30.04.2015
Close down financial casinos
Flash crashes, high-frequency trading and chicanery - ‘spoofing’ is just a symptom, writes Michael Roberts
If you watch sport on British TV (mainly Rupert Murdoch’s Sky), you find that a large proportion of the ads that break up the action are for online betting. There are umpteen ways of betting, not just on the winners and losers, but in football on the time of goals, the goal scorers, the corners, the tackles and so on. And the visuals in the ads often present a massive casino where everybody is playing to win.
It is a perfect description of global financial markets - simply a global betting casino with bets by the minute, by the second and by the fraction of a second being made by bank traders. Casinos in Las Vegas and Atlantic City can be rigged - and so are the global financial casinos online. And every day people are trying to beat the casinos, including by cheating, while the casinos themselves try to make sure that the punters cannot win.
The latest example of this useless, wasteful and damaging activity is the case of Navinder Singh Sarao. Sarao lives with his parents next to London’s Heathrow airport. According to the US Commodity Futures Trading Commission (CFTC), his trick was to enter a load of big, phony orders to sell US stock market futures. Then on May 6 2010, something very odd happened. There was suddenly a huge drop in the price of the stock market index, in just seconds. Then there was a quick recovery. It is called a ‘flash crash’ - something that has been increasingly happening in the global financial casino.
Immediately after this particular flash crash, Eric Hunsader, founder of the Chicago-based market data company, Nanex, which has access to all stock and futures market orders, detected lots of socially dubious trading activity that day: high-frequency trading firms sending 5,000 quotes per second in a single stock without ever intending to trade that stock, for instance This is called ‘spoofing’. And it seems that CFTC reckons Sarao was spoofing. On the day of the flash crash, Sarao never actually sold stocks. He was trying to trick the market into falling so that he could buy in more cheaply. He tricked the big casino machines in investment banks that execute the stock market trades of others. He ‘gamed’ them and made huge profits - some $40 million is reported.
Does any of this matter? Is it not amusing that some clever, nerdy type in the Heathrow flight path, using a computer and making split-second trades, can dupe a whole stock market into crashing, if only a for less than a minute, and clean up?
High-frequency trading is all the rage in the US. HFT firms, using sophisticated mathematical models and algorithms, are gaining faster knowledge about the movement of prices in financial markets. So they can get in to buy and sell a millionth of a second before others.
Two things come from this: speedier information gives an advantage, but also allows the ‘rigging of the market’. High-frequency trading is an advance in efficiency because it is speedier, but it is open to the usual chicanery of speculative investment. HFT is just another example of speculative capital engaged in arbitrage, simultaneously buying and selling two equivalent positions, or at least as instantaneously as possible. Time is risk. So reducing the time between buying and selling reduces risk to the speculator: HFT has taken that to the nth degree.
Arbitrage
In one sense, high-frequency trading is nothing new in financial investment - it is just the latest technical revolution in speculative financial trading and, in particular, what is called arbitrage. That means taking advantage of slight differences in the price of the same stock or bond before others notice.
Since the beginning of financial speculation, arbitrage has existed. The most famous example is that which made the legendary banker and speculator, Nathan Rothschild, hugely rich from the Napoleonic wars between Britain and France. Rothschild had an agent at the Battle of Waterloo in 1815. His agent saw that Napoleon was losing and rushed back to the coast, hired a boat for a humungous sum of 2,000 francs through a storm to England. On getting the news, Rothschild rushed to the London Stock Exchange and acted as though he wanted to sell British shares, giving the impression that British commander Wellington had lost. Everybody pitched in to sell and Rothschild quietly bought them all up before the news arrived of the British victory.
Let me quote Nasser Saber, author of three volumes on HFT, Speculative capital:
HFT is the adaptation to the new circumstances of old ways … when a find places an order to buy, say, 100,000 shares of a stock, the order has to broadcast to reach the market. But if before it reaches the market, we can intercept it and get ahead of the trade, buying as many shares as we can, that would push the share price higher, if only by a very small amount. We then sell for a profit, maybe razor-thin. If we repeat this process tens of millions of times a day, our low margin will be compensated by large volume … that’s HFT in a nutshell.1
The difference between Rothschild and high-frequency traders is that the former used a man and the latter use computers and software. Yes, it is efficiency and front running together - as it always has been. That is what financial speculation is all about. But then financial speculation creates no new value: it merely redistributes existing value or produces fictitious capital way out of line with real value. As such, it is not just no use at all, but positively dangerous to productive sectors.
Those with the algorithms and the maths and the technology can gain a momentary advantage over the average punter. And, of course, the average punter does not have access to the technology and also to the special ‘private exchanges’, where those ‘in the club’ can take advantage of these minute differentials at speed. Indeed, these private exchanges and dark pools of stocks were set up by the investment houses to stop the small HFT operations ‘stealing’ their arbitrage gains.
Back in 1998, Long-Term Capital Management (LTCM), a hedge fund, engaged highly-leveraged speculative investing, using a ‘foolproof’ and highly ‘efficient’ risk model called Black-Scholes. Its bets went wrong and it collapsed, losing $3.8 billion and nearly taking the 14 largest US investment banks, who invested in it, down with it. LTCM and its investors were bailed out by public money from the Federal Reserve.
With HFT, spoofing and other forms of speculative capital, disaster brews more frequently. Speculative capital and trading is an accident waiting to happen and now at flash speeds. High-frequency trading and spoofing are very exotic and toxic forms of financial trading and are generating flash crashes. But speculative capital, as an extreme form of financial capital, is also unstable and spills that instability into the accumulation of productive capital.
The global financial crash in 2008 was engendered by global investment banks engaged in speculative betting on US home mortgages and various derivatives of mortgage bonds. This created what the world’s greatest financial investor, Warren Buffet, called “financial weapons of mass destruction”.2
Regulation of these speculative activities was never applied. Bank derivatives were graded by credit agencies which were owned by the banks themselves and the agencies gave these products a top grading for safety. Governments and officials in the US turned a blind eye. In the UK, Labour, supported by the Tories and City minister Ed Balls (now the finance spokesman for the Labour Party), adopted what was called “light-touch regulation” of banking activities.
And now in 2015, after flash crashes and HFT, nothing has changed. Joseph Stiglitz, the Nobel laureate economist, recently called for a tax on high-frequency trading, and was blocked from a government panel that will advise regulators on spoofing and HFT: “I think they may not have felt comfortable with somebody who was not in one way or another owned by the industry,” Stiglitz said in a phone interview.3
Criminalities
Seven years since the global financial crash, the scandals and criminalities of the banks continue to come to the surface like scum on top of the barrel. The very latest is the record $2.5 billion fine on the German Deutsche Bank for its role in rigging the short-term interest rate, Libor, which sets borrowing costs for households and small firms globally. This follows huge fines on Barclays and RBS.
And it is not so long ago that America’s biggest investment bank, JP Morgan, had to pay the US government $13 billion in compensation for selling ‘toxic’ mortgage assets to federal agencies, knowing full well that these mortgages were rubbish. The payment is in settlement to avoid criminal charges. It includes $4 billion to settle claims by the Federal Housing Finance Agency that JPM misled Fannie Mae and Freddie Mac about the quality of loans it sold them in the run-up to the 2008 financial crisis, another $4 billion in consumer relief and $5 billion in penalties to be paid by the bank.
And JPM got off lightly. The bank had already made provisions of $23 billion to cover these settlements. If the federal agencies and others had pursued their claims of misdoing to court, JPM was expecting to pay over $30 billion, wiping out the past six quarters of profit. Instead it has got away with less than half that. And no banker has gone to jail for knowingly misleading government agencies. One analyst reckoned:
JPM and Dimon are getting a pretty darn good deal from the government. I suspect, when the settlement is actually disclosed, it will turn out that JPM’s payout for rep breach violations/FHFA stuff are actually lower than for other banks and lower than that B of A $8.5 billion settlement.4
All this took place after the global financial crash. JP Morgan continue to run a risky trading outfit out of London engaged in outsized trades in derivatives. The ‘London whale’, as it was called, eventually lost the bank $6 billion! The main trader, Bruno Iksil, told his senior executives that he was worried about the “scary” size of the trades he was engaged in. But they ignored him. And the US supervisors of the bank, the Office of the Comptroller of the Currency, supposedly now closely monitoring the banks, also did nothing. In a separate settlement, JPM also agreed to pay $100 million and acknowledge wrongdoing to settle allegations by the Commodity Futures Trading Commission related to its botched ‘London whale’ trades. And the bank agreed to pay $920 million to settle similar charges with US and UK regulators related to that 2012 trade.
The most awful example of financial criminality is the activity of HSBC bank, now threatening to move its head office out of the UK after the shame of its latest scandal. Stephen Green, former chairman of HSBC, is an ordained vicar, and in 2009 published Good value, an extended essay on how to promote corporate responsibility and high ethical standards in the age of globalisation! The good reverend was in charge of HSBC’s private banking division based in Switzerland, before he became chief executive and chairman of the whole bank. And it is this Swiss division that was engaged in hiding the ill-gotten gains of thousands of rich people in many countries who did not want to pay tax for income made out of people in their home bases. HSBC went further in arranging clever ways to enable these rich people to recycle their cash back to the UK and other countries without tax payments.
Green’s defence, provided by his supporters (he will not say anything himself), is that HSBC’s federated corporate structure prevented group management getting to grips with tricky local details, such as spotting those customers who were running multi-billion-dollar drug cartels and arms deals. But, as Margaret Hodge, chair of the UK parliament’s public accounts committee, put it, “Stephen Green was either asleep at the wheel or involved in dodgy tax practices.”
“Light-touch regulation” and the neoliberal aim of reducing tax for the rich and ‘creative’ has been the norm in all the major capitalist economies, with corporate tax being cut back sharply to boost company profits and huge exemptions on tax allowed for the very rich to swan round the world avoiding their share of the burden of providing public services, infrastructure and communications paid for in taxes by the rest of us. And nobody in the big banks has been charged for these immoral and probably illegal activities. Instead the likes of the CFTC go after single traders like Navinder Sarao.
‘Wealth creators’
Why was nothing done? First, because the rich and powerful are always to be supported by governments that believe they are necessary to make capitalism work. And, second, because, in the case of Britain and the US, big banks like Goldman Sachs or HSBC are seen as necessary ‘wealth creators’ through financial markets that are so important in decaying modern capitalist economies. Despite recent attacks on tax avoiders by Labour leader Ed Miliband, his finance spokesman, Ed Balls, seems less combative: at a recent meeting with City financiers he was reported as saying: “You might hear anti-City sentiment from Ed Miliband, but you’ll never hear it from me.”
The financial sector is not a wealth creator: at best, it is a wealth distributor or facilitator, and at worst, and increasingly so, it is a parasite on the productive sectors of the capitalist economy. Is the financial sector useful and productive? Even mainstream economics doubts it. Andy Haldane, now chief economist at the Bank of England, has shown that banking is not productive and even positively damaging to the ‘real economy’.5 And a paper by the Bank for International Settlements (BIS) finds that, as the financial sector grew its share of GDP in the major economies, overall economic growth slowed. The BIS reckons there was a causal connection.6
First, the high salaries commanded in the financial sector made it harder for genuinely innovative firms to hire researchers and invest in new technologies. Second, the growth of the financial sector has been concentrated in mortgage lending rather than in loans for investment in new technology. Credit has gone into a property boom, not in boosting investment. The BIS found that manufacturing sectors that are dependent on either external finance or proportionally high research and development (R&D) suffer disproportionate reductions in productivity growth when finance booms. By draining resources from the real economy, financial sector growth becomes a drag on real growth.
For 40 years, the financial sector stayed roughly the same size relative to the rest of the economy. Then a phase shift occurred, starting in the late 1980s, and it has since commanded a share twice as large. The growth rate in productivity was systematically faster when the finance sector was relatively smaller and then, when the finance sector became bigger, productivity growth became smaller. The BIS found that a sector with high R&D intensity located in a country whose financial system is growing rapidly increases by between 1.9% and 2.9% a year slower than a sector with low R&D intensity located in a country whose financial system is growing slowly. Financial booms are not, in general, growth-enhancing.
Banking should be a public service, not turned into speculative capital operations. The proposed reforms of the banking system - more regulation, higher capital adequacy ratios, breaking up the banks into smaller units, separating the risky investment arm from the ‘safe’ retail and commercial arms and a financial transactions tax - all these will not be enough to make banking a public service. If we stop short of that, as nearly every set of reform proposals does - like, for example, the recent one proposed by the Keynesian-style think tank, Class, promoted by the British trade unions7 - then it will fail to do the job.
We need public ownership of the main banks globally and in each country. We need to close down these financial casinos. That is the only way to stop the unstable speculative financial sector from ruining the economy and destroying jobs and incomes.
Notes
1. www.amazon.ca/Speculative-Capital-Nasser-Saber/dp/0977179028.
2. www.businessinsider.com/financial-weapons-of-mass-destruction-2013-5?IR=T.
3. www.bloomberg.com/news/articles/2015-01-05/stiglitz-blocked-from-sec-panel-after-faulting-high-speed-trades.
4. www.nakedcapitalism.com/2013/10/the-ridiculous-jamie-dimon-as-victim-meme-on-the-pending-jp-morgan-mortgage-settlement.html.
5. https://thenextrecession.wordpress.com/2013/10/31/the-value-of-banking-according-to-mark-carney-and-alan-greenspan.