it’s not about microstructure
Steal a little and they call you “thief”… Steal a lot and they call you “King” – Bob Dylan
I try to avoid the news during the trading day. I never trade manually and as I’ve mentioned before, I’ve never yet had much success trading the news and none of our models presently use news feeds for decision-making. So I really try to avoid keeping excessively abreast of the news as it’s just a distraction from real work.
That said, this morning I noted a pretty good jump in our pre-market p&l and wanted to see what splendid news had prompted the spike. So I scanned some headlines.
On Bloomberg I saw:
Unemployment down? AIG profitable? Dollar rumbling to strength? Splendid, splendid and splendid.
I also saw the bit about Hank Greenberg paying the SEC $15M as he “thought it would be good to get it behind us.” Indeed, good thinking.
Within a few moments, I’d identified the likely causes for our spike in p&l: optimism. Thank you, optimists!
My immediate question was answered, but the news about Mr Greenberg stuck with me for a moment. After all, one of the positions we made some money on this morning was AIG, a firm perhaps as central to our current financial crisis as any could possibly be. A *personal* $15M fine over accounting um irregularities. Ouch, that’s gotta hurt. Could you imagine paying a $15M fine? “Without admitting wrong-doing.” Remarkable. I’d own-up to a fair amount of wrong-doing if it meant saving me $15M. Of course, if the average American got hit by a $15M fine they’d be bankrupt. What’s it do to Mr Greenberg?
Last I could find him on the Forbes list of “World’s Richest People” was 2005 when he was ranked #79, weighing-in with a fortune of ~$3.2B. Of course, it’s been a tough few years and he’s probably taken it on the chin. How much? No idea, but for the sake of argument, let’s say he’s down to a lightened but still respectable fortune of ~$1B.
The average American instead has a “fortune” of somewhere between $0 and $1M, according to the FED’s most recent Survey of Consumer Finances.
For the sake of our back-of-the-envelope calculation, we’ll say that the average American family is worth $1M, though this is surely fanciful. This means that Hank is only about 1000 times richer than our fanciful American family who’s equivalent fine would be $15K.
Now, $15K will get you a beer and more, so I’ll never be the one to spit on $15K, but for a $1M family it is something that will look a lot like an ordinary item on their taxes. Not fun, but a lot of people would rather part with $15K than pass a kidney stone. Actually, when you pass a kidney stone in the US you also typically have to cough up something like $15K, but that’s another story altogether..
It’s just not the kind of fine you’d think would be very effective at getting people to not ruin the global economy so they can pocket a few quick billions, thank you very much. If I know I stand to make billions at the cost of being fined in the millions, I just might spin the wheel. Not much deterrent there.
So, Hank really didn’t do so badly as all that.
Now that that’s out of the way, regulators can address important items like flash orders, short sellers and high-frequency trading. Meanwhile, an almost manufactured-looking populist backlash suggests darkly that Goldman’s trading gains are ill-gotten.
I don’t personally believe that Goldman is front-running their clients, but I’d prefer to avoid the possibility entirely by disallowing firms with proprietary trading operations from handling client accounts. In programming, the best way to deal with concurrency issues is to prevent them from happening structurally by employing producer-consumer queues and other such mechanisms. In just the same way, front-running should be structurally prevented by regulation. Just make it effectively impossible. But this eminently sensible model was over-written in the twilight of the Clinton I years by some of the super heroes who brought us all the marvelous financial innovations we’ve enjoyed over the subsequent decade.
Back to Goldman. While I don’t think they’re front-running, everyone ethical/sensible will agree that if they were, it would be bad. How bad? Well, 252 trading days times $100M of ill-gotten gains yields something like $25B annually. Big money by my proletarian standards, but let’s say that Mr Barofsky overcooked his stew by an order of magnitude and this bailout will only cost us ~$2.5T. That would make the worst case scenario for HFT hijinks something like 1% of our crisis tab.
Worth pursuing, if there’s something there, but probably not the most bang for regulatory buck out there.
What’s an ambitious regulator to do? Well, faced with symptoms like those evident in today’s US markets, the IMF would recommend breaking-up the finance oligarchy outright:
The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform.
As Americans we are participants to a historic transfer of wealth from the US taxpayer to [?]. We don’t know how much, but we know it’s measured in Trillions. And we really can’t say where it has gone. Remarkable circumstance.
Some are saying that modern finance is so complex that we can’t hope to understand what just happened. But I don’t think we need people with sophisticated intuitions about volatility smiles or nuanced appreciation for the creative engineering of structured products to solve these mysteries.
We just need garden-variety, honest and empowered investigators.
The “Untouchables” and other real-life gang-busters come to mind. The techniques they employed would be effective for identifying and bringing down the people who’ve contributed to this epic transfer of wealth.
Just as they identified the “associates” of their prime suspects and then pieced together their activities by following money trails, our own regulators need to do some straightforward investigation of the people involved in this mysterious money hole. Some will be innocent, some will have committed crimes.
Start with someone central to the fracas. AIG has a few candidates with both Greenberg and Cassano likely suitable, but there are any number of lists out there implicating people with our “credit crisis.” Pick one. Look closely at his (or her) taxes, offshore holdings, business interests. Identify 50 of their top social & business contacts. Again, start with taxes. Do this for a few cycles and you’ll have unwittingly collected the cream and dregs of international finance. Investigate them. Look at their taxes. Follow the money.
People who committed crimes go to jail. People who didn’t don’t. Some new laws will need to be made and probably others will need to be taken off the books. Minimal math required.
But what few honest and competent regulators we have are not empowered to do anything except kvetch pleasantly on the John Stewart show and perhaps muck about with market microstructure. They are certainly not empowered to take on the beneficiaries of the crisis we’ll spend a generation paying for. It’s even difficult to imagine how a regulator could be empowered to take down the architects of this most ambitious of capers. The arch-villains of Mario Puzo or David Chase’s most feverish moments never approached the sophisticated operations unfolding today.
Focusing on market microstructure in an environment like this is truly missing the forest for the leaves.