Fantex: One Born Every Minute

Felix Salmon had a hilarious (if perhaps not intentionally so) column the other day detailing the ludicrous reality behind Fantex, the heavily hyped company putting together an “IPO” of Arian Foster.  It is basically securitizing Foster’s earnings – giving him $10 million in exchange for a 20% claim on future earnings, and selling off the shares.  The entire idea is ridiculous on a number of levels, even before the extremely shady aspects of it unrelated to the core investment.  As Salmon details:

In reality, however, there are even more non-Foster risks to this stock than there are Foster risks. Your stock, for instance, can only be traded on an exchange which is owned and operated by Fantex. The directors of Fantex can, at their sole discretion and at any time, convert all your Foster shares into common Fantex shares, at any ratio which they determine to be fair. Or, more realistically, they can just go bust: after all, as the prospectus notes, they have no experience in this business. And if they go bust, then the holders of the tracking stock will end up owning about 1% of a bankrupt company, no matter how successful Foster is.

…

In other words, when the directors decide “to reattribute assets, liabilities, revenues, expenses and cash flows”, their duty is to Fantex, the holding company, and not to the chumps with the Foster shares, who between them account for less than 1% of Fantex’s equity. And in general, as the prospectus also says, “any of our tracking series will be subject to the risk associated with an investment in Fantex as a whole”.

Yglesias remarked the other day, in a different context, that the whole idea of efficient markets implies massive market failures. If beating the market is impossible – and it’s close enough that individuals should look at it this way! – then why is the wealth management business as fantastically large and profitable as it is.  If markets are basically efficient, then it’s obviously pretty foolhardy to be putting your money into Fantex or paying a hedge fund manager 2-and-20 to manage your money.  In other words, given the empirically-shown efficient market hypothesis and the empirically-shown popularity of crappy investment products we can reasonably conclude that people make highly irrational investment decisions.  As Yglesias suggests, one could then say there’s a strong case for paternalistic regulation in financial services.

It might make more sense to adopt a harm-minimization approach here – rich people ripping off other rich people simply isn’t a top policy priority.  People will very likely lose their shirts on the Fantex deal, and they’re also most likely people with more money than sense.  Compared to the harm that is done by payday lenders, shadowy mortgage dealers, or any other of an array of predators targeting the poor, regulating wacky investment products seems like an area of relatively low-percentage gains in social welfare.  If you’re looking at how to actually improve social welfare with securities regulation, I would imagine the greatest bang for your buck by far is in reforming 401(k)s.  The one thing you wouldn’t want to do is loosen “accredited investor” laws that allow shady financial products to market to less well-off consumers.

It’d be a shame if we just passed a major bipartisan bill to do precisely that.  Allowing general solicitation for alternative investments seems like such a horrible idea that it’s hard to imagine anyone in good faith could support it.

Ideology and Rationality: An Irrational Relationship

Ezra Klein has a great interview up with Robert Shiller today, who was just awarded the Nobel Prize for his work on the inefficiencies of financial markets and valuation.  The whole thing is good, but there’s this wonderful quote in particular:

When I look around, I see a great deal of foolishness, and I can’t believe it’s not important economically.

Shiller is referencing Larry Summer’s famously brusque maxim:

“THERE ARE IDIOTS. Look around.”

The point of this is to rebuke the idea that markets are “efficient”.  The word “efficient” is tossed around a lot in popular discussion, but it has a specific meaning here, which is the Efficient Market Hypothesis.  This is the idea that the price of a financial asset accurately reflects the best possible guess at the discounted future value of the asset.  In weak form, it encompasses all publicly available information – in the strong form, it encompasses all information (in other words, assume that insider trading is rampant and informative).  The upshot of this is that one cannot consistently achieve “alpha”, which is an edge over the market as a whole.  It has turned out to be true enough to be a very useful guide for investors (avoid active investing!) and false enough to be a very poor guide for policymakers (bubbles are impossible).

In the United States in 2013, these opposing views have clear ideological flavors.  The focus on people’s irrationality is strongly entrenched on the left wing, whereas the focus on people’s ability to make rational self-interested decisions is integral to right-wing policy.  For example, Bush’s Social Security privatization initiative hinged on the idea that individual investors would be able to manage their portfolios better than the central managers of the Social Security trust fund…and liberal opposition was focused on disputing that exact point (as well as the benefit cuts, but that’s beside the point).

This ideological valence isn’t inherent to the nature of leftism and rightism.  Early liberals (think Adam Smith, not Karl Marx) were very focused on man’s often-irrational behaviors. the root of their emphasis on constitutionalism and rule of law.  As Madison wrote, “If men were angels we should have no need of government”.  And Marx built his entire model of society based on the concept that people were rational maximizing economic agents and thus there exist immutable economic “laws of motion”.  20th-century leftism was absolutely fixated on the idea that people’s behavior was comprehensible (read James Scott’s Seeing Like a State sometime, it’s focused on this very question).

The question of whether people’s behavior is rational or not is very frequently a key dividing question between left and right…but the position of both on the question is not stable and never has been!