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Written by José D. Roncal
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Tuesday, 15 June 2010 01:09 |
Exactly how the Congressional debates over Wall Street Reform will shake out is anybody's guess. But one thing is for sure; there are going to be winners and losers.
If you've been following the news, you know that both sides of the debate are still duking it out over the details. In one corner you've got the aggressive Rocky, the Bank Lobby fighting to protect Wall Street's bottom line.
In the other corner is Team Transparency, trying to push derivatives trading out of the shadows so everyone can see what's really going on.
OK, maybe that's an oversimplification. The issues also include placing caps on the amount banks can charge retailers for credit card purchases—the swipe fee. Another is about forcing banks to separate their derivatives trading from normal banking operations.
For a refresher course in derivatives, see our earlier posting,Bubbles and Regulation.
No matter how many definitions for a derivative you sift through, you'll find that they are basically a bet on a bet on a bet. No matter how you slice it or rationalize it, most derivative trading is pure gambling. And since banks have access to cheap money from the Federal Reserve, why should they be allowed to gamble with it?
True banking is based on evaluating the credit worthiness of borrowers and the value of their collateral. Speculation, on the other hand, is all about betting on the how the markets are moving—and betting that the value of an underlying asset will drop. Essentially, while banks were betting on failure and collapse, (a collapse they could foresee because of reckless sub-prime lending), they were generating massive profits while the rest of the economy unraveled.
We think it makes perfect sense to separate regular banking activities from pure speculation and gambling. If you read our bookThe Big Gamble: Are You Investing or Speculating? you'll get a real sense about the difference.
The proposed reform also includes some pre-emptive methods for spotting risk and for pulling the plug on troubled financial institutions—before taxpayers end up having to foot the bill for more bailouts. There are also calls for stricter oversight of credit-rating agencies and some form of national consumer protection agency.
But even if the proposed reform does pass, it's not likely to be a major game-changer in terms of averting a future crisis. There will still be plenty of risk left in the system as a lot will be left to the regulators' discretion, and we all know how astute regulators can be . . .think the SEC and the repeatedly ignored warnings about Bernie Madoff!
In our opinion, we can't expect real order and balance in the financial system until derivatives are traded on transparent exchanges. Then if a bank violates those requirements, they should get slapped with hefty penalties. Banks should also be required to protect taxpayers from future TARP scenarios by setting up a kind of escrow account to cover costs associated with the dismantling of failing institutions—much like BP has been forced to do for the clean-up mess in the Gulf of Mexico.
The bottom line is this: if some version of this Financial Reform Bill is to be effective, it will require Wall Street to put investors’ interests first and to play by the rules that prevent more financial disasters. Anything less is not real reform and leaves the doors wide open for the next meltdown. |
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Written by José D. Roncal
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Tuesday, 01 June 2010 17:49 |
If you've read our book,The Big Gamble: Are You Investing or Speculating? or any number of our blog postings here, you already know the main theme: There is no such thing as investing; it's all speculation.
To prove that point in our book, we gave examples of every financial market sector imaginable in which people have had their hopes dashed and savings decimated—stocks, bonds, real estate, commodities, etc., you name it; none of them come with guarantees.
We still stand behind our statement that it's all speculation, however, with the recent so-called "Flash Crash" of May 6, we're strongly favoring a different label for the stock market: High-risk Gambling.
Remember when most of the Wall Street action happened on the floor of the New York Stock Exchange? There was something about those stressed-out guys frantically racing around in colorful jackets, shouting, arms flailing . . . it gave you an odd sense of security that you just might get your fair shake at a fair exchange.
But that's all changed. Back in 2005, eighty percent of all trades took place on the NYSE. By 2005, that percentage was down to fifty. Now it's less than twenty-five percent! We're starting to think that maybe the colorful jackets still swarming the exchange floors are just for the benefit of CNN viewers.
The vast majority of trades today are just quick blips on a screen generated via a staggering number of banks of computer mainframes. Up to sixty percent of those trades are made by high-frequency traders (HFTs) doing business in what they call "dark pools," out of the public's view. HTFs are playing a high-stakes mathematical game of chess, and the companies you and I buy into are merely their pawns.
We've all known that things were happening behind the scenes, but the speed at which the May 6 Flash Crash occurred caught even the most savvy "investors" off guard. When the market suddenly plunged 998-points, it revealed the unsettling scope of HTF trading.
These high-frequency traders are not experienced financial analysts with an interest in the intrinsic value of corporations or industries. These are former math whiz kids and computer geeks who view securities trading as a precarious and addicting game of digital stealth.
With their computers placed as close to the mainframes as possible (to shave off even a split second of trading time) their mission is to spot any minute discrepancy in the flow of data and be ready to strike. For instance, if they spot a futures contract that's out of sync with the underlying stock, they jump on the trade with lightening speed. Remember, these guys grew up playing computer games. They can multi-task faster than most people can think.
When the action is that fast, and the volume is that vast, things are bound to break down. That's what happened on May 6 when 19 billion shares were bought and sold. By comparison, in 1998, three billion shares traded was considered a heavy volume day.
And here we are, nearly a month later and the SEC still can't figure out what went wrong on May 6. Does that give you a sense of confidence? With the high level of complexity, speed, and obscurity in today's market, are you willing to go up against the odds? If you're a high-risk gambler, have at it. If not, better take a step back from the action and find another way to manage and grow your hard-earned money. |
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