Office rents are falling, vacancy rates are approaching 10%, and construction of the new World Trade Center continues.
Anyone with an option is fleeing Manhattan, the smoking bans, transfat bans, proposed taxes on free bridges, higher income taxes, MTA claiming new budget shortfalls – and living and working in the most obvious target if/when there is another large terrorist attack.
A few of you are aware that in a previous life, I worked for a major equity trading venue (not the NYSE – think #2) doing programming and software design of electronic order matching (trading) systems. People who personally knew Bernie Madoff from when he ran that market in the early 1990s made it clear they would rather I leave and stop pestering them about planning for the future – things like in 2000 and 2001 having a real disaster recovery plan in the event of a terrorist attack that destroyed our facility) – so it made my decision to leave in 2002 that much easier.
Many politicians – and radio people like Bob Brinker and Michael Savage – believe one of the root causes of the past year’s collapse of equity prices is to the end of a quaint rule called the “Short Sale Uptick Rule”.
Without getting completely boring, the purpose of this rule in the 1930s was to allow the person who manages a stock on the NYSE (call the Specialist) to prevent a sudden fall in the stock of a price – by people who wanted to bet that the price will go down further by creating a stampede. 70 years ago, this was a really great idea to avoid market instability and prevent 1929 from happening again.
If you wanted to sell IBM stock 40 years ago, your order was sent to New York on a teletype, printed out, hand carried to the specialist on the floor, and he would find a buyer or if nobody was buying – the specialist would directly buy your stock at a price that HE set. Pricing information was delayed 15 or 20 minutes to the general public, so he had a lot of time to “work things out”. Your sale reported on the “stock ticker”, a machine at your local stock broker so they could keep somewhat current on the day’s trading.
By controlling what traded when and at what price, the specialist (one person) could block a surge in selling using the “tick” when he did not want to be the buyer (because he also believes the price is headed down and wants to get the prices adjusted lower first and get out of the way in the 15 minute window before the entire world found out).
So if this rule was working so well to prevent market panics, why did the SEC allow exchanges to get rid of it in 2007? The main answer: Electronic trading. Only the most inefficient markets now involve human decision making to routinely manage the trading of a market. Note that “program trading” and “electronic trading” are different things. Program trading is the computers for a customer making automated decisions to buy and sell. Electronic Trading is the actual matching of buy and sell orders. You don’t need electronic Trading to do Program Trading – but it does make it faster and potentially more dangerous to market stability.
With automated trading in 2009, the last sale price (which controls the uptick rule) can go up and down 100s of times a second. That crawl you see on the cable TV channels is no more real than the Pirates of the Caribbean ride at Disneyland. It’s nothing but a snapshot of some recent stocks at a speed the human mind can absorb.
A TV picture only updates 30 times a second (computer monitors typically are 70-90 times/second). You just can’t enforce a rule like the uptick rule – even if you still thought it was a good idea. A human being cannot absorb information at 100 times a second and certainly can’t click a mouse at the “right” time to not break the rule.
Just how is an electronic market so different in 2009? Here are the specs for the Universal Trading Platform that NYSE Euronext is rolling out in Europe, and recently replaced the ARCA trading system that trades NYSE stocks in Chicago (not New York, Andrew Cuomo)
“Customers trading on NYSE Euronext European cash markets will realize reduced latencies […] of 150-400 microseconds per roundtrip on the Universal Trading Platform . In addition to delivering exceptionally fast transaction speed and system-wide reliability, the Universal Trading Platform sets new industry standards for capacity with the ability to handle 100,000 orders per second.“ (The system my group designed in 2001 was shooting for a target of 150 matches per second)
To put this in context, light (and electricity) travel at 186,000 miles per second. In 400 microseconds, electricity travels only 74 miles. 400 microseconds is their “worst case” total time for the Euronext UTP to get an order, match it and give the answer back to the buyer and seller.
There are other reasons the Uptick rule also makes no sense in 2009 – because stock options, single stock futures, ETFs (like SPDRs and contra ETFs that bet on an index going down) and a variety of other financial products allow people to “bet the market will keep going down” without any regard to whether the last sale that happened 572 microseconds ago was at a better or worse price than the 2nd older sale.
Making things even uglier – there is no such thing now as “the exchange” where a stock is traded – no more than there is an “American Car”. There are multiple trading platforms all trading the same stock at the same time all over the world. By the time each trading venue “hears” about the last trade at another exchange, it is probably no longer the most recent trade.
This is why I described the NYSE trading floor as nothing but a TV studio living out the quaint fiction for the masses that there is still a trading floor. Any humans you see on the floor are there for very little reason in 2009, and with each passing day there is less and less reason for humans to stand around on “Wall Street” in New York City.
Mayor Bloomberg, Governor Paterson and Andrew Cuomo have no leverage over “Wall Street”to keep them under the jurisdiction of any part of New York State goverment – they just are too blinded by their own desire for power to realize it yet. That’s especially odd in the case of Mayor Bloomberg – since his fortune was made on selling information to people on Wall Street, and knows every detail of the business.
The Federal Government only has nominally more control because it controls the creation of US dollars by the US Treasury and Federal Reserve. That power card has now been put on the table for the last time. Globalism is going to win this fight, and that’s not a good thing if you believe in the values of the United States, individual freedom and representative government based on our national interests.
But to finish on a positive note, Congress did solve that problem with Baseball Players taking steroids and Michael Vick is in jail for those dog fights. We need to keep the inportant issues in focus. Who do you think is going to win American Idol this season?
For those of you who still think the NY in NYSE stands for New York (because you see a TV picture from their NY studio each morning – quaintly still called the “Trading Floor”)… the French man responsible for merging Europe’s dominant electronic trading system EuroNext into the former New York Stock Exchange making the NYSE a truly global business – has decided to “retire”.
I’m sure this has absolutely nothing to do with the US President and Congress proposing punitive income tax rates, Andrew Cuomo suing to get the names and salaries of people on “Wall Street” so thugs from ACORN can show up at their houses to extort money from them, and the Governor of New York saying that if he knew raising taxes would make rich people leave New York (Rush Limbaugh), he would have done it sooner. Nothing at all.
On the eve of the meeting of the World’s 20 most important economic powers in London, President Obama is signalling that he believes the best course of action for GM is bankruptcy, with a new Board of Directors appointed by him running the company (and probably owned by the UAW employees).
Globalism (as represented by the G-20) is a very divisive topic in Europe and large and possibly violent protests are expected. A year ago, Candidate Obama was greeted in Europe as if he was the Second Coming of the Messiah – this week he appears in the role of the leader of the country that many point to as the cause of the economic collapse (never mind it was European banks who bought the Credit Default swaps from AIG with no gun pointed to their head).
This will be the first serious test of President Obama’s skills on the world stage. Germany, England and others are already in finger pointing mode and looking for someone to blame. Many believe that President Obama will “accept blame” for the entire mess “caused by George Bush” (ignoring that Tim Geithner was the head of the NY Federal Reserve Bank at the time)
The world’s leaders will not be impressed if Obama is just reading scripts from a teleprompter. This is his chance to convince the world he has substance or prove that he is a clueless Chicago A.C.O.R.N. street thug with no clue how the real world actually works.
No matter how it turns out, this is a very important week for your future.
Sunday, the US Government told Rick Waggoner – the CEO of General Motors – that he no longer has a job. The government automobile rescue commission has declared that the viability plan is not workable.
Tim Geithner has declared that the problem with the economy is that he hasn’t done enough, not that he has done too much. At the same time, he is lashing out at banks for being unwilling to take on additional risk.
Markets in Asia responded by dropping over 4%. Futures suggest the same will happen here. If you didn’t already sell to take advantage of the recent upswing, you probably missed your chance.
Geithner is now trapped by the reality that the hedge funds are not going to fund his latest toxic solution plan since Congress did the 90% AIG tax thing to punish those working hard to unwind the company. Add to that the threat of “taking over” the same companies by decree of the Federal Reserve Board of Governors (which has no jurisdiction over anything except its members), and Geithner is in a real dilemma. If he makes nice with the hedge firms and seeks to protect them from populist retaliation for making big profits by rescuing the banking system – he could face the rath again of those who want his head on a platter. If he doesn’t shield them, they won’t voluntarily help.
No wonder nobody wants to work for him.
Most of the press about the current crisis points to Credit Default Swaps (CDS), but there is another type of “swap” that may end up blindsiding us – the Interest Rate Swap contract. What is an interest rate swap and how would it affect you?
Let’s say your local water district needs to raise about $100 million to build a new sewage treatment plant. The district doesn’t have that kind of money, but does have a revenue stream to pay off borrowed money. Typically in the past, how this would have been handled is an underwriter would create a bond offering, sell them as fixed rate municipal bonds via competitive bidding and then the revenue would pay the bonds off over 20 or 30 years.
Enter the “hot shot” investment banker… [these are hypothetical numbers to explain what an interest rate swap is and to explain the concept]. The banker from New York says to the unsophisticated local politician…. I have a deal for you – it’s not that old fashioned bond thingy that nobody uses any more. You need to borrow $100 million. If you do this as a fixed rate offering, you’ll need to pay 7% interest. Rather than do that, I can get you the money at 5% (LIBOR + 3%), and save you $2 million a year in interest. (assuming LIBOR = 2%)
If the borrower has a clue, they will say “Hold on a second – LIBOR is a variable interest rate. If interest rates go back up, we’ll have to pay more interest. If LIBOR goes above 4% we’ll end up paying more for a variable rate loan than if we had sold fixed rate bonds. (assuming that 7% was even a real number)
Enter the Interest Rate Swap – the hot shot banker says “Have I got an answer for that. I can arrange with an insurance company (think a company like AIG) that will guarantee this won’t happen. Here is the deal – you pay them 5% up front ($5 million) and they will guarantee to pay you Libor +3% and you agree to pay them 5% if LIBOR goes back above 3%. We’ll just add the 5% to the loan and in a couple years the savings will pay that premium – it’s a win-win deal.
So how could that possibly go wrong? “Counterparty Risk“… the Interest rate swap agreement is only worth something if the seller stays in business. If the swap seller is unable to honor the agreement (let’s say AIG declares bankruptcy), then the buyer is now left with a variable rate loan for $105 million at LIBOR+3% without the “hedge” in place to protect it from rising interest rates. It’s pretty likely that over 20 or 30 years that LIBOR will float back up and the revenue won’t cover the interest and water rates will have to go up, or if the interest payments aren’t met, then the bank can force new higher rates onto the agency due to the default.
The seller books an upfront fee as complete profit and looks very profitable, and the contingent liability of what they might have to pay in the future might be zero, or it might be essentially infinite (how high could LIBOR go in 30 years?).
The really bad part of this is that once local governments became aware of interest rate swaps, some of them were talked into acquiring interest rate swaps in the secondary market as the guarantor. Say the company in the example finds another city that will take the swap off their hands by giving them $1 million (to fill a budget hole) and they get themselves completely off the risk and book a $4 million pure profit. When the deal falls apart, that $1 million in “free” money could quickly turn into $500 milion in real liability.
That’s how this could bite you – if someone in your local community is playing around in the interest rate swap market way over their head, thinking they found a source of “free” money to fund their own pension plan.
*** Update March 25th 2009 ***
Guy in charge of setting the rules for Municipal Bonds underwriting realizes it was a mistake to not prohibit local government agencies from playing in the interest swap market. Jefferson County is expected to file for bankruptcy. You want goverment running your health care?
Congress – in order to deflect attention from their stupidity – is talking very stridently about the executives of “their” company AIG.
These are incredibly stupid actions. While the folks getting the bonuses may have played a role in the losses, threatening them is extremely stupid. These are the only people who have the skills to unwind this mess. One click of a button (or failing to click a button after they quit) and they can make the entire global economy lose $75 trillion.
The problem was that the government stepped in to bailout a failed company, not that the employees want their earned income. The reason that there are bonuses at all is that Congress imposed a “salary cap” on “executives” and forced companies to pay employees based on performance. If you don’t pay the “executives” what they were promised, they -will- leave AIG. Will Chuck Schumer now force them to continue to work for AIG without paying them?
Fascism has arrived and it is bi-partisan.
Forbes has text of speech here
The Dictator of Treasury is in Europe to talk about Global Governance of the financial markets with his couterparts in the Group of 20 largest economies in the world
Now that the US Government defacto owns CitiGroup, and Robert Parsons – a man with no experience in banking – is it CEO, what is the first major initiative that CitiGroup announces? Going into the stock brokerage business in Vietnam, Malaysia, Indonesia and Thailand.
Did you know that President Obama’s mother worked for Timothy Geithner’s father in Indonesia? Peter Geithner ran the SouthEast Asia Program for the Ford Foundation, and was their first representative to China. Tim Geithner graduated from high school in Thailand and is fluent in Japanese and Chinese. Connecting any dots yet?
How is helping businesses in SouthEast Asia raise money to start businesses “saving American jobs”?
Geithner wants G-7 to stop blaming China
One really interesting aspect of Dictator of Treasury Tim Geithner’s biography is that he lived most of his youth in Asia. His father worked for the Ford Foundation handing out money, and his father had met Barack Obama’s mother, who worked for the elder Mr Geithner in Indonesia.
Timothy Geithner is fluent in both Japanese and Chinese.
Worrried yet?