In May I wrote a piece - "Does the Punishment Deter the Crime" - about the blatant insider trading in the stock market and the oil market. My humble opinion is that article is worth a reread. For those who refuse to indulge in my engagement farming, the gist is that financial markets only work when participants believe they are fair, and that perception of fairness comes in large part from appropriately sized punishments for malfeasance that are consistently applied.

At the time, the CFTC announced that they would investigate the insider trading allegations. I was skeptical at the time that they would do their job. For one, the CFTC has been gutted. Since the start of the current Trump administration, their staffing has been cut by 25%. This includes a total zeroing out of their Chicago office, which historically was where the most complex and important fraud investigations were conducted. Our sources on the inside tell us that the 25% was disproportionately the most experienced and capable enforcement staff, and that the 25% number actually understates the drop in capabilities. The decision-makers that are left seem more or less content to just legalize gambling through euphemisms like “prediction markets” and “event contracts” and let the actual crime just happen.

The second cause of skepticism was that we were hearing chatter from insiders that the administration was looking for hedge fund partners to help them manipulate oil prices before it happened. There are always rumors on Wall St, and most turn out to be hogwash, so it’s dangerous to believe everything you hear. However, the rumors we heard were very specific and then consistent with what ultimately happened. The CFTC was obviously not going to go after fraud and manipulation if the “call was coming from inside the room.”

Which brings us to this week’s news. To the credit of whoever was involved, a team within the CFTC’s Division of Market Oversight did the forensic work and filed a referral with the Division of Enforcement. A “referral” in this context is them saying “this smells fishy enough to pursue further." At this point, the political appointees at the top of the CFTC stepped in and told them to retract the referral. That’s not a thing. It flies in the face of the entire point of a regulatory agency and has probably literally never happened before. They (specifically Mel Gunewardena) said they wanted to handle the investigation themselves. It’s not hard to imagine what happens next. I only wish Kalshi would list a contract on “is insider trading practically legal in the US now” so that I could buy it. In May, I wrote:

"To function, participants have to believe that markets are fair. Why don’t investors from the largest economy in the world invest much in the stock market of the second largest economy in the world? Because, rightly or wrongly, a large swathe of US investors (and frankly Chinese investors) don’t think they are going to be treated fairly in the Chinese stock market. And because of that, the Chinese stock market suffers from much weaker demand. Over the last 10 years, the Chinese stock market has cumulatively grown less than the Chinese economy. Good luck finding another country with that badge of dishonor."

US markets are often called “the cleanest dirty shirt.” This is largely a reflection of a relative advantage in rule of law and investor protection. Being the cleanest dirty shirt means you attract a disproportionate share of global capital relative to your fundamentals. That’s not a theoretical thing. US capital inflows allow the government to fund itself at manageable rates and keep the stock market high and rising. Does this incident knock the US off its perch? Probably not. But it’s another big erosion of our standing in global markets. We are still the cleanest dirty shirt, but damn, those armpits are really starting to stink.