Google announced it is working on an economy-wide Google Price Index, but has not decided whether to make it public, per Google Chief Economist, Hal Varian, who spoke at the National Association of Business Economists conference this week.
- This development has under-appreciated implications for insider trading and also spotlights how Google's online dominance of market-relevant information suggests market failure and a new potential systemic vulnerability to the integrity of global capital markets.
I. Insider Trading
In March, Google CEO Eric Schmidt said: "One day we had a conversation where we figured out we could just try and predict the stock market... and then we decided it was illegal. So we stopped doing that."
Now any hedge fund (or market regulator not born yesterday) understands that if Google is actively working on a Google Price Index, Google has not stopped trying to use its uniquely comprehensive and timely, repository of sensitive market information to predict information highly useful to predicting the stock market.
- Per the FT, Mr. Varian "said that he is working on predicting the present by using real time search data to forecast official data that are only released with time lags."
- Mr. Varian also suggested that search data could be a good tool for predicting unemployment numbers (obviously before the official ones are released.)
- Mr. Varian also teased that Google's Price Index already identified a deflationary price trend in the U.S., but an inflationary trend in the UK.
- This is exactly the kind of data-driven directional insight into key macroeconomic precursors to interest rates and economic growth rates, that most all major investors covet in order to invest, arbitrage or speculate in capital markets more successfully.
Given how globalized and algorithmic financial markets have become, anticipating the direction and intensity of key macroeconomic variables (prices, inflation, growth, employment, etc.) by nation, arguably are the most essential "input" variables investors must get right in order for their hedging and trading to succeed.
- There are time-tested strong reasons why Governments handle the fair collection and dissemination of market-moving macroeconomic statistics; and why they must have strict internal controls and oversight; it's to prevent insider trading, market manipulation, or harm to the integrity of public capital markets.
- As I explained in my March 2010 post, "Will Google redefine insider information/trading?," DOJ, Treasury, the Federal Reserve, the SEC and CFTC, have to be cognizant and vigilant that immediate macroeconomic data from Google represents a new unique threat to the systemic integrity of public financial markets.
- Regulators trying to anticipate and address systemic vulnerabilities or spot potentially large fraud/market manipulation, should be vigilant to at least the following obvious problematic scenarios that Google's latest envelope-pushing presents.
- First, has Google ever used its unique and monopoly total information awareness power to trade its ~$30b investment portfolio, or to hedge its multi-billion dollar multi-national currency risk?
- Second, does Google have robust internal controls, supervision, and third-party oversight to prevent Google employees, directors, contractors or partners from gaining improper access to this inside information to front run the market for personal gain?
- Third, does Google have sufficient management systems and controls, and do regulators have enforcement personnel focused on preventing hedge funds or others from gaining access to this extremely valuable inside information to front run or manipulate the market?
- There are real reasons for regulators to be especially concerned about the effectiveness of Google's management internal controls to prevent or detect illegal market manipulation activity.
- First, Google recently had to fire an engineer for accessing and abusing private information on minors per the WSJ. Google's internal controls did not detect this serious breach.
- Second per the NYT, hackers from China stole Google's "crown jewel" password system code named Gaia last December.
- Third, Nikesh Aurora, Google Head of European Operations told the FT: "We try not to have too many controls." "People will do things that they think are in the interests of the company. We want them to understand the values of the firm and interpret them for themselves."
II. Market Failure
So what's the problem with Google innovating and competing with Governments to improve the speed and quality of government statistics?
First, unlike democratic governments that have the legal authority, checks and balances and public responsibility to handle highly sensitive market-moving macroeconomic information confidentially and to enforce laws to protect capital markets from fraud and manipulation; Google has none of these responsibilities.
Second, capital markets assume functioning antitrust enforcement to ensure that no market participant has the market power to corner a public market or to become a de facto unregulated market maker.
- The market failure here is that:
- There is no market competition for the type of market sensitive information that Google has and intends to harvest; it is ill-gotten monopoly-generated information that no competitor could possibly reproduce.
- The reason there is no market competition for this information is failed antitrust enforcement that was supposed to prevent anti-competitive and harmful cornering of markets.
- Despite explicit warnings that allowing Google and DoubleClick to combine the two largest online data collection entities in the world, the FTC approved the transaction 4-1 and tipped Google to monopoly by giving Google most all the Internet users, advertisers and publishers that Google did not already have.
- Thus the failure to enforce antitrust law in electronic markets has created market failure in electronic public capital markets that assume competition for market information and assume no entity has a monopoly on information inputs necessary for the fair and honest operation of public capital markets.
- Another aspect of market failure here is that public markets assume that no broker can be an unregulated market maker. Decades of law, regulation, and common sense have understood that any market maker, i.e. someone in position to see most all the supply and demand of a particular commodity, cannot operate without third party accountability, otherwise the financial incentives to self-deal and front-run other market participants are too overwhelming to not to engage in.
- The market failure here is that Google has effectively bought its way to monopoly, and is vertically leveraging that ill-gotten monopoly over a wide variety of information markets.
- Google already has cornered the de facto electronic marketplace for keyword advertising, as it sees most all the supply and demand in the marketplace and routinely self-deals and front runs others because it has no third-party accountability or real competition.
- Google is poised to corner the market on immediate macroeconomic data as well as there is no market competition or possibility of market competition, because of serious antitrust enforcement mistakes.
In sum, the DOJ, Treasury, the Federal Reserve, the SEC and CFTC are faced with a serious market failure problem that is beginning to cascade.
- A monopoly player with no third party accountability is threatening to become a systemic threat to the integrity of public capital markets.
- Markets require competition, law enforcement and third party accountability systems to function efficiently and honestly.
- It will be interesting and telling to see if Government has learned from their many oversight lapses and mistakes over the last fifteen years or whether this problem will have to totally spin out of control and create real economic carnage and dysfunction before it is appropriately addressed.
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Also see: Will Google redefine insider information/trading?
