Dear Friends,
We have said many times here over the past few years that the blackboxes have captured the US financial markets. The lowly individualinvestor, the shareholders looking for value and a decent rate ofreturn on their hard-earned investment capital, have become nothingless than chum for these sharks that operate with the full blessing ofthe government.
What else can you call a situation where transactions are completedin milliseconds and nearly the entire market cap of a publicly tradedfirm can be wiped out in 30 minutes by these “Machines Gone Wild”? Whatis a hard working citizen supposed to think when he comes home fromwork and learns that 10% or more of his entire net worth was wiped outin a single day?
This is no longer investing in any sense of the word – it is agigantic feeding tank where the order flow from the public is the foodthat sustains an insatiable parasite that thrives by draining thevitality and substance out of its host, slowly killing it in theprocess.
I did not think Wall Street could sink any lower in the eyes of theinvesting public given the headlines of the last two years, but thefollowing article from Bloomberg disabused me from that notion ratherswiftly. What it details is almost mathematically impossible in thereal world.
In a world in which markets are genuine, buyers and sellers meet todiscover “value” in a given product when their decisions to buy or tosell taken collectively set a price upon a security that both groupsare happy with on a given day. Sellers are pleased when they receivetheir asking price and buyers are pleased when they acquire a stock atthe price they felt reflected its value on that day.
What makes markets interesting and so challenging is that no oneknows in advance exactly where the “value” assigned by this collectionof buyers and sellers will be on any given day. That is why goodtraders plan in advance a level or price at which they are willing toadmit that their judgment of the “value” of a stock was wrong. If theyare prudent, limit their losses and can maximize their winning trades,they will take 3 steps forward for every step backward. But the fact iseven the best traders sometimes err.
Not so in the brave new world of the high frequency algo crowd. Yousee, they never have a plan for getting out of a trade that goes southbecause in the world in which they live, there exists no such thing. Upuntil now, I had believed that only God was omniscient (knows allthings particularly in advance because He decrees them). Suddenlyhowever, this new breed of mortals has achieved “godlike” status withperfect foreknowledge and flawless insight and can claim to stand onthe same level with the Almighty in the realm of future knowledge.
Here is the truth – these huge firms have now become the market. It exists only to serve them.
Once upon a time, banks helped to create wealth by providing loansto build factories, start businesses and other creative enterprises. Inthe process of lending money, they received a fee and if they werethrifty and prudent managers of their customer’s wealth, they grew andprospered along with their customers as those businesses grew.Somewhere along the line, these behemoths lost sight of the role of abank and have now morphed into giant black holes, that instead ofcreating wealth, suck it out of the pockets of the public engorgingthemselves like the hideous, loathsome tics that they have become.
Somehow I do not believe that this was what the Founding Fathers envisioned for our nation.
Trader Dan
Rigged-Market Theory Scores a Perfect Quarter: Jonathan Weil
Commentary by Jonathan Weil
May 13 (Bloomberg) — Score another triumph for the rigged- market theory.
In a feat that would seem to defy the odds, Goldman Sachs,JPMorgan Chase and Bank of America this week each said its trading deskmade money every day of the first quarter. Goldman said its daily nettrading revenue topped $100 million 35 times last quarter out of 63trading days. JPMorgan and Bank of America disclosed similareye-popping stats. Citigroup, too, recorded a profit on each tradingday, Bloomberg News reported, citing unnamed people who knew theresults.
The intrigue is high. If a too-big-to-fail bank’s traders wereable to make money every day of a quarter, were they really trading inany normal sense of the word? Or would vacuuming be a more accurateterm? What kinds of risks do such incredible profits entail, for thebanks and the rest of us taxpayers? And are results such as these toogood to be true?
There seems to be no satisfying way to answer those questions, oreven the more basic inquiry: How exactly do these banks’ tradingdivisions make money? Reading the companies’ impenetrable financialreports is of little help. However they did it, the data suggest it wasas easy last quarter as hitting the side of a barn with a baseball fromthree feet away.
This isn’t the way “trading” works in the real world. A simple exercise in measuring probabilities is instructive here.
Long Odds
Let’s say you manage a highly leveraged, diversified investmentfund, and have become so skilled at playing the markets that you have a70 percent probability of making money any given trading day. Thiswould be a remarkable achievement in most markets. The odds that youwould post a daily net gain 63 times in a row, though, would be aboutone in 5.7 billion. The formula for calculating this is: 1/(0.70 to the63rd power).
Even if you had a 95 percent likelihood of a winning day, youwould have only a 3.9 percent chance of doing it 63 trading sessions ina row.
Now consider that four of the biggest U.S. banks just pulled offa quarter-long win streak — all in the same quarter. Why would any ofthem even want to? Do they think the public doesn’t despise themenough? Surely it would have been easy to tweak the values of someilliquid “Level 3” assets lower for a day if they had been so inclined,just enough to avoid looking perfect. Yet none of them did.
These banks have the advantage of an unlevel playing field, ofcourse. They can borrow money for next to nothing at current rates andlend it for more, simply by buying longer-term Treasuries. They haveaccess to information that their clients lack. They havecomputer-trading platforms that operate in milliseconds. There’s lesscompetition now that Lehman Brothers and Bear Stearns are gone. Yeteven taken together, these factors don’t offer a satisfactoryexplanation for last quarter’s amazing streaks.
More…
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