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Peter F. Way, CFA
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Peter Way Associates provides investment professionals and individual investors with forward-looking, market-derived Risk:Reward tradeoff assessments for widely held and actively traded common stocks and Exchange Traded Funds (ETFs). The firm maintains daily the odds of higher and lower next 3... More
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  • Cop Now on the Beat! 0 comments
    Apr 19, 2010 12:04 PM | about stocks: GS, NYX
    Finally some meaningful, active, operational discipline is returning to financial markets.  The SEC’s fraud charges against Goldman Sachs (NYSE:GS) and related parties hopefully are the first sign of a realistic return of morality to a community desperately in need of public confidence.

    Fifty-plus years ago at the beginning of our involvement with investment markets, the cop on the beat was the New York Stock Exchange (NYSE:NYX).  They were the ones monitoring trading activity, setting the rules of engagement, and controlling access to the market that really counted.  If you wanted to be a part of the game, you had to play by the rules and behave.  Otherwise, you got thrown out, permanently.

    That role continued up until the last few years, when it became undermined as major brokerage houses shed their partnership structures in favor of public-ownership corporation status.  Then when the exchange itself became a for-profit corporation with its own IPO, pretenses at discipline from that quarter disappeared.

    During all this time the SEC was a paper pussy-cat, kept understaffed and emasculated politically, to the benefit of the investment community.  Only trivial matters of form, rather than substance, were dealt with.

    Finally, when the Madoff affair appeared, publicly and politically obvious, postures at the SEC became intolerable.  Separately, the subsequent CDO/CDS whitewash and taxpayer-paid bailout of the perpetrators was the final straw.  Now national outrage is widespread, and we hear of tea-parties.

    Nothing happens in the beltway until the involved bureaucrats are sure their backs are covered, regardless of which political party is nominally in power.  For the SEC to frontally challenge the king-pin of political influence from the investment community appears to mean that the oval office has been kept fully apprised and endorses the action.

    That suggests major difficulties for congressional “financial reform” movements that simply tut-tut the status quo.  The GS fraud case probably is not going to be a single-purpose or single-event action.

    There may be a parallel here to the recent 7.2 Richter earthquake in our neighborhood just south of the border.  In the following week there were over 2800 aftershocks agitating the immediate topology.  We may hear more from the Feds at Justice, and certainly from the “plaintiff’s bar” that have now been notified that suits against one of the “deepest pockets” imaginable will provide an ongoing legal fee lottery for some time to come.

    While much will be made in the media of how terrible all this is, in fact the true nature of the events are beneficial in the longer term if the public can see that regulation of securities markets is being taken seriously.  Fair and honest markets are essential to the way society must operate in our style of democracy.

    Because of the SEC charges of deception and fraudulent actions in the GS case, it is important that our subscribers know that all of our information comes from publicly available sources that are highly transparent and cannot be fudged.

    The whole issue of derivative securities is poorly understood by the bulk of the public at large, including politicians, and unfortunately, even economists.

    When there is a central clearing facility for all transactions in a given type of security, then for each trade a buyer can be matched up with a seller, and proper balances can be maintained to assure each one’s responsibility to act under the terms of the deal.  When those terms are standardized, as in listed stock options via the Options Clearing Corporation, the job gets much easier.  Major problems don’t happen.

    That did not exist in the CDO/CDS world, and is becoming clearer in the SEC charges.  It is also explained somewhat in Michael Lewis’s book “The Big Short.”

    To allow a return to a “dealer market” in these securities invites a repeat of the catastrophe already encountered.  When banks – either “investment” or “commercial” – are allowed to traffic as “dealers” without any disciplined track kept of who owes and who owns what, then pirates are again abroad on the mortgage seas and the buck will stop only at the least able buccaneer.

    When the NYSE was in control, a broker that behaved like a “proprietary trading organization” was regarded as a “bucket shop” and was excluded from dealing with the investment public as a transaction agent.  Its role as a counter-party principal adversary was quite clear.  A return to that distinction is now badly needed.

    Disclosure:  No current positions in GS or NYX.



    Disclosure: No current positions in GS or NYX.
    Themes: SEC, Regulation, Options, CDO Stocks: GS, NYX
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