Us vs Them part 2

I'm happy to see more people writing about the conflicting agendas of long-term capital investors and short-term speculators. This is a excerpt from an article by Dallas Mavericks owner Mark Cuban.

Regulators have got to start to recognize that traders are not investors and vice versa and treat them differently. Different regulations. Different tax structure. Different oversight. Individual investors and the funds that just invest in stocks and bonds are not going to crash the market. Big traders who are always leveraging up and maximizing the number of trades/hacks they make will always put the system at risk. We need to recognize that they do not serve much of a purpose other than to add substantial risk to the global economy. That their stated value add of liquidity does not compensate the US and World Economy nearly enough for the risk of collapse they introduce into the system.

Wall Street as a whole needs to be in the business of creating capital for companies and selling shares to investors who believe they are shareholders. The Government needs to create incentives for this business and extract compensation from the traders/hackers for the systemic failure level of risk they introduce.

This assessment is spot-on, except that I don't think the government can extract enough to compensate for the risk of disrupting the economy and all the lives and businesses in it. There are some things you can't write a check for, and years of people's lives is one of those things.

Better to limit destructive activity to non-critical levels. High frequency trading accounts for 73% of all equity trades, and it's already been rigged to get around the law. Do we really need this at all?

Flash Crash Cash

The spin has already started on the flash crash that sent yesterday's market down 1000 points (largest one-day drop ever) and most of the way back up in the space of less than half an hour. After a lot of speculation, the trigger now stands identified as NYSE's brief (under two minutes) mechanical pause in trading for five stocks whose buyers and sellers had drifted too far apart. (I suspect there is more we don't know yet).

How did such a small action cause such fallout? The answer comes from computerized trading where algorithms tell computers when and how to execute trades. There are so many of these that we saw extreme results: some stocks trading at zero (which is a computer finding no buy orders and therefore bidding a penny) and a stock that started and ended the day around $34 a share but in between hit $100,000 a share (Sotheby's).

What was it about the NYSE pause that set this in motion? The answer is liquidity, much like the credit crunch that hit a few years ago. When the NYSE used to control most of the stock of the companies on its exchange, it could pause trading without incident. Today, the NYSE controls only about 25% of the stock of the companies on its exchange. The rest is controlled by private, mostly computerized companies like Tradebot (yes, that is its real name).

When the NYSE shut off its trading momentarily, other traders registered the event as a sudden loss of liquidity--as if trading volume had suddenly left the market. This triggered a computerized panic followed by a human panic long after the triggering event was over. And even more reassuring, nobody's quite sure why the market rebounded so fast; it's suspicious. (How computerized trading is rigged.)

Among many automatic actions that were triggered, firms like Tradebot suspended trading at -500 points. At first glance, this sounds like a bad thing. Dick Rosenblatt, chief executive of Rosenblatt Securities (whose site features a Dark Pool Liquidity Tracker right on the home page), was quoted in The Wall Street Journal saying that the triggers were bad because by halting trading, the tradebots of the market withdrew more liquidity and thus accelerated the fall. He said,

"How have we incented algorithmic traders and high-frequency traders to enter our markets in times of stress? We really haven't."

In other words, he suggests that there are traders out there who would enter the market in times of stress to add liquidity if only there were financial incentives for doing so. We could avoid future flash crashes by rewarding these white knights who add liquidity to the market.

How would they add liquidity to the market? By buying up falling stocks at below-market prices. And....they need extra incentive for this?

Yes. As it turns out, exchanges like NASDAQ are backing out the most extreme of the transactions that occurred during the flash crash, 2/3 of which involved ETFs. Only transactions that were within a certain percentage of the pre-trigger price were allowed to stand--and that could hang speculators--excuse me, white knights adding liquidity to the market--out to dry.

For example, suppose a stock began the day at $60. A trader bought the stock at $10 then sold on the rebound at $50. The buy is wiped out because the price is too extreme. But the sale is within acceptable price range and would stay. Thus, the trader is left holding the shares short at $50. His previous profit is wiped out. To make a profit now, he must buy again at a price far enough below $50 to cover trading costs—and this on a stock that started the day at $60.

I want to point out here that the esteemed Wall Street Journal only interviewed HFT (High Frequency Trading, aka speculating, day trading, and churning) insiders for its article. The other quoted source was from a company that creates computerized trading programs. What were they going to say, that algorithms are a mixed blessing, allowing greater efficiency in trading and portfolio design while also creating potential market energy that can be manipulated by speculators?

Not hardly.

Did the esteemed Wall Street Journal talk to anyone not profiting from HFT? Public official? Long-term investor? Investment science academic?

Not hardly.

So what we have here is a WSJ article whose only quoted sources represent the speculators that are still, even now, siphoning short-term profits out of the economy. The article presents only the idea that speculators, who are quite able to CAUSE crashes, should be let loose to fully profit from crashes.

Fortune starts off with good skepticism, zeroing in on the trigger as the key question, but then says,

What, if anything perpetuated the selloff? And did so in seconds? There's a lot of speculation about high-frequency traders vanishing from the marketplace. The consensus is that high-frequency guys didn't provide the liquidity and that's what allowed for prices like one penny on Accenture.

In point of fact, this is accurate: HFTs withdrew liquidity. But the implication here is that HFTs should have provided liquidity--should have bought in at below-market prices to save the market.

Why in the world settle on HFT? Why not government? Why not shut the whole market down if things go nuts?

I don't favor a particular solution to this problem, but I do have a problem when only one solution is considered and that "solution" perpetuates bad financial management.

On the other hand, I do own a soapbox called "putting limits on speculation as a percentage of total market volume to prevent bubbles and steer more money toward true economic growth." Congress and economists have not embraced this idea the way I'd like, but I still hope that regulating derivatives is a first step toward limiting gambling and HFT.

Toward that end, I can just picture future Congressional testimony that we can't possibly limit HFT because we need their liquidity to stabilize the market in the event of a crash.

We must always remember this is us vs. them. Speculators profit from market volatility--and know how to cause it. Long-term investors and our national economy prosper from stable market growth.

Now the speculators say that only they can save us from market instability, but we both know what they are asking for is protection money--and the financial press is willing to be their mouthpiece.

We Need Norman Lear

Norman Lear had a way of exposing the hollow center of people who were afraid of social upheaval and blamed anyone different from them for anything they didn't like. His archetypal creation was Archie Bunker, a middle aged white guy meeting 1970 with the social awareness of 1950. His every gaffe, malapropism, and outright expression of bigotry was an opportunity for us to laugh and for his educated son-in-law to explain--to Archie and the nation--why Archie's way of thinking was outdated or just plain wrong. And the nation listened. All in the Family took on the most sensitive topics of the day, and it was the number one show for years.

Who is the next Norman Lear out there, ready to present a smart political sitcom that exposes the inconsistencies, switchbacks, and muddleheaded thinking of the Tea Party to the regular laughter of today? We need you.

Here is some of Archie Bunker's classic humor from the early 1970s. Any parallel to the present is purely intentional.

Archie: ....Petey, the white-nosed Commie.

Larry: Petey? A Commie?

Archie: That's right. Remember that night we was all talkin' about Spiro Agnew--and what did Petey say?

Larry: He didn't say nothin'.

Archie: On orders from you-know-who. That's how them Commies work. And you're his friend.

You think William Buckley's gonna give blood to some Commie punk what's just blowin' up a building?

"And the rib which Lord God had taken from man made He a woman and brought her unto the man. And Adam said this is now a bone of my bones and flesh of my flesh and shall be called woman because she was taken out of man." There it is in black and white! So we didn't crawl out from under the rocks and we didn't have tails and we wasn't a bunch of monkeys neither, you atheistic pinko meathead, you!

Archie: Listen, you and me had this argument before over Jesus and I ain't going over old ground again. Jesus was white and so was Santa Claus.

George (who is black): Listen Bunker--when I was a kid, the guy who filled my stocking on Christmas Eve was black.

Your colored run faster. They jump higher. They don't bruise as easy. And because of their what you call it, jungle heritage, they see a lot better, good for night games. All I'm sayin' is it was unfair to the white ball players...who weren't exactly fortunate enough to be born with the same natural endorsements.

Fun at LATFOB!

Last weekend was the Los Angeles Times Festival of Books, and some of us book tweeps got together for drinks and Indian food in the Westwood area:

@CallieMiller

@Shayera

@booksquare (Kassia)

@KatMiller

@pablod

@KirkBiglione

not pic: gamesafoot

My camera shutter did a strange thing for some of the pictures. I could say I did this cool artistic effect on purpose, but I'd be lying.

Cutting Back the Kudzu

Long-term investors want growth products and smooth, steady upward market growth.

Short-term speculators want betting products and volatile market performance.

These two groups will always be in conflict and will always be competing for money. But the health of our economy is firmly on the side of the long-term investors.

Stocks and bonds support the economy. They provide capital for growth and a return on investment the way a home garden provides food for the table.

Speculators are the kudzu of the market. Give them room, and they will take over. Then the market will crash because no market can survive when speculation chokes off growth.

Congressional reform is about requiring speculators to be more transparent, have stricter accounting, and higher security standards. All that is good, but we also need to limit the actual volume of speculation, both in the market and in the unregulated areas that speculators naturally seek out.

We must start treating speculators like kudzu. You never get rid of kudzu completely. Cutting it back is an ongoing job.

It is the nature of speculators to seek out new things to bet on, and the less regulated, the better. Just this year, a market opened up to bet on box office grosses. After flooding the market with junk mortgages, speculators are now sweeping up the devalued mortgages and even the tax liens for another go-round.

The government, probably the SEC, has to take on the job of staying on top of speculators--not just in regulated areas or "the market" but wherever they go.

Everybody understands the principle behind regulating casino gambling (whether or not you agree). It's not just a moral objection; it's also about the economic health of individuals and the community.

We all must understand that our economic health--in the U.S. and the whole world--depends on limiting gambling disguised as speculation, and that means constantly watching for speculation in all the forms it can take.

Whither Democracy?

Quick question that wouldn't fit into a Tweet:

We are alarmed that a notable percentage of Americans say that there may be circumstances when violence against the government may be justified. Violence is not the answer.

At the same time, many such as Noam Chomsky say that our two party-system is an illusion of democracy created by corporations to appease the masses and disguise the real nature of our corporate state. Electing more of the same corporate puppets is not the answer.

So...what is the answer?

This IS Small Government--And That Is Why It Isn't Working

For years, Republicans have argued that small government is better than large government and business is better still. Republicans want to bring corporate efficiency to government. California gubernatorial candidate Meg Whitman explicitly states that her experience building a business will make her a better governor (as a former ebay seller, I would disagree, but I digress).

So let's talk about bringing principles of business management to government.

Businesses don't generally come to business consultants to learn how to do what they do better. They already know how to make glass or sell vacuums or whatever it is they do. They come to learn how to do the business end better. They come to learn why their growing business that was working so well is now dysfunctional. It's harder to schedule meetings. Executives are wasting time on administrative work. Stuff isn't getting done.

A business consultant takes a goal-oriented approach. Let's look at what you want to accomplish, lay out the best steps to get there, measure the man-hours to do what you need, and staff accordingly. A consultant expects that routines and structures that used to work will have to be jettisoned in favor of new ones. (Single payer, anyone?)

When I was a business consultant, I found that the many of the businesses that came to us had similar and predictable problems having to do with expanding infrastructure.

For example, three people starting a business can communicate by calling out. "Hey, did you order us some business cards?" "Yeah, be here Friday." Done. At a dozen people, you can't shout, but you can still get up and walk into someone's office for most communication. At 30 people, you need to rely more on email, and so on.

At each stage of growth, there has to be more structure to support the organization. Things you can do casually in a small group have to be structured for a larger group. Roles become more specialized. Quality control and layers of accountability enter the picture. It all gets more complicated, and there's no getting around that if you want to function properly.

That undisputed principle was behind the 1982 business bestseller In Search of Excellence by Tom Peters. Peters believed that by keeping businesses under 200 employees or so, you could prevent it from getting bogged down in administration. Thus it would be both more responsive to market changes and more profitable. When a business grew too much, you were supposed to spin off a unit into a new business.

Coincidentally, this was around the same time that Ronald Reagan was telling us that smaller government would be less wasteful and more responsive to change.

But just as Reagan's small government utopia didn't quite turn out as advertised, the promise of small business didn't solve every problem.

Even a cluster of businesses has to be managed, and that creates some administrative overhead. Moreover, managing multiple autonomous businesses can be like herding cats--much more challenging than managing subordinate departments.

And, some businesses have so many moving parts that they can't achieve efficiency of scale at only 200 employees.

So again, it is undisputed that larger organizations need more infrastructure.

In 1900, the U.S. population was 76 million, about 1 million of which (1.3%) were government employees.

In 2010, the U.S. population is about 307 million, about four times what it was in 1900. By 1900 standards of 1.3% government employees, we should have about 4 million government employees. In fact, we only have 2.15 million, and this is the highest federal payroll ever.

Small government advocates should be delighted by how we've kept expansion down. Instead, they claim it is a "return to the era of big government." They claim that government is inadequate to its many tasks because it is a "bloated bureaucracy."

The truth is, it's just inadequate.