When you came into this business 20 or more years ago, you were taught a few basic things:
* Price Discovery - working with buyers, sellers, specialists and the crowd on the floor (see the original Wall St movie to see how it worked) to determine where a stock could be bought and sold in size. Now you just hit a button on a keyboard or set up an algorithm and let it do the work for you. When its man versus machine, machines win.
* The requirement to study for, take and pass a registration exam. Usually on Day 1 you were given a Series 65 notebook and told to study. Futures and Options specialists and RIAs had their own exams. Nowadays most market participants have no registration whatsoever. They live life off the regulatory grid. I operate under a Series 65.
* Respect for Regulators - before I started the Equity swap business at Merrill Lynch I spent countless hours with attorneys to make sure we did not run afoul of the SEC, Federal Reserve or other regulators. Now, either people don't care about the regulators or the regulators are so inept or conflicted that they are just ignored.
* Maintaining the markets' integrity - there was an unwritten code to preserve the order and integrity of the market. We built a system in which all market participants could have a high degree of trust. I am not saying that there was no profit motive, there was and should be. A bid was a bid, an offer was an offer and a price on the screen was good. Who can trust a bid and offer now when they can be nothing more than financial apparitions?
We learned our lesson in 1987 after a brief bout of insanity and failure to operate within the framework of the markets that I just mentioned. That insanity was caused by the escalation of the use of stock index futures and their perversion to implement portfolio insurance strategies. Market participants and regulators came together subsequent to the 1987 Crash to fix the problem.
However, we have had 3 or 4 crashes since then. First was the United Airlines “mini-crash on Friday October 13, 1989. No true reason was ever identified for that breakdown other than perhaps the failure of the junk bond market.
Our next challenge came in 2008. Unfortunately by then an entire generation of market participants were brought up putting profits and their 20% performance fees above all else. Regulators were more concerned about where their next job would come from rather that the integrity of the market place. Did leveraged and inverse leveraged ETFs really benefit the markets? Where we really better off without an uptick rule? Were Credit Default Swaps (CDS) so benign as to not require regulatory oversight? The SEC, CFTC, Treasury and Federal Reserve all got caught in the same political lobbying net that has ensnared lawmakers in Washington DC. An individual investor is no longer being protected by a system that protected them for generations. The integrity of the markets has been eradicated.
Then we had the 2010 Flash Crash. This was the first time that the markets came face to face with the High Frequency and Algorithmic Trading menace. Without warnings these computerized trading systems took control of the market and sent stocks plummeting without any explanation to investors who were accustomed to an orderly market.
Now we have the August 2011 market crash. This did not happen in one day but over several. We have seen extreme market moves in less than an hour on multiple occasions. We have also seen some of the largest intraday moves from up to down or down to up in percentage terms than ever before.
Of course it is still easy to manipulate a market down. Load up on CDSs, some puts and inverse leverage exchange traded funds. Spread some rumors on the internet; make a few calls to selective media agencies that are happy to report on any rumor; and, then start shorting stock on down ticks. You can ring up some nice 20% performance fees and make your year in a few minutes.
Where is the SEC? Where is the CFTC? How about state regulators? They holed up in meaningless meetings, making speeches at conferences, testifying on Capitol Hill or off on a boondoggle.
Occasionally someone comes along to try to make things right. When Elliot Spitzer was the New York AG he took on Wall Street analysts and improved a system that broke down and destroyed the markets' integrity during the tech and dotcom boom. (Please note that I am not endorsing his personal improprieties while Governor of New York). Insider traders and tax cheats are still prosecuted. Occasionally the cavalry does come riding in. Unfortunately, it tends to be a cavalry of one.
All of those so called legislative fixes that were enacted in the last decade are pretty worthless. The Sarbanes-Oxley made it more difficult for a company to become or remain public, thus hindering American companies’ competitive advantage. The Dodd-Frank “Fin Reg” bill was a step back for financial markets but it did help get attention for those legislators that were fighting the “bad actors” on Wall Street. Of course, its Volker Rule just opened the door for High Frequency and Algorithmic Traders to become modern day pirates.
Is there a legislator or regulator that will step up to do the right thing? Does someone have the fortitude to protect individual investors and pension plans and forgo some campaign contributions and goodies from lobbyist? I hope so. If there is one out there please contact me and I would be happy to help them.