January 30, 2013
[Copyrighted material redacted. Authour cites:this highlights the problem, but i don't agree that high frequency traders/hedge funds should be allowed to present the ideas on what is wrong with the market. in my opinion, hedge funds do not represent the viewpoint of potential investors. the timeline of any investing that hedge funds may do is usually much shorter than other investors. further, the lack of transparency of hedge funds also damage the opinion of any panel that GAIM presents.
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the structure is wrong with the market. practices have deviated very far from the idea of the capital markets. should high frequency traders be allowed to take out a daily profit from any capital that comes into the market? i don't think we should allow that. the timeline for investing is too short. daytrading adds no value to the economy, just causes the $ to switch pockets, is a capital outflow from the market. i don't think daytrading should be protected from risk, or should be guaranteed a return.
retail investors' confidence is shaken because they know that traders are trading against them and those traders have more $ than they do.
the banks and the FED/regulators should not be fighting. apparently the banks have taken self-interest to a new plateau. banks have charters from the government, so they have to be mindful of not harming their community. the banks should be looking forward to economic recovery, not trying to cause a great depression for profit. worse, we need to address the size of banks, the breadth of their businesses because of the idea that taxpayers guarantee their depositors' money.
so where do we go from here?
1) there should be no locates at all. if you cannot borrow stock, you cannot sell short. i am inclined to say that the pendulum has gone too far and perhaps we don't need shortselling at all. shortselling is selling something you don't own with a promise that you will replace it later, except the clearing and settlement piece does not guarantee that your promise will be fulfilled. the abuse of shortselling increases the float of the stock and delays the buyback. this is the only industry where you can sell something you don't own and claim that you have a right to do that. i don't think shortsellers have a right to do that. the fact that they do that does make people suspicious that the customers don't have their portfolios.
2) margins to trade are too low. this increases leverage, which is debt. and people will do extraordinary things to make sure they don't lose $. but there is no way to predict unexpected things that will keep happening in the market. it is just a question what will take the market down and what will happen as a result. when the markets break down, we are looking at political instability all over the world. when this occurs, there will not be a policeman on the corner to make sure that you can own and enjoy your 7 houses. there will not be a gas station open to put fuel into your limousine. we learned this lesson with the great depression - when margins are too low, speculation increases. and this speculation is the enemy of the investor because people try to reduce the risk to their positions by trading faster. there is no no-risk position in the market. further, margins to trade future orders should not be less than the margins to trade the meat-and-potatoes, such as the equities.
the financial position of traders can be used to guarantee the fulfillment of a particular trade, however this financial position cannot be used to guarantee several unfulfilled orders that would compete for the financial position of trader. in other words, if you place $100 in the bank, you cannot continue to write $99 checks until previous checks are cleared. so if financial firms have 12 open accounts with brokers, then the principals must designate different financial balances to back any orders that are given to these different brokers. margins must be decreased as orders have been written against the margin and this margin must be shared among any that have claims to those margins. this sharing can be accomplished through clearinghouses. but under no circumstances should a customer put up a $50,000 balance in order to write $750,000 worth of orders with various brokers.
3) high frequency trading depends on small price changes. so we should increase the best price increments. maybe tax orders. certainly the people who generate the most noise should not be claiming rebates from exchanges. investors, you know the buy-and-hold folks, pay for this cancer in small increments in worse prices to buy, worse prices to sell. marketmakers have also been a problem for the market, but when that trusted position becomes an adversary to the investor, we need to change this model. perhaps we don't need HFT or marketmakers. perhaps we should just buy and sell what we own. if our order sits in the bucket for 5 minutes or 2 days, perhaps it is the fault of the investor that they bought a security that doesn't trade often. shortselling and high frequency changes generates a volume of trading activity but if this trading activity is false because of the sale of imaginary stock, then the volume is not impressive to the investor. investors need a price to trade. they do not need all these subterfuges to hide the price from the investor.
4) financial statements must be real. no more off-balance sheet items. accounting standards must be uniform. management must sign that the financial statements represent the true financial position of the business.
5) clearinghouse practices should attempt to clear all transactions soonest. what causes the clearinghouse to leave the money on the table for an extended period of time? can we not transfer ownership when something is bought? if we cannot, perhaps we should stop netting a short position against the long. this harms the market in general and the particular investors in a stock. we should not allow the imaginary stock transfers. if the clearinghouse will not be a counterparty to a particular trade, perhaps there should be a notice to the financial markets. counterparties to the trade should become aware of inability of a financial company to put up sufficient margin, to successfully execute a trade, or if the terms of an agreement cannot be guaranteed for any reason.
6) segregation of customer assets: there should be no excuse for brokers to treat their customers as muppets because the customers own their portfolio. begin with the idea of a broker bankruptcy. customers do not turn their assets over to their brokers so that the brokers can do what they want with the customers' property. brokers are agents, not principals. the bankruptcy of a brokerage should recognize that brokers cannot trade away the customers' portfolio, that customers are in front of any debt that the broker incurred, such as bonds, credit lines, swaps. brokers have a fiduciary duty to all of their clients and favoring one type of trading over another is a breach of that duty.
7) order types should be transparent and simplified. i disagree with the video that the anti-HFT camp cannot come up with a proposed solution. i think the only way that this can be said is when the conversation is narrowed to a small topic. because the market structure and market practices ARE the problem, narrowing the topic to one small item can produce a lack of agreement on how to re-structure the market. this is because order types to accommodate shortsellers and HFT is just one problem.
8) there should be no dark pools or invisible orders. no broker should trade against their customers' orders because then the customers' order are not placed and do not reflect a market price. the last price is not the market price. the market price is formed by the execution of the order where a buyer and seller agree to trade. let us say that a billionaire wants to sell a million shares of a stock. can they use the last trade as the last price executed where 100 shares were sold? no. the million share order may change the price. this is the risk of accumulating such a position. however, if this million share sale could be executed over time, perhaps the holder of those shares can sell out of their position over time with little change in price. under no circumstances should there be a guarantee that any position could be bought or sold on the basis of last price, or in the blink of an eye, or without risk. if shares must be transacted in a visible market, then such dark pools or invisible orders will disappear. when you place an order through your broker, you don't expect that your broker will short against your order. you expect that your broker will execute your order, that your order will be part of the price/volume performance of the stock for that day.
9) if regulators make a rule, there has to be a determination whether the penalty is civil, whether the license of the offender should be immediately terminated, whether the penalty is criminal. as far as i am concerned, the softest civil penalties would be a fine, perhaps tripled if they harmed investors through their actions. but if the financial firm harmed price, harmed the stock market generally, then the penalties should be criminal in nature, in addition to a tripled civil penalty. and if the financial firm is bankrupt or predatory, perhaps a loss of license to trade is mandated. all rules must be implemented within a reasonable time period. giving financial firms 2 years notice before implementation should not occur. the harm of not implementing a necessary rule takes a terrible toll on the market. this is tantamount to telling financial firms that they can continue perpetrating fraud for x more days.
10) all swaps should be cleared for initial margins and settled weekly. no swap can be created deviating from this structure. no equities should be a component of the swap in order to delay settlement.
11) all stock should have verified ownership. there should be no counterfeit stock trading in the market. if any stock has been reserved, then all legal conditions for a sale should be satisfied. this verification should extend to quarterly inventory audits. there should be no election without verifying the ownership of the stock and the right to vote. brokers, as agents of the owner, should not control the reporting of any votes. care and custody requirements are essential to the market. if a broker cannot demonstrate care and custody of their customers' assets, of their margins, they are broke and cannot continue trading. the clearinghouse, the counterparties, the auditors and the customers should be able to make a complaint and immediate regulatory attention should be paid to such a complaint.
12) we certainly have to address netting swaps/trades and cross-asset classes. while some firms have taken some positions, they cannot guarantee a return in all circumstances. it is the circumstance that was unplanned that will upset the apple cart. for instance, let's say a bank is a long and a short on six month treasuries. if one counterparty cannot pay, and the clearinghouse who has many such trades that cannot pay, then the bank will have to forgo the profit and the principal. if the clearinghouse is undercapitalized, we are just asking for trouble.
we should not protect the various services that have grown up out of the unfair market structure. if this means commissions increase, so be it. if people chose to develop an illegal business model, they knew that the investor was not getting the best price.
i am not in the industry. i would welcome hearing of those practices that are harming price or supply and demand. but i think we need an open discussion of the financial markets. this market structure problem has been now causing economic uncertainty, causing an economic recovery to lag. how can anyone talk about fiscal policy and monetary policy, if we have a gigantic capital structure problem in the market.
suzanne hamlet shatto