The 'Stock Market Is Rigged' and an Epidemic of Fraud

You have probably heard by now that the popular US news magazine style program 60 Minutes carried a segment interviewing Michael Lewis about his new book last night. In it Lewis says that the 'US Stock Market is rigged,' referring to the front running of basic price data taking place with the cooperation of 'the exchanges, the banks, and the traders' in order to regularly cheat large institutional and fund investors on their stock transactions.

You may rightly say that this is nothing new. You have heard about this new type of organized and systemically arranged 'front running' here and other places on the web many times over the past five years. And there were people who had been interviewed, occasionally but not so much of late, on some of the financial news networks complaining about it.

This morning NY AG Eric Schneiderman was interviewed about the investigation he is conducting on Bloomberg TV. Schneiderman was quite politic, praising HFT itself as 'providing liquidity' and pointing to some of the trading firms grasping for milliseconds of advantage as some sort of misguided bad apples.

The lady anchor on the show who questioned him was quite adamant that is it the fault of the regulators for allowing it to happen. She likened these Wall Street traders to her children, who are constantly looking for ways to circumvent her rules, and the shame is on her when they succeed.

I don't think the anchor really understood what she was saying in that awful comparison. These are not children, in the morally formative stage of relative innocence. They are adults, with tremendous advantages and often in positions of power, who have often taken oaths and fiduciary responsibilities. And they too often violate them, and twist the laws to escape responsibility, shamelessly.

This is the unspoken entitlement of the privileged class, the price of their naturally beneficial role in society, that is, the entitlement of being above the law, because they are so special, and so legally advantaged and well connected.   This is the twisted reincarnation of class and racial arrogance,  the one percent's burden of bringing order and direction to its social and genetic inferiors.

Well, that is the moral hazard of excusing Wall Street's criminal thefts, of giving a slap on the wrist when they are caught lying, cheating and stealing, of believing canards like the exchanges are responsible and self-regulating, and ignoring the key role that they and the Banks play in enabling widespread fraud and financial plunder.

Why do people ever listen to those apologists for financial fraud, who dismiss all accusations of market manipulation as mere conspiracy talk? Yes they are skillful in creating doubt, and since all fraud is founded on the hiding and control of information, there is always room for doubt.

Perhaps the worst of this is that 60 Minutes and other are willfully ignoring the power of money in silencing regulators, cutting their budgets, and using political influence to kill their attempts at enforcing the law by corrupting the political process.

Complicating matter, the Federal Reserve has taken the policy of shoving manufactured liquidity into the system through these very Wall Street banks and their exchanges, who are taxing the stimulus like warlords who take Red Cross aid for themselves, allowing a trickle of them to go to the intended recipients. This 'trickle down' approach by the entitled is a sick joke, because it continues robbing the public to pamper the privileged few.

And anytime a whistleblower steps forward, they are smeared and charged with crimes. What a world we are giving to our children, who we apparently teach by our words and example that breaking the rules is a fine art, and that justice is a poorly defined and highly debatable abstract concept. And the truth is merely what we say it is, if we say it well enough, and have enough powerful people and credentialed experts to back us up. Whatever 'is' might mean.

And there are other frauds still going on, like the blatant manipulation of the futures markets with large scale buying and dumping of positions in quiet markets to shove the price around, with regulators turning a blind eye to it. As long as the exchanges, the biggest traders, and the politicians are getting their piece of the action, nothing will be done about it. But such actions have real world consequences.

Old story, always with a bad ending.

Banks Manipulating Trades and Rigging Benchmarks in Foreign Exchange Markets

Are there any markets that have not been corrupted by lax regulation, and as a consequence by Banks who have been emboldened in their insatiable greed by the lack of effective enforcement of the rules and equal justice for all?

It is somewhat ironic that this news of routine price rigging comes on the revelation that Obama is replacing Gary Gensler, Chairman of the CFTC, for being too aggressive in seeking to regulate the Swaps markets and angering some foreign banks (read London trading operations of the big multinational banks). 

London has become a favored haven for corrupt financial practices such as 'the London Whale.'

I will suggest to you that this is still just the tip of the iceberg.  And for those who assert that there is no manipulation in the precious metals markets, despite all the odd price action and blatantly predatory selling raids, I would suggest that they are obviously lacking in something, exactly what I cannot say.

There will be no sustainable recovery until the impediments to honest price discovery and the pernicious tax of corruption is eliminated through greater transparency, equal enforcement of existing laws, and serious reform. 

One can seriously wonder how confident they can be that the governments of the US and the UK, and of Europe as well, are seriously committed to performing the basic function of maintaining honest markets for their constituents.  If market confidence breaks, there will be hell to pay.

Even if they hide and tolerate this corruption for the sake of 'confidence, ' markets have a significant role to play in the economy.  That function has become warped and perverted through corrupt practices, with serious real world results, which accumulate and worsen over time, with consequences that we have yet to discover.

Breaking News from Bloomberg:

"Traders at some of the world’s biggest banks manipulated benchmark foreign-exchange rates used to set the value of trillions of dollars of investments, according to five dealers with knowledge of the practice.

Employees have been front-running client orders and rigging WM/Reuters rates by pushing through trades before and during the 60-second windows when the benchmarks are set, said the current and former traders, who requested anonymity because the practice is controversial. Dealers colluded with counterparts to boost chances of moving the rates, said two of the people, who worked in the industry for a total of more than 20 years.

The behavior occurred daily in the spot foreign-exchange market and has been going on for at least a decade, affecting the value of funds and derivatives, the two traders said. The Financial Conduct Authority, Britain’s markets supervisor, is considering opening a probe into potential manipulation of the rates, according to a person briefed on the matter..."

Front Running the Fed In the Treasury Market

I had a friend from the old neighborhood who was Comptroller of a major casino in Las Vegas in 1970-80s, where I also was married in 1981. Only lasting win from there, ever.

According to this dour son of Italy the way he could spot a problem, besides the more aggressive methods of observation and detection, would be to examine the returns on a table basis. In the short run they will vary, but in the longer term each game will provide a statistical return that rarely deviates from the forecast, unless someone is cheating. We would walk through the casino, and he would point to a table game and say "at the end of the month, this table will bring in xx percent."

It was he who introduced me to Bill Friedman's book, Casino Management, which is a useful read if you wish to learn more about that end of the speculative business from the house perspective.

Attached is some information from a reader. I cannot assess its validity, not being in the bond trading business. But it does sound like someone has tapped into the Fed's buying plans to monetize the public debt and is front running those buys, essentially 'stealing' money from the public. Its what they call 'a sure thing.'

To try and figure out who might be doing it, I would look for some big player who is showing extraordinary returns on their trading, with consistent profit that is not statistically 'normal,' too consistently good. The problem with cheaters is that they sometimes get greedy and call attention to themselves.

In Las Vegas the bigger cheats were often taken out into the desert for further inquiry and final disposition. On Wall Street they are somewhat more arrogant and persistent, defying resolution with that ultimate defiance, "We'll just find other ways to cheat again."

Time for a trip to the desert?

Here are a reader's observations from the bond market.

From a reader:

I used to work for a BB on a prop desk until the financial crisis took hold and they fired the less senior guys on the desk. I now trade US Treasuries, for a small prop firm in xxxxx, to scalp basis trades in mostly on the run securities. Occasionally, I will also take position in the repo markets for off the runs if I see something "mispriced." Your recent article piqued my interest because we too have noticed "shenanigans," of sort, in the QE program of USTs.

What we noticed, especially in smaller issues like the 7 Year Cash is that before a Fed buy back would be announced the price would pop significantly as buyers would run through all the offers on two major electronic exchanges (BGC Espeed and ICAP BrokerTec). This occurred more than several times as the 7 Year Cash would be overvalued both by its BNOC by 20-30 ticks and its relative value to similar off the runs. This buyer(s) would lift every offer they could, driving the price substantially above its "value" for sometimes a week at a time. After this buying would occur, the Fed would then announce the purchase of that security sometimes a handle above its approximate value. This "luck" did not just occur in the on the run 7 Year sector, it also occurred in the 30 Year Cash, 3 Year Cash, and more than several off the runs. Again, it was especially prevalent in the less liquid treasury products. Often the "appetite" for these securities would begin approximately 2 weeks to 1 week before the official Fed announcement. The buying was well organized and done in such a way as to completely knock it off kilter from its relationship with like cash Treasuries and the CME Ten Year Contract. If you examine the charts of some of the selected buy backs before the official announcement, you will see a similar occurrence.

While I have not broken this down into a paper to prove it (and I see nothing positive coming out of contacting the ESS-EEE-SEE about this issue), I can assure you that it was occurring on a consistent basis across the entire curve.

A certain issuance would be bid up through the market (substantially above value, as derived by several metrics) only to be later gobbled up by the Fed at the unreasonable price. These player(s) had substantial pockets as we, the small guys (but with a decent capital base), would take the other side of what seemed to be an obvious fade. While this did not occur in every single issuance of the QE program, it occurred often enough to be obvious to any learned observer.

While I am not sure if this can be attributed to purposeful Fed policy or someone at the Fed talking to his pals, I am certain it transpired."

Corruption is inevitable when the government is engaged in manipulating the markets with public monies. That portion of the Fed's activities needs to be scrutinized by the GAO on a continual basis. And the activities of the Exchange Stabilization Fund and the Treasury in market intervention should be subject to review by the legislative branch on behalf of the people.

Of course another option is to keep the Fed and the Treasury out of the public markets altogether excepting short term interest rates and specifically identified emergencies.