Steve Waldman unleashes
a heartfelt cry in the face of uncaring markets – a cry for the short
seller, a breed among which he counts himself. He’s responding to my blog
entry saying that there’s no legal case on behalf of short sellers against
investment banks and the like, and he’s not convinced:
Bears who were right deserve to get paid just as much as bulls who were right,
and justice delayed is justice denied for shorts. Similarly, investment banks
who knowingly overpay for assets in order to prevent larger losses on derivative
positions are market-manipulators, and should face consequences for that.
As should central banks and sovereign wealth funds, if their trading in markets
other than their own debt is driven by anything other than direct return maximization
as ordinary price-takers. There is no theory that lets us give real-world
meaning to market prices when price-setters are driven by second-order side
effects rather than direct valuation of the assets being traded. We have no
reason other than blind faith or ideology to believe that anything resembling
efficient allocation of real resources would occur in an economy driven by
capital markets with bizarre feedback loops. I think we are watching capital
market failure happen all around us, and it will work out badly.
I feel for Steve, but I don’t agree with him. For one thing, there’s only one
species of investor who "deserves to get paid", and that’s an investor
with a contract which guarantees him money. I think they’re called bondholders.
If you buy a security in the hope that its price will rise, or sell a security
in the hope that its price will fall, you don’t "deserve to get paid"
anything, whether you’re right or whether you’re wrong. Markets are not some
kind of primary-school sports day where prizes get awarded to the most deserving.
In the words of parents worldwide, "life’s not fair".
Secondly, no one is accusing invvestment banks of knowingly overpaying for
assets. The only real accusation is that they might be knowingly holding onto
assets for which they overpaid in the past, rather than selling them and revealing
their real market value. The only time an investment bank will knowingly overpay
for an asset is when it knows that there’s a buyer in the future who will pay
even more for it. (Think Nigerian barges, here.) That might well be fraud, but
it’s not market manipulation.
Thirdly, central banks and sovereign wealth funds and other international institutions
such as the IMF have lots of motivations beyond "direct return maximization"
in terms of how they invest their money. They always have, and they always will.
Traders and investors know this, which is why they can make lots of money buy
buying Mexican debt in 1994 on the true grounds that Mexico won’t be allowed
to default. (They can also, of course, lose lots of money buy buying Russian
debt in 1998 on the false grounds that Russia won’t be allowed to default. That’s
markets, that is.) If China or Norway wants to be long Treasuries or short Wal-Mart
for non-economic reasons such as supporting exports or punishing union-bashers,
that’s entirely their prerogative.
Steve is living in cloud cuckoo land if he believes in the "real-world
meaning of market prices on the basis of direct valuation of the assets being
traded". If that was really the case, then there would never be any price
difference between voting shares and non-voting shares, for starters. Capital
markets, in this sense, have been failing for as long as they have existed.
And a lot of smart, long-term investors have made a lot of money by arbitraging
those failures. On the other hand, a lot of smart, long-term investors have
also lost a lot of money by attempting to arbitrage those failures.
Being smart and right is not enough to make you rich.
If Steve is really punting his life savings on a belief in "efficient
allocation of real resources," he’s got much bigger problems than market
manipulation which may or may not be going on in some dark corner of the CDO
world. Yes, Adam Smith’s invisible hand has been surprisingly effective over
the past couple of hundred years. But the surprising thing is precisely that
there is some efficient allocation of real resources – not that
there is inefficient allocation of real resources. Real resources have always
been allocated inefficiently, and they always will be. Just look at the fashion