Laws are like cobwebs, which may catch small flies, but let wasps and hornets break through.

~Jonathan Swift, A Critical Essay upon the Faculties of the Mind, 1707

Update: This article was included in the 10th Edition of the Canadian Personal Finance and Investing Carnival at Personal Dividends as well as the Carnival of Personal Finance #286 at Prairie EcoThrifter. Thanks!

Have you read about the massive insider trader probe being conducted in the U.S. at the moment? Recent news reports of numerous FBI raids on hedge funds and at least one arrest have been met with mixed reactions and much debate. I thought I might as well throw my two cents in the hat as well, and of course, ask you what you think about all of this.

Perspective Matters

As with any other contentious news story, I suppose your position on this one depends on your perspective. Here’s a look at some of the ideas I’ve heard and read about over the past week or so:

Media Anchors: Will this drive even more investors away from the stock market, proving once and for all that the game is rigged?

Buy & Hold/Passive Index Investors: These scandals pop up relatively frequently. They cause a few ripples in the market, but then we move on. Let’s not over-react. History shows that the stock market always rises.

Active Traders: A few bad apples don’t necessarily spoil the bunch. These things sometimes provide great trading opportunities as favoured companies can go on sale for a while.

Financial Industry Insiders: This is a government witch hunt designed to quiet the unjustified populist rage against banks.

Politicians: See? We’re doing something. Our system works . . . eventually.

As with so many other debates, there’s probably some truth in all of these arguments. Before this news story broke, many pundits were asking why we haven’t seen any “perp walks” related to the economic implosion of 2008-2009. If you want to restore confidence in the political, economic and financial systems, we need to see some heads roll, they said. I’ve been a huge proponent of more transparency, integrity, and accountability myself. Is that what this probe has to offer?

Are the Right Heads Rolling?

So it looks like heads are rolling. Some bad guys are going to prison. The FBI is on the case. The coast is clear and it’s now safe to go back in the water. But wait. Was insider trading to blame for the housing bubble? Did hedge funds receiving privileged information about retailers, biotech and engineering firms blow up the markets in 2008? Ummm … That’s not how I remember it.

From my recollection, banks and consumers taking on too much leverage, ultra-low interest rates, and deaf, dumb and blind regulators blew up the economy. The political and monetary response involved bailing out the profligate speculators with taxpayer money, keeping interest rates artificially low, and further easing regulations on banks. The result has been ballooning sovereign deficits and debt, an annihilation of savers and pension plans, and make-believe balance sheets where banks are allowed to pretend they are not insolvent.

Now I’m the last person to ever condone insider trading. But let’s face it: the line between due diligence and inside information is pretty blurry. Perhaps that’s something we need to address. But do we really have to do it now? Can’t we worry about the flies after we’ve dealt with the wasps and the hornets?

Dragnet or Smoke Screen?

Before this news story broke, another was a lot more prevalent in the financial headlines. Remember the fraudclosure hullabaloo? Bank of America, JP Morgan, Citigroup and several other banks were on the ropes. More and more information was coming to light about fraudulent foreclosure practices. We started hearing some estimates about possible hits to bank capital, and the whole thing was starting to feel like 2007 and the subprime fiasco all over again.

I’m definitely not wishing for a return to those days, but a lot of dirty laundry was finally seeing the light of day after several years in the dark. It wasn’t pretty, but at least we were finally hearing the truth. The back room deals, conflicts of interest, exploitation of less sophisticated consumers, and outright fraud that many of us suspected were there all along was gradually being unveiled.

Then the insider trading probe burst onto the scene, stealing screen time on television and hogging pixels on the internet. What happened to fraudclosure? Is that resolved? I didn’t see any hornets caught on that one, and my guess is that there are plenty buzzing around out there. (The link in this paragraph takes you to a clip of an interview with Janet Tavakoli, one of the few unbiased people who is knowledgeable on this stuff. I highly recommend it. Thanks to Danielle Park for posting it.)

One might wonder whether this new web was unfurled to truly bring culprits to justice or to placate growing anger with the financial and political establishment. A cynic might take it a step further, insinuating that this fly-catching dragnet is nothing more than a smoke screen to distract the gathering posse from the hornets and wasps they seek. Which is the truth?

Honestly, I have no idea. Either way, however, it seems to me that our investigative resources could be put to much better use trying to bring the king pins of this whole thing to justice rather than rounding up the small-time bookies and waving their arrest warrants around like victory flags. It seems our leaders have chosen to fight a peripheral battle rather than engage themselves on the front lines of the theatre. Why that might be, I leave you to speculate.

What do you think about the insider trading investigation?