What Business is Wall Street In ?
May 9th 2010 11:36AM
My last two posts were designed to stimulate discussion. But lets talk the real problem that regulators, public companies, investor/shareholders and traders face. The problem is that Wall Street doesn’t know what business it is in. Regulators don’t know what the business of Wall Street is. Investor/shareholders don’t know what business Wall Street is in.
The only people who know what business Wall Street is in are the traders. They know what business Wall Street is in better than everyone else. To traders, whether day traders or high frequency or somewhere in between, Wall Street has nothing to do with creating capital for businesses, its original goal. Wall Street is a platform. It’s a platform to be exploited by every technological and intellectual means possible.
The best analogy for traders ? They are hackers. Just as hackers search for and exploit operating system and application shortcomings, traders do the same thing. A hacker wants to jump in front of your shopping cart and grab your credit card and then sell it. A high frequency trader wants to jump in front of your trade and then sell that stock to you. A hacker will tell you that they are serving a purpose by identifying the weak links in your system. A trader will tell you they deserve the pennies they are making on the trade because they provide liquidity to the market.
I recognize that one is illegal, the other is not. That isn’t the important issue.
The important issue is recognizing that Wall Street is no longer what it was designed to be. Wall Street was designed to be a market to which companies provide securities (stocks/bonds), from which they received capital that would help them start/grow/sell businesses. Investors made their money by recognizing value where others did not, or by simply committing to a company and growing with it as a shareholder, receiving dividends or appreciation in their holdings. What percentage of the market is driven by investors these days ?
I started actively trading stocks in 1992. I traded a lot. Over the years I’ve written quite a bit about the market. I have always thought I had a good handle on the market. Until recently.
Over just the past 3 years, the market has changed. It is getting increasingly difficult to just invest in companies you believe in. Discussion in the market place is not about the performance of specific companies and their returns. Discussion is about macro issues that impact all stocks. And those macro issues impact automated trading decisions, which impact any and every stock that is part of any and every index or ETF. Combine that with the leverage of derivatives tracking companies, indexes and other packages or the leveraged ETFs, and individual stocks become pawns in a much bigger game than I feel increasingly less comfortable playing. It is a game fraught with ever increasing risk.
The Pimco (who I think are the smartest guys on the Street) guys talk about a new normal as it applies to today’s state of the world economy. I think just as important is the new normal as it applies to Wall Street. Wall Street is now a huge mathematical game of chess where individual companies are just pawns. This is money in the bank for the big players like Goldman, Morgan, etc. Why ? Because the game of chess is far too complicated for 99pct of the institutions out there investing money. So to keep up, they turn to Goldman, Morgan and the like to invent products for them. “You don’t know how to play the housing boom, let us show you”. “You think the housing boom is about to crash, let us show you how to play that”. “You think that PIIGS are in trouble because they can’t print money to pay debt holders, let us create a product to allow you to play that game” The big houses have the best hackers in the business and they put together the games and sell them to the many, many institutions managing Billions and Billions of dollars. They are the ultimate Hackers selling their attacks to the highest bidder, regardless of which side they are on. That is a new normal.
Again, I’m not passing judgement one or the other. I’m just recognizing what is going on in the financial world today.
It’s rare for companies to go public these days. Just as rare for secondary offerings. The only thing that keeps me in the market is that most of the stocks (not all) pay dividends or some other sort of cash payout. For the first time in my life, I bought outside the United States. I bought Australia in a big way because it is becoming increasingly hard to find new domestic investments that are not influenced by the “hackers” and the games being played on a macro level. It’s hard to believe, but evaluating countries as an investment is now easier than evaluating companies . Even with all the unrest in Europe. Or maybe because of it.
So back to the original question. What business is Wall Street in ?
Its primary business is no longer creating capital for business. Creating capital for business has to be less than 1pct of the volume on Wall Street in any given period. (I would be curious if anyone out there knows what percentage of transactions actually return money to a company for any reason). It wouldn’t shock me that even in this environment that more money flows from companies to the market in the form of buybacks (which i think are always a mistake), then flows into companies in the form of equity.
My 2 cents is that it is important for this country to push Wall Street back to the business of creating capital for business. Whether its through a use of taxes on trades, or changing the capital gains tax structure so that there is no capital gains tax on any shares of stock (private or public company) held for 5 years or more, and no tax on dividends paid to shareholders who have held stock in the company for more than 5 years. However we need to do it, we need to get the smart money on Wall Street back to thinking about ways to use their capital to help start and grow companies. That is what will create jobs. That is where we will find the next big thing that will accelerate the world economy. It won’t come from traders trying to hack the financial system for a few pennies per trade.
And solutions won’t come from bureaucrats trying to prevent the traders from hacking the system. The only certainty when bureaucrats step in is that the law of unintended consequences will smack us all in the head and the trader/hackers will find new ways to exploit the system that makes them big money and even more money for the big institutions that develop products for the other institutions that are desperate to play the game.
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.
There will be another crash, because there are too many players looking for the trillion dollar score. They can’t all win, yet how many do you think wouldn’t risk everything, even what is not theirs, for that remote chance to score big ? Put another way, there is zero moral hazard attached to any trade. So why wouldn’t traders take the biggest risk possible ?
Update at 10pm 5.9.10
One more consideration. If there are traders of any kind that are unregulated or unmonitored, and trade for their own account, how do we know how big they are and how much of a threat they pose to the system, individually and in aggregate ?. For any High Frequency or big leverage derivative folks out there- is it possible there could be firms that have billions at risk with questionable ability to make a margin call or fulfill their side of the trade if things went against them ? Could there be hidden AIGs that few people know about or a bunch of AIG like situations ,which in aggregate fail and put the system at risk ? I have no idea. Just asking the question.
51 Comments »
Hi Mark
This is a very cogent note which could do a lot of good if expanded a little and published in other places with a larger audience.
Best wishes,
Alan
Comment by alanone1 — May 9, 2010 @ 11:49 am
You hit the problem squarely on the head; the only people who know what is really going on are the traders. Further oversight and/or lower taxes while two extreme solutions to this knowledge deficit that exists only sweeps this problem under the rug. An economy where education serves financial lubrication is the key to this big league swindle occurring daily on Wall Street.
Mark, I am not sure if this will be done soon i.e regulating wall street to go back in the business of creating wealth for the companies.
I dont recall exact figures but for Goldman Sachs High Frequency trading constitutes 5B in profits. I would suppose thats the case for other companies i.e generating lot of revenue. So these companies would be highly against these regulations.
Following is an argument that i heard on MarketPlace some time back about financials vying for bailout money and indeed they got the bailout.
All these financial companies hire pressure groups/individuals who seem independent and are not employed by the financial firms. These guys will pressure the Washington against reforms and laws that go against companies interest. Washington bails out or lets the laws be that the companies continue making money. Companies make money so they pay these pressure groups millions. So they continue the pressure.
(I dont intend to say i am against bailout or anything but wanted to bring about a point why its so difficult to bring about the change you mentioned).
So the first change Washington should do is make the pressure groups independent of the financial firms.
I still get the feeling Wall St.will win at the expense of stupid
people who give their money willingly to investment companies.Then they hope like hell being in stocks,funds and other equity
based investments,will help them in retirement.Good luck.But I don’t think government intervention will help.They’ll make
it worse.Frankly they don’t have the political will to do the
right thing.Nor do I want the government to run the stock
market.They’re already screwing with bonds and treasuries.The debt loads
from other countries on these bonds could literally cripple good
hard working people.Hell,what do I know? I keep my money away from equities.Do what
Mark says and at least keep your money safe.Takes a lot of balls to screw with the market,and that’s what
Goldman Sachs and company will do.So hats off to em!Mark
Comment by mdgrove500 — May 9, 2010 @ 1:22 pm
Guys: The danger with NOT being invested in equities/the market is that WHEN (not if, but most definitely when) inflation comes back to rear its ugly head, your money is not “safe.” Its value will get whittled away consistently and that’s not opinion, it’s inevitable fact. At issue for me is that not long ago, you could invest in solid, low cost mutal funds—even relatively low risk index funds—and buy individual stocks in a few good dividend paying companies—and have a pretty good chance of increasing your wealth and preparing for retirement. Money in a bank or mattress (they’re paying about the same interest lately) will not grow enough to help wage slaves like me working in the private sector—-with no pension or government stock pot to dip into. Lately, I’ve come around to thinking that maybe I should take some of my investments out of the market and buy some real estate, which seems to be on sale. I’m not a dummy, but this stuff is way over my head. If it’s a little complicated even for people like Cuban, just think what it feels like to people like me.
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Mark,
I agree, Wall Street has moved far away from its initial mission.
However, the exchanges are all privately owned and operated entities, they can do what they like. Also, I think that all of the investor protection regulations that have been added over the years make it difficult for Wall Street to serve its original purpose. Lastly, the relationship between corporation and investor has been disintermediated largely by online brokers who hold securities in street name.
Seems, though, that there is a business opportunity to start a new exchange that encourages investing, not trading; and patience, not panicky trigger fingers. It might be that trading can only occur periodically, like once a quarter or once a year. How about it? You could call it the Cuban Stock Exchange. How ironic would that be? Also, how about scaling dividends, so that investors who have been continuously invested in a company get a larger relative share of the dividends than the newbies or the traders?
Anyway, thanks for the stimulating discussion.
Sincerely,
Alex Panelli
CEO
Orbit Media, Inc.Comment by alexpanelli — May 9, 2010 @ 3:57 pm
I propose to take the Robin Hood (RH) proposal a step further by giving someone (probably the manager of the Central Bank) the power to raise and lower the RH fee on speculative trades. In times of market volatility, when the traders are dumping their risky assets, the fee can be raised, quite considerably even if panic is setting in. This would immediately lower the dumping of stocks etc because of the extra losses as a result of the higher RH fee. It will give the Central Bank a much more powerful tool to regulate the market than what he has available to him now. It will also be an inducement to less risky behaviour by the banks etc since they will know they may be unable to dump their stocks etc whenever they feel like it.
For what it is worth.
Comment by nicodaams — May 9, 2010 @ 4:00 pm
Mark, shame on you!
You know better than to use the maligned media defined hacker term..
I assure you that no real a hacker wants steal anyone’s credit card or anything else as the real hackers are about learning and passing on skills not stealing.
If you want to lean towards a more accurate term its black hat hacker..
Comment by Fred Grott — May 9, 2010 @ 4:53 pm
Great post and very timely. I have been exploring this from a tech angle related to XBRL: http://www.readwriteweb.com/archives/is_xbrl_the_key_to_escaping_small_cap_hell.php I think there will be a market based answer and that some combo of social media and XBRL will be part of that answer. Bernard
Comment by bernardlunn — May 9, 2010 @ 5:04 pm
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Mark –
You mention that solutions won’t come from government bureaucrats & more regulation, yet that’s exactly what you’re advocating, no? I’m all for cutting capital gains taxes but to me that’s just side skirting the real issue, which is government and the Federal Reserve creating the moral hazard to begin with. I think the speculators are just playing by the rules of the game that are being set by the government.
What the government needs to do in my opinion, to really solve this problem, is to get out of the way, stop CREATING the moral hazard with assurances of bailouts and programs that distort the marketplace (incentives to get people into houses they can’t afford, etc.)
If firms like Goldman knew that they weren’t going to be bailed out by the American people, there’s no way they would take the kind of gambles they took in the years leading up to the housing crisis. If you give somebody a million dollars to play poker with, of course they’re going to take some wild bets. Who wouldn’t? What we need is the government to regulate itself.
From MC> no one at goldman cares or cared about getting bailed out. That has no influence on their trading. Here is what it comes down to. How many people on Wall Street are willing to risk as much of other people’s money as they possible can in order to make insane profits ? Pretty much all of them. If it happens fast enough (the mortgage meltdown happened in slow motion with enough warning for the smart ones to get out of the way or short it), then there will be no bail out. No work out. It will be a cascading catastrophe. (and gold won’t be worth shit because no one is going to trade their corn or oil for that big gold bar you are lugging around)Comment by blairmacgregor — May 9, 2010 @ 6:20 pm
I swear, I have never … ever in my life … met as big a bunch of BABIES and investors and traders nowadays. There is the old expression from that old classic movie “There is no crying in baseball”
Well I was attracted to this business – because I * thought * “There is no crying in investing and trading”
Quit your freaking crying will ya?
High Frequency Trading. Quants. Blackbox algorithms. I have established my reputation in the last few years as a DESCRETIONARY … old style trader. But at the same time … I’ve established my reputation as an OLD STYLE value, dividend INVESTOR that holds onto a stock for years. I’ve also done quite well for myself on the investing route. If you haven’t, then maybe you need to stop blaming those around you
Providing capital to companies? Are you serious? Seriously? Wealth creation is alive and well. Start ups abound. More people than ever before are being taught to invest in the long term, for themselves, and not leave it to a fund manager.
If you are soooo foolish, as to believe that Thursday was “caused” by Quants, blackboxes, and algorithms? As Sean O’Brien put it: “Yesterdays action in the tape was for real and deserves respect and certainly a retest. Outside of my time spent in the profession of arms I have never seen anything as violent and destructive as that 45 minute period ever! Veins pop out in my fore head when I hear that it was all just the action of one swollen finger at C. If any one could F up that much it would be C but it is still Crap. I cannot believe it is being blamed on hitting B instead of M!!!!! I have been executing for 15 years across many different platforms and have never seen a system that requires you to spell out an order! Buy at market …….T W E N T Y S E V E N B I L L I O N S P O O Z. What is this the Dr. Evil execution platform?”
So if you’re going to sit and cry and whine about someone elses trading box? That you don’t even deserve to be sitting at this high stakes table with the rest of us. I’m too busy making money for myself, providing capital to companies, receiving dividends … than to cry about what others are doing.
There is no crying in trading OR investing.
From MC> Did you even read what I wrote. I could care less whether or not you make or lose money. I care even less about your reputation. This isnt about whether or not I make money. Ive always done pretty well in the markets. This isnt about whats good for me. This is about what happens to everyone.
if the markets crash because traders exploit the system to the point where there is no recovery, then your reputation or your independence wont matter. We all will have far bigger issues.
No one has their arms around the total risk in the markets. NO ONE. Does that mean everyone should just “man up” and take their chances. Yes, but it also means that someone needs to recognize the systemic risk involved. What happened the last few years is just an “oops” compared to what could happen because so few seem to understand that whatever the amount of risk that can be taken to crash the system, will be taken by as money people as can figure out how to lever up to that amount, and then some. Then your trading plans/style/approach is won’t matter because there wont be anyone on the other side of the trade left
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Mark, thanks for responding.
This is a very valuable discussion. Some points if I may:
“no one at goldman cares or cared about getting bailed out. That has no influence on their trading.”
I disagree with this because in the end, even with all of the backchannels between themselves and the federal government (Geitner, Paulson and the other ex-GS employees in gov’t just to name a few), they’re still beholden to their account holders and in a scenario without bailouts and/or “too big to fail,” the performance of their client’s accounts is still what makes or breaks them as a company. Take care of people’s money and make smart, strategic bets and you win. Use that same money to make insane, idiotic, overly reckless bets and the firm itself implodes and people pull out their money, lawsuits begin etc. The same is true with any company that has a large pool of capital to allocate; smart companies don’t go out and dump an overt percentage of those funds into a speculative technology that would bring down the entire business in the process because of the fear of bankruptcy and the fear of potential legal action by its shareholders. By knowing the game and knowing they would be able to insulate themselves from what otherwise would be catastrophic loss, the Goldmans of the world made riskier bets than they otherwise would’ve made.
This to me is not something that regulators (even those with the best intentions) can stop if the moral hazard still exists. If mortgage companies are given access to a limitless supply of cheap credit thanks to Alan Greenspan, it seems silly to me to then throw one’s hands in the air and deride the banks for using that cheap credit to put people in houses who clearly can’t afford to make the payments and to blame speculators for profiting on it. These are market actors being directed to respond a certain way by government intervention and I just don’t see how even the most stringent regulations would correct that. As you rightly pointed out, the traders/speculators will simply find another way around the system.
I agree that the speculation right now is at crazy levels; I just feel that what’s going on is indicative of a much larger problem, particularly with our banking system & currency. And if the next catostrophe ends up being our dollar, then absolutely gold will be worth plenty because people will be looking for a safe store of value in a currency that can’t be papered over. By then, the dollar will be worthless IMO.
Anyway, just my two cents. Thanks Mark.
Blair
http://www.costrefuge.comComment by blairmacgregor — May 9, 2010 @ 8:59 pm
Mark – Would you be willing to testify to Congress? They need a dose of what you have to say and I know some on the Hill who would like to hear your perspective. Email me at david.weild@cmaparters.com
Dave
Mark,
I don’t disagree with the idea that there needs to be some regulations on the financial system. I also agree that Wall Street’s job doesn’t directly ‘create’ value by trading securities… they are identifiers of value (and implementers of efficiency) not creators of value. I worked at Goldman for a couple years and didn’t find the job as a professional public market investor particularly gratifying. I’m an entrepreneur at heart.
But I think your example is way too simple and therefore wrong. And someone as well respected as you needs to be more careful about perpetuating the ignorance and populis reaction to Wall Street. “Wall Street” is way too broad of a term and any given firm (like GS). Goldman has 100s of businesses which do a million different things. Goldman has a business where they manage assets for investors, they have a market making business where they help other institutions facilitate trades and of course an advising business. Your contention of 1% of volume is ‘creating capital’ is wrong and you can clearly see this looking at Goldman’s 10-K.
On any given market making desk on Wall Street, traders make >50% of their revenues from providing a bid and ask for clients… essentially taking a fee to facilitate a transaction. How is that any different from Paypal? That creates capital and provides an important value (just as paypal does…it builds value for the business owners and allows two people to transact money, thats a service.) Yes some market making traders make proprietary bets and they are allowed to take a perspective, there’s nothing wrong with that. In asset management divisions, people work to invest money on behalf of clients. They charge a fee. Again, the service they provide (in theory) is value creation on people’s assets and they charge a % of assets as a service fee. (btw, most ‘high-frequency’ trading is actually an asset management business… meaning they are using money from pension funds, endowments and other investors to do this… and the capital/transactions are a small piece of the market) Investment banking advising on transactions and take a fee. And all of these divisions are closely guarded from talking to each other.
So I think this whole concept of traders being hackers and too sophisticated is oversimplified and wrong. There is so much money in the market doing different things. And you know that an efficient and strong capital market systems ALLOWS for the amazing growth that the American economy has seen. There is some capital in ‘high frequency’ trading, some in Buffet-style strategies, Trillions managed from Fidelity, Vanguard, etc which work on behalf of consumers. Those guys move markets WAY more than the ‘traders’ on Wall Street firms. Wall Street is mostly middle men, helping buyers meet sellers. They provide important services for any economy.
I’m all for debating these issues (and have more thoughts) but I think we should all start helping people understand capital markets before debating the issues.
From MC> my understanding is, and maybe Im wrong, that most of Goldmans earnings come from trading for their own account.By the way, I’ve co-authored two studies that you will want to read – “Market structure is causing the IPO crisis” and “A wake up call for America” – both published by Grant Thornton and both available on the web. You and I met many years ago. Let’s do something more than just blog about it.
Goldman and the other too big to fail banks create capital out of thin air when they make loans (and Goldman made loans). The nastier creation of capital is that of derivatives. Two parties can come together and make a bet on interest rates, the price of a security, bonds, soybeans, oil, whatever. Each party can then carry their derivative bet on their books however they choose to value it (particularly if that party is an unregulated (but let’s be honest the SEC has shown itself to be utterly incompetent) hedge fund or private equity). All of a sudden the hedge fund or bank has value on its books against which it can borrow and create more capital. The employees lather on trades to generate “profit” which they extract via the bonus.
Risk rachets up and no party to the derivatives game can fail because then reality would have to be reckoned with and the government must be threatened in order to obtain funds for counterparties. The game is rigged anyway because the pensions are backstopped to some degree by the government anyway so the hedge funds, private equity, and banks can abuse them endlessly (creating both inflation and the need for higher taxes in the future . . . and the middle class gets its legs cut off while it watches American Idol).In the days when bankers were respected, they respected deflation as the preferred choice for the stability of society. The ideology of inflation infected the religion/pseudo-academic pursuit of economics so now anything that creates more inflation must be defended.
Derivatives are the printing press for hyper inflation.
Mr. Cuban also hints at a good point about creating a real, sustainable economy again. All of the Bush jobs disappeared because they were all to service rampant speculation and ill-conceived risk taking (housing bubble, derivatives, and two wars). If Obama wants to get the fraud machine cranking again, and it seems to be his goal based on his policy decisions so far, then, at best, he too will create millions of jobs that will rapidly vanish in a couple years. As long as this inflation-seeking continues there will be no sustainable job creation. Asset valuations (homes, education costs, health care, commodities) must fall to the point where new non-speculative businesses can be formed by those unwilling to borrow the huge sums of money now required to create many businesses.
Bankers should be on the golf course by 3 PM. There was a reason for that. Productive society needs financial services to be slow and limited. The ideology of inflation and the idiotic hallucination of bankers as industrialists needs to end. Bankers are the stewards of a fractional reserve, central banking currency, nothing more. Bankers in this system should be cold, reserved, and of impeccable discrimination and judgment . . . not risk takers, not even in the slightest.
Great post Mark.
- DK
Comment by pdkl22 — May 9, 2010 @ 10:25 pm
Mark,
This is an excellent post. You’ve made a very keen analogy between traders and hackers. You’ve also shared an insight which requires much more awareness:
Wall Street has shifted from custodians of wealth to self-interested traders.
I think this has something to do with the natural evolution of power. The question now is whether the public realizes capitalism has been malignantly corrupted, and what everyone chooses to do about it.
If we sit back with our superphones and craft beers, the next crisis is only a few quarters away.
Thanks.
Damien
Comment by wallstcheatsheet — May 9, 2010 @ 11:11 pm
Great post, Mark
Just eliminate the SEC. Sounds crazy, but everything productive sounds crazy until it’s popular.
Today’s conundrum is impossible without securities regulation and is possible because of securities regulation.
Comment by Jeff Nabers — May 9, 2010 @ 11:39 pm
@MC and @jspujji
one would think (or at least be led to believe that) Goldman’s prop earnings come from its own capital. truth is far from it… i would recommend taking 10 mins to read the following (“A Forensic Reconstruction of Goldman’s Prop Earnings) link from zerohedge.com…their use of their Sigma X platform and “child” algos are disturbing – in fact, their internal trading performance is very poor as most of the earnings comes from raping clients on the bid-ask and using “child” algos to frontrun the hell out of their own clients.
From the article:
“The observations above are troubling: Goldman’s trading is by no stretch of the imagination better than average. In fact, in 2008, the firm’s prop trading was on par with some of the worst performers on Wall Street. Which begs the question: just how has Goldman managed to transform itself into a behemoth that over the past 6 months has had only three trading days of losses? The answer is simple: with no Lehman and no Bear to curb its tentacular dominance of all aspects of the Fixed Income market, Goldman can now rely almost exclusively on its monopolist agency position vis-a-vis mutual, pension, and hedge funds who are desperate to maintain a good relationship and an open dialog with the firm which rewards its best clients with market moving information ahead of all others peasants. In exchange, Goldman can collect an arm and a leg in the form of wide spreads, child algos that get executed efficiently and, always, profitably, and a trading platform (REDI) which has become ubiquitous, and in which Goldman preaches the mantra of VWAP trading.”Hell, the client access agreement that one signs with Goldman to trade throught them (GSEC or the old SLK entity) says it all:
“You acknowledge that we may monitor your use of the Services for our own purposes (and not for your benefit)….” read as frontrunning.
http://www.zerohedge.com/article/letter-senator-charles-schumer-ban-goldmans-sigma-x-dark-pool
Goldman is a scam and are raping America right before our very eyes…And we havent even covered the Supplemental Liquidity Program that it runs at the moment.
Comment by ghostpirate9 — May 9, 2010 @ 11:53 pm
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Pingback by Across Weirdish Wild Space » Blog Archive » What Business is Wall Street In? — May 10, 2010 @ 12:50 am
Mark, I think buybacks are often a sign
of poor management but not always. Depends
on the buyback price among other considerations.Understanding why and when they are
a bad deal for owners (shareholders)
is key to understanding many aspects
of corporate governance.Is the company expensing options?
If not, why not?Are they buying $1 of value for
$0.50 or $2.00? One is smart, the
other is not.Are they borrowing money to
fund the buyback or is this
coming out of excess funds? At
some point money has to flow back to
shareholders in the form of
buybacks, dividends, or acquisition
or the shares have only Ponzi value.If buybacks result in some shareholders
receiving cash for less than the
intrinsic value of the shares with the
remainder getting a higher percent ownership
of the company and any potential dividends
I’m not sure I see a problem with this.Comment by ziplockdoc — May 10, 2010 @ 1:19 am
Mark,
Why not do a post on what happened in the bond markets at 2:45 p.m.? Seems like a pretty good way to make or break the argument you advance here.
Comment by Michael F. Martin — May 10, 2010 @ 1:30 am
Maybe the boom and bust cycle of markets is because they don’t scale. They grow bloated and inefficient, until they topple under their own weight. Are we just trying to frantically patch a fundamentally flawed system? Can we redesign it to fit our needs or is there a limit to our growth on our current path?
Comment by michaelnussbaum08 — May 10, 2010 @ 2:15 am
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Pingback by What Business is Wall Street In ? « blog maverick - Viewsflow — May 10, 2010 @ 4:28 am
As always Mark, your analysis seems spot on.
Implicit in your findings is that “we” should do “something” to fix it. Even if “we” could ever be identified as a group, it is not so obvious what “something” is that could be done.
It would be fun to watch you, or anyone, assemble a kind of model that could be used to approach such an objective. Not just a “do this” model, but a more complex model with back and forth actions, consequences, reactions etc. Without such a model, the religious zealots who propose chaos as a self correcting model win every round at the game of system design.
And yes, it is a system design issue. Lack of mutual intent does not mean lack of design, it just leaves design in the hands of whoever has the moxy to do so.
Comment by petecarapetyan — May 10, 2010 @ 5:50 am
Mark, absolutely brilliant post. Speaking as someone who has been on both sides of the fence, running a successful hedge fund for 4 years, and then facilitating capital formation and raising capital for for my own venture, I think you have hit the nail completely on the head here.
Wall Street has lost it’s raison d’être, and is no longer generally facilitating the greater social good.
We need to take the keys away from these hacker-types, and give them back to the adults that make the economy run. Your suggestions about how to do it are the best I have heard to date. I will leave the discussion of whether to do it with a tax cut for good behavior, a hike on the bad behavior, or both, to the political types. Whatever is done, it has to create a sufficient delta that it will force capital flows back to where they belong: fueling the economy and the vital industries, not screwing Joe and Mary mutual fund out of a few bucks on every execution (not to mention their long-term capital appreciation).
We have GOT to stop worshiping at the temple of “liquidity = good”, and get back to the basics. Give me a more illiquid market if it means I am not playing a rigged game. And while we’re at it, let’s at least severely curtail these guy’s ability to short early stage companies into oblivion. It is profoundly destructive, and is functionally forcing many to stay private so as to avoid shark-infested waters.
Keep up the good thoughts.
- Stephen
Comment by sfjsynfuels — May 10, 2010 @ 6:00 am
This is also being discussed on Fred Wilson’s blog and I told that group about the “Cuban tax” idea – which I think is great. It is simple and aligns motivations the way that is good for the real market (the market of companies raising money and investors investing). Here is what I wrote:
Anything that adds to the ability or buyer and seller to exchange information is a good thing. Companies can raise money on public markets because buyers can sell when they need to. Liquidity is good and trading enhances liquidity. I don’t think high frequency trading is bad. It is a perfectly legitimate way to make a living. But in terms of value to the market it is diminishing returns. Beyond a certain point it does not add to liquidity. Does an investor really care whether P&G is traded 10x per second or 1,000x per second? Traders may care but investors don’t. And investors are more important to the real market – to companies raising money so they can grow and hire – than traders.
That is why the Cuban tax proposal is smart (boy, “Cuban tax proposal” sure has a good ring to it, you can see people having fun with that). It is both propositions together:
1. 25c per trade, incentive to trade slightly less frequently (or if you can find a way to still do that very profitably, the the tax $$$ roll in).
2. Zero Tax Capital Gains & Dividends if you hold for 5+ years. Incentive to invest rather than trade.
Incentives matter.
I would love to see blogosphere/social media momentum behind this. That has worked on other public policy matters.
Comment by bernardlunn — May 10, 2010 @ 6:45 am
Mark:
I completely agree with your post and your sentiment. I believe that the markets need to move back to the world of Ben Graham where long-term the market is a “voting scale” and long-term, a “weighing scale.” Right now, the markets are a rollercoaster driven by millions and millions of long-short and other technical-driven trades that have nothing to do with underlying value. While this does create fundamental mispricings (and opportunities for money to be made on these mispricings, because ultimately the “machines” will recognize value once the switch is flipped on their target metrics), it does introduce unnecessary volatility. I similarly have shifted most of my capital out of the public markets and am focused on private investments where I can control and personally drive value. Much better place to play (and much easier to sleep at night)
- p.s. I similarly agree on Australia. Resource-rich, near China, governed by rule of law. Agreed.
Comment by lpstier — May 10, 2010 @ 6:48 am
I’d like to see this thinking expanded upon Mark. It is an – interesting and cogent viewpoint and more specifics might even get it on a path to public support.
Comment by markkolier — May 10, 2010 @ 7:20 am
[...] a Dow component trading to $1 in 20 minutes. But Mark Cuban asks the fundamental question – What Business is Wall St. in? var a2a_config = a2a_config || {}; a2a_config.linkname="Mark Cuban on the Wall St. Volcano"; [...]
Pingback by Mark Cuban on the Wall St. Volcano - benatlas.com — May 10, 2010 @ 7:51 am
Mark,
Easy fix that will never get implemented:
All trades made can not be exited until they are settled, at T+3. Buy on Monday, then you have to hold it until at least Thursday. No total return swaps or anything that has the effect of synthetically exiting a position prior to T+3.
Day trading and HFT problem solved.
Comment by numbers23 — May 10, 2010 @ 7:57 am
Ha, are you serious Mark?
In order to be concise, I’ll give you the following retorts:
1. HFT trading is not as you describe (of jumping in front of orders). What you describe is Flash trading, which was banned on most exchanges. HFT is a simple term for trading a lot of shares and making slim margins. It’s been popular for years; only recently sensationalized by the media due to flash orders.
From MC> its not the same as flash trading, but its not that far off. Its exploiting/Arb some variances in pricing in big volumes. But they are transactions that were going to take place any way. yes, they are hedged, but its still false liquidity and its still just pulling points from deals that would have gotten done anyway. It adds no value2. Why is it rare for companies to go public these days? Because we are in the midst of a recession! And secondaries? Have you been watching how many secondaries have been hitting the market in the last year?? There has been more capital raising via secondaries in the last year than I’ve seen in a LONG time. Hell, a big chunk of some banks (not GS), profit was from issuing secondaries for companies.
From MC> Actually the size of the 2ndaries are huge, but the number of deals is far from it. And IPOs have been down for a while. The big chunk of profits for GS has been from trading its own account hasnt it ?If you ever thought wall street wasn’t out for it’s own self interests, you were blind. For years the NYSE had an extreme grip on their stocks and the specialist would funds over backwards – instead of making a penny, they were making a quarter or a half.
From MC> No question. The HUGE DIFFERENCE between now and then is the risk it attached to overall economy. Back then the volumes and amounts weren’t going to put the entire world economy at risk. Today, the leverage and the lack of visibility of trillions of dollars of derivatives and other instruments and whether or not the counterparties have enough liquidity to cover a black swan type situation, creates a level of risk that dwarfs the past. You are arguing over who is making the money and how much. I dont care who makes the money. i care whether or not they put world economies at risk. Which i think they do.3. For all the talk of taxing a trades that puts short term trading out of business, you admit that they will continue to innovate and ‘hack’. Thats exactly what would happen. Spreads on stocks would widen out. You want to buy a million shares of MSFT, it will cost a LOT more because instead of a spread of 1c, it will be 25c or more.
From MC> You are exactly right. So what ? For an investor, if you dont think Microsoft is worth more than 30cents more than you paid for it, why are you buying it ? For a trader, who gives a shit whether or not they can churn a stock to make money. The amount of liquidity and the reduction in spread doesn’t help investors/shareholders. It just speeds up the game for traders.hackers. Traders are different than investors and they need to be treated differently. Someone who wants to be an active shareholder in a company and actually feel like an owner is far from the HFT you refer to that exploit /arb the difference in prices between markets. Dont we all wish we could jump in front of an amazon shopping cart and place an electronic order with the vendor for the product and pick up a few pennies…thousands of times per minute. That would be a nice business for anyone. But it doesn’t add value.And let’s talk for a brief second about what happened on Thursday. Let me tell you want happened actually. The liquidity providers, the ones that you abhor so much, turned off their systems. They’ve come on the record in the washington post saying that when the dow was down 500 points they turned off their systems. All the black boxes that arb ETFs like SPY or their derivates were no more. At one point there was a 3 point spread in SPY with both sides getting hit. I don’t think you fully understand how important liquidity providers are for the market.
From MC> Actually, you make my point. They aren’t true liquidity providers. They , again as you refer to, are trading for no one but themselves. As I wrote in a post, its the illusion of liquidity. If they pull the chair out on their trades, as they did, the markets crater. In this case some pulled the chair for minutes. What if it happened for days ? longer ? So we have this false source of liquidity just so these HFT firms can mislead everyone about the role they play, so they can make some of the money market makers and exchanges used to make, while introducing more risk to the markets then we have ever seen in the history of this country. Nothing could be worse.4. There will be another crash, and another boom, not because of the stock market, but because of capitalism, free market society. It is a normal part of it: the boom bust cycle. Study some history Mark. The markets have been crashing since they were created. I’m sorry, we can’t just go up all the time. This has nothing to do with a trader looking for a trillion dollar score.
From MC> we agree and i have said it many times. First there are the innovators, then the imitators, and then the idiots. And there are far more idiots than the first 2. So markets will boom and crash over and over forever. I don’t wan’t markets to go straight up. I want the value of the markets to be based on the underlying assets. The value of the companies who issue securities, whether stock, bonds, preferred, whatever. I’m afraid that when markets move because people are trading derivatives on indexes and a counter party can’t come through, we get a crash that drags down more than the market. Or when indexes based their trading on established liquidity trends, which works until the HFTs, whose volume is unknown, pull the chair on their trading, causing the index/EFT to not be able to function and starts a cascading effect. Let me put this another way. Trading problems become viral very quickly. They spread because EVERYTHING is interconnected across the world these days. That changes the risk profile to far more than spreads and who gets the money.
I’ll end with this: One of my favorite bloggers (stockbee) posted this on Thursday and I think it is very true for you and many of your readers.
“You will see two types of traders today:
Those who will externalize the problem
Those who internalize the problem
The first kind will learn nothing from today. They will spend their time shouting at quant funds, fat fingers, SEC, exchanges, Washington, Obama. Goldman and so on…..
The second kind will develop method to as best as they can avoid a situation like this again….
The easiest thing is to externalize the problem..
But at same time you know there are traders who were on right side of this trade.
Not base
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