January 6, 2009
Last month, we recalled how landscape architects know how to please the eye with artful variety. The artist is there to appeal to our senses, our feelings, our mind, while nature endlessly provides original material. Take the remarkable Madoff scam. According to Samuel G. Freedman (*), the author Tova Mirvis declared that "if you wanted to write a novel about this, nobody would ever think it was plausible". From the true story, I cannot indeed free the novel. Fortunately life's teeming generosity can be filtered in many a way and I see there two lessons in eprivacy.
Among the inevitable speculations on how Bernard Madoff could fool so many investors for so long, Henny Sender highlights a clever theory (**). For Union Bancaire Privée, "the perceived edge was Madoff's ability to gather and process market-order flow information and use this information to time the implementation of [a winning] strategy". Forget about the particular strategy mentioned. Other ones have been suggested (1). Ask not whether the explanation is accurate or not. Gullibility accepts all kinds of fuels. Focus instead on what the suggestion implies.
Madoff had been Chairman of the NASDAQ. He operated his own brokerage firm. To boost transaction volume, he paid for order flow (2). Madoff market magic may have been illegal or simply unethical. This was not, little did they know, his investors' problem. For them a position to aggregate information flow on a large scale was reason enough to mint money. This is the most ringing popular endorsement I can conceive of my call for "economic mechanisms to be confidential by design".
It turned out Madoff used new investors' money to pay the income promised to old investors, hardly a financial innovation. But what if tomorrow NASDAQ and NYSE market makers openly decide together to offer their services for free with the understanding they be allowed to engage in a bit of front running? Could the SEC oppose a measure which would only replicate what Google does with the blessing of the FTC?
The SEC would most certainly object to using de facto monopoly power to impose bundled offers as unfair. Privacy depends on industry. Do you agree that, indeed, money matters more? Please reread Samuel Freedman's analysis. "The community's greatest virtue [is] its thick mesh of personal relations, its abundance of social capital". Shouldn't it matter that Bernard Madoff raided the social capital of his community as surely as he did its money? Should Facebook and others be able to skim this social capital with wanton abandon?
Confidentiality is not an absolute good, but a tool to safely enjoy the benefits of "our shared information society". From this utilitarian perspective, we have repeatedly stressed the importance of recommendation mechanisms (3). How else can one manage the risks created by online encounters? What then to make of Aline van Duyn's sharp attack on the undue reliance of the public on "recommendations from respected investors" (***)?
A whole network of trusted recommenders have abetted Madoff's confidence game. Can one fault her exhorting us to "think independently"? I do. Not that I disagree. "Herd behavior" is destructive and, yes, it is the common link behind the general financial bubble and Madoff's spectacular fraud. Yet superficial readers may take her too literally and, overlooking a potential logical conundrum, forgo all recommendations but hers.
The real issue, and it has not escaped Aline van Duyn, is scale. Nobody can dispense from recommendations, but the bigger the recommenders, the more risk enters the system. Therefore dominant players must be checked and decentralization encouraged. Yet does it follow, as she fears, that "the potential scale of the financial system shrinks dramatically"?
My answer is two-sided. I argued before the future belongs to globally local systems, connecting local agents over global networks. While ePrio's technology enables such systems, I am well aware that current ones rest instead on linking isolated users to ever bigger central servers. As long as it is the case, Aline van Duyn's dilemma will stand. Cut all actors down to size for greater market efficiency and per force you shrink the system.
To free the economy from its stony state, regulations need to mix something old, local recommendations, with something new, true confidentiality.
- (*) ..... Trust and Exploitation in a Close-Knit World, by Samuel G. Freedman (New York Times) - December 27, 2008
- (**) ... Madoff had 'perceived edge' in the markets, by Henny Sender (Financial Times) - December 21, 2008
- (***) . Who's afraid of thinking for themselves on investments, by Aline van Duyn (Financial Times) - December 19, 2008
- (1) see front running in the Wikipedia
- (2) see Bernard Madoff in the Wikipedia
- (3) see "recommendation mechanisms" in the list of Major Themes of these fillips.