Felix Salmon

On Thursday, Pimco CEO Mohamed El-Erian told an audience at Thomson Reuters how he was buying “shadow equity” in Pimco on SecondMarket. On Friday, John Carney put up an intriguing post alleging that deals done on SecondMarket are subject to insider-trading laws. If he’s right, it seems to me that almost anybody buying or selling shares of a private company on SecondMarket would be breaking the law, at least if that company puts out little or no public information about itself. And then today, on Sunday, Zero Hedge picked up on a passing comment in David Sokol’s CNBC interview, where Sokol said that Charlie Munger owned 3% of Chinese auto and battery maker BYD before recommending the stock to Berkshire Hathaway.

We can certainly assume that El-Erian knows material information about Pimco: he is the CEO, after all. And that such information is non-public. Should that then bar him from buying Pimco stock through SecondMarket? And as for Munger, assuming that Sokol’s allegations are true, first read Nocera on Sokol:

How is this not, on its face, evidence of insider trading? A guy buys stock in a company and then talks his boss into buying the company. The fact that his boss is Warren Buffett makes it even more “material,” to use the word the S.E.C. favors when it investigates insider trading. If a company executive trades on material information, knowing that he is privy to stock-moving news that hasn’t yet been divulged to other shareholders, he is likely to be committing a crime. When Warren Buffett buys a company, the stock price goes up. Everybody knows that.

If you apply this logic to Munger, with his monster personal 3% stake in BYD, he looks significantly guiltier than Sokol. Maybe this is why Buffett went so easy on Sokol: he didn’t want to set a precedent which would drag down Munger.

The SEC, when it goes after insider-traders, nearly always looks for trades in which third parties — people like Raj Rajaratnam — trade on information they’ve carefully cultivated from insiders, often taking great care to ensure the utmost secrecy of what they’re doing. But there’s a case to be made that much if not most insider trading is much more overt, and simply never punished. In this sense, pretty much every stock trade by any CEO is a trade done with knowledge of material non-public information. Those trades might well end up being disclosed, but that doesn’t make them any less insidery.

I’m not for a minute saying that all these trades should be prosecuted, although a zealous prosecutor wanting to make a name for himself might well feel like giving it a try. I do think though that people like David Sokol and Charlie Munger should ask themselves why they’re trading stock for their personal accounts in the first place. Is any profit they make ever going to be worth the possible downside in terms of public embarrassment?

Two highlights of the Kauffman Bloggers Forum were the presentations on the broken nature of the pharmaceuticals market. And they came from opposite ends of the left-right spectrum: Megan McArdle went first, followed by Dean Baker.

McArdle’s talk was narrowly focused on antibiotics. The problem here is resistance: even before antibiotics start being tested, resistance to them starts showing up. McArdle’s thesis is that this isn’t just a problem of drugs and biological science, but is a market problem too.

The size of the problem of multi-drug-resistant bacteria is immense: more than a million cases a year, many of which end in death. And the cause of the problem, McArdle says, is that “all of the incentives are bad”.

For one thing, the suppliers of antibiotics — doctors and farmers — have no incentive to reduce the quantity of antibiotics they hand out. At the margin, for the individual patient or cow, there’s no great harm in feeding them antibiotics even if they don’t need them. Some patients even explicitly ask for antibiotics “just in case” the infection turns out to be bacterial. But in aggregate, this behavior is exactly what’s causing the rise of multi-drug-resistant bacteria. The way McArdle puts it, “pharmaceutical profits in Europe are marginal, and they’re volume-driven. And in antibiotics, the last thing you want is volume-driven profits.”

Taxing antibiotics would reduce their over-use, at least at the margin — but would also reduce the incentive to develop new antibiotics which can be used where old ones are useless. Stockpiling new antibiotics might also be useful — but again that reduces incentives to develop new ones.

And the patent system is very much part of the problem as well. The way it works, the clock start running out on a new drug the minute it’s invented, even before it enters hugely expensive and time-consuming testing. So drug companies have every incentive to sell as much of a new antibiotic as possible as quickly as possible, while they still have a few years left with their patent in effect. After that, generic copies come on the market, and the price falls dramatically — which again is not necessarily a good thing, in the realm of antibiotics.

Baker’s talk picked up on the problem of pharmaceutical patents, and looked at it more generally. We spend about $300 billion a year on prescription drugs, up from essentially zero a few decades ago. That brings drugs out of reach of people who can’t afford them, and results in people cutting their dosages. It encourages companies to spend billions of dollars developing copycat drugs in order to chase patent rents. It discourages companies from doing R&D on diseases which aren’t tractable to cure by pills. And it means that an enormous amount of valuable of scientific research is kept secret.

Baker’s alternative to all the distortions created by the patent system is simple direct public funding for medical R&D and education: the costs of such a scheme would be lower than the amount we’re already paying on publicly-funded prescription drug benefits, so it would save money on a fiscal basis. All patents and research results would go into the public domain, which would generate huge global benefits.

Both presentations raised more questions than answers: for one thing, it’s politically impossible to enact a wholesale restructuring of pharmaceutical patent rules. These things are path-dependent, and we’ve gone far too far down this particular path to be able to make the enormous leap to something completely different. But even pharmaceutical companies will concede the current system isn’t working: McArdle’s slides came from a researcher for Pfizer, who is desperate to get the word out about how screwed up the current system of discovering, manufacturing, and distributing antibiotics is. Something, clearly, must be done. But I fear that in reality, nothing will be.

The NYT’s declared war on the Huffington Post shows no sign of dissipating, and as ever the new-look NYT Magazine is at the front lines of the attack. Andrew Goldman’s interview with Arianna Huffington is quite astonishing, but first it’s worth looking at other news of the week.

On Monday evening, HuffPo’s Shahien Nasiripour got his hands on a photocopied internal document from within the Consumer Financial Protection Bureau. Marked “confidential for AG Miller”, it shows that the CFPB is deeply involved in putting together the AGs’ settlement with mortgage servicers. Nasiripour wrote:

Perhaps most important to some lawmakers in Washington, the mere existence of the report suggests a much deeper link between the Bureau of Consumer Financial Protection, led by Harvard professor Elizabeth Warren, and the 50 state attorneys general who are leading the nationwide probe into the five firms’ improper foreclosure practices, a development sure to anger Republicans in Congress and a banking industry intent on diminishing the fledgling CFPB’s legitimacy by questioning its authority to act before it’s officially launched in July.

Earlier this month, Warren told the House Financial Services Committee, under intense questioning, that her agency has provided limited assistance to the various state and federal agencies involved in the industry probes. At one point, she was asked whether she made any recommendations regarding proposed penalties. She replied that her agency has only provided “advice.”

The Republicans in Congress reacted exactly as Nasiripour said they would. Spencer Bachus immediately posted Nasiripour’s document on his website (the exact same photocopy, not any other version), and came out fighting:

Financial Services Committee Chairman Spencer Bachus and Financial Institutions and Consumer Credit Subcommittee Chairman Shelley Moore Capito are asking Elizabeth Warren, the Obama Administration official charged with setting up the Consumer Financial Protection Bureau, if she wants to clarify or correct her recent testimony regarding the Bureau’s role in the ongoing mortgage servicing settlement negotiations. Recent reports indicate that the CFPB’s role in these negotiations has been more extensive than Professor Warren suggested during her testimony before the Subcommittee earlier this month.

The Huffington Post’s document caused so much of a stir in Washington that even the NYT felt compelled to report on the developments:

Last week, Ms. Warren told the committee that she provided “advice” to the Treasury secretary and others about a possible settlement but was not involved in the negotiations. State attorneys general and federal officials are discussing a settlement with mortgage service companies in response to questionable foreclosure practices.

On Wednesday afternoon, Mr. Bachus released a seven-page document titled “Perspectives on Settlement Alternatives in Mortgage Servicing,” which, in a letter to Ms. Warren, he said demonstrated that she had a larger role than she had indicated to the committee.

Nowhere in the NYT story, which was written by Edward Wyatt, was there any indication that the document had been ferreted out by an assiduous reporter at the Huffington Post. And of course his link to the document was to house.gov rather than anything with HuffPo branding. In hindsight, Nasiripour would probably have been smart to put some kind of HuffPo watermark on the front page of the document, because both Wyatt and Bachus (with his vague reference to “recent reports”) seemed determined to ensure that Nasiripour got no credit for finding it at all.

And so to Goldman’s interview, which includes this jaw-dropping exchange:

I think that hiring a slew of traditional journalists seems counter to the model that made buying you appealing to AOL.

We already had 148 journalists on payroll at The Huffington Post. I don’t know how you can say that.

I look at your writers much less than I find myself clicking on stuff that’s been aggregated or the more salacious, boob-related posts.

Nasiripour’s scoop was hugely popular on the HuffPo site: wonky news and grainy photocopies can still generate 1,173 Facebook shares, 1,627 comments, and 2,760 Facebook likes. Total pageviews were surely much higher than on the NYT piece in which Wyatt aggregated Nasiripour’s information without crediting him. But Andrew Goldman doesn’t seem to be drawn to that stuff: instead he “finds himself” clicking on boobs. Which surely says more about Andrew Goldman than it does about the Huffington Post.

What’s certain is that Goldman is taking his cues from his boss. Here’s Keller:

The queen of aggregation is, of course, Arianna Huffington, who has discovered that if you take celebrity gossip, adorable kitten videos, posts from unpaid bloggers and news reports from other publications, array them on your Web site and add a left-wing soundtrack, millions of people will come.

Goldman, before he starts talking about aggregation and boobs, asks the same question — “aren’t you left-wing” — four different times before finally letting it drop. Which of course was the whole subject of Keller’s second attack on Huffington.

The big picture here is that the NYT is obviously feeling very threatened by the Huffington Post, and is reacting by lashing out blindly in a fit of name-calling, rather than actually trying to learn from what the HuffPo does well.

So long as the NYT continues to consider the Huffington Post to be boobs and kittens set to a left-wing soundtrack, Huffington has nothing to fear. If the NYT instead treated HuffPo with respect, and linked to it when it deserved such credit, the NYT’s staffers might begin to learn a bit more about what HuffPo is doing right. And that has to be more valuable, over the long term, than criticizing it for what they think it’s doing wrong.

Update: Auros notes in the comments that the leak is not, actually, particularly damaging to Warren, calling it “a total non-event”. Which again redounds to HuffPo’s favor. The NYT covered the leak only in the context of political horse-race news — as a stick which one party was using to bash the other party. HuffPo, on the other hand, concentrated on the substance of the report. The headline was “Big Banks Save Billions As Homeowners Suffer, Internal Federal Report By CFPB Finds”; the stuff about angering Republicans came reasonably far down in the 1,300-word story.

I got some predictably super-smart reactions to my questions about private equity markets at the Kauffman Bloggers Forum today.

Matt Yglesias said he couldn’t see what the fuss was all about: the SEC was created to protect small individual investors from having access to super-risky companies that disclose highly limited amounts of information, and that’s exactly what it’s done. It’s a good point, especially in the context of another idea, from Steve Waldman, which was echoed in the comments to my post by absinthe.

It’s the concept of the winner’s curse: that it’s maybe no coincidence that the Russian clients of Goldman Sachs who are falling over each other to bid ever-higher prices for Facebook shares are much the same people as the Russians paying $100 million for trophy Picassos, or Los Altos mansions.

The theory here is that Goldman Sachs, SecondMarket and the like have identified a group of buyers who are willing and able to pay through the nose for assets which are rare and special and which few other people can have. So long as companies like Facebook and Zynga meet those criteria, the winners in any auction for their shares are likely to be cursed — or, to put it another way, the final auction price is likely to significantly overvalue the company.

Looked at in this way, the market in private equity is less an opportunity for plutocrats to get excess returns, and more an opportunity for intermediaries to extract large profits by selling them overpriced equity in overhyped tech stocks.

As for the timing of all this, Virginia Postrel said that maybe all it took was one or two companies going this route successfully, and then everybody — both management and investors — wanted to join in the fun. A catalytic event is by its nature unpredictable, but once the idea got out that there was a lot of money and attractiveness in private markets, it became self-fulfilling. It’s important not to use Facebook as an example of what can happen when companies go the private route — especially since recent news implies that it might go public early next year. It really is sui generis. But Facebook can still be an important catalyst, inspiring many others to take a serious look at alternatives to expensive and stressful public markets.

On which subject, many of the bloggers in Kansas City were convinced that Sarbox really is an important reason why public markets have become less attractive. The year 2001, in this view, saw not only the 9/11 attacks, which gave birth to the security theater of the TSA; it also saw the Enron scandal, which gave birth to the regulatory theater of Sarbox.

Finally, Tyler Cowen had a good point: now that the rich are getting richer, it’s easy to see how there might be no need for companies to tap the power of millions of small investors any more. If you can get all the equity capital you need from a handful of plutocrats instead, that’s surely a preferable route to go down. In this view, the rise of private equity markets is correlated to the rise of the international plutarchy. Which makes sense to me.

Update: Here’s the talk, for those of you who want to see the questions as well as the answers:

Mike Bloomberg is one of the richest and most sophisticated philanthropists in the world. And yet:

Mayor Michael R. Bloomberg and City Council Speaker Christine C. Quinn today announced that employees of the City of New York will be able to set aside part of their paychecks directly to aid in the Japan disaster relief efforts…

“We brought generous New Yorkers together to raise $2.2 million for Haiti relief and we are asking anyone who can contribute to help those in dire need in Japan,” said Mayor Bloomberg. “The Mayor’s Fund will complete the necessary vetting and ensure contributions will go to reputable organizations with low overhead that are delivering services on the ground. Any help is appreciated – big gifts or small gifts; it all adds up and can make a real difference.”

This is the point at which political realities trump realistic philanthropic priorities. It’s simply not true that a small gift to Japan can make a real difference, at least not in terms of what it buys on the ground. But if you’re leading a city of people who want to help, then telling them that they can’t help is never a good measure to send. If on the other hand you tell them that they can help, they will feel much better. It’s the job of the mayor of New York to make New Yorkers feel better, so you can see why he therefore says things like this.

I got an email from Tom Glocer, the CEO of Thomson Reuters, this morning, announcing that the company has matched some $150,000 of employee donations to emergency relief efforts in Japan. (Not including donations from people like me, which were also matched, but which weren’t directed to Japan.)

This is great news with respect to morale in the company, where all of us, I think I’m safe in saying, felt dreadful about what had happened in Japan and wanted to show our support for our colleagues there, their families, and the areas of the country so devastatingly affected. One Japanese employee said that “I think I can speak on behalf of everyone in Japan when I say how touched we have been by the warm support by our colleagues across the company. I really feel like we are part of a global organization who cares about us.” Our messages of support, and our donations of money, are a signal which does make people feel better.

What we’re seeing here, I think, can be considered “philanthropy theater”, much as the TSA engages in “security theater”. The point is really to be seen to be doing good, to feel as though you’re making a difference. And frankly that’s not a particularly bad thing. There are lots of reasons why people donate money to good causes, and not all of them are or should be entirely selfless. If acts like these acculturate us to giving money to charity, then maybe the effects here can be positive. Certainly there’s no sense in which giving money to Japan does any harm.

Still, I do worry about the way in which philanthropists like Bloomberg continue to conflate giving money, on the one hand, with making a real difference, on the other. If we continue to concentrate overwhelmingly on inputs rather than outputs, we’ll only serve to encourage ever more inefficiency and even fraud in the non-profit world.