Thursday, July 30, 2009

Nothing to See Here

Thanks to everyone who took the time to read my most recent post, "We Fear What We Don't Understand" on the topic of some common high frequency trading misconceptions. I appreciate the positive feedback which illustrates the intelligence of my audience here.

This morning, I was surprised to see the market trading higher on "positive jobless claims numbers" - as the press had hyped them. Look - this isn't rocket scientist. You don't need a PhD in economic theory to understand, but empirical evidence suggests that you do need to be smarter than the average reporter. I wrote a post a full 6 weeks ago describing the record "exhaustion rate." More people than ever are using up their unemployment benefits and dropping off the continuing claims tally - so the continuing claims number goes down, but things are getting worse, not better.

Elsewhere in the "things aren't looking so good" file this week:

1) NYC pays to send homeless people back to where they came from

"The Bloomberg administration, which has struggled with a seemingly intractable problem of homelessness for years, has paid for more than 550 families to leave the city since 2007, as a way of keeping them out of the expensive shelter system, which costs $36,000 a year per family. All it takes is for a relative elsewhere to agree to take the family in."

2) MISH: "You can only sell the capitol building once." Arizona is needs to raise money to close a budget deficit.
"State properties now being considered for sale and leaseback include the House and Senate buildings, the Phoenix and Tucson headquarters of the Arizona Department of Public Safety, the State Hospital and the state fairgrounds, according to a document obtained by The Arizona Republic. Some prison facilities also are under consideration."You can only sell the Capital Building once.

What will they do next year to balance the budget?

3) Karl Denninger: "Barney Frank - STFU" Now, I don't agree with everything Karl Denninger says, and I don't like that he has the same monogram as me (KD), but I won't hold it against him for stealing the title of a post I wrote back in October of 2008 (STFU Barney Frank) - because in this case, he's totally correct. Barney Frank is threatening to revive the mortgage cramdown bill because lenders aren't being aggressive enough in modifying troubled loans. Denninger says:

"The banks are not modifying these loans in that fashion not because they want to be "mean", but rather because on a market value basis for these loans they are all insolvent right now and have been for over a year"

The sick thing is that Barney Frank knows this - so it's likely that Frank is just pulling more populous grandstanding, knowing that the banks can't redo the mortgages without recognizing losses, but still wanting to appear like he's fighting for his constituents.

4) I though this Wall Street Journal Op-Ed on "speculation" was pretty decent:

"The oil speculators are back—that is, back in the cross-hairs of the political class. On Tuesday, Commodity Futures Trading Commission Chairman Gary Gensler uttered the Pentagon-like phrase that “every option must be on the table” to curb “excessive speculation.” If you’re wondering what makes speculation “excessive,” in Washington the answer is this: Speculation becomes excessive when prices move in a politically inconvenient direction. Which brings us to the real meaning of the three days of theater, er, hearings that Mr. Gensler is conducting this week."

5) The market gave up half of its gains today when two Bloomberg headlines came out:

Really? That caused the selloff? I mean, I guess there's no use looking for a good reason to sell off when there was no good reason to rally, but doesn't Ackerman's comment win the "NO SHIT SHERLOCK" award of the day? Bad loans were the FIRST wave of the crisis. We still haven't dealt with them!

This seems like a good time for a Ludwig Von Mises quote:

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."


disclosure: short the market (SPY)

Sunday, July 26, 2009

We Fear What We Don't Understand

"For those who believe, no explanation is necessary. For those who do not, none will suffice." - Joseph Dunninger.

I've resisted writing a piece about high frequency trading lately. Although I have a very good understanding of the subject, I see it as a kinda lost cause to try to educate people about - uninformed people want to believe that computers are front running them, stealing their money and manipulating the markets. People who understand equity trading know that this is just the culmination of technology advancement and competition for spreads, which has resulted in equity bid/ask spreads being narrowed to their lowest levels ever. There has never been a better time for the individual stock trader to execute orders: our bid ask spreads are narrower than ever. A high frequency trader may have a computer program trying to scalp a penny or a fraction of a penny from you - but this is better than it's even been - better than the days of specialists scalping 1/8ths and more.

I left a comment stating as much on Floyd Norris's latest article "What Should be Done," only because he got it precisely backwards when he wrote "In one sense, this is a return to the bad old days. Before reforms, the Nasdaq market kept the bid-asked spread for the brokers. The public had to buy at a higher price and sell at a lower one." On the contrary - high frequency trading has resulted in competition to capture those exact spreads, and has narrowed them drastically.

In my opinion, reaction to high frequency trading is all about the quote at the top of this post if you change the word "believe" to "understand." I will at least try to educate those who do not understand high frequency trading, so that they can form intelligent opinions - although I still fear that "no explanation will suffice."

Joe Saluzzi of Themis trading has gotten a ton of press based on a paper he published about the evils of high frequency trading. It's important to notice that Saluzzi is an execution trader, and that algorithms and high frequency traders make his life very difficult, because no human can do the job as well as an algorithm can. Saluzzi concludes his paper "We also recommend that institutions use algo systems only for the most liquid of stocks. Anything less must be worked, the same as in the “old days.” Institutions need to re-learn how to “watch the tape” and take advantage of, or work around, high frequency traders." Or, institutions can embrace technology and use or develop better algorithms. Either way, Saluzzi's suggestion that it's kosher for him to execute the orders by "watching the tape" to gauge optimal timing, but that it's unfair for a computer program to do the same thing reeks of hypocrisy. The best comment I've read on the subject was this (emphasis mine):

"Frontrunning is trading in front of a customer order. It is illegal. Collecting and analyzing publicly available information and trading based on your insights is legal. And guess what, someone will be the fastest and most accurate in doing this. The result of their actions is to translate meaningful information (strained from a stream of mostly noise, it's incredibly difficult to do) into price changes which make the price more accurate relative to what's knowable at the time. Unfortunately for people like Saluzzi, a 19th century "tape reader", a lot of the information that quicker, more talented, machine-using, more insightful players uncover is information about large size that he's trying to deceptively move without anyone knowing the truth about what he's doing. There's nothing wrong with what Saluzzi is trying to do. What's wrong is crying foul when the one-sided benefit you wanted to obtain is defeated by people who have made a bigger investment in what's important for trading. The big winners in all this are small traders who are not fleeced by large professional size deceptively getting them to buy or sell at insufficient prices. I can understand Saluzzi's campaign against technology and modern information processing, it's his ox that's getting gored. The thing that's truly hilarious is that what Saluzzi wants to be legal, his "tape reading", is just another example of where professionals have an edge over the little guy. But it would never occur to Saluzzi to outlaw what HE does, only what his competitors are doing better than him."

Let's get one thing straight: front running is when someone sees your order and executes ahead of it. It's illegal, and no one is advocating it. What many of these high frequency trading algorithms do, however, is not front running. High frequency trading is about using computers to do what human traders used to do - take advantage of available information (such as orders that are visible in the marketplace) and try to figure out where a stock is going. They do it better than humans can do it. They try to figure out what you want to do, and try to profit from what they think you want to do. They do it faster and more accurately. That's called trading - it's the nature of the beast.

If you put in a limit order to buy 100 shares of IBM at $80.50, and a computer or anyone else immediately bids $80.51 for IBM, that's NOT front running. That's someone willing to pay more for the stock than you are. It doesn't matter if that someone hopes to buy the stock and offer it back to you immediately like a high frequency rebate trader, or if they plan to hold it in their IRA for 50 years. Similarly, if, at the time you bid $80.50 for IBM, stock is offered at $80.51, and as soon as you put your bid in someone takes the offer, that's NOT front running. You had the opportunity to take that offer - you chose not to. This is the first key realization people need to make.

The next realization is that no algorithm can force you to pay more than you want to for stock. One thing the algo's do is "psyche you out" - when you bid $80.50 and you see the $80.51 and $80.52 offers get lifted, you might get nervous and panic. That's your problem. If you put your limit order in and go to the kitchen to make yourself a sandwich, you'll probably find that your order is filled when you get back. Any algo that expected you to panic and lift stock from them lost on their gamble. You can defeat the psychological game by refusing to play it (place your order and don't stare at the screen) - or by lifting the offer in the first place, paying the narrowest spread you've ever paid due to the massive competition by various high frequency trading algorithms to maintain quotes on the inside market.

Let's talk about Chuck Schumer's proposed ban on "flash" orders. Flash orders are a little bit trickier. From the NY Times article:

"When buy or sell orders are submitted to marketplaces like Nasdaq, they are sometimes flashed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — before they are routed to everyone else. In that half-second, (sic) fast-moving computer software can gain valuable insights regarding growing or declining demand in certain stocks and can trade ahead of other market participants, pushing prices up or down.

Although anyone can gain access to flash orders by paying a fee, they are useful only to traders who have computers powerful enough to act on the data within milliseconds"

First, note that ANYONE can gain access to flash orders. Similarly, anyone can gain access to co-located servers at the NYSE to have super fast execution speeds. These are not just available to a select chosen few - they are available to anyone who wants to make the investment in capital and technology. Now, the intent of flash orders is to allow participants in a given market center the opportunity to improve the current bid or offer so that an order doesn't need to be routed away to another market center.

An example: let's say GE is trading $11.45-$11.50 at DirectEdge, but that there is an $11.46 bid on ISLD (an ECN). If you submit an order to sell stock at $11.46 on DirectEdge, they flash this order to select market participants to offer them the opportunity to fill your order - otherwise the order gets routed out to ISLD and you (the seller) have to pay an extra fraction of a penny for the routing. As I tried to explain on some other posts regarding flash trading, this is basically a hyper-speed modernized version of how the NYSE specialists used to verbally quote orders to offer people in the crowd the opportunity for price improvement: "if GE was 11.25-11.27 50k up, and you walked in to sell 50,000 shares, the specialist would say out loud “25c bid 50,000, 50,000 at 26c, SOLD.” Anyone could say "TAKE or BUY'EM" before the specialist said "SOLD" which would result in the seller getting price improvement to $11.26 and if no one interrupted him, the trade was done at $11.25. Markets have NEVER been setup such that every participant has the same opportunity to trade on every quote."

The problem is if systems receiving flash orders can then turn around and hit that bid in front of the seller. That is blatant front running, and needs to be stopped. Here's a quote from a user of flash quotes explaining why he doesn't want them banned - a key point is that no one forces you to place flash orders:

"responding to: "there are different forms of HFT. Flash is clearly frontrunning and anyone who says otherwise is delusional. its designed to cheat "

Not true.

It is designed to keep orders from being routed-out under Reg NMS - which saves the person placing the trade money.

I am a small fry (sole employee of my small stat arb company) placing small to modest sized limit orders directly on ECNs. If I want to avoid paying a route-out fee when my order would otherwise become marketable on another exchange or ECN, the best execution + cost structure that I can get is to first have an order flashed locally to see if I can have a fill on the local ECN.

If a HF trader on the ECN gets the flash and 30ms later fills my order, I avoid paying a route out fee. If no HF trader responds to the flash, or the flash never existed because it got outlawed, then I end up paying a route out fee.

That is the intent behind flash orders. It keeps orders that become marketable more frequently on the local ECN rather than having them route-out....

I keep saying the same thing over and over again... but anyone who cares about orders flashing and doesn't want them to flash should just send the order through a different venue. It isn't rocket science. If you don't like the facilities provided by Direct Edge to execute your market moving large institutional order, then place it on Island.

Why is that so friggin hard?

No one is forced to place any order types that they don't like, or use any ECN that they think disadvantages them.

If your broker forces you to place trades on venues that flash orders and you have no control over it, then you need to get a better broker.

Outlawing an order type that some people actually like to use under certain circumstances is ridiculous.

More constructively - make flash default to off, so that a trader needs to explicitly ask for a flash, and make all brokers who don't pass on fine grain order control to their customers set the default to off...."

I'm somewhat indifferent when it comes to flash orders - on the one hand I don't care if they get banned if they are being prolifically front run, but on the other hand I like the suggestion of defaulting the flash order status to "off" and allowing traders to still flash their orders to try to get price improvement. If traders are getting worse executions on their flash orders because they are constantly being front run, then they will stop using them.

Let be take a brief detour to negate one blatatly erroneous insinuation made in today's financial times article:
"Themis also suggests reintroducing the New York Stock Exchange's curb on program trading that would apply whenever the market was up or down by more than 2 per cent for a day. This constraint was removed in October 2007, which is - maybe not coincidentally - when world stocks peaked."

The NYSE never had curbs that prevented program trading. The NYSE used to have curbs that imposed restrictions on index arbitrage orders, a specific subset of program trading, after market moves of a certain magnitude. The curbs ensured that index arbitrage buy orders had to be executed on a downtick, and that index arbitrage sell orders had to be executed on an uptick. It's basically like the uptick rule for short selling, only it applied to buy orders as well. This had little or nothing to do with high frequency trading, and is completely irrelevant to the discussion, except for the ludicrous assertion that the removal of the curbs somehow may have led to the depression of the markets. If Themis thinks that high frequency traders are manipulating the market higher, they need to realize that the re institution of NYSE index arb trading curbs would have no effect.

While I'm on the topic, let me debunk a few more of Themis's blog posts. Saluzzi's assertion that high frequency traders were manipulating the price of CIT higher so that it would be eligible for a rebate was proved wrong before he even published it, when the price failed to maintain the $1 level. CIT was trading massive volume because it was in the process of basically declaring bankruptcy - not because HFT guys were manipulating the price. Second, Saluzzi's post titled "The Three HFT Horsemen" is perplexing. He alleges:
"The three HFT horsemen are C, BAC and CIT. These three stocks traded 860 million shares today which is 10% of all US Equity volume. Think about that – 3 stocks in a universe of over 5000 U.S. stocks represented 10% of the volume. How could this be? Look at the intraday chart of all three of these stocks and you will see a something in common: an early morning move followed by a flatline with a very tight range (around .05). Meanwhile, while these stocks were flatlining the market was heading higher. The S&P 500 gained around 10 points in the afternoon (or 1%) but these 3 stocks did not move. There was a constant bid to these stocks yet anytime they wanted to lift there seemed to be a constant offer just a few pennies higher."
Never mind the fact that C and CIT are low priced stocks that should theoretically trade in tight ranges: what is the problem with this? As a trader, Saluzzi should be sending thank you notes to the high frequency traders for making sure the price of the stock didn't move much at all - this makes his job easy, regardless of if his client is a buyer or a seller of stock. There was ample liquidity all day, and the prices barely moved. This is a good thing.

I am a capitalist. I like competition in markets. Our competitive markets have resulted in evolution to the point where traders have written computer algorithms that do the job traders used to try to do by hand - profit from stock movements and from what they feel net supply and demand for a given stock is. This is the main reason I'm against most attacks on high frequency trading. SOMEONE will always be the best - the fastest - the closest - regardless of if you ban co-located servers, or install mandatory latency in order execution pipes. Would there be anything really wrong with making sure that all orders placed are valid for a 1/2 second or a full second? No, I don't think there would be - and that might be the kind of compromise that we move toward - but we need to recognize that the playing field will never be level. It never has been level and it never will be level - there is always someone smarter than you, and it would be a shame to try to legislate that edge away.


full disclosure: no agenda here: I do not run a high frequency trading system, and a ban on HFT would not have much if any impact on my life. market position: short the market.

Friday, July 24, 2009

How Not to Fix Anything

First, this absolutely absurd headline of a NY Times article - I swear - it's NOT from The Onion: "California Pension Fund Hopes Riskier Bets Will Restore Its Health." Oh jeez - what can you even say about that? Marty Up!

Then, this article about banning "naked" credit default swaps. A refresher course - CDS is a way for investors to protect themselves against default. However, you don't have to actually own bonds in the underlying entity on which you're buying protection (CDS). Some say this is akin to "buying insurance on a house you don't own." It's no different from an equity put option - you seek to profit if the underlying decreases in value. There is nothing nefarious about buying insurance on a house you don't own, provided you don't burn the house down. Of course, others who don't understand will suggest that speculators buy CDS, short the underlying company's stock, create panic, and destroy the company. Those who understand know that you cannot destroy a company by shorting its stock or taking a protective position against its risk of default. Lehman brothers blew up not because people were short selling its stock, but because their liabilities greatly exceeded their assets. AIG blew up not because they bought massive amounts of naked CDS - but because they SOLD massive amounts of CDS.

I don't know why it's so hard for people to understand that the problems we had were not related to investors/speculators/traders buying credit default swaps. Not ONE hedge fund, mutual fund, sovereign nation, insurance fund or bank blew up from buying credit default swaps. The problem was not people buying put options / credit protection. The problem was people SELLING CDS without sufficient collateral. This is a very very simple concept, and it shocks me greatly that authorities don't get it.


Tuesday, July 21, 2009

Put Down That Government Crutch

There is an article in the NY Times today detailing a problem that I've been observing for almost two years now - the proliferation of vacant retail space in NYC. Rents are still so high that it seems that every time a store's lease comes up for renewal, they have to close up shop. The Times article mentions storefront vacancy rates of roughly 6.5% citywide, with the rate expected to climb to 10%.

"And those numbers do not capture the full story. Some of the more desirable shopping districts are littered with empty storefronts. For example, Fifth Avenue between 42nd Street and 49th Street, the stretch just south of Saks Fifth Avenue, has a vacancy rate of 15.3 percent, according to the brokerage Cushman & Wakefield.

In SoHo, from West Houston Street to Grand Street and Broadway to West Broadway, among the high-end boutiques, art galleries and restaurants, 1 in 10 retail spaces are now empty or about to be.

“I’ve never seen such an across-the-board problem,” said Lorraine Nadel, a lawyer who has represented tenants and landlords for 18 years. “Store owners can’t pay their rent, and they can’t keep their businesses going.

It has long been difficult to run a small business in Manhattan, but a number of struggling store owners cite high rents and their landlords’ unwillingness to negotiate as the leading obstacles to their survival.”

What disturbed me was when I got to the line,
"But as jobs disappear and neighborhoods suffer, the tide of opinion is growing that the government may need to step in."

Ummm- the government may need to step in and do WHAT exactly? There is a problem with Manhattan retail spaces - the rents are too high. It's that simple. The best thing the government can do is to stand idly by and let the rents fall to levels where business owners can afford them again. This is exactly what they should be doing with residential real estate too, incidentally - instead of thinking of new ways to prop up home prices, keeping them UNaffordable.


Friday, July 17, 2009


So I wrote this piece a few days ago as soon as I read that Einhorn swapped his GLD for physical bullion, anticipating that it would bring out more cries about how the GLD is a scam. Not but a few hours later, SeekingAlpha published an article from J.S. Kim where he explained his skepticism about the GLD and SLV products. There are a plethora of comments, some explaining why he's incorrect, and some thanking him for illuminating the problems. SeekingAlpha publishes my posts too, and my GLD post generated some discussion/debate in the comments section.

I realized there is no reason for me to waste any more time arguing about the validity of the products, as I can sum it up simply. Some people prefer GLD, some people think you need to own physical gold. I left the following comment on both my own post, and Kim's:

" When you buy physical gold, you can get ripped off - right? whatever chance there is - someone could send me a brass bar plated in 24k gold - I'd have no friggin' clue. do you have a machine at home that verifies the gold you're buying is real gold?

Bottom line for ME, is that I think the chance of being ripped off by the GLD is much lower than the chance of being ripped off buying physical gold bars (not to mention GLD is much easier to trade.).

if the GLD trust gets sold to FlyByNight Securities, and they moved the gold to a warehouse in Secaucus, then the story/risk would change."

'nuff said.


Thursday, July 16, 2009

Odds and Ends

-I found this NY Times article on rationing health care to be pretty interesting. How do you value a human life? Does the life of an 18 year old have more value than the life of an 85 year old? Does the life of a disabled person have the same value as the life of a non-disabled person? How much would you pay to extend someone's life for one year? There are certainly no easy answers to these questions, yet they are central to the future of our health care policy.

-CIT bondholders are considering a debt for equity swap. Good - that's exactly what's SUPPOSED to happen. Bondholders taking a haircut or converting their stake to equity is number one on the list of answers for "How would you have done things differently if you were in charge of the financial mess?" While it may not have been feasible to simply let every firm in trouble die like Lehman Brothers, it certainly would have been feasible to require bondholders to contribute, which did NOT happen (note: it DID happen with the auto bailouts - why not with the bank bailouts?). I even asked Barney Frank about this at the Weston High School Town Hall meeting a few months ago, and he acknowledged that there were concerns about what would happen if the bondholders had to take losses.

-Finally, I don't know how anyone can look at this picture of Barney Frank playing volleyball in a pool and not think of this classic SnL parody ad for Shmitt's Gay Beer.


Roubini's Comments Manipulated

Again today we saw another case of the vicious attempt (successful again) by the media to manipulate the stock market higher. I was absolutely SHOCKED to see the market rip 1% late in the day today off a headline "Roubini says worst of economic crisis over, sees end of recession by year end." No story, just a headline. Anyone who has been following Nouriel Roubini knows that he's been pretty skeptical of the recovery (and before that, was super bearish for a long time leading into the collapse.) So I went on over to his blog and looked at his comments from July 14th, which were anything but bullish. Now, as I write this, Roubini has a new post up explaining that the quote was taken out of context!

“It has been widely reported today that I have stated that the recession will be over “this year” and that I have “improved” my economic outlook. Despite those reports - however – my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.

“I have said on numerous occasions that the recession would last roughly 24 months. Therefore, we are 19months into that recession. If, as I predicted, the recession is over by year end, it will have lasted 24 months with a recovery only beginning in 2010. Simply put I am not forecasting economic growth before year’s end...

“While the recession will be over by the end of the year the recovery will be weak given the debt overhang in the household sector, the financial system and the corporate sector; and now there is also a massive re-leveraging of the public sector with unsustainable fiscal deficits and public debt accumulation.

“Also, as I fleshed out in detail in recent remarks the labor market is still very weak: I predict a peak unemployment rate of close to 11% in 2010. Such large unemployment will have negative effects on labor income and consumption growth; will postpone the bottoming out of the housing sector; will lead to larger defaults and losses on bank loans (residential and commercial mortgages, credit cards, auto loans, leveraged loans); will increase the size of the budget deficit (even before any additional stimulus is implemented); and will increase protectionist pressures.

“So, yes there is light at the end of the tunnel for the US and the global economy; but as I have consistently argued the recession will continue through the end of the year, and the recovery will be weak and at risk of a double dip, as the challenge of getting right the timing and size of the exit strategy for monetary and fiscal policy easing will be daunting."

You can read Roubini's full post on his blog. File this one under "read the facts before you react."


full disclosure: short the market (SPY)

Getting in Front of It - GLD

One group of people that's even more fanatical than the Goldman Sachs conspiracy theorists are the Goldbugs. As I read David Einhorn's (Greenlight Capital) quarterly letter last night, one thing jumped out at me:

"We made a couple of modest changes to our macro hedges. First, after extensive investigation, we switched our entire GLD exchange traded fund position into physical gold. At a minimum this will provide some savings as the costs of storing gold are less than the fees on GLD."

Now, I happen to believe in GLD as a product. I have read the prospectus multiple times, which states that the GLD owns physical gold bullion - not gold futures or other paper versions of gold. GLD shares can actually be redeemed for physical gold bullion (if you have enough shares). This doesn't stop the Goldbugs from trumpeting about how the GLD is NOT the same as gold, and that if you really want to own gold, you should buy bullion instead. Well, GLD is not gold - it's a share in a trust that owns gold, but the difference is that I actually believe that the trust owns the gold, while some Goldbugs think the whole thing is a giant scam.

Anyway, I'm CERTAIN that in the coming days, you'll be able to find some rantings about how Einhorn's "extensive investigation" which resulted in him swapping out of GLD and into bullion is evidence that there are problems with GLD. Look - I cannot guarantee to you that the GLD is a perfect product - I have not seen and audited the gold in their vault (although I am close to someone who works intimately with the GLD trust, and who offered me exactly such an opportunity, should I make it to London in the near future). However, Einhorn explained one reason for the switch - cost. He's got a sizable position, and the means to store physical gold, so he holds the cheaper version.

Also, I could interpret this as a validation of GLD. Although I don't know how Einhorn swapped his GLD for physical bullion - I'd be willing to bet he simple "redeemed" the GLD shares he had with the trust, and took delivery of gold bullion. This is great news for those who fear that the GLD is a paper pyramid - that Einhorn was able to do exactly what he was supposed to do - that GLD and gold are essentially fungible. Again, I can't be sure that's what Einhorn did, and if anyone has any evidence or inkling that he actually sold his GLD position and bought physical bullion, I'd LOVE to hear about it, as that would nullify my whole point.

We could also draw the conclusion that perhaps Einhorn plans to hold this position for a longer period of time - although, since GLD and gold are fungible, he could easily liquidate his position by shorting GLD and creating shares of the ETF with the trust to close out his position - relax, it's not as confusing as it sounds - you can take your GLD and give them to the trust in exchange for gold bars, or you can take your gold bars (redeem) and give them to the trust in exchange for GLD (create). In other words, the GLD is just a more liquid way for the average person (or the professional hedge fund manager) to trade gold.


full disclosure: long GLD and SLV

and note to Goldbugs: PLEASE do not leave me comments saying that the GLD is fraudulent because it can be shorted - it's a false logic argument, and it's incorrect.

New Proposals, and back to GS

Yesterday I wrote about misplaced blame. I think the general public is mad at Wall Street, when in reality they should be mad at the government for the way it's treating (coddling) Wall Street. When we funnel tens of billions of taxpayer dollars to these firms, they are going to try to make money with it - that's what they do. Instead of being mad at GS and JPM for ringing up huge second quarter profits by "gambling with the taxpayer's dime" as the populist line goes, be mad at the government for giving them the taxpayer dime in the first place.

Today, I read this story (yesterday actually):

July 15 (Bloomberg) -- Federal Deposit Insurance Corp. Chairman Sheila Bair, with support from Federal Reserve officials, is pushing for tougher measures to curb the size and risk-taking of the nation’s largest financial firms.

The FDIC will propose slapping fees on the biggest bank holding companies to the extent that they carry on activities, such as proprietary trading, outside of traditional lending. The idea goes beyond the Obama administration’s regulation-overhaul plan, which would have the Fed adjust capital and liquidity standards for the biggest firms, without any pre-set fees.

I hate this idea, as it basically sounds like it's sanctioning the behavior - as long as you pay the price, you can do it. Many of the problems we've had in our financial system come as a result of the breakdown in the distinction between commercial banking (that's lending and borrowing) and investment banking (that's underwriting and trading). These two were separated for a long time by the Glass Steagall act, which eroded over the last decade. As I've written before, it's ok for a firm to lose its own money - it's NOT ok for a firm to lose everyone else's money - which is what happens 1) when commercial banks ring up massive proprietary trading losses and 2) excessive leverage is extended.

My point is, if the administration passes the new regulations mentioned in the Bloomberg article above, I won't be mad at Wall Street - I'll be mad at the lawmakers for passing ridiculous legislation that sanctions risks under the name of "pay to play" when the proper solution is to limit leverage and consider re-instituting the distinction between investment and commercial banking.

Finally, here are 3 more interpretations of Goldman Sachs and their behavior:

1) Andy Swan "Stop Blaming Goldman"
"Goldman is out to take your money, and they are REALLY good at it.

You have three options:

1) Quit. If you really think it’s an unfair conspiracy that’s producing your losses, then this is the only rational thing to do.

2) Keep losing and whining. This is the most annoying one, for everyone around you. I do not recommend this.

3) Win. Play to win. Think like Goldman, and see the world of retail traders as they are. Research. Learn. Practice. And most importantly, do the opposite of what best-selling books have told a million other shmoes to do."

2) Falkenblog "Is Goldman Evil?"

"Goldman is self-interested, which means they don't share all their ideas, and they don't hire everyone capable who wants a job there, but that's inevitable and you can't let that color your views. The latest hatchet job in Rolling Stone is by Matt Taibbi, who has a profoundly adolescent and paranoid world-view that seems clever and witty only at a distance. Those who think Goldman was the prime mover in our financial mess are simply wrong, as Goldman was as guilty as everyone who did not second-guess the assumption that aggregate housing prices do not fall in nominal terms (academics, legislators, regulators, investors, home buyers, investment bankers, rating agencies—did I forget anyone?)...

I think GS as an example of what happens when you have a bunch of smart, highly connected people working together to get rich. There is a lot of inside ownership, and so their large bonus structure clearly implies they understand the Lafffer curve, in that giving people stronger incentives helps everyone—capital and labor."

3) Curious Capitalist: "Vampire squid"

"At Goldman the focus has been on hiring the smartest group of people employed by any American institution, and putting them to work—in the most collegial atmosphere of any major Wall Street firm—in the relentless pursuit of arbitrage opportunities (a.k.a. money). It is Goldman's edge at talent acquisition and development, together with a slightly more public-spirited ethos than is prevalent on Wall Street, that best explains its colonization of the federal government. The end result of it all is deeply disturbing and problematic for our democracy—no argument from me there. But it has come about because Goldman is really good at what it does."


Wednesday, July 15, 2009

Goldman Sachs

Many thousands of words have been written about Goldman Sachs lately, and today there are 3 worthy reads:

1) Clusterstock criticizing Taibbi's Rolling Stone piece. (Megan McCardle's criticism too).

2) NY Times: Goldman's Gain, America's Risk.

3) Jim Bianco (via Barry Ritholtz): What Is Goldman Sachs?

Anytime you read an article about GS, you'll typically find a slew of comments from angry people describing how corrupt GS is, or how they cheat the system. I was trying to decide if I should even bother putting my own 2 cents in on my own post, and then I read this comment on the Clusterstock piece:

"Most of the people here: You are blaming a company that is gaming a corrupt government . You are once again trying to fix the effects of problems instead of fixing the cause. If a company can legally do something to make a profit then they have a duty to do that. Companies are in business to make money. (Shocking, i know). Now if the problem is a completely corrupt government why don't we try and fix that instead? Gaming the government should not be a valid business tactic. It only is because our government is vastly over-sized and overreaching. This is the true problem. You will never have a fair system when you spend all your time trying to fix the wrong problems."

I think that sums it up nicely. The average person hates Goldman Sachs. When GS gets paid billions and billions of taxpayer dollars directly funneled through AIG, it makes people mad - RIGHTFULLY so. But the point is that we should be mad at the GOVERNMENT for making this happen - for allowing it to happen - not at GS. Don't hate the playa - hate the game.


Friday, July 10, 2009

Quote of the Day

From Oaktree's Howard Marks, in his July letter:

"My greatest concern surrounds the fact that we’re in the middle of an unprecedented crisis, brought on by never-seen-before financial behavior, against which novel remedies are being attempted. And yet many people seem confident that a business-as-usual recovery lies ahead. They’re applying normal lag times and extrapolating normal decline/recovery relationships. The words of the late Amos Tversky aptly represent my view: “It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.”


Thursday, July 09, 2009

Flawed Measures of Inflation

Wall Street Cheat Sheet did an interview with Barry Ritholtz last week, and I thought these several paragraphs from Barry on misconceptions regarding inflation were very well stated and worth reading:

"Damien: If the government hired you and sent you in with a team to work on some of these models, do you think the political pressure would still be there, thus continuing to cause a lot of these problems?

Barry: Well, the pressure would not be on me, but whoever comes after me [laughing]. If they hire me they know what they are getting. They are getting someone who is going to say, “Let’s go back to the Boskin Commission.” The Boskin Commission determined inflation was overstated by one-point-something percent and they came up with some hair brain ways of lowering it. For example, when steak goes up in price and a consumer purchases chicken instead of steak, the economists call that ‘substitution’. Therefore, the Boskin Commission says this substitution doesn’t reflect a price increase in the basket of goods that that consumer purchased. Thus, they say inflation is moderate.

Now, anybody else would look at that and say, “No, you stupid sons of bitches. I was just priced out of steak and now I’m buying the cheaper meat because I can’t afford the more expensive meat.” Anybody with two eyes and a brain should be able to figure that out. Boskin is obviously sheer absolute and unmitigated nonsense. If steak goes up in price, that’s inflation by definition. The fact that I can no longer afford steak doesn’t mean I’m buying something else or there’s no inflation. It means I’ve been priced out of that product!

I hold Boskin indirectly responsible for the whole credit collapse and the entire stock market crash because his lame hair brained rationales for understating inflation gave Greenspan the ability to say, “Well, rates are dangerously low back in ‘01, ‘02, ‘03, but look inflation is contained so it’s really not too bad.” I make that connection in the book [Bailout Nation] in a chapter called ‘Strange Connections, Unintended Consequences.’ The chapter explains how all these weird things took place and they all ended up having extremely bizarre consequences. Boskin is a perfect example.

Hedonic adjustments are another example. I think there is a terrible mistake economists make: they don’t understand technology. They don’t understand the life cycle of a new technology that comes out and there are economies of scale unfolding. For example, when the first plasma screen came out it was $100,000 and eight of them were sold. They cost that much because only eight of them were sold. Then, you build a factory and amortize the cost of the factory, and a few years later you are selling 10,000 of these things a year. Now they are going for $10,000 and $12,000. Then, a few years later you’ve gone from a small factory to a big factory and are selling a million of these a year. At this point plasmas are down to $6,000 a piece.

So, you had the early adopters who were unsure about the technology but bought it. Then you had the later adopters. Fast forward a few years later until finally the item becomes a mainstream product and you have huge factories all over the place. You are cranking out 100 million of these a year and these 50″ plasmas are going for under $1,000. The economists would have you believe this is proof inflation is contained. However, in reality the product cycle is a normal, natural cycle for all technologies and has nothing to do with inflation. This cycle happened with the cell phone, the iPod, PCs, laptops, etc. The cycle doesn’t mean that there is less inflation. The cycle means there is a normal life cycle of a product.

Meanwhile, you’re buying all these goods that didn’t exists 20 years ago. You didn’t have an iPod, an iPhone or a plasma screen. So, you are actually spending more of your discretionary income on all these toys. All the economists listening to this are going to say, “No. He’s wrong. Those are prices coming down. It’s deflationary.” I disagree. This stuff happens with every technology. It doesn’t matter what is going on with the money supply, the deficit, issuing dollars, etc. Every product goes through that life cycle. It’s normal and natural. It sure as hell isn’t deflationary. When something new comes out, you can expect that eventually — as it goes from a limited custom product to a more luxury product, to a more mainstream product, to a ubiquitous product — the economies of scale bring the price down. I don’t believe we can accurately describe that process as deflationary or disinflationary.


People Who Live in Glass Houses...

Isn't this the definition of "irony?"

"Shares of American International Group Inc (NYSE:AIG - News) plummeted 22 percent on Thursday after a Citigroup analyst said the value of the troubled insurer's equity may fall to zero."

Talk about the pot calling the kettle black...


Wednesday, July 08, 2009

Kim Jong Il Hates Goldman Sachs

It all makes sense now:

AP: WASHINGTON (AP) -- The powerful attack that overwhelmed computers at U.S. and South Korean government agencies for days was even broader than realized, also targeting the White House, the Pentagon and the New York Stock Exchange.

An early analysis of the malicious software used in the attack found its targets also included the National Security Agency, Homeland Security Department, State Department, the Nasdaq stock market and The Washington Post. Many of the organizations appeared to successfully blunt the sustained attacks.

The Associated Press obtained the target list from security experts analyzing the attack. It was not immediately clear who might be responsible or what their motives were.

The attack was remarkably successful. Some of the affected government Web sites -- such as the Treasury Department, Federal Trade Commission and Secret Service -- were still reporting problems days after it started during the July 4 holiday.

So it was North Korea that sabotaged the NYSE's systems, causing a trading halt last Thursday, and dropping Goldman Sachs off the weekly program trading report. It all makes sense now.


full disclosure: grain of salt...

The Lawlessness of Large Numbers

Pop Quiz - What was the value of the 1998 bailout of Long Term Capital Management?

I graduated college in 1998 and went to work on Wall Street. Amazingly, in just the last 10 years in the markets, I've seen several major financial events. The first was the collapse of LTCM in the wake of the Russian debt crisis. The second was the dotcom bubble and subsequent collapse. The third was the recent collapse of the housing bubble and structured products associated with it.

Before the most recent crisis, the collapse of Long Term Capital Management was probably the biggest systematic financial threat of my lifetime. The Federal Reserve had to orchestrate a cabal of big banks to provide capital to essentially fund the massively levered assets of LTCM, a private hedge fund. This was deemed necessary because otherwise losses from LTCM's positions, purchased (with huge leverage) with borrowed money, could threaten the entire financial system.

Why am I mentioning this today? John Meriwether, one of the principals at LTCM, just announced that he's shutting down his latest hedge fund, JWM partners.

"JWM Partners LLC is closing its main Relative Value Opportunity II fund after losing 44 percent from September 2007 to February 2009. Meriwether, credited with generating billions of dollars of revenue at the former Salomon Brothers in the 1980s through so-called relative value trades, returned an average of 1.46 percent a year with his new fund since opening in 1999, compared with 2.4 percent for the Credit Suisse/Tremont Hedge Fixed-Income Arbitrage Index.

Long-Term Capital, which assembled a team of top Salomon traders and Nobel laureates, lost more than 90 percent of its $4.8 billion of assets in the weeks following Russia’s currency devaluation and bond default. The Federal Reserve orchestrated a $3.6 billion bailout by the fund’s 14 banks to calm fears that the firm’s lenders and trading partners would be dragged down.

“For many investors, John Meriwether is by now just another hedge-fund manager,” said Tammer Kamel, president of Toronto-based Iluka Consulting Group Ltd., which advises clients on investments in the private pools of capital. “LTCM’s infamy was a big story in 1998, but the events of 2008 might finally relegate LTCM and 1998 to footnote status.”"

I was shocked to be reminded that the LTCM bailout - the mother of all financial interventions (previously!) was less than four billion dollars. Wow. Remember when money had meaning? Now BankofAmerica pays nearly $4B annually in INTEREST on the bailout funds they alone have received - and they're but a small piece of the pie. Indeed - the current bailout renders LTCM a footnote. The difference in size between the LTCM systematic threat and the 2008 housing/subprime/leverage crisis is striking, and an indication of the magnitude of notional expansion we created in the last 10 years. It should also serve as an indication that we likely have a very long way to go before we get back to the sorts of numbers we saw at the peak of the housing bubble.

If you haven't read Roger Lowenstein's account of the rise and fall of LTCM, "When Genius Failed," I strongly recommend it.


Tuesday, July 07, 2009

Micro Managing - Readings

Lots of talk about new regulations and laws in the last week or so. Here are some pieces worth reading:

1) Barry Ritholtz on new short selling restrictions:
"Of all the anti-free-market proposals out there, turning equities into a one way bet is by far the least defendable (sic), most ignorant, most damaging to the markets we have seen."

2)Yves Smith on the new legislation to allow refinancing for up to 125% of home value (from 105% previously):

"Homeowners refinancing their mortgages through loans backed by government agencies will be able to borrow up to 125 percent of their homes' value under new regulations enacted Wednesday.

The rule changes, part of the government's attempts to restore housing affordability and stem the foreclosure crisis, apply to loans backed up by Fannie Mae and Freddie Mac.

Yves here. Huh? This is beyond Orwell, it's patently silly. "Housing affordability" has traditionally meant "let's do things so people can afford to BUY houses." It even once included stuff like Section 8 housing, giving tax breaks for rental housing targeted to lower income people. The intent is to prop up prices by keeping stressed borrowers from selling their houses and possibly also sending an information signal through the 125% figure, that housing really ought to be priced higher. That is anti affordability. And the concept of "affordability" to my knowledge has never before been extended to keeping homeowners in place."

and then...

"in most states, a purchase money mortgage is non-recourse, but a refi is. So some borrowers will put themselves in worse shape it they take up this offer."

3) Mish reiterating some points I've been mentioning for the past 18 months - you can't spend your way out of this.

"The problem with Keynesian clowns is they never look ahead to when the stimulus stops. By definition "stimulus must end" and as soon as it does, unless the stimulus created lasting new jobs, there will be nothing to show for it other than debt.

And interest must be paid on that debt. And that interest has to come to come from somewhere, either more taxes, or printing money and cheapening the dollar. That means there is a price to pay down the road for stimulus today. Keynesian clowns act as if there is no price down the road.

Since you cannot spend what you don't have (without long-term negative consequences), the key to a solid recovery comes from a buildup in savings, lower taxes, and letting consumers keep more of their money (as opposed to government deciding how and when it should be spent)."

4) Mish on Cap & Trade legislation and the potential for resulting job losses (quoting the Washington Times):

"Workers who lose their jobs if the pending climate change legislation becomes law could get a weekly paycheck for up to three years, subsidies to find new work and other generous benefits -- all courtesy of Uncle Sam -- under a little-noticed provision of the bill.

Touted by its House Democratic authors as a jobs engine, the bill offers extraordinary compensation for those who would lose their paycheck as a consequence of its passage.

Adversely affected employees in oil, coal and other fossil-fuel sector jobs would qualify for a weekly check worth 70 percent of their current salary for up to three years. In addition, they would get $1,500 for job-search assistance and $1,500 for moving expenses from the bill's "climate change worker adjustment assistance" program, which is expected to cost $4.2 billion from 2011 to 2019.

The bill passed the House a week ago in a hotly contested 219-212 vote, with supporters arguing that a principal reason to support the bill is that it would create millions of new jobs. But analyses from the political left and right argue that potentially millions of jobs in industries tied to traditional fossil fuels would be lost and, at least initially, not enough "green" jobs would be created to replace them.

"Can you name another jobs-creation bill that was so concerned about its potential impact that it preemptively included a benefits' program for the millions of workers it expected to displace?" asked Chris Tucker, a spokesman for the Institute for Energy Research, a pro-oil industry independent think tank."

5) Restricting speculators in the oil and gas market (Bloomberg):
"U.S. regulators say they may clamp down on oil and gas price speculators by limiting the holdings of energy futures traders, including index and exchange-traded funds. "

"Billionaire investor George Soros told a Senate hearing in June 2008 that the oil price increase that year was caused partly by index funds that buy only oil contracts. Index funds and exchange-traded funds, which mimic an index, can hold oil contracts in excess of available supply. "

See, commodities became an asset class. Pension funds and others bought oil (futures) just like they bought stocks, gold, mortgage backed securities and government bonds. I hate the idea that we're going to interfere with market pricing to try to make the price of everything we want low stay low, and everything we want high stay high. We're talking about limiting short sellers of stocks... We're STILL artificially pumping up the price of houses. We're talking about basically preventing people from buying oil futures. We should also outlaw homelessness and unemployment - then we can solve all of our problems. Oh - war too - I forgot - we need to outlaw war.


Finally, ALPS launched a new equal weighted ETF - but someone forgot to tell them about the special sauce: it's not levered at all! Why bother launching a new ETF if it's not at least an Ultra (2x) product?

"The new ALPS Equal Sector Weight ETF (NYSE Arca: EQL) takes an equal-weighted position in each of the nine Select Sector SPDR ETFs and rebalances that position on a quarterly basis. The fund is designed to avoid overinvesting in “bubble” sectors, such as telecom in 1999 or finance in 2007, and thereby achieve higher risk-adjusted returns. Looking backward, the EQL strategy has outperformed the S&P 500 by more than 3% per year over the past 10 years."

Intuitively, I'm very surprised by the claim that an equal weighted portfolio has outperformed the SPX by at least 3% annually for the past 10 years. Essentially, the EQL portfolio is always selling its winners and buying its losers - that means it should underperform during periods when one sector has a big run (like financials did for a few years) and then outperform when bubbles pop.


Monday, July 06, 2009

Yep - Data Error

As expected, the NYSE has responded to the relentless hounding from Zerohedge regarding Goldman's suspicious disappearance from the weekly program trading report, admitting that they had a system error and that the report is not accurate. Turns out it was not related to a Russian spy stealing the code that maintains the integrity of our financial markets systems and thus threatening national security.

This report is usually published on Friday. This week, Friday July 3rd was a holiday, and I'm guessing that some junior guy was working on the report, rushed through it in an effort to get to the Jersey Shore, screwed up his copy & paste, and somehow dumped GS off the report.

Occam's Razor.


Can't See the Forest For the Trees

I can't believe I go distracted from the simple truth behind the NYSE's change in the reporting of the weekly program trading statistics that I missed the obvious explanation. I spent several posts debunking conspiracy theories and blatantly incorrect assessments of the future of the program trading data, but I failed to find the real story, until it jumped out at me this morning.

Let's check the facts again - last week the NYSE announced a change in their reporting requirements for the weekly Program Trading statistics which they report. Instead of relying on firms to submit their volumes to the Exchange, the Exchange is going to take the order entry data right out of the order that is sent to the Exchange, and compile the report itself. The story was totally bastardized into conspiracy theories of "Goldman is trying to hide that its trading all its shares for its own account," and "So much for transparency, THEY don't want us to see what's really going on" when in reality, the new methodology will just make the data more accurate.

I spent so much time trying to debunk falsehoods that I missed the simplest explanation: the NYSE has been losing market share to other marketplaces. In an effort to recapture volume, they are telling the member firms, essentially, that only shares executed on the NYSE will be counted in the weekly program trading statistics. Thus, if you want to draw any sort of foil-hat conclusion from the change, it's that the NYSE is exerting pressure on the firms to trade on the NYSE itself, in order to have their volumes advertised on the report. This is almost certainly true, but I don't see a conspiracy. If the firms want the data advertised, they will trade with the NYSE. If they don't care, they will trade elsewhere.

I am almost certain that we'll soon find out that the mysterious disappearance of former leader Goldman Sachs from last week's program trading stats was a data error. However, if you want a conspiracy theory, forget the one about the Russian spy who stole Goldman's quant trading code which resulted in Goldman working to suppress the dissemination of their trading data in order to hide the magnitude of the theft. A much more logical theory, although one which I still don't think explains what really happened, is that Goldman didn't like the NYSE's "blackmail" attempt to force volume onto the NYSE, and decided to take all of their volume off-Exchange. Since the NYSE didn't announce the reporting change until 6/24, and the most recent program trading statistics are for the week of 6/22-6/26, it seems logical to anyone who bothers to do the work that even this explanation doesn't hold water. Although Goldman almost certainly would have been aware that the NYSE was considering changing their methodology, it's monstrously unlikely that they'd have decided to pull all of their volume during the week of the Russell Rebalance, where they'd need to execute at the NYSE closing price via the exchange.

The NYSE's change in reporting methodology for program trading statistics is an effort for the exchange to recapture volume that has been migrating to other market centers. Firms want to show up in this volume report so that they can market themselves as large providers of liquidity to their clients. If anything, Goldman wouldn't be in cahoots with the exchange to suppress their data - they'd be trying to amplify it. This is a great time for Occam's Razor - the simplest explanation is usually the correct one. In this case, the simplest explanation for GS's descent from number 1 to non-top-15 in the statistics is that either 1) they were trying to prove a point to the NYSE (which seems impossible, as I explained above) or 2) there was a data error, which we'll hear about shortly.


p.s. - the NYSE will still publish stats derived from the firm-submitted daily program trading reports for a few more weeks. After that point, I expect the volume numbers on the report will drop substantially, as all off-Exhange volume will no longer be counted. Of course, when this happens, hypesters will write about the amazing red flag data that is coming out, and I'll have to link back to this post to explain how it was something that could have been easily foreseen by anyone who understands the situation.

Sunday, July 05, 2009

Take A Deep Breath...

Ok - I was nice and relaxed Sunday evening, popped open a few websites to check for evening business news, and came across the latest shitstorm that's circulating with ZeroHedge in the eye of the storm.

Last week Zerohedge wrote a post about Goldman Sach's continued dominance of the principal program trading statistics that the NYSE publishes weekly, and about the overall ramp up in program trading volume. Anyone who knows anything about program trading knows that this streetwide increase was due to expiration: large baskets of stock are traded against expiring index futures and options, and the S&P 500 also does a quarterly rebalance on the same day. Thus, the program trading numbers for the 3rd week in June are always large. I took the time to comment on Tyler's post, "and yes - last week's large program trading numbers are from June expiration - and yes, this weeks will also be huge due to Russell Rebal." I even added "and there will be a massive jump next week in the "customer facilitation" numbers on the weekly program trading statistics. There is no conspiracy theory to be derived from it - it's the Russell data."

See, I know what I'm talking about when it comes to program trading, and this happens every year. The Russell Rebalance is the biggest event of the year, resulting in massive volumes. Of course, the weekly report came out, and the customer faciliation numbers were up massively. Although this is completely normal, and I'd even mentioned it on Zerohedge itself, Tyler still chose to characterize the data as follows: "This week's NYSE Program Trading report was very odd: not only because program trading hit 48.6% of all NYSE trading, a record high at least since the NYSE has kept tabs on this data, and a datapoint which in itself was startling enough to cause some serious red flags," before getting into the real oddity, which I agree with, and will get to in a minute. I can't tolerate the fact that he chooses to mislead people with hype of "startling" data which should raise "serious red flags," when I had even taken the time to explain to him a week ago that this data would be coming! There is nothing surprising, conspiratorial, or doomsday about it!

There was something strange about the report - which I again took the time to mention as a comment on another Zerohedge post four days ago, as I think this is actually interesting: Goldman Sachs is completely missing from the report. This is a virtual impossibility for Russell week.

Sadly, the story quickly morphed into a self-feeding conspiracy theory, with Tyler @ Zerohedge and Matt Goldstein at Reuters somehow each quoting the other's article in their own story. Naturally, hype-first-ask-questions-and-do-proper-research-later savant Karl Denninger hopped right on the paranoia bandwagon.

There is definitely a story regarding Goldman's sudden falling off the program trading league tables, but it is most certainly not, as Reuters' Goldstein suggests

"On the week ending June 19, Goldman was ranked first on the NYSE program trading list. But on the week of June 22, Goldman mysteriously didn’t appear on the list of the top 15 firms at all. It simply vanished without any explanation. Then the NYSE stopped reporting the numbers. The Zerohedge blog was all over this controversy a week ago."

We know, if we simply read the report from the NYSE, which I explained last week, that 1) The NYSE did NOT stop reporting the data. The report will continue, using automated, more accurate data, and that 2) the "NYSE stopped reporting the numbers" foil hat explanation is especially ridiculous considering that the changes haven't gone into effect yet! I would have expected more journalistic integrity from Reuters. Anyway.

Perhaps Goldman also misread the rule change (unlikely) and stopped reporting their DPTR numbers a few weeks ahead of time - this is extremely unlikely. Perhaps they totally pulled their quant models from the marketplace, as a result of the theft of some intellectual property, which Tyler covers extensively in his post. Still, I am very confident that GS would have still had significant program trading volumes to report. Perhaps there was a simple error in the report and Goldman's data got wiped off the grid portion - this seems most likely to me, as the numbers in the report appear to be inconsistent, with the "Total for all member firms" volume being lower than the "total for top 15 reporting member firms" volume, which shouldn't be possible.

There is an interesting coincident story which the Zerohedge post focuses on - that of a former employee of what appears to be the Goldman Sachs quant desk, who basically stole the code from his former firm and brought it to his new firm. He was stopped by the FBI on his way back from Chicago. This is a standard intellectual property case, although Tyler Durden is asking why the FBI is involved. Well jeez - for a guy who has a PhD in Goldman Sachs conspiracy theories, TD should have been able to answer his own question: you don't mess with Goldman. If you do, they release the hounds on you.

Unfortunately, the two stories get combined into a clusterfuck of a conspiracy theory that is sure to light up the blogosphere tomorrow. I would have really liked it if someone with the will and the means to get to the bottom of the mysterious program trading statistics without Goldman Sachs, such as Zerohedge, had stuck to that question first, instead of morphing the story into a global financial espionage conspiracy that they claim should require a dicslosure from both Goldman and the NYSE (no doubt about the pending immolation of the stock market) as a result of a former employee stealing quant code.

oy vey.


America - FK Yeah!

That's right - I am also a highly skilled baker. Above, you can see my special patriotic 4th of July vanilla flag cake with Cool Whip, strawberries and blueberries. You can't see that the cake is dual layer, with another layer of Cool Whip, strawberries and blueberries inside. Boom.

No 4th of July themed post would be complete without the Team America World Police theme song (NSFW):


Wednesday, July 01, 2009

Two Sides to Every Story

It really shouldn't be this hard. I don't want to spend every day correcting the ignorant rantings of other bloggers, but when they completely misunderstand simple press releases in my area of expertise, I can't help myself.

Last week I addressed some misunderstandings regarding the risk (or lack thereof) in the ETF-Underlying trade. Yesterday, I mentioned how ZeroHedge erroneously got all wound up about an announcement from the NYSE regarding a change in the reporting of the weekly program trading statistics. ZeroHedge received a reply from the NYSE relatively quickly, which they published.

Today, Karl Denninger has a ludicrous rant on his website which gets the story completely wrong, incites his readers who follow him blindly, and stokes more conspiracy theories which are a waste of time. Again - I enjoy reading Denninger - but he and his readers need to understand that not everything is a conspiracy. By "crying wolf" when there is no wolf, Denninger discredits himself, and also distracts himself from his legitimate arguments and causes.

Denninger writes
"what this means, in short, is that the ability of people (like you and I) to see the fact that a handful of banks, most specifically Goldman Sachs, constitute the majority of NYSE trading volume - and they're trading for their own book, not for customers, will no longer be disclosed."
On the contrary - this is not even close to correct. I invite Denninger to contact me any time he needs an explanation of program trading related items - I'll be happy to explain it to him.

As I explained previously, Broker-Dealers were previously required to file a nightly report with the NYSE called the DPTR - the Daily Program Trading Report - detailing their program trading activities. A "Program Trade" was classified as a trade consisting of 15 or more different stocks, totalling at least $1MM in notional. There are different kinds of program trades: agency (for customers), principal (for the firm) and index arbitrage (capitalizing on differences between the price of futures and the baskets of stocks they represent). In addition, there is "customer facilitation," which is when the brokerage firm commits its risk capital in executing the trade for the client - it takes the risk off the client's books and onto its own books.

Here's what the new rule change from the NYSE does: it automates the DPTR. It's that simple. When program trades are entered into the NYSE systems, they are already coded as "agency," "principal" or "index arbitrage." The exchange is just updating their reporting to take advantage of technology and use this data that they already have, instead of relying on the firms to submit it themselves. It will result in MORE transparency, not less. Why rely on the brokerage firms to submit the data to the NYSE when the NYSE already has the data? That's why they are making the change.

Of course, the headline

"NYSE Uses Simple Technology to Improve Data Quality and Transparency"

isn't quite as catchy as Denninger's "Conspiracy to Hide Bubble Formation."

Brokerage firms like to report large volumes so that they can show their customers that they have the most liquidity and, presumably, expertise in the area. The new rule change will likely reduce reported volumes, as it will prevent brokers from reporting questionable trades such as ETF creations and redemptions on the DPTR. Also, I'm not sure what will happen to the "risk trades" which were previously classified as "customer facilitation." Such trades were somewhat double counted - the trade would be counted when the client traded it to the broker, and again when the broker traded out of the positions.

So why does it bother me so much when someone errs in reporting a simple story? Well, I read the comments on Denninger's site to see how his readers would react. Sadly, they follow like hypnotized sheep. It irks me to no end to read "Well, this is the straw that broke the camel's back for me. I've just stopped contributions to my 401k." Really? You read an article about finance on a website (written by a guy who has expertise in network and computer systems) that's not even close to correct and you're stopping your 401k contributions? Ouch.

Our role as financial bloggers should be to educate people into making smarter decisions - not to scare them into making dumber ones.


note: I have never worked for GS or the NYSE, and have no particular love for either of them. Also I am still short the broad market (SPX), long gold, long silver, and long TBT.