Arnold Kling  

Stock Market Regulation

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Regulatory Pollution... Comment of the Week, 2003-04-3...

'Jane Galt' casts doubt on the deterrence value of the settlement in which Wall Street investment firms agreed to pay a large fine.


I don't want this to be the opening act in some morality play, directed by Spitzer, in which the rest of America is absolved for speculating wildly on investments they don't understand.

Meanwhile, a wire service reports that Vanguard's index fund has gained in popularity.

A stock index fund run by the Vanguard Group was the best-selling U.S. mutual fund last month, as investors who have poured money into bonds showed new interest in stock portfolios, according to data released on Thursday.

In contrast to the nonsense perpetrated by stock analysts, Vanguard sends investors the analysis of experts informed by economic wisdom on efficient markets and portfolio theory. For example, their latest newsletter has advice from seven respectable experts, all of whom decry strategies that involve frequent trading. For example, William J. Bernstein writes,

The sooner [investors] learn about market efficiency and the importance of a long-term strategy that takes this efficiency into account, the better off they will be.

...turn off the TV, stop browsing the Internet, toss out their financial publications, and read books. There are two classics that everyone should digest before they invest a dime. Burton Malkiel's A Random Walk Down Wall Street and John Bogle's Common Sense on Mutual Funds.


The New York Attorney General can punish those who gave poor financial advice. But it's more heartwarming to see the Darwinian market process reward investment firms that offer respectable economic advice.

For Discussion. The alleged abuses occurred while the market was going up. Should they have been prosecuted at that time, rather than after the crash?



COMMENTS (4 to date)
David Thomson writes:

"The alleged abuses occurred while the market was going up. Should they have been prosecuted at that time, rather than after the crash?"

How does that old saying go? It's better late than never. We are presently paying the price for not listening closely to Adam Smith's warning that business people are inclined to collude against the general public. Regretfully, the ultra-Libertarians were able to seduce our political leaders into allowing the foxes to guard the hens.

Mark writes:

"The alleged abuses occurred while the market was going up. Should they have been prosecuted at that time, rather than after the crash?"

Prosecuting any complicated case takes time, so a significant time lag in cases like this is unavoidable.

David Thomson writes:

"Prosecuting any complicated case takes time, so a significant time lag in cases like this is unavoidable."

You are only half right. Actual prosecution might take a little time---but the very fear of prosecution would have had an immediate impact for the good! Moreover, even a mild hint might have been sufficient.

Bob Coleman writes:

The fine of $1.4 billion is less than 7% of the $21 billion in pretax profits for the ten Wall Street firms for the single peak year 2000 out of a multi-year fraudulent scheme of tainted stock research. By comparison, the top marginal income tax rate for New York City is 12.15% and for New York State is 7.7%, and the highest sales tax rate is 8.625% for New York City and 8.75% for New York State. In other words, such a penalty is merely a relatively small cost of doing business.

In addition, about 2/3 of this fine is tax-deductible and covered by insurance reimbursements. This means that the U.S. taxpayers are going to pay much of the cost of this massive fraud scheme, and the other customers of the related insurance companies are going to pay higher premium rates in future to recoup the claims payments.

Self-regulation does not work in the investment banking and stock research/brokerage arena. The stakes are now far too large, and the degree of financial sophistication is now far too great, often PhD machinations. The result will be regulatory capture. Who is watching the watchers? The new SEC Chief, William Donaldson, has a long Wall Street career and related network to protect. What is needed is a true outsider to the financial services industry, maybe a retired high-ranking military officer, to clean up the manifold conflicts of interest sufficiently to restore investor confidence.

The corrupt greedy CEO's and senior managers in the chain of command of all ten of the firms in the recent record-size settlement should be investigated, and where appropriate charged individually for criminal fraud, take a perp walk on video-camera, and serve time to think about their shameless publicly announced attitudes (arrogant gloating, for example, by Merrill Lynch and Morgan Stanley in the The Wall Street Journal) and their corporate cultures of greed and crime while behind bars in state prisons, not in federal minimum-security country clubs.

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