ms, 2 ms faster data) while also trying to find the maximum price people are willing to pay for those times. In short, you are trying to both match people to their most preferred product while also charging different prices for these profits. As such, it seems like a matching algorithm along the lines of Gale-Shapley with wages would be appropriate. For more information, see here

    • Yichuan first, thanks! We will be moving to Iowa, but I expect to be in the Philly area for college sometime mid-August, and we will probably go around NE around that time.

      I thought about private information a bit. The example I had, but finally scrapped, was information about Steve Jobs’ health. We could, effectively, make insider trading legal so long as it was traded on an open exchange. I realized the regulations would be too complex to be worth it (even with a high tax on all earnings thereof).

      Your example is better and more feasible because we’re trading a report, rather than a policy statement (like Jobs vs. Obama’s nomination for XX), and there’s less of an agency dilemma. To be honest, we just learned about the Reuters thing, I would not be surprised if this was more common than previously expected (with private estimates of PMI, etc.) As you point out, with price discrimination, they can also achieve much better welfare.

      I need to think about the two-stage auction more, but I thought of it as a way for one auction to capture and remove the rent from knowing information early, and the second part as a way to capture some of the profit from knowing the information at all. The two are very different products, the way I was thinking about it.

      Would Gale-Shapley work with the way early information is structured? It’s not rivalrous, and I don’t know the technical term, but the earlier you buy something, the earlier I will want to buy it, as my chance at rent is inversely correlated with the distance from the person with the most “milliseconds”.

      As such, I don’t really have a most preferred product (however many milliseconds early) without seeing the market work on which to form expectations, as well. Do you know of any searching algorithms that deal with such dynamics? I certainly sense that mine was unnecessarily convoluted!


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