Asymmetrical Information

But I think that the SEC was what allowed many of these practices to become institutionalized, because it prevented newcomers from competing away the enormous financial incentives to cheat.

What the hey? Was the market more honest before the SEC showed up?

I'm only an amateur student of the period. I don't know if you can answer that question. The market was very, very different, and some of the practices that took place before Glass-Steagall we would frown on, such as pools and short corners and bear raids. But it wasn't a free-for-all either. The New York Stock Exchange didn't let you list if you lied to shareholders, and the cosy insider relationships mitigated some of the temptation to cheat that exists now, since the people you were cheating were more likely to be your friends from the club.

Overall, I'm hard put to say whether there's a substantial difference in honesty. There might be -- I'm no economic historian. But while there were more market shenanigans, there might have been less widespread fraud. (There were a lot of banks selling crap to the public in the run up to 1929, but many of them apparently believed their own advertising.)

There were, I think, some ways in which the system was better. The primacy of moneyed principal shareholders mitigated the principal-agent problem, which our SEC is still having trouble cracking. And the bankers expected to make their money on investments, rather than transaction fees. You did not have the ability for moderately talented young people to amass vast fortunes by putting through a trade or working on a merger. To get rich, they had to own a piece of a growing company. So I think in many ways the incentives are better. There was more insider dealing. But because the players were known, it was harder to get away with than you'd think -- possibly harder than now, since it's mathematically apparent in market activity that insider dealing is still very much alive and well, even without the titillating Martha Stewart type scandals.

There's possibly more disclosure. But the small investors who made prices in the bubble markets didn't know how to read the disclosures, so is there a material difference?

Well, it was a completely different market, yes.

Why we're on this: I just remembered that I've never seen a good explanation of why mutual funds charge you a percentage of *assets* instead of a percentage of *profits.*

It's a wierd incentive. You'd assume, what with their giant positions and ability to ride out short-term dislocations, that one of them could clean the clock of the rest with a profit-based revenue plan. The current situation, where they charge you to consistently fall short of index fund performance, is pretty odd.

From their perspective it's a winner -- they get all the upside, and still profit on the downside.

I'm not sure that you could get a mutual fund to work on profits -- five years like the 1973-1978 period and they'd be out of business. Besides, they still wouldn't participate in your down side. You also might give them perverse incentives to churn.

It might have been nice to have pointed out that I have a *specific disclaimer* at the top of my post pointing out that there was no general or specific argument in favour of public goods in there! I never said a dang word in favour of or against "Chicago economics"; my post was about bloody lighthouses!

In all seriousness, I think that Zimran was talking at cross purposes to me. I have no real horse in the race of government provision of public goods; I'm concerned with these things, when I care about them at all, on grounds of equality, not economic efficiency. My simple point was that Coase was dead wrong in trying to claim the lighthouses as an example of Coasian negotiation. Zimran actually repeats one of my points (about rent-seeking), thinking that I hold the diametrically opposite view to the one I do hold, which I suppose says something about my skills as a writer.

I think Zimran's numbers are a little off; there are *no* manned lighthouses in the UK anymore, and GPS systems cost quite a bit more than $100 in 1995. But frankly, I think that it's stretching things a bit to claim that the voting power of the lighthouse-keepers' lobby was ever going to be a massive power in the land. I also doubt whether GPS will necessarily take the place of lighthouses; an unmanned light is pretty cheap to run and it's a decent failsafe if the GPS breaks down.

Finally, in the context of financial services regulation, it is quite bizarre to conclude: "I've yet to see any regulator say "stick a fork in it -- we're done." What about the massive experiments in deregulation of financial services between 1982 and 1995?

For my part, I think that the changes needed in the financial sector go far beyond mere regulation ...

Jason:
I don't have a good answer on the "why," but fees based on return are currently prohibited by federal law. I think the idea was along the lines of Megan's response; a half-assed attempt to mitigate incentives to churn and otherwise take actions in the interests of the investment adviser rather than the investor.

Wow, I didn't know they were banned. Why would paying out strictly on profits result in an incentive to churn, though? Asset goes up 20%, they get a cut of the increase; I'm not sure why they'd need to sell anything.

I'm not sure that you could get a mutual fund to work on profits -- five years like the 1973-1978 period and they'd be out of business. Besides, they still wouldn't participate in your down side.

Well, the current situation does a pretty shitty job of beating the market.

> But frankly, I think that it's stretching things a bit to claim that the voting power of the lighthouse-keepers' lobby was ever going to be a massive power in the land.

All they have to do is be one of 51 groups, each representing 1% who are willing to log-roll and they are a decisive power.

At least in the US, the dominant political parties consist of such aggregated minorities.

I haven't checked the legislative history, but I think there was a fear of investment advisers designing "heads-I-win-tails-you-lose" performance fees at the investor's expense.

The reason Coase failed to show that lighthouses were an example of Coasian negotiation is that Coase was not trying to show that lighthouses were an example of Coasian negotiation. What he was trying to do in the article was argue for less reliance on abstract theory in economics, and more study of actual institutions. From his concluding section:

"Despite the extensive use of the lighthouse example in the literature, no economist, to my knowledge, has ever made a comprehensive study of lighthouse finance and administration. The lighthouse is simply plucked out of the air to serve as an illustration."

A note on "rent-seeking" -

It seems to me that while there are possiblities for rent-seeking behavior in both the private contractor and government run models, the potential opportunities are far vaster in the private contractor case.

Under the "old" (pre 1834 or whatever) system, a private business got a right from the crown to to collect money from every ship (or at least every ship that put in at port in England). This was an open opportunity for the politically connected to either build unecessary lights, or build the needed ones in bad locations (why go through the expense of building out on the rocks? Put it closer in to town...) One could have a fairly large continuous stream of income - a pretty big prize.

In the government case, what are the opportunities for graft or pork? The people who build lighthouses, of course - but I doubt that it would be a big enough job to be worth bothering for. The local communities - but it's hard to see people clamoring for a light that wasn't really necessary, in the same way they might a road or a bridge.

So it seems (to me, anyway) that aids to navigation (including, ahem, GPS - and personally, if the UK does decide to do away with some of it's lighthouses, I think at least some of the savings should be remitted to the US treasury...) are a clear case where the private sector COULD provide it, but a government agency, on balance, does a better job. Which is what Davies (and Samuelson) were saying in the first place. It's also what the UK decided back in 1834 - the private sector was NOT "doing a perfectly fine job", as the history shows. This basic truth seems to so upset UC types as to reduce them to a comic display of hemming and hawing and irrelevant quibbling. Fun stuff, though...

Why are you writing about Glass-Steagall, when the act was repealed a few years ago?

>>All they have to do is be one of 51 groups, each representing 1% who are willing to log-roll and they are a decisive power.

Yeh but ... think about the numbers, man. 1% of the population of the UK is 600,000 people. I doubt that there have ever been more than about a thousand lighthouse keepers in the UK.

If you have ever navigated you will realize the value of visual aids to navigation. GPS units can fail and a visual check is always necessary. Nighttime at sea can be very disorienting. I remember entering a private marina one night when a light on a breakwater was out and it made the final approach down the channel to the entrance to the creek difficult (the marina was farther down the creek). Yes, GPS placed us in the right location, but being fifty feet off course would put us aground. Finally getting a visual on the light stanchion and lining it up with the range light was necessary to complete the approach. It isn't always a clear case of dollars and cents in this wonderful world - there is always that mysterious x that can not be properly quantified (such as the value of my neck to me).

Glass Steagall wasn't repealed; many of the noticeable features, such as the divide between commercial and investment banking, were undone by later legislation. But the SEC and the rest of the regulatory apparatus created by the group of legislation usually referred to under the rubric of Glass Steagall, remain yet.

Mike:

The subject in question is not lighthouses at ports; there's a mechanism for paying for those, under hte port fees. The lighthouses under discussion are the non-port lighthouses used to steer and warn.

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