Fallacious Keynesianism: Alive Or Dead?

An anecdote that dramatically illustrates the fallacy of fake Keynesianism is sometimes attributed to the great economist Milton Friedman.  Quote investigator has its doubts about whether Friedman is the original source of the anecdote, so I'll use the letters MF to designate the protagonist.  The anecdote goes like this:  MF was visiting China during the Maoist era, and was taken by his hosts to observe the construction site of a huge new dam.  There MF saw thousands of workers toiling away using picks and shovels to move the massive amounts of earth needed for the project.  MF asked, "Instead of having thousands of workers toiling with picks and shovels, why not use modern tools like bulldozers and other mechanized equipment?"  His hosts answered, "This is a jobs project.  We want to employ as many people as possible."  MF responded, "Then why not give them spoons instead of shovels?"

Keep this anecdote in mind if you find yourself somehow going along with the idea that the answer to some slack in the economy is more government spending, no matter how wasteful.   Anybody who observes the world economy can see that the governments that watch every nickel of spending carefully have the most successful economies (Singapore, Switzerland), that those that engage in wildly uncontrolled blowout spending are the least successful (Venezuela, Greece), that uncareful spenders that let wasteful government spending grow too much languish (Europe) while somewhat more careful spenders are able to maintain growth, if somewhat impaired (United States).  And these correlations can be clearly observed despite the unsupportable convention of counting government spending at 100 cents on the dollar in GDP even when it is intentionally wasted. 

In an op-ed in the Wall Street Journal last week headlined "An Autopsy for the Keynesians," John Cochrane of the University of Chicago is ready to declare the most recent post-financial-crisis burst of Keynesianism dead. 

This year the tide changed in the economy. Growth seems finally to be returning. The tide also changed in economic ideas. The brief resurgence of traditional Keynesian ideas is washing away from the world of economic policy.

Cochrane gets to the point of ridicule in listing some of the fallacies you have to believe if you buy into the fundamental Keynesian proposition that more government spending "stimulates" an economy:

Hurricanes are good, rising oil prices are good, and ATMs are bad, we were advised: Destroying capital, lower productivity and costly oil will raise inflation and occasion government spending, which will stimulate output. . . .  In Keynesian models, government spending stimulates even if totally wasted. Pay people to dig ditches and fill them up again. By Keynesian logic, fraud is good; thieves have notoriously high marginal propensities to consume.

And thus Cochrane concludes that Keynesianism has thoroughly disproved itself and isn't coming back.  Well, one can hope.  But look around and the evidence is that this is an idea that needs to be killed at least a thousand times.  Take for example the cover story in Business Week on October 30, "John Maynard Keynes Is The Economist The World Needs Now," by Peter Coy.

Is there a doctor in the house? The global economy is failing to thrive, and its caretakers are fumbling. . . .  There is a doctor in the house, and his prescriptions are more relevant than ever. True, he’s been dead since 1946. But even in the past tense, the British economist, investor, and civil servant John Maynard Keynes has more to teach us about how to save the global economy than an army of modern Ph.D.s equipped with models of dynamic stochastic general equilibrium.

Coy goes on to advocate for blowout government spending as the cure to current slow economic growth, although he does grudgingly concede that government spending that goes to real projects is at least preferable to pure waste.  Well, Peter, how about hiring workers to build a dam with spoons?

And how about the case of Japan?  If there is any example that conclusively disproves the Keynesian hypothesis that fiscal "stimulus" spending can get an economy moving, it has to be Japan.  Since its economy went into stagnation in approximately 1990, Japan has had one Keynesian "stimulus" program after another, the result being the 25 years of stagnation plus bonded debt exceeding 200% of GDP.  But the stagnation continues, so over the weekend Prime Minister Abe announced the latest government program to get the economy moving again.  Yes, it is another round of so-called "stimulus":

Japanese Prime Minister Shinzo Abe on Saturday approved a $29.17 billion stimulus package meant to boost consumer spending and regional economic activity, seeking to revive an economy in recession. The spending package focuses on small businesses, rural communities and post-disaster reconstruction.

Well, Mr. Abe, if you believe the Keynesian hypothesis that the "stimulus" of more government spending gets an economy going, instead of the $29 billion why not make it $1 trillion, or for that matter $10 trillion?   

A Christmas Tale Of New York's Housing Follies

If you are looking for a heartwarming story to savor this Christmastime, perhaps you will enjoy the tale of Ms. Noelle Penraat of Manhattan.  Ms. Penraat's tale illustrates the results that New York has been able to accomplish by putting in place an array of housing programs designed to achieve perfect fairness between and among all people through government direction.  

Ms. Penraat, 62 years old, occupies a four-bedroom duplex apartment overlooking Central Park at 315 Central Park West, corner of West 91st Street.  Those familiar with the most expensive sub-markets of super-expensive Manhattan real estate will recognize this address as something quite close to the very top of the food chain.  Yes, a similar apartment a little further south on CPW in the 60s or 70s would command yet a higher price, and maybe something on Central Park South would go for even more still.  However, even without being given the square footage of the apartment, we can be sure that its monthly free market rental value would be at least $10,000, and likely even $15,000.  In other words, Ms. Penraat is a top member of the New York real estate nobility.

But despite her status as a top member of the real estate nobility, somehow New York City has decided that Ms. Penraat should be entitled to a massive rent discount.  She is a beneficiary of a New York City program called "rent control," which limits rent increases to minimal amounts for a now small class of tenants who have occupied their apartments continuously since 1971 (or earlier).  (Today there are fewer than 40,000 "rent-controlled" apartments in New York City.  Another program called "rent stabilization" regulates the rents of another one million plus apartments.)  And then there's another New York City program called "Senior Citizen Rent Increase Exemption," or "SCRIE," under which those 62 and older with incomes less than $50,000 can claim exemption from any further rent increases for the rest of their lives, and the taxpayers pick up the increases through credits against the landlord's real estate taxes.  Ms. Penraat has also claimed the benefit of this program.  

According a December 23 article in the New York Law Journal, Ms. Penraat's controlled rent is $4477 per month, minus another $284 per month for her SCRIE exemption, leaving a net of $4193 per month.  In other words, by virtue of New York's rent regulation efforts, Ms. Penraat receives discounts off market rent of something in the range of about $6000 to $11,000 per month, or $72,000 to $132,000 per year -- none of which, of course, counts in her "income."  Somehow, this is what the City of New York has determined to be "fair" in the case of Ms. Penraat, although it is not really possible to explain exactly why she is the one out of all of New York's 8.4 million residents who gets the premier CPW park view apartment at a huge discount. 

With lots of extra space in the apartment and great Central Park views, Ms. Penraat then did what any self-respecting American would do with the opportunity, namely she listed various bedrooms in her apartment on Airbnb to make a buck.  By early this year she had quite a business going.  According to the Law Journal, she averaged $6500 in monthly rental income in the period January to June 2014 -- well in excess of her $4193 monthly rent outlay.  

Somehow, though, all this did not meet Ms. Penraat's landlord's concept of "fairness."  He has filed a case in New York State Supreme Court against Ms. Penraat asserting that she is taking unfair advantage of New York's rent regulation programs.  A decision in the case by Justice Carol Edmead got coverage on December 23 here in the New York Law Journal and here in the New York Post.  Per the Law Journal, Justice Edmead has granted a temporary injunction against Ms. Penraat, prohibiting further use of her apartment as a B and B:

The judge, who issued a temporary injunction against Noelle Penraat, said records Penraat presented indicated she made substantial income from renting to visitors arranged through Airbnb in 2013 and 2014 in an "incurable" violation of Rent Control Laws.

Well, but if she has committed an "incurable" violation of the Rent Control Laws, does she lose the massive rent discounts, or for that matter, get evicted from the apartment?  No word on that in this decision.  My bet is she will neither lose rent-controlled status nor get evicted.  In New York there is virtually no such thing as a lease violation sufficient to cause a person to lose out on rent control status.

And you are probably asking, how does Ms. Penraat get the SCRIE exemption -- supposedly available only to those with income under $50,000 -- when she gets a minimum of $72,000 in annual rent discounts, let alone $65,000 in revenue from the Airbnb rentals in just the six months from January to June 2014?  Clearly the $72,000 does not count for these purposes.  And I guess the $65,000 didn't count either, at least in the flexible mind of Ms. Penraat.  Hey, she's New York housing nobility!  She's just got the system figured out better than the rest of you saps who make cash income at a job and pay full taxes before taking most of what's left to pay your rent.  

Can We Eliminate All Tough Choices With The Infinite Credit Card?

One theory is that the whole idea behind capitalism is to force the making of tough economic choices.  Examples would be the decision of an employer to fire some people when the revenues of the business just don't support them any more; or the decision of a family to sell a beloved home when the expenses get too high.  Another theory is that the government has an infinite credit card, which can be drawn at any time, and the money given to whomever they want, so why is there ever a need to make a tough choice?

The best arena to observe the game of using the infinite credit card to avoid tough choices is the arena of healthcare.  And thus here in New York we have a state Assemblyman named Richard Gottfried (his Manhattan district is adjacent to my own) trying to push the idea of so-called "single-payer" healthcare for New York.  "Single-payer" means that all healthcare is paid for by one entity, namely the government.  Medicare is an example of a modified form of "single-payer," although it has some deductibles and co-pays that must be covered by the patient.  Lacking a federal single-payer program for those not covered by Medicare and Medicaid, Gottfried for a couple of decades has been advocating that New York should set up its own program at the state level.

Recently Gottfried was in Rochester holding a town meeting on the subject.  Here's a report from the Rochester Democrat and Chronicle on December 8.   According to Gottfried and his supporters, this is a moral issue, which I suppose means that if you oppose it you must be immoral and, probably, evil.  For example, here is one of the witnesses from Gottfried's Rochester hearing, Rev. Dr. Richard Gilbert, quoted in the D&C article:

"Healthcare is a human right," Gilbert said, "grounded in the moral fiber of major world religious traditions. It's not a commodity subject to political whims, economic theories, or social fashion, but grounded in the moral foundation of our very humanity."  Gilbert was one of several speakers expressing support for the proposed legislation. "It's passage is a moral imperative of our time," he said.

Well, Rev. Dr. Gilbert, does cost have anything to do with this?  In particular, is it morally permissible to ask, for example, how much taxes must be raised to pay for this and what burdens that might impose on people of limited means?  Actually, it appears that Gottfried and his witnesses at the hearing had what they thought was an answer to this question:

"New York can have a universal health coverage system that covers all of us, without premiums and deductibles and co-pays and restricted networks," Gottfried said. "It could save New Yorkers over $20 billion a year by not having to pay for insurance company administrative personnel and profit."

That's right, we'll have universal coverage for any and all medical problems, it will all be free to the consumer, and it will cost less than our current system.  No problem!

No mention in the D&C article (or other coverage I have found of Gottfried's hearings) of what is going on across the border in Vermont.  There, Governor Peter Shumlin has made enactment of a single-payer healthcare system his signature initiative.  This article from Avik Roy at Forbes on December 21 gives some background and current developments.  After pledging in his first campaign to bring single-payer healthcare to Vermont, Shumlin got to work on the plan promptly after taking office in 2011.  He started by hiring lefty healthcare economists William Hsaio of Harvard and Jonathan Gruber of MIT (yes, that Gruber) who came up with the grand comprehensive socialized scheme.  A report on the projected costs of the plan was due in January 2013, but Shumlin failed to produce it.  A suit to force him to produce it failed.  That brings us to the recent 2014 election, where Shumlin's Republican opponent said, "the difference between Peter Shumlin and Scott Milne is that I will tell you before the election that single payer is dead.”  Shumlin kept quiet on the subject and won by 2,095 votes.

Then last week, safely re-elected, Shumlin let the cat out of the bag.  The projected cost of the Hsaio/Gruber Green Mountain Care single-payer system for 2017 would by $2.6 billion.  Did I mention that in Vermont, a state of just over 600,000 people, the entire existing state tax system only raises $1.6 billion per year?  To pay for GMC, that $1.6 billion would have to go to $4.2 billion, a 151% increase in the aggregate tax burden.  Supposedly this would be paid for by a brand-new 11.5% tax on all payrolls.  Needless to say, small businesses screamed bloody murder -- and small businesses are the only kind they have in Vermont.  As of now, it looks like GMC is completely dead.

But how to explain the discrepancy between the view of single-payer supporters, who think that single-payer can save enough from elimination of overheads and insurance companies that the aggregate cost of healthcare will fall, and the enormous costs that emerged in Vermont when they actually tried to design and implement a real-life system?  After all, don't many European countries with single-payer or modified single-payer systems spend a lower percent of GDP on healthcare than does the U.S.?  Megan McArdle of Bloomberg has a take on that in an article today.  The gist is that a government takeover of the healthcare system will inevitably start with a need to pay for nearly the full cost structure already in place:

Our spending is indeed high compared with the rest of the world, but that's because it started high. And while restraining government spending is easy, it is a walk in the proverbial (government-funded) park compared to actually cutting spending. Cutting spending means that a number of people are going to lose income and employment. They will have trouble paying their mortgages, car loans and little Johnny's bill for travel soccer. Then they are going to get organized and march on Washington and vote against the politicians who cut their jobs. 

And Megan doesn't even consider some of the major tough choice issues that simply must be confronted.  In healthcare, a big one is the recent proliferation of new pharmaceuticals, often for particular cancers, priced at $50,000, $100,000 or even $200,000 for a year of treatment.  According to this article from Bloomberg yesterday, there are now some 300,000 people in the United States taking drugs that cost an aggregate of $50,000 or more per year.  Well, in your single payer system, are you going to pay for those drugs or not? -- "not" of course meaning that someone dies.  And if you agree to pay for this latest drug at $100,000 per course of treatment, what's to keep the next one from being priced at $200,000, or, for that matter, $1,000,000?  What you thought was your infinite credit card will be tested very quickly.

The New Yorkers advocating single payer apparently think that we can avoid these problems because we are bigger, and maybe because we can just impose the costs on some big business, or maybe on a handful of foreign billionaires with apartments in Manhattan.  I would say that we may be able to avoid the tough choices for a longer period, but definitely not forever.  And the federal government can undoubtedly avoid the tough choices for even longer; but still, not forever. 

State-Controlled Capitalism, New York Edition

New York may well be the business capital of the world.  While most of the other original U.S. states began their existence as religious colonies of one sect or another, New York/Amsterdam was a trading center from day one and today stands as the premier world marketplace in finance and many other areas of business.  And yet we overwhelmingly elect politicians who have no comprehension whatsoever of how this works.  Our City also serves as the home to dozens of media outlets that define themselves by incessant bashing of our wealth-generation as somehow evil and immoral.

So, instead of relying on the free-wheeling capitalism that has made us so hugely successful, how about trying some of the state-controlled capital allocation that has done so well by places like Russia, Venezuela, Iran, and Argentina?  There have been multiple examples of that in New York over the last several days.

On Wednesday a state entity called the Gaming Facility Location Board recommended approval of three large new Las Vegas-style casinos in upstate New York.  Here is the report on the approvals from the New York Times.   The three approved locations are: one in relatively remote Sullivan County in the Catskills region (actually next to what once was the famous Concord Hotel); one in the Albany area; and one in the northern Finger Lakes between Syracuse and Rochester.

Now you are undoubtedly asking, why does this require a state "facility location board"?  Why doesn't anyone who wants to open a casino just open one wherever he wants, as we do with, say, laundromats or card stores?  That's a long story that has a lot to do with the unsavory coalition of Baptists and bootleggers, but suffice it to say that once casinos initially got banned, the process of handing out exceptions offers way too many opportunities for graft for the politicians ever to let go.  And thus we have come to a situation where to build a casino you must spend years making the right political contributions and cultivating the pols.  And the investment capital goes where the pols direct it to go and when they direct it to go there.  So after a process of consideration that has extended over decades, we now are getting these three casinos granted to the politically favored.

The timing of these casino approvals couldn't be more ridiculous.  Have they even noticed that Atlantic City is imploding right now before our very eyes?  This research report from UNLV (the Nevadans are rubbing it in!) shows Atlantic City gaming revenues off about 45% since a peak in 2007.   Casinos there are closing left and right.  The same New York Post today that has an op-ed by Bob McManus commenting on the ridiculous New York casino approval also has a news article in the business section reporting on the latest in the "Perils of Pauline" tale of the bankrupt Taj Mahal casino, second largest in Atlantic City, just (maybe? temporarily?) rescued from closure through an investment by Carl Icahn.

Casinos were supposed to be the salvation that would rescue Atlantic City from poverty.  The first casino opened in 1978.  Thirty-six years later, Atlantic City is a one-industry town with the industry collapsing -- remind anyone of Russia?  And it's still poor.  But don't worry, in upstate New York, casinos built by political favor and at political direction are going to bring you economic development!  Here's my favorite line from the Times article reporting on the Location Board approvals:

[The GFLB] rejected six applications in Orange County, the region closest to New York City, in favor of a single resort in neighboring Sullivan County, to the north, citing the need for economic development.    

Got that?  We won't allow these things where they might actually succeed, and instead we're going to duplicate the Atlantic City model of forcing them into economic backwaters because "economic development."

Meanwhile, the economic decline of upstate New York continues, and the experience of Atlantic City (and state-controlled capitalism in general), combined with the high taxes imposed by the City-and-suburban-centric political culture make it highly likely that the decline will continue.  The population declines in upstate New York, and particularly in the triangle defined by these three new casino locations, are really stunning.  Syracuse has declined from a peak of 221,000 people in 1950 to 145,000 (35%); Utica from a peak of 102,000 in 1930 to 62,000 (39%); and Binghamton from a peak of 81,000 in 1950 to 47,000 (41%).  The last person to leave should turn out the lights.

But there is another industry that very much wants to come into this area and create lots of jobs and wealth.  That, of course, would be the industry of "fracking" natural gas out of the shale formation that extends under most of New York's so-called southern tier.  This industry would require no government effort at all -- all the government needs to do is get out of the way and let it happen.  Oh, yesterday our Governor permanently banned it.  A permanent ban on investment in an industry is another example of state-controlled capitalism.  Sorry, upstate New York, but you'll just have to take your chances on the casinos.

UPDATE December 23, 2014: The Census Bureau has just announced that, according to new data as of July 1, 2014,  New York has slipped another notch in the state population rankings, this time getting passed by Florida.  The  populations of the four most populous states as of July 1 are now:  California 38.8 million, Texas 26.9 million, Florida 19.9 million, New York 19.8 million.  In case you're curious, when I first noticed census statistics back in 1960 the populations of those states were:  New York 16.8 million, California 15.7 million, Texas 9.6 million, Florida 5.0 million.  The consequences of high taxes and crony capitalism:  gradual, relative decline.

The Curse Of State-Controlled Capitalism

Actually, let's start with the blessing of not having state-controlled capitalism.  Here in the U.S. our free-market economic system erodes little by little with the ongoing expansion of government micromanagement, but we still have the basics in place.   And thus when the price of a major commodity like oil suddenly falls by about half -- as it has over the course of about the past four months -- this is actually a net positive for the economy and very likely for the stock market as well.  Granted, it's not so great if you're an upstream producer of oil who just sank millions of dollars into drilling a few wells and now you're only going to get about half the revenue you expected.  But the smart drillers sold much or all of their output long ago in the derivative markets, at prices that locked in profitability, and they won't be hurt much at all.  Lots of other entities in other parts of the oil business -- like refiners, shippers, and retailers -- don't really care much whether oil prices are high or low.   And throughout the rest of the economy, lower oil prices mean lower costs of energy inputs and therefore increased profitability and/or lower final prices.  Consumers get cheaper gasoline, cheaper electricity, cheaper heating fuel, cheaper everything that has energy as an input -- and that's pretty much everything.  What's not to like?  A few incautious upstream oil producers will likely go bankrupt.  Hey, that's capitalism!

Over in Russia, things don't work quite the same way.  There, if you are an ambitious young risk-taker, don't think that you can just go out buying up oil rights and drilling some wells.  These things are the privileges of the big companies, who need the patronage of the big kahuna to keep away from government predation.  So you can be big in the oil and gas industry if you are Rosneft (69.5% owned by the Russian state) or Gazprom (50.23% owned by the Russian state).  Or you can try being a fully private company like Yukos, by having your chief (Khodorkovsky) be a well-connected ex-member of the Communist Youth League.  But that's only good enough until the day he crosses Putin.  In case you didn't keep track of the story or don't remember, Khodorkovsky, up until then the richest man in Russia through being CEO and part owner of Yukos, was arrested in 2003, charged with fraud, convicted, and then spent 8 years in jail through 2013.  Meanwhile, Yukos was charged with tax crimes and was broken up by the government.  Just a few months ago the former owners of Yukos won an arbitration award of $50 billion against the Russian government.  The basis for the decision was that the alleged tax crimes were not real and the whole government prosecution was just a disguised uncompensated taking.  Good luck collecting on that award!  There are other nominally private oil and gas companies in Russia, but you'd better believe they have learned their lesson about staying on the right side of the big guy.

Anyway, with government functionaries in Russia directing the allocation of capital either overtly or behind the scenes, Russia has done what seemed like the obvious thing of getting deeper and deeper into oil and gas as the sole driver of their economy.  The economy is remarkably undiversified.  According to Bloomberg News here, the oil and gas sector accounts for about 25% of GDP (in the U.S., it's 2.5%),  and for about 50% of government revenues.  On the pure business side, it has seemed like easy printing of money.  On the geopolitical side, it can be loads of fun periodically to use your oil or gas weapon to put the squeeze on a Ukraine or even a Germany.

It all seemed to be working brilliantly until the price of oil suddenly dropped by half.  Now what?  It's not just that GDP is taking a sharp hit.  The biggest immediate problem is that the ruble is collapsing.  The Wall Street Journal reports this morning that the ruble fell a full 20% just yesterday, even after the large declines of the past several months.  The people have cleaned the banks out of all foreign currency.  And it'll be a while before we even learn of the effects on Russia's budget, which can't be pretty.

And it's not just Russia, not by a long shot.  Wouldn't you think that the United States would understand what makes its own economy a success, and after spending hundreds of billions of dollars to liberate and stabilize a country, would at least take the trouble of establishing a real capitalist economy?  Well, Iraq is about as bad a case of state-controlled capitalism as exists.  Of course, this is another country totally dominated by the oil and gas sector, in fact even more so than Russia.  And essentially all of it is government-owned.  And the same state control extends into much of the rest of the economy.  Here are some quotes from a three-year-old article from Megan McArdle.  I can't find newer numbers, but I have no reason to think that things have changed much:

Half of the labor force works for the national government, either directly or indirectly, and another 20 percent or so is unemployed. “Iraqis believe that the only real job is a government job,” [Lehigh University Professor Frank] Gunter says. It “pays more, has benefits, you can’t be fired, and the work intensity is lower than in the private sector.” Gunter estimates that if the price of oil falls below $40 a barrel, the government is in serious trouble: below that price, it will not have enough revenue to pay salaries and pensions, even if no services are provided at all.     

And you could really go on all day listing the countries getting terribly burned by going the route of state-controlled capitalism:  Iran, Venezuela, Argentina . . . .  Quite a collection of rogues!  It's really hard to feel too sorry for them.  Oh, and did I mention that the U.S. has recently gone into state-controlled capitalism in the health care sector?

Looks Like Bharara Will Definitely Not Do The Right Thing

In my post Wednesday I asked whether SDNY U.S. Attorney Preet Bharara would now "do the right thing" with respect to the dozens of innocent people out of whom he has improperly coerced guilty pleas in his multi-year jihad against non-insider insider trading.  Well, it only took Bharara a few hours to put out his own statement telling the world that doing the right thing is just not part of his make-up.  Since the statement is short, I'll quote the whole thing:

Today’s decision by the Court of Appeals interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information. The decision affects only a subset of our recent cases, and in those cases – as in all our criminal cases – we investigated and prosecuted misconduct based on our good faith assessment and understanding of the facts and the law that existed at the time. We are still assessing the Court’s decision, which appears in our view to narrow what has constituted illegal insider trading, and are considering our options for further appellate review.

Wow -- Don't they realize that they are dealing with the criminal law and that peoples' lives are at stake?  They have put legitimate companies out of business, put hundreds of people out of jobs, conducted midnight FBI raids over conduct that we now know was wholly legal all along, put dozens of honest hard-working people who committed no crime in jail, forced the expenditure of hundreds of millions if not billions of dollars to defend against their prosecutions, seized billions of dollars of fines and forfeitures without legal basis, and all they now have to say is they are "considering [their] options for further appellate review"?  Well, I predict that their appeal is going nowhere in the Supreme Court, but meanwhile they are keeping these innocent people in limbo for another year while we wait for the denial of cert and they work on landing their next job.

I find it amazing how long this travesty has continued.  As Charles Gasparino points out in this morning's New York Post, there never was any theory under which this non-insider insider trading had anything to do with causing the recent financial crisis.  But in our prosecutors' thirst to produce scapegoats, somehow we have without thinking completely lost track of the principle that you can't be sent to jail for a federal crime unless you violate a statute passed by both houses of Congress and signed by the President and that clearly prohibits what you did.

And thus we have endless amounts written about this non-insider "insider" trading program by people who refuse to acknowledge this fundamental issue.  Start with the headline in the New York Times yesterday in their front-page article about the Second Circuit reversal:  "Appeals Court Deals Setback to Crackdown on Insider Trading."  Just no.  This is not about a crackdown on insider trading, but rather about a crackdown on trading by non-insiders that the feds would like to make illegal without statutory basis because they think they can get a jury angry that somebody made too much money.  Or consider former AUSA Patrick Cotter quoted by CNBC:

"The stunning decision ... has the potential to rewrite the book on insider trading, while also dealing a body blow" to Justice Department and the Securities and Exchange Commission efforts, former assistant U.S. attorney Patrick Cotter said in a statement to CNBC.

Well, isn't dealing a "body blow" to government lawlessness the whole reason we have courts?

I haven't seen any article give a short clear statement of the law on this subject, and the Second Circuit's opinion itself really makes the whole thing seem far more complicated than it actually is.  So for those who want to understand the basics, I'm going to tell you what you need to know about the application of insider trading law to non-insiders in the next fourteen sentences:

The underlying common law of fraud in the United States in general applies to false statements and not to omissions.  That is, if you say nothing to your counterparty in a business transaction, you have not committed fraud, even if you know something important that your counterparty does not know; sometimes this is phrased as there being no "general duty to speak" to your counterparty. There are some exceptions, but very limited.  The federal securities laws then have their own obligations, which do include a general duty to speak, which applies to the issuer of the securities.  In the massive text of the federal securities laws, going on for mind-numbing hundreds of pages, you will not find anything about a general duty to speak applying to those other than the issuer, including those who trade in the security.  Corporate insiders of issuers, who could include officers and directors at the top end down to the lowliest messenger or clerk, are then their own special case.  While there could well be exceptions, assume for these purposes that insiders of the corporate issuer are subject to the issuer's general duty to speak.  But now consider non-insiders, such as investment professionals who do not work for the company: the statutes do not mention anything specific about a duty to speak by such people.   And yet the government criminally prosecutes dozens of them for trading without first disclosing everything they know to the marketplace.  How?  The entire basis for criminal prosecutions, out of all the hundreds of pages of statutes, consists of the following in Section 10(b) of the Securities Exchange Act of 1934:

It shall be unlawful for any person . . . [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance . . . .

Can you find a general duty to speak in there when it does not exist anywhere else in our common law or in our normal understanding of the words "manipulative or deceptive device or contrivance"?   We're talking here about criminal law, where people who violate it go to jail.  The fact is, it's not there, and certainly not in a form specific enough to give anybody reasonable notice of what is and is not legal.

The government starts with a position that if you bribe a corporate insider -- hand over a bag of money -- for information on which to trade, you thereby become subject to his and the corporation's duty to speak, and thus can be prosecuted for insider trading.  My view is that this position  is wrong:  this being a criminal law, if Congress wants to prohibit such conduct, they need to say so specifically.  It's not that hard to do.  If I were on the Second Circuit, the government would lose on the bag of money non-insider insider trading prosecution.  But actually, the Second Circuit has specifically bought into that one.  You can look at the statutory text above and form your own opinion as to whether the government's position on the "bag of money" case is reasonable.  You don't need to be some kind of fancy lawyer to form an opinion on this.  There is nothing about it any more complicated than the statutory text quoted above and the underlying fact that there is no "general duty to speak" in our society, certainly not in a criminal context,  unless a statute specifically imposes it on you.

And anyway, in Newman/Chiasson and many others of the current round of non-insider insider trading cases, we are way, way past the bag of money.  In fact the government's position is effectively that if you know anything sourced from an insider of the company and you make too much money trading, you are going to jail.  They have even phrased their position as being that "friendship" alone constitutes a sufficient "quid pro quo" to make any trader take on the issuer's duty of disclosure.  Is it "friendship" if you once had dinner with the guy, or if you talked to him one time before this time?  Suppose (like Newman and Chiasson) you don't even know the insider who provided the information or anything about the relationship between him and the guy he first gave the information to?  Too bad, you're guilty too.  And now we have thousands of Wall Street professionals who make what they think is an honest living casting about among friends and acquaintances for tidbits of information and tips, with no way to know or find out about the circumstances by which the information was first obtained, and the government's position is, if you made enough money it's a crime if we want it to be.

We find then on the website of Cornell Law School the following statement of the current state of the law on insider trading:

Because friends do not satisfy the definition of an insider, a problem arose regarding how to prosecute these individuals.  Today, a friend who receives such a tip becomes imputed with the same duty as the insider.  In other words, a friend must not make a trade based upon that privileged information.  Failure to abide by the duty constitutes insider trading and creates grounds for prosecution.        

Well, that was never more than the government's phony position and was completely wrong, and as of two days ago the Second Circuit has told us why.  (Cornell has not yet taken its statement down.)  Shame on them for unquestioningly buying into the government's outrageous position without taking a critical look at whether there was any basis for it in the underlying statutes.

Even the Second Circuit in my view does not go far enough.  The Second Circuit opinion says that non-insider insider trading liability will now be limited to situations where the corporate insider received "something of consequence" in return for the information.  Well, what is that?  Forgive me for being soft on Wall Street, but I think that people trying to earn an honest living are entitled to fair notice of what conduct is criminal and what is not.  And that fair notice cannot be something made up by a prosecutor's or regulator's whim, but must get through majorities of two houses of Congress and a signature by the President.  Is that so complicated?  This "something of consequence" standard still gives the government plenty of room for abusive conduct, and we have no reason to believe that the current crop of people occupying the prosecutors' offices will not abuse every bit of power that they are given.