May 6, 2010
As I discussed on April 26, expectations for serious financial reform are pretty low. Worse yet, Lloyd Blankfein (CEO of Goldman Sachs) felt confident enough to make this announcement, during a conference call with private wealth management clients:
“We will be among the biggest beneficiaries of reform.”
So how effective could “financial reform” possibly be if Lloyd Bankfiend expects to benefit from it? Allan Sloan of Fortune suggested following the old Wall Street maxim of “what they promise you isn’t necessarily what you get” when examining the plans to reform Wall Street:
President Obama talks about “a common sense, reasonable, nonideological approach to target the root problems that led to the turmoil in our financial sector and ultimately in our entire economy.” But what we’ll get from the actual legislation isn’t necessarily what we hear from the Salesman-in-Chief.
Sloan offered an alternative by providing “Six Simple Steps” to help fix the financial system. He wasn’t alone in providing suggestions overlooked by our legislators.
Nouriel Roubini (often referred to as “Doctor Doom” because he was one of the few economists to anticipate the scale of the financial crisis) has written a new book with Stephen Mihm entitled, Crisis Economics: A Crash Course in the Future of Finance. (Mihm is a professor of economic history and a New York Times Magazine writer.) An excerpt from the book recently appeared in The Telegraph. The idea of fixing our “sub-prime financial system” was introduced this way:
Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel. Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.
* * *
Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis. Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again. The crisis was less a function of sub-prime mortgages than of a sub-prime financial system. Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.
Roubini and Mihm had nothing favorable to say about CDOs, which they referred to as “Chernobyl Death Obligations”. Beyond that, the authors called for more transparency in derivatives trading:
Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis. So-called over-the-counter derivatives — better described as under-the-table — must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted. Moreover, the regulation of derivatives should be consolidated under a single regulator.
Although derivatives trading reform has been advanced by Senators Maria Cantwell and Blanche Lincoln, inclusion of such a proposal in the financial reform bill faces an uphill battle. As Ezra Klein of The Washington Post reported:
The administration, the Treasury Department, the Federal Reserve, and even the FDIC are lockstep against it.
The administration, Treasury and the Fed are also fighting hard against a bipartisan effort to include an amendment in the financial reform bill that would compel a full audit of the Federal Reserve. I’m intrigued by the possibility that President Obama could veto the financial reform bill if it includes a provision to audit the Fed.
Jordan Fabian of The Hill discussed Congressman Alan Grayson’s theory about why Treasury Secretary Tim Geithner opposes a Fed audit:
But Grayson, who is known for his tough broadsides against opponents, indicated Geithner may have had a role in enacting “secret bailouts and loan guarantees” to large corporations, while New York Fed chairman during the Bush administration.
“It’s one of the biggest conflict of interests I have ever seen,” he said.
With the Senate and the administration resisting various elements of financial reform, the recent tragedy in Nashville provides us with a reminder of how history often repeats itself. The concluding remarks from the Roubini – Mihm piece in The Telegraph include this timely warning:
If we strengthen the levees that surround our financial system, we can weather crises in the coming years. Though the waters may rise, we will remain dry. But if we fail to prepare for the inevitable hurricanes — if we delude ourselves, thinking that our antiquated defences will never be breached again — we face the prospect of many future floods.
The issue of whether our government will take the necessary steps to prevent another financial crisis continues to remain in doubt.
Avoiding The Stock Market
May 18, 2010
In the wake of the stock market’s “flash crash” on May 6, there have been an increasing number of reports that retail investors (“Ma and Pa”) are pulling their money out of stocks. Beyond that, some commentators have stepped forward to speak out and advise retail investors to steer clear of the stock market, due to the volatility caused by “high-frequency trading” or HFT. One recent example of this was Felix Salmon’s video message, which appeared at The Huffington Post.
HFT involves a practice wherein firms are paid a small “rebate” (approximately one-half cent per trade) by the exchanges themselves when the firms buy and sell stocks. The purpose of paying firms to make such trades (often selling a stock for the same price they paid for it) is to provide liquidity for the markets. As a result, retail investors would not have to worry about getting stuck in a “roach motel” – not being able to get out once they got in – after buying a stock. Many firms involved in high-frequency trading (Goldman Sachs, RGM Advisors, Tradebot Systems and others) have their computer servers “co-located” in the same building as the exchange, in order to get each of their orders processed a few nanoseconds faster than orders coming from further distances (albeit at the speed of light). The Zero Hedge website has been critical of HFT for quite a while. They recently published this informative piece on the subject, pointing out how HFT firms caused the catastrophe on May 6:
At The Market Ticker website, Karl Denninger explained how HFT platforms often use “predatory algorithms” to drive a stock’s price up to the full extent of a customer’s limit order (a practice called “frontrunning”):
The extent to which frontrunning takes place was the subject of a recent conversation between Larry Tabb of Tabb Group and Erin Burnett on CNBC. The Zero Hedge website provided this analysis of the video clip:
A recent piece by Josh Lipton at the Minyanville website focused on the activity of retail investors since the recent “flash crash”:
The current risk-aversion experienced by retail investors is compounded by the ugly truth that stocks are currently overvalued. Shawn Tully of Fortune made this very clear in a May 17 commentary, wherein he provided us with a sage bit of prognostication:
Considering the unlimited number of awful news events unfolding in America and around the world right now, we could be headed for a market crash much worse that that of October, 1987. Cheers!