Monday, August 6, 2012 – Front Running and Money Laudering – All in a Day’s Work
DOW + 21 = 13,117
SPX + 3 = 1394
NAS + 22 = 2989
10 YR YLD -.02 = 1.55%
OIL -.10 = 93.86
GOLD + 8.00 = 1612.60
SILV +.08 = 27.98
PLAT – 5.00 = 1407.00
A couple of weeks ago I said we had entered the Dog Days of Summer; technically that was correct, however the Economic Dog Days officially start this week; there is almost nothing on the calendar, trading volume has dried up; today was the lightest volume of the year, excluding holidays. Knight Capital was trading again but not with the same vigor of last week. Knight managed to find a consortium of investors to pony up $400 million to allow the company to continue to scalp trades. High-frequency trading algorithms have flourished in the past few years, as under-regulation made way for non-regulation. The mega banksters and their attendant trading firms figured out a way to make huge trading profits virtually every day, off of their customers, by front-running, which means they inserted themselves as middle-men into every trade.
The high frequency traders set up computer rooms right next to the exchanges to assure they get super fast trade information, just a few milliseconds is enough. The high frequency trade algorithms submit bids-to-buy and offers-to-sell hundreds of times per second, and the computer programs determine exactly what price sellers and buyers are willing to accept. The bids and offers would be near-immediately canceled, because the investment banks had no interest in actually following through with them — for all intents and purposes, these were fake bids and offers, or a type of quote-stuffing. The brokerage firms would then run-in-front of the buyers, hence “front-running”, to buy the stock first, then immediately turn around and sell it to the other buyers for just a bit more.
So, for example, if your pension fund tried to buy a million shares of company XYZ, they put in a bid, the HFT companies like Knight Capital get that info a few hundreds of a second before the public; their computers come up with fake bids and offers, and then they front run the sale and it ends up costing your pension fund an extra half penny per share. It adds up over time.
And so it’s no surprise, that a consortium of Wall Street investment banks would want a piece of this High Frequency action. It is almost like a transaction tax that the investment bankers can impose on customers, you know, the same kind of transaction tax that the investment bankers claim they can’t be forced to pay.
Stocks closed at 3 months highs. Spanish and Italian bond markets recovered a little. European Central Bank President Mario Draghi has said the ECB may buy short-dated bonds to lower borrowing costs to help Europe. Draghi will have to wait for the Germans to determine if they want to participate and if they think Draghi’s plan is legal, and the whole deal will take at least a few weeks, and most of Europe goes on vacation in August and nothing, really nothing gets done. Nothing has been fixed in Europe, but things seem to be getting better or at least not worse, and it seems unlikely that there will be any kind of real blow-up, and that is problematic for the market bears, so there is a bit of a short squeeze. Why fight it? Go on vacation. European shares closed at 4 month highs.
The New York Stock Exchange has confirmed it is in talks with securities regulators to settle allegations that the exchange violated rules intended to promote fair competition. The SEC is investigating whether the NYSE is violating the regulation that prohibits an exchange from sending out data on a private feed to certain clients faster than on public data feeds. The SEC ramped up its focus on market structure issues like the one at the heart of the NYSE probe in the wake of the May 6, 2010, “flash crash” in which the Dow Jones Industrials plunged about 700 points in several minutes, but there is no indication the current investigation deals with the flash crash. Earlier this year, the SEC’s market abuse specialized unit disclosed it was conducting roughly 20 different inquiries, ranging from order types to how exchanges police their markets.
Standard Chartered Bank reaped hundreds of millions of dollars of fees by scheming with Iran’s government to hide roughly 60,000 transactions over nearly a decade. The bank violated anti-money laundering laws by scheming with Iran to hide more than $250 billion of transactions, New York state bank regulators say Standard Chartered may lose its license to operate in New York State.
The bank was “apparently aided” by its consultant Deloitte & Touche LLP, which hid details from regulators, and despite being under formal supervision by regulators including the Federal Reserve Bank of New York for other compliance failures involving the Bank Secrecy Act and money laundering.
According to regulators, the bank’s actions “left the U.S. financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes, and deprived law enforcement investigators of crucial information used to track all manner of criminal activity.”
So, five years ago the banking industry imploded, and over the past few weeks we’ve seen example after example of how the problems with the finance industry have not been fixed. We’ve had the frightening risk management at JPMorgan, where the London Whale lost $5.8 billion and counting, we had the complete breakdown of PFGBest; we still don’t have any response to the vaporization of more than a billion dollars of MFGlobal accounts; the misuse of insider information at Nomura, the Libor scandal at Barclays, which is growing daily and just involves the global standard for anything with an interest rate; the software glitch at Knight Capital that led to a miniature flash crash, so their traders can scalp a few pennies on everything; money laundering at HSBC; and now money laundering at Standard Chartered. This latest deal was more than just trying to avoid taxes, it was literally aiding Iran.
According to Reuters, the regulator described how Standard Chartered officials debated whether to continue Iranian dealings. In October 2006, the top official for business in the Americas, whom the regulator did not name, warned in a “panicked message” that the Iranian dealings could cause “catastrophic reputational damage” and “serious criminal liability.” A top executive in London shot back: “You f—ing Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians.” The reply showed “obvious contempt for U.S. banking regulations,” the regulator said.
Standard Chartered allegedly moved money through its New York branch on behalf of Iranian financial clients, including the Central Bank of Iran and state-owned Bank Saderat and Bank Melli, that were subject to U.S. Sanctions. Such transactions were permissible until November 2008, when the Treasury Department prohibited them on concerns that they were being used to evade sanctions, and that Iran was using banks to fund nuclear and missile development programs.
Maybe treason is too harsh a word.
And then there is the case of Capital One, just a small problem, hardly worth a mention. The Justice Department says Capital One has agreed to pay $12 million to resolve allegations the bank violated special consumer protections in federal law for members of the military. Capital One wrongfully foreclosed on some homes and improperly repossessed some cars, the bank obtained wrongful court judgments against some service members, and improperly denied interest rate relief on some credit card and car loans.
In a settlement under the Servicemembers Civil Relief Act, Capital One will pay $7 million in damages, including at least $125,000 to each service member whose home was unlawfully foreclosed upon and at least $10,000 to each service member whose vehicle was unlawfully repossessed. The Act basically says you can’t foreclose on a service member while they are on active duty. Some guy in the mountains of Afghanistan really should not be worrying about his family, back in the states, being kicked to the street while he’s trying to fight Taliban armed with the latest rocket launcher purchased by the ayatollahs in Iran and financed by Standard Chartered and audited by Deloitte and Touche.
Earlier today at a conference in Massachusetts, Fed Chairman Ben Bernanke said:
“ ..aggregate statistics can sometimes mask important information. For example, even though some key aggregate metrics–including consumer spending, disposable income, household net worth, and debt service payments–have moved in the direction of recovery, it is clear that many individuals and households continue to struggle with difficult economic and financial conditions. Exclusive attention to aggregate numbers is likely to paint an incomplete picture of what many individuals are experiencing. One implication is that we should increase the attention paid to microeconomic data, which better capture the diversity of experience across households and firms. …”
Another implication is that policymakers such as Ben Bernanke should do more to help individuals and households who “continue to struggle with difficult economic and financial conditions.” So why isn’t he pushing the Fed to do more at every opportunity?
Banks are also stockpiling cash; they’re sitting on more than $1.5tn in excess reserves in the US. Corporations are sitting on much more cash than that. Many are not even rewarding investors or accelerating their growth with the money, thereby causing harm to themselves, according to a recent survey by Ernst & Young. Economists also say that cash hoarding is blocking a recovery in Europe.Another study by the Political Economy Research Institute at the University of Massachusetts found that if corporations and banks invested $1.4bn in cash into productive investments and job creation, unemployment would fall below 5% by the end of 2014.
To be sure, the purpose of these companies – and of capitalism itself – is to create profits, not jobs. But as the Great Depression and the Great Recession have demonstrated – and as a famous philosopher-economist once said – capitalism sows the seeds of its own destruction. Sometimes it makes sense to take a long term view, and invest in your customers.
Of course, the question will arise: how can we make quarterly profits-obsessed corporations tap their vast reserves to invest and create jobs to serve their long-term interests? I don’t know. But we do know where the money is.
And then we hear the story of the geniuses in San Diego. San Diego’s Poway school district is paying $1 billion to borrow $105 million. According to a story in the Voice of San Diego, the city really had no choice. It was either raise taxes or float what appeared to be just another bond to fix its schools.
“Without increasing taxes, the district couldn’t afford to borrow money in the conventional way. So, instead of borrowing from investors over 20 or 30 years and paying the debt down each year, like a mortgage, the district got creative. With advice from an Orange County financial consultant, the district borrowed the money over 40 years in a controversial loan called a capital appreciation bond. The key point for the district: It won’t make any payments on the debt for 20 years.”
Never mind the irony of the advice coming from a consultant in Orange County, which once hailed as being the home of the biggest US bankrupt county. This 40-year capital appreciation bond is really a zero-coupon bond that doesn’t require any payments for the first 20 years.
“And that means the district’s debt will keep getting bigger and bigger as interest on the loan piles up. The bottom line: For borrowing $105 million in 2011, taxpayers will end up paying investors more than $981 million by 2051, or almost 10 times what the district borrowed. That’s wildly more expensive than a typical school bond, in which a district pays back two or maybe three times what it borrowed.”