The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business. . . .

Of late, it’s not so easy to tell this to my law students with a straight face. Last year saw the market lurch like a madman, dropping almost 2000 points in one week alone, and nearly 800 points in one day. That doesn’t look like a market that’s open and efficient (and perhaps just a bit noisy here and there); that looks more like a market [...]]]> Basic v. Levinson clearly sets out the theoretical justification for the fraud on the market theory:

The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business. . . .

Of late, it’s not so easy to tell this to my law students with a straight face. Last year saw the market lurch like a madman, dropping almost 2000 points in one week alone, and nearly 800 points in one day. That doesn’t look like a market that’s open and efficient (and perhaps just a bit noisy here and there); that looks more like a market that was completely out of whack.

The problem with Basic is well known, and commenters like Larry Ribstein have suggested various solutions (such as more careful focus on causation issues) to combat general noisiness.

But is there a solution that addresses complete insanity? Try asking this one in class some time, and just listen to the discussion that follows.

The bank’s unprecedented reach and power have enabled it to turn all of America into one giant pump-and-dump scam, manipulating whole economic sectors for years at a time, moving the dice game as this or that market collapses, and all the time gorging itself on the unseen costs that are breaking families everywhere — high gas prices, rising consumer credit rates, half-eaten pension funds, mass layoffs, future taxes to pay off bailouts. All that money that you’re losing, [...]]]> That’s how Matt Taibbi describes Goldman Sachs in the opening paragraph of his 12-page Rolling Stone article (which, as far as I can tell, is available online only here, in moderately annoying scanned form). From there, Taibbi picks up steam. For instance, we learn that:

The bank’s unprecedented reach and power have enabled it to turn all of America into one giant pump-and-dump scam, manipulating whole economic sectors for years at a time, moving the dice game as this or that market collapses, and all the time gorging itself on the unseen costs that are breaking families everywhere — high gas prices, rising consumer credit rates, half-eaten pension funds, mass layoffs, future taxes to pay off bailouts. All that money that you’re losing, it’s going somewhere, and in both a literal and a figurative sense, Goldman Sachs is where its going.

Yikes!

Is this just another crackpot conspiracy theory? (Paging Mr. Stein, Mr. Ben Stein.) Nay — Taibbi has give us proof of Goldman’s nefari-iety. It goes more or less along these lines: 1. Goldman survived the Great Depression. 2. Goldman made some savvy bets in the past ten years. 3. Goldman pays really big bonuses.

But wait, you ask, what does that prove? Let’s go over it in detail.

After noting that Goldman Sachs is almost 150 years old, Taibbi pronounces that of Goldman’s first 100 years, “there’s really only one episode that bears scrutiny now,” and then cites John Kenneth Galbraith for the idea that Goldman’s investment trusts were an important part of the Great Depression. So far, so good. (But why exactly would an evil vampire want to blow up its own money-printing scheme? Something about this conspiracy theory doesn’t make sense. Hold that thought for a moment — we’ll get back to it.)

From there, Taibbi jumps to 1999, and begins an analysis of the past ten years. (All of financial history boils down to 1929 and the past ten years, folks.) The breakdown of the last decade proceeds as follows: Taibbi notes that the stock prices during the internet bubble were not always based on sound principles (in other news, the sky is blue); that Goldman helped drive up prices by problematic practices like laddering and spinning; that Goldman put risky debt into overpriced CDOs with badly understood risks; that Goldman’s commodities trading sub made some good bets when oil prices spiked; that regulators were surprisingly compliant with Goldman’s commodity trading; and of course, that Goldman almuni have been heavily involved in the current bailout. Also, repeatedly, that folks at Goldman and other investment banks have made a lot of money, and earned big bonuses. Add it all up, and it is incontrovertible proof that Goldman has taken over the world.

The story also takes swipes at AIG and other entities. And yet, again and again, Taibbi’s narrative runs into the too-many-villains problem. Is AIG a co-vampire? Well, the market crisis has not been particularly good for AIG, to say the least. Taibbi throws stones at Merrill, too (err, the financial services sub of Bank of America) — but he offers no explanation for why these smart vampires (smart enough to take over the world) are so busy drilling holes in their own lifeboats.

And the same goes for not just AIG and Merrill, but for Goldman as well. (Remember what we said earlier about the Depression?) Taibbi’s narrative is one where Goldman deftly rigs the housing market and makes massive profits, only to gleefully blow it up a few years later, because they apparently know that they will be able to rig yet another market. At what point does the supervillain story begin to stretch credulity? If Goldman has the power and acumen to rig the market so well in the first place, why wouldn’t they just keep the rigged game rolling? Apparently the Goldman vampire is smart enough to take over the world every two years, but stupid enough that it continually blows up its own highly profitable and effective schemes — for no reason except the sheer joy of being able to suck the life out of the little guy.

It’s unfortunate, because there really are interesting stories to tell. The CFTC account seems like a fascinating example of the problems of regulatory capture. (Goldman disagrees.) And, as a number of commenters have noted, it’s true that Goldman alumni have been quite effective in shaping and steering the bailout. As Felix Salmon notes, there’s certainly evidence to support a somewhat more staid, less hyperbolic story about regulatory capture. Unfortunately, Taibbi chose to tell a vampire story instead.

(Hat tip to the inimitable Elisabeth for pointing me to the Taibbi article.)