Juggling Dynamite

More useful detail on HFT comes out in this segment.

Michael Lewis, author of “Flash Boys,” talks about high-frequency trading, the U.S. stock market and financial regulation. Here is a direct video link.

Yes the stock exchanges need to go back to being unbiased utilities versus the for-profit-prostitutes they have become. That one has been obvious for years.

There is also another important point here missed in the red-herring argument that “trade commissions are cheaper today than years ago, so hasn’t HFT made it better for investors.” Financial markets devolve into an unethical abyss in direct correlation with the degree of opaque activities, hidden fees and conflicts of interest that the system (the public, investors and regulation) tolerates. We have seen this throughout time.

If financial institutions are allowed to take big risks underwritten by the taxpayer, they will take crazy risks that will bankrupt the economy. If they can make fortunes selling people capital risk and calling it “advice” they will sell them tons of risk at every price and harm the clients. If they can hide their fees and take profits in a million different ways, they will be on the take from many and charge more. If they are allowed to operate in complex webs of conflicting interests they will take advantage of those conflicts. If their executives are allowed to move freely back and forth between private companies and government policy roles, they will use inside knowledge of the regulatory rules to slant policy in the industry’s favor and degrade the public trust. Transparency of fees, disclosure, a division of risk sellers from advisory service, fiduciary standards surrounding conflicts of interest…this is all patently obvious stuff–reforms that need to be restored as they did in the 1930’s.

As Lewis says, we can’t blame lions for eating antelopes if we keep putting the lions in positions of control and trust over the oblivious and trusting antelopes. But we will keep paying huge, debilitating socioeconomic costs. And 5 years after the great financial crisis, we still are.

At some $5 trillion of daily transactions, foreign exchange is the world’s largest, most liquid market. Collusion and fraud in FX price fixing by bank traders has been terrifically profitable for them as they worked to rebuild from the debt bomb of 2008. It also made FX a perfect playpen for HFT algos to rip worldwide. Over the past 16 months in particular, we came to observe that the “carry trade” in FX has been the driving force behind daily price moves across equities, commodities and high yield debt. As Abenomics drove the Japanese Yen lower since December 2012, the Yen became the favorite place to borrow and speculate in global asset markets: lower Yen meant higher, higher and higher stocks. Yen strength on a given day, meant stocks lower, nearly without fail.

Case in point this week, as more deflationary data out of Japan confirms Abenomics is failing to stimulate exports and targeted inflation; the Yen has weakened once more in anticipation of yet more [ineffective] stimulus to come as stock markets surged to yet another maniacal high on relentlessly vapid volume. See: High-Frequency Traders chase currencies as stock volume recedes

All of this makes a complete mockery of free markets, price discovery, economic progress and investment prospects of course. Particularly embarrassing are all the clueless financial types trying to rationalize and justify an investment case for today’s historic stock valuations now second only to the peak of 1929 and 2000. ‘Dumb money’ is an understatement.

At least we can credit Micheal Lewis’s new book campaign and media blitz with finally bringing attention to the sinister forces that have been happily stealing the public’s breakfast, lunch and dinner the past 5 years. Hopefully it may also shame prosecutors and policy makers into taking long overdue action. For the moment at least, we are also seeing a scurry among some of the big banks to retreat from this space and distance themselves from coming lawsuits and deserved public anger.

Time will tell if any of the necessary reforms finally stick. Given years now of shocking abuses, it’s hard to be hopeful, and yet, exposed to enough sunlight, eventually corrupt regimes always do fail.

Over the past 5 years, anything that has helped to push security prices higher and rebuild bank coffers (insider trading, skimming, front-running, money laundering, HFT, re-hypothecation, price fixing, QE) are considered by the status quo–central banks, regulators, financial heads– desirable and worth the financial costs to everyone else. It is a catch 22 however, because all of these short term prods have served to undermine the stability and durability of current prices and markets.

Once that reality is revealed and losses hit once more, all of these same factors will be cited as “bad guys” that caused the collapse. Of course no one will be compensating or bailing out individual investors; many of whom will have their life dreams and plans thwarted in the process. By then, as in 2000 and 2008, this period will be just another sad and foreseeable chapter in the secular bear book.Here is a direct video link.