Trading in Hubris: Pride, Overreach, and the Inevitable Blowback and Consequences

"We have always known that heedless self-interest was bad morals; we know now that it is bad economics. Out of the collapse of a prosperity whose builders boasted their practicality has come the conviction that in the long run economic morality pays...

We are beginning to abandon our tolerance of the abuse of power by those who betray for profit the elementary decencies of life. In this process evil things formerly accepted will not be so easily condoned..."

Franklin D Roosevelt, Second Inaugural Address, January 1937

The hubris associated with the trading crowd is peaking, and heading for a fall that could be a terrific surprise. It seems to be reaching a top, trading now in a kind of triumphant euphoria after the European capitulation and the recent equity market volatility.

I had a conversation this morning with a trader that I have known from the 1990's, which is a lifetime in this business. I have to admit that he is successful, more so than any of the popular retail advisory services you might follow such as Elliott Wave, for example, which he views with contempt, a useful distraction for the little guy, the same way that casino operators view most gambling systems except counting cards. He is a bit of an insider, and knows the markets internals and what makes them tick. I remember a time when some of the more obvious market shenanigans used to bother his conscience a little. But he is well beyond that point now.

He likes to pick my brain on some topics that he understands much less, such as the economic relationships and monetary developments, and sometimes weaves them into his commentary, always without attribution. He has been a dollar bull forever, and his worst trading is in the metals. He likes to short gold and silver on principle, and always seems to lose because he rarely honors his first stop loss, which is a shocking lapse in trading discipline. That stubbornness is probably what kept him from making top management.

His tone was ebullient. The Street has won, it owns the markets. They can take it up, and take it down, and make money on both sides, any side, of any market move. I have to admit that in the last quarter his trading results are impeccable.

We diverged into the dollar, which he typically views as unbeatable, with the US dominating the international financial system forever. He likes to ask questions about formal economic terms and relationships, or monetary systems and policy. He relies on others for that knowledge, although he almost never admits it and will argue from pure emotion if necessary, until he gets what he wants to know.

I am not a social worker. Its a quid pro quo. He gives me insights into the trading world, and the pits where he dwells. What they are thinking, and what is going around in his crowd, with which I rarely associate these days.

He thinks the euro is done, and the dollar will remain the sole currency. His attitude is, "What will replace it?" He cannot even imagine anything different than what we have today. But interestingly enough he does not believe that the US government is running things. "Things are being run by a new world order, and have been for some time." He said that so matter of factly that it made me catch my breath.

And he's good with that. Does not bother him in the least little bit, as long as he is making money. And that is where our conversation started to go downhill, quickly. I was in no mood to hear his usual perspective on the future and the triumph of the willful.

If there is a new Mussolini in the US to maintain order, he's good with that. If they start putting people on trains to resettlement camps in the southwest, he's ok. If there are starving people in the streets, it doesn't bother him because he lives in a gated community. If the middle class gets crushed by a new market crash that is ok. He made a killing shorting the Crash of 1987, and was able to enjoy the resort where he spent the winter even more than ever because they were so few people there.

I would like to say he is an outlier, a one of a kind. But he is not. He is typical. He is driven purely and almost solely by personal greed, and he makes no bones about it. Life is a war, and he wants to conquer you.

But he is not a monster. If you met him you might like him. He's affable, conservative, a decent conversationalist, and personally well kept and engaging. But he is missing something, like the derivative of a human being. If you talk about the 'bad guys' he doesn't identify with them. He thinks he is 'us.' It's never occurred to him that he is the problem. Because his value system is utterly one dimensional and egocentric. In some ways he is the most intelligent twelve year old I have ever met. But I am sure he considers me a fool and an idealist. And I might agree. But it is not so much who you are, but why. Who or what do you serve?

He is a microcosm of Wall Street, and the prevailing attitudes in the Big Banks in particular. If you wish to form public policy, if you want to create a stable system, one based on human values, never ask a trader or a trading company for advice. They are incapable of framing the question in a way that will provide you a workable answer. What is good is whatever works for them in the most narrow definition of the terms. They think they are being altruistic when they take a little bit of a haircut on terms that are already well into the realm of usury.

The problem is the ability of Wall Street to buy power and influence among the regulators and politicians, and bring their unbalanced world view to bear so heavily on the formation of public policy and governance.

That is not to say that they are necessarily bad people. They are what they are. It's just that they need to be restrained by regulation, and certainly should not be in the driver's seat of anything outside of their own accounts, and those with external supervision and transparency. But certainly not in control of things in general, of running the system by proxy, which is where they are today. Or at least where they think they are.

Goldman trades big, but more probes loom
By Steve Eder
May 10, 2010, 11:55 am EDT

NEW YORK (Reuters) - Goldman Sachs Group Inc on Monday showed how its trading operations are stronger than ever, but warned that more litigation and investigations loom.

Goldman, in a quarterly regulatory filing, said it made it through the first quarter without a single day of trading losses, the first time it had accomplished such a feat. The firm reported trading revenue of more than $100 million on 35 days in the quarter.

In the same filing, Goldman said it still faces a number of probes and reviews, which could be damaging.

It said it anticipates additional shareholder actions and other investigations related to its offerings of collateralized debt obligations, which are at the heart of charges against the firm filed by the Securities and Exchange Commission.

Goldman shares have tumbled more than 20 percent since the SEC accused the bank on April 16 of failing to tell investors who bought risky debt tied to subprime mortgages that hedge fund manager John Paulson helped select the underlying portfolio for the security and was shorting the deal.

Goldman shares were up 2.1 percent to $145.99 in morning trading but lagged behind others in the Amex Securities Broker/Dealer Index. Equities were rallying after tumbling last week.

Goldman, in its filing, said the SEC case "could result in collateral consequences to us that may materially adversely affect the manner in which we conduct our businesses." It said certain outcomes could impact the firm's ability to act as broker-dealer or provide certain advisory and other services to U.S.-registered mutual funds.

The Wall Street Journal reported last week that Goldman had begun settlement talks with the SEC.

Some analysts and investors have speculated that scrutiny surrounding Goldman would lead to the resignation of Chief Executive Lloyd Blankfein. But at the bank's annual shareholder meeting on Friday, Blankfein said he had no plans to resign.

More Investigations

For the past year, Goldman has faced a backlash over its quick rebound from the financial crisis, while benefiting from various government bailout programs, and its bonus pool, which topped $16 billion last year.

Goldman, which reported record profit in 2009, has been trying to live down a Rolling Stone article last year that labeled the firm a "giant vampire squid wrapped around the face of humanity"

Its blockbuster trading performance in the first quarter, coupled with the SEC charges, could heighten the public furor surrounding the firm, which has been cast as profiting from the subprime mortgage meltdown.

Goldman, criticized for not disclosing it had received notice last year of the likelihood of SEC charges, discussed several investigations on Monday, including probes by the Financial Industry Regulatory Authority and the UK's Financial Services Authority related to CDO offerings and related matters.

The bank said it is cooperating with a number of investigations and reviews into its sales and trading operations related to corporate and government securities and other financial products.

The firm also said it is facing investigations and reviews relating to the 2008 financial crisis, including the establishment and unwinding of credit default swaps with American International Group Inc. Goldman has been criticized for benefiting from the government rescue of AIG.

Inquiries into the financial crisis are also looking at Goldman's transactions with Bear Stearns and Lehman Brothers.

Goldman also disclosed that it is subject to inquiries related to its transactions with the government of Greece, including financing and swap transactions.

Risk? What Risk? We Don't See No Stinkin' Risk..

"It is the absolute right of the state to supervise the formation of public opinion." Paul Joseph Goebbels

As measured by the VIX, the volatility index, the perception of risk in US markets has declined significantly in the last twelve months from over 50 to current readings around 20.



As a response to this changed perception, mutual funds are once again fully invested, with levels of cash reserves at record lows. In other words, the 'other people's money' crowd are all in.



There is an interesting distribution top forming in the US equity markets. This rally has been driven by liquidity delivered from the Fed and the Treasury primarily to the Wall Street banks, who are deriving an extraordinary amount of their income from trading for their own books, at least based on published results.

Much of the rally in US stocks has occurred on thin volumes and in the overnight trading sessions. Definitely not a vote of confidence, and a sign of potential price manipulation in fact.

Is this a 'set up' to separate the public from even more of their own money, using their own money? Perhaps.

The government is frantic to restore confidence in the US markets, and the toxic asset rich banks are more than capable of using that sincere interest to unload their mispriced paper on the greater fools again.

The perception of risk is a powerful tool in shaping the response of markets, and as an instrument of foreign and domestic government policy actions. It is nothing new, as indicated by the quote from Joseph Goebbels, but it is rising to new levels of sophistication and acceptance in nations with at least a nominal commitment to freedom of choice and transparency of governance.

"There is a social theory called reflexivity which refers to the circular relationship between cause and effect. A reflexive relationship is bidirectional where both the cause and the effect affect one another in a situation that renders both functions causes and effects.

The principle of reflexivity was first introduced by the sociologist William Thomas as the Thomas theorem, but more importantly it was later popularized and applied to the financial markets by George Soros. Soros restated the social theory of reflexivity eloquently and simply, as follows:

markets influence events they anticipate – George Soros

This theorem has become a basic tenant of modern central banking. The idea is that manipulation of the psychology of market participants affects the markets themselves. Therefore, if you artificially suppress the price of gold, you reduce inflationary expectations and reduce inflation itself…so the theory goes."

Why Do the World's Central Banks Manipulate the Price of Gold?

For now we must watch the key levels of resistance around 1115 in the SP. A trading range is most probable but there is a potential distribution top forming with a down side objective around 870 on the SP 500.

It does bear watching, closely, keeping in mind that this is an option expiration week, and the traders expect the market to misrepresent its price discovery, as the result of conscious manipulation.

Proprietary Trading and Credit Default Swaps - Mission (Not) Accomplished

Here's why the Volcker Rule ran into a brick wall of Senatorial gravitas and pusillanimous punditry.

Give up prop trading AND banking status? The mutant Zombie Banks would not allow it.

Who needs insured deposits? What a bother. Its the Treasury guaranteed bonds and Discount Window access that count. When you are levering up Other People's Money you want it in bulk and wholesale, not retail.

Goldman is no surprise, because they are nothing but a hedge fund with the right connections and a rolodex full of Senators. But JPM bears watching, since they are at least nominally a bank, and Too Big Not To Leave a Mark (TBNTLM).

Prop trading - why lend when you can play at the tables?



Well, at least we have the Credit Default Swaps situation covered with the bailout of AIG, right?

Well, maybe not.... Two trillion down, but thirteen trillion to go.

I can see why the Fed completely failed to notice this little trend change in its banking oversight.



If the markets turn significantly lower, and the banks' balance sheets start wobbling again, and threaten to crash the system, or else, perhaps Obama can send young Tim up to the Congress with another scribbled request for a trillion dollar bailout. I can hear the sound of knives being drawn as he walks in the door...

Obama Proposes to Restrain the Banks from Speculation

A good first move, but almost a year late.

It still remains to be seen if it can pass with any teeth in it through a deeply conflicted and compromised Congress. The devil is in the details, loopholes, and exceptions.

Allowing the banks to speculate for their own accounts in the markets inexorably intermingles their risks with those of the broader financial system. It is also a tilt to the playing field to allow these market makers with access to proprietary information, very favorable positioning with the exchanges, and the Fed discount window and special programs to sit at the same table with other investors and funds.

This is so basic a move that one has to wonder why Obama waited so long to propose it. Or rather to listen to Paul Volcker who has been advising it, and largely unheeded.

Goldman and perhaps Morgan Stanley will give up the charade of commercial banking to become a full time investment bank, aka hedge fund, again. One positive outcome is that the next time they get into trouble they are on their own. And given their blind greed it won't be all that long before they do.

It is nice to see Paul Volcker gaining a voice in an administration dominated by Wall Street sychophants.

Let the threats, whining, tales of doom, financial media spin, and an army of lobbyists now go forth from Wall Street to try and stop this very basic reform.

It's a beginning. Barney Frank is already talking about putting a five year transition period on the change. Ludicrous really considering the banks that just grabbed their charters. Barney is part of the problem. A bigger part than most people probably suspect.

A good next step would be fire Larry Summers and Tim Geithner, and to permit Bernanke to gracefully step aside and go back to grading term papers. Obama needs to nominate someone with a stronger practical experience profile in that job. Volcker could do quite well.

National Post
Wall Street reels over plan to ban prop trading
Jeff Mason and Kevin Drawbaugh, Reuters
January 21, 2010

WASHINGTON -- President Barack Obama proposed stricter limits on financial institutions' risk-taking Thursday in a new populist-tinged move that sent bank shares tumbling and aimed to shore up the president's political base.

Mr. Obama, a Democrat who is just starting his second year in office, laid out rules to prevent banks or financial institutions that own banks from investing in, owning or sponsoring a hedge fund or private equity fund.

He also called for a new cap on the size of banks in relation to the overall financial sector that would take into account not only bank deposits, which are already capped, but also liabilities and other non-deposit funding sources.

"We should no longer allow banks to stray too far from their central mission of serving their customers," Mr. Obama told reporters, flanked by his top economic advisors and lawmakers.

"Too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward."

The rules, which must be agreed by Congress, would also bar institutions from proprietary trading operations, unrelated to serving customers, for their own profit.

Proprietary trading involves a firm making bets on financial markets with its own money, rather than executing a trade for a client. These expert trading operations, which can bet on stocks and other financial instruments to rise or fall, have been enormously profitable for the banks but also increase market volatility.

The White House blames the practice for helping to nearly bring down the U.S. financial system in 2008.

Mr. Obama's move is the latest in a series to crack down on banks and comes as he reels from a devastating political loss for his Democratic Party in Massachusetts on Tuesday, when a Republican captured a U.S. senate seat formerly held by the late Democratic senator Edward Kennedy.

Bank shares slid and the dollar fell against other currencies after Mr. Obama's announcement.

JPMorgan Chase & Co fell 5.8%, helping push the Dow Jones Industrial average lower.

Citigroup Inc fell 6.36% and Bank of America Corp fell 7% while Goldman was down 5.5% despite posting strong earnings Thursday.

"This is going to have a tremendous impact on big-name brokerage firms like Goldman Sachs and JPMorgan," said Ralph Fogel, investment strategist at Fogel Neale Partners in New York.

"If they stop prop trading, it will not only dry up liquidity in the market, but it will change the whole structure of Wall Street, of the whole trading community."

Mr. Obama targeted banks for taking big risks while assuming taxpayers would bail them out if they failed.

"When banks benefit from the safety net that taxpayers provide, which includes lower-cost capital, it is not appropriate for them to turn around and use that cheap money to trade for profit," Mr. Obama said.

"That is especially true when this kind of trading often puts banks in direct conflict with their customers' interests," he said.

Before the announcement, Mr. Obama met with Paul Volcker, the former Federal Reserve chairman who heads his economic recovery advisory board and who favors putting curbs on big financial firms to limit their ability to do harm.

The House approved a sweeping financial regulation reform bill on Dec. 11.

The House bill contains a provision that empowers regulators to restrict proprietary trading by financial firms subjected to stricter oversight because they are judged to pose a risk to the stability of the financial system.

The Senate has not yet acted on the matter, but the Senate Banking Committee continues to seek bipartisan agreement on financial regulation reform.

Gold Hit With a Bear Raid Yesterday - Memories of Citi's Eurobond Price Manipulation

If the longs had been exiting the market, the open interest would have declined more significantly.

These big plunges in price look to be driven by short selling, with weak hands being driven out, and then short covering or determined buyers stepping back in to maintain the overall number of contracts at a relatively steady level, but with some good profits from covering their short positions at cheaper prices.  There is also a lucrative cross trade to be had in other markets like the mining stocks.  An operation in bullion is often preceded by some noticeable movements in the miners.

Recall the case in the Euro bond market, wherein Citi came in and sold an enormous volume precipitously, running the stops and driving the price down sharply. The Citi trader came back in and covered his shorts, pocketing the difference in his market disruption based on size. This trading strategy was known as 'the Dr. Evil' trade at Citi, but has deep roots in speculative market manipulation, with its counterpart being the bull pool.

Citi Fined for Euro Bond Trades By British Regulator; Italy Indicts Citi Traders; Citi Haunted by Dr. Evil Trades in Europe; Citi Agrees to Pay 14m in Bond Scandal

I recall reading at the time how the Citi traders were incredulous at being outed by the regulators, because that is how they would do things in the States, running the stops and using outsized positions to perform short term price manipulation. In the states 'price management' has become quite notorious around key market events, such as option expiration. It is so prevalent that it has its own momentum among traders. The only time that it is remarked by the exchanges in the states, however, is when other prop trading desks are caught by it unawares and complain. The public is fair game.

Even the Treasury recently got into the act, with young Tim's Treasury granting a $38 Billion tax break to Citi in order to enhance their financials and the price of their stock.

Citi had quite a record of bad behaviour around the world a few years ago. Citi Never Sleeps The power of money corrupts, and under-regulated banks that have the power to create and confer wealth can corrupt all that they touch, absolutely: regulators, media, exchanges, economists, politicians.

Has Citi cleaned up its act? Well, it was one of the banks at the heart of the debt securitization scandal that almost brought the US financial system to its knees last year, and is still a major source of global instability. The US seems unable to do anything to keeps its house in order. But in fairness, all the big US banks were caught up in the scandals, most notoriously in those exposed by Eliot Spitzer, who was later 'taken out' in a scandal exposed by a special federal investigation ordered by the Bank's good friends in government.

This may give you some idea of how the US markets continue to operate these days, with the banks loaded with cash and regulators turning a blind eye to their antics and outrageously non-productive economy related trading positions. The large hedge funds do the same things, but do not have the clout that the banks have, especially with the commingling of guaranteed deposits and subsidized liquidity from the Fed. These banks do not lend; they gamble while rigging the game. The most outrageous example is Goldman Sachs, the upstart which bought the lordly title of Bank from the Fed, and all the privileges of seignorage therein. Droit du seigneur with the public money, at the heart of its creation.

It was not all that long ago that speculative manipulation by the predators at Enron in the energy markets caused widespread disruption in the State of California. And little has been done by the US regulators to prevent this happening again and again. All is hushed up to maintin the facade of freedom and public confidence. Reform is continually weakened and placed on hold for "the good of the financial system" and its global competitiveness.

Barrick Gold filed a motion to dismiss the 2003 price manipulation lawsuit against it and J. P. Morgan on the basis that some foreign central banks (England, Germany?) and other bullion banks were involved, but were not named as defendants. These foreign central banks were immune from litigation. Naturally the scandal kicked up by this caused the defendants to regroup their strategy and the motion was withdrawn. Barricks February, 2003 Motion to Dismiss

The claim that J. P. Morgan was engaged in fulfilling government policy in its price manipulation was intriguing indeed. It is too bad that it was not granted and sent to discovery and disclosure. But it does highlight one potential reason why a government might not wish to downsize its 'too big to fail' banks, who can become instruments of financial engineering and policy, both foreign and domestic. Who can say what is truth, because unfortunately despite the many abuses, cases are normally settled with no admission of guilt, wristslap fines, and genuine reform is push aside for the sake of temporary expediency.

In closure, the opaque short position in the silver market held by J. P. Morgan and a few other banks is a potential scandal and a disgrace for a 'reform' administration. They do not deserve the benefit of the doubt any longer. Innocent until proven guilty is correct procedure for the courts, but 'where there is smoke there is fire' and 'once bitten twice shy' has its own place in the court of public opinion where trust is a necessary component of good judgement.

Friday, December 18, 2009

The CME Final, just posted, indicates that open interest yesterday rose 475 lots (1.48 tonnes) to 502,930 contracts. Volume remained as reported in the Preliminary at 258,576 lots, 15% above the estimate. See CME Daily Bulletin.

For a $28.80 down day (indeed down $46 intraday) this result is astonishing. Considerable stop losses must have been triggered, but apparently fresh short selling predominated.

Of course, the CME reported a similar event following gold’s $48.80 drop on Friday Dec 4th – only to apparently slip a 21,000 lot fall into the following Monday’s data

But then they did have the excuse of huge volume –almost 400,000 lots that day. And presumably they do not actually want to make these errors.

So on its face the gold market has seen the entry of a large volume of new Shorts, who will have to contend with reviving Eastern physical appetite. If commercially motivated, this is likely to be an alarming experience.