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Rigging The Markets - How They Do It
By Joel Skousen
Editor - World Affairs Brief
Begin Excerpt
While the rest of the financial world struggles, it might seem strange that four of the largest US banks have made record profits this past quarter--and not just on average, but every single trading day. Too good to be true? Indeed. No one can do this consistently unless they are part of the special group of insiders that are allowed access to market information at the exchanges that no one else has. In fact, normal people get sent to jail for trading on inside information, but not these guys.
They are even able to execute trades after hours. Even during regular exchange hours they are given priority to execute trades based on foreknowledge of what others are about to do, which allows them to go short or long in the markets to take advantage of known future trading volumes. With access to almost unlimited low or zero interest money from the FED, or using naked shorts (illegal for others) and naked hedges they can also drive the markets in either direction and profit from those predictable moves. The financial world is starting to wake up to this rigged system, but can do nothing about it. The manipulators collude with high level regulators, the Treasury and the FED. It is also doubtful that a controlled Congress and judiciary will do anything to stop it. Predictably, even the new Supreme Court nominee, Elena Kagan, has a history of playing along with establishment powers, both financial and political. That's why she is being groomed for the high court.
Addressing the growing outrage. Jonathan Weil of Bloomberg comments on the obscene profits the big banks are reaping from this rigged system: "Score another triumph for the rigged- market theory. In a feat that would seem to defy the odds, Goldman Sachs, JPMorgan Chase and Bank of America this week each said its trading desk made money every day of the first quarter. Goldman said its daily net trading revenue topped $100 million 35 times last quarter out of 63 trading days. JPMorgan and Bank of America disclosed similar eye-popping stats. Citigroup, too, recorded a profit on each trading day, Bloomberg News reported, citing unnamed people who knew the results.
"The intrigue is high. If a too-big-to-fail bank's traders were able to make money every day of a quarter, were they really trading in any normal sense of the word? Or would vacuuming be a more accurate term? What kinds of risks do such incredible profits entail, for the banks and the rest of us taxpayers? [no risks at all] And are results such as these too good to be true? There seems to be no satisfying way to answer those questions, or even the more basic inquiry: How exactly do these banks' trading divisions make money? Reading the companies' impenetrable financial reports is of little help. However they did it, the data suggest it was as easy last quarter as hitting the side of a barn with a baseball from three feet away. This isn't the way 'trading' works in the real world. A simple exercise in measuring probabilities is instructive here.
Cliff Kincaid covered how last week's 1000 point drop in the stock market was manipulated. "The major media say the chaos on Wall Street was the result of a 'trader error, possibly a typo,' as the Washington Post put it. Some reports claim the culprit was a 'fat finger' on a computer somewhere that pressed the wrong key. But Zubi Diamond, author of the Wizards of Wall Street, says these claims are all lies. 'What happened in the market on Thursday is a typical example of pure market manipulation' by unregulated hedge fund short sellers.
"His book warns that the same hedge fund short sellers were behind the financial crash of 2008 that paved the way for Obama's election to the presidency [that conspiracy was owing to powers even higher than money]. Diamond says the historic market plunge on Thursday was 'due to computerized hedge fund short selling because there is no protection for the invested capital in the equity markets. There is no uptick rule, no circuit breakers [actually there are some, but they are so mechanical and predictable that they are easily circumvented] and no trading curbs. Our market is primed for manipulation.' Diamond is referring to financial regulations, which have been repealed, designed to prevent market manipulation. Diamond has been adamant in his view that the financial reform bill being pushed by Obama and liberal Democrats on Capitol Hill will do nothing to solve this problem and regulate the hedge fund short sellers.' No one will come on TV to tell the truth,' he complained. Instead, he says representatives and apologists for the hedge fund short sellers, who operate as the Managed Funds Association(MFA), 'go on TV and provide false explanations of what happened.'
"Diamond says that the repeal of the safeguard regulations, such as the uptick rule, circuit breakers and trading curbs, and the introduction of the short ETFs (Exchange traded funds), which began under Christopher Cox at the Securities and Exchange Commission, has given the members of the MFA tremendous power and influence. He says these individuals include George Soros, John Paulson, Jim Chanos, James Simon, and other hedge fund short sellers, including those who operate Quant Funds and engage in computerized trading. 'They have the ability to manipulate U.S. and some international markets,' he says. Indeed, Diamond maintains that the MFA has basically taken control of the U.S. stock market.
"'The only financial reform needed today is to regulate and monitor the hedge funds and the hedge fund short sellers, some of them which are registered off-shore to avoid scrutiny. These global operators, with investors who remain mostly anonymous, must be compelled to register with the Securities and Exchange Commission (SEC), publicly disclose their positions in the markets, and maintain accounting and trading records for a period of 10 years so their activities can be monitored and scrutinized. Just like mutual funds, they must be prohibited from engaging in day trading activities.'
"'What happened on Thursday happens to a select group of individual stocks on a daily basis as the hedge fund short sellers prey on common investors,' he asserted. 'They are now expanding the manipulation to include the whole market. They can now crash the market, panic shareholders out of their stocks, buy to cover their short positions for hefty shorting profits, and then buy back in at the bottom to open long positions and then recover the whole market (indexes) to normal levels.' These market manipulators, he notes, have the ability to drive prices down and then drive them back up, all within a 15 minute period. 'How's that for no-risk investing?' he says. 'They make money through stock price volatility and market volatility. They manipulate stock prices through unrestricted short selling.'"
ZeroHedge.com explains through Jim Rickards why derivatives and naked shorts are such a danger: "Jim Rickards, who recently has gotten massive media exposure on everything from the JPM Silver manipulation scandal, to the Greek default, was back on CNBC earlier with one of the most fascinating insights we have yet heard from anyone, which demonstrates beyond a doubt why any attempt by Europe to print its way out of its current default is doomed:
"'Look at what Soros did to the Bank of England in 1992 - he went after them, they had a finite amount of dollars, he was selling sterling and taking the dollars, and they were buying the sterling and selling the dollars to defend the peg. All he had to do was sell more than they had and he wins. But he needed real money to do that. Today you can break a country, you don't need money you just need synthetic euro shorts or CDS [which don't require any real money to execute]. Goldman can create 10 trillion of euro shorts. So it just dominates whatever governments can do. So basically Goldman can create shorts faster than Europe can create money.' Just wait until Europe finally realizes that the CDS 'speculators' had all the cards in the poker game all along [having foreknowledge of what the EU Central bank and the IMF were going to do relative to Greek debt]. And we hope Europe listens to the man."
Financial analyst James Quinn did everyone a great service this week in his exposition on how market shorts were facilitated by Credit Default Swap derivatives. Here are some excerpts: "By the time Greg Lippmann, the head sub-prime guy at Deutsche Bank, turned up in the FrontPoint conference room, in February 2006, Steve Eisman knew enough about the bond market to be wary. Lippmann's aim was to sell Eisman on what he claimed was his own original brilliant idea for betting against -- or short selling -- the sub-prime mortgage bond market. Eisman didn't understand. Lippmann wasn't even a bond salesman; he was a bond trader: 'In my entire life, I never saw a sell-side guy come in and say, 'Short my market.' But Lippmann made his case with a long and involved presentation: over the last three years, housing prices had risen far more rapidly than they had over the previous 30; they had not yet fallen but they had ceased to rise; even so, the loans against them were now going sour in their first year at amazing rates.
"He showed Eisman this little chart that illustrated an astonishing fact: since 2000, people whose homes had risen in value between 1% and 5% were nearly four times more likely to default on their home loans than people whose homes had risen in value more than 10%. Millions of Americans had no ability to repay their mortgages unless their houses rose dramatically in value, which enabled them to borrow even more. That was the pitch in a nutshell: home prices didn't even need to fall; they merely needed to stop rising at the unprecedented rates they had been for vast numbers of Americans to default on their home loans.
"Lippmann's presentation was just a fancy way to describe the idea of betting against US home loans: buying credit default swaps on the worst sub-prime mortgage bonds. The beauty of the credit default swap, or CDS, was that itsolved the timing problem. Eisman no longer needed to guess exactly when the sub-prime mortgage market would crash. It also allowed him to make the bet without laying down cash up front, and put him in a position to win many times the sums he could possibly lose. Worst case: insolvent Americans somehow paid off their sub-prime mortgage loans, and you were stuck paying an insurance premium of roughly 2% a year for as long as six years -- the longest expected life span of the putatively 30-year loans.
"Later, whenever Eisman set out to explain to others the origins of the financial crisis, he would start with what he learned in Las Vegas. He'd draw a picture of several towers of debt. The first tower was the original sub-prime loans that had been piled together. At the top of this tower was the safest triple-A rated tranche, just below it the double-A tranche, and so on down to the riskiest, triple-B tranche -- the bonds Eisman had bet against. The Wall Street firms had taken these triple-B tranches -- the worst of the worst -- to build yet another tower of bonds: a collateralized debt obligation (CDO). Like the credit default swap, the CDO had been invented to redistribute the risk of corporate and government bond defaults, and was now being rejigged to disguise the risk of sub-prime mortgage loans.
"It was in Vegas that Eisman finally understood the madness of the machine. He'd been making these side bets with major investment banks on the fate of the triple-B tranche of sub-prime mortgage-backed bonds without fully understanding why those firms were so eager to accept them. Now he got it: the credit default swaps, filtered through the CDOs, were being used to replicate bonds backed by actual home loans. There weren't enough Americans with [bad] credit taking out loans to satisfy investors' appetite for the end product. Wall Street needed his bets in order to synthesize more of them. 'They weren't satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn't afford,' Eisman says. 'They were creating them out of whole cloth. One hundred times over! That's why the losses in the financial system are so much greater than just the sub-prime loans. That's when I realized they needed us to keep the machine running. I was like, This is allowed?'
"What he [Eisman] underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA. But he couldn't figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. 'I didn't understand how they were turning all this garbage into gold,' he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. 'We always asked the same question,' says Eisman. 'Where are the rating agencies in all of this? And I'd always get the same reaction. It was a smirk.' He called Standard & Poor's and asked what would happen to default rates if real estate prices fell. The man at S&P couldn't say; its model for home prices had no ability to accept a negative number. 'They were just assuming home prices would keep going up,'
"Steve Eisman had virtually no respect for the large Wall Street firms, particularly Merrill Lynch. 'There is going to be a calamity, and whenever there is a calamity, Merrill is there.' When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust, Merrill was there. Way back in the 1980s, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit. That was Eisman's logic----the logic of Wall Street's pecking order. Goldman Sachs was the big kid who ran the games in this neighborhood. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things. The game, as Eisman saw it, was Crack the Whip. He assumed Merrill Lynch had taken its assigned place at the end of the chain.
"Wall Street became greedier, nastier, more corrupt, more arrogant and more incompetent. He traced the biggest financial disaster in history back to his old boss John Gutfreund. His decision to convert Salomon Brothers from a private partnership to a public corporation opened Pandora's Box. The other Wall Street partnerships followed like lemmings. The risk of failure was shifted from the partners to the shareholders and the citizens of the United States. Lewis details this fateful decision: From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished.
The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith. No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.'s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.'s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.
"This decision unhinged the concept of risk from the concept of return. Compensation was no longer tied to long term profits and success. Clients were no longer the customer. They were just fee generating suckers. Wall Street kept all the profits, took ungodly risks, lost trillions and got bailed out by Main Street. The poker game continues, as these criminals are again paying themselves billions in bonuses at the expense of Main Street. Michael Lewis completes the 20 year circle of greed with his brilliant book:'
The people in a position to resolve the financial crisis were, of course, the very same people who had failed to foresee it. All shared a distinction: they had proven far less capable of grasping basic truths in the heart of the U.S. financial system than a one-eyed money manager with Asperger's syndrome... The world's most powerful and most highly paid financiers had been entirely discredited; without government intervention every single one of them would have lost his job; and yet these same financiers were using the government to enrich themselves.'" Now, that's a powerful indictment!
End Excerpt
Copyright Joel Skousen. Partial quotations with attribution permitted.
Cite source as Joel Skousen's World Affairs Brief http://www.worldaffairsbrief.com
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