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Category: Financial Institutions

The Free Market in Automated Options Trading

Will Goldman get relief denied to Knight Capital?  That’s a big concern as the firm, not all that great at automation, finds itself in a bit of a mess:

[Computers] at Goldman Sachs responsible for trading options whose symbols start with the letters H through L traded a bunch of options at the wrong prices and put Goldman out by a hundred million dollars or so. [V]arious exchanges are sitting down and pondering whether to give Goldman that money back.

Turns out that the rules for a “free market” can get pretty complicated.

How to Win Friends & Influence People

The ambitious might wonder: what does it take to succeed in China? Finance appears to have an answer:

U.S. authorities have opened an investigation into whether JPMorgan Chase & Co hired the children of powerful Chinese officials to help it win business in China. . . . Investment banks have a long history of employing the children of China’s politically connected. While close ties to top government officials is a boon to any banking franchise across the world, it’s especially beneficial in China, where relationships and personal connections play a critical role in business decisions.

Poor JP Morgan. Just as newspapers offer definitive lists of its legal troubles, another one pops up.

Score One for the Commons (or maybe not)

I was just listening to Dave Levine’s interview of Mike Madison, which touched on his work with Strandburg and Frischmann on constructing commons. Here’s one more possible case study for the group, suggested by Michael Lewis via Felix Salmon:

[T]here are smart [high frequency trading] HFT shops, and then there’s Goldman Sachs. The smart shops execute their strategies using lightweight, open-source, flexible code. Goldman, by contrast, considers its enormous, clunky, proprietary codebase to be a source of competitive advantage — it has to, in order to justify the bonuses it gives to the people in charge of that codebase. Goldman knew that Aleynikov was its best programmer, but it never really grokked why he was good: he was an expert at replacing clunky Goldman code with much simpler and more elegant open-source solutions.

So while Aleynikov thought he was streamlining Goldman’s technology, Aleynikov’s bosses got million-dollar bonuses by claiming that he was adding to a proprietary codebase in which they placed enormous value. And when Aleynikov thought that he was simply emailing his own notes to himself, Goldman decided that he was stealing proprietary information of enormous value — and that, since it was enormously valuable, of course Aleynikov intended to use that code against Goldman in his new job.

Three cheers for open-source! Or maybe 2…or 1. Because the ultimate endeavor here–HFT–is not exactly a boon to the economy. As Wallace Turbeville has demonstrated, “HFT siphons value from the pipeline of capital intermediation, impeding the long-term investments the economy needs for sustained job growth.” I make the case against HFT here; let’s just say that it’s hard to argue that a queueing rule keyed to thousandths or millionths of a second is any better than one that simply allocates trades that happen to come in at the same hundredth, tenth, or (horrors!) half of a second at random, or in (roughly) equal lots.
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Berkshire Hathaway’s Unique Permanence

aaa rock of gibralterPermanence is the most distinctive trait of Berkshire Hathaway, the diversified Fortune 10 conglomerate whose unusual features, thanks to iconoclastic chairman Warren Buffett, are legion. Permanence is salient because, unlike any other conglomerate in history or rival in the acquisitions market, Berkshire has never sold a subsidiary it acquired.

Ironically, the experience that led to this unique practice culminated in the reluctant sale of Berkshire’s original business, textile manufacturing, in 1985. That sale was so painful for management, employees and other stakeholders that Berkshire committed to avoid a replay.

Instead, it adopted a policy of up-front screening, rigorous acquisition criteria that cut the chances of owning a business that would be tempting to sell. Berkshire then turned that policy into a huge advantage, assuring prospective sellers of companies a permanent corporate home.

In turn, the assurance of permanence appealed strongly to the kinds of companies that would meet Berkshire’s rigorous acquisition criteria: those owned and loved by families, entrepreneurs and other owner-oriented types. Some fifty acquisitions later, the promise has never been broken.

That is why I found so peculiar the following passage in William Thorndike’s well-selling book, The Outsiders, a profile of select big-name CEOs, including Buffett, whom Thorndike considers to have been similar to each other but different from everybody else. After referencing the 1985 closure of Berkshire’s ailing textile business, he writes: Read More

Modern Wealth: The Commodities Shuffle

I’ve collected a series of articles on questionable modes of wealth accumulation. Today’s piece by David Kocieniewski in the New York Times on useless commodity shuffling offers yet another example:

[In] 27 industrial warehouses in the Detroit area[,] a Goldman subsidiary stores customers’ aluminum. Each day, a fleet of trucks shuffles 1,500-pound bars of the metal among the warehouses. Two or three times a day, sometimes more, the drivers make the same circuits. They load in one warehouse. They unload in another. And then they do it again.

This industrial dance has been choreographed by Goldman to exploit pricing regulations set up by an overseas commodities exchange, an investigation by The New York Times has found. The back-and-forth lengthens the storage time. And that adds many millions a year to the coffers of Goldman, which owns the warehouses and charges rent to store the metal.

Law professor Saule T. Omarova explains the legal basis for large bank holding companies engaging in such activities:
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Income Based Debt Forgiveness: The Least the Government Can Do

In our era of austerity, many want to see government support for university budgets on the chopping block. It doesn’t matter to them that state support has already been cut dramatically (click to enlarge):

Why? There’s always ideological opposition to higher education. That’s hard to reason with. But there is also a persistent meme that student loans are some massive drain on the treasury. That view is getting harder and harder to square with reality:

“The federal government is due to book $51 billion in profit this year off new and existing federal student loans, according to estimates by the nonpartisan Congressional Budget Office. The record amount brings the government’s profit haul to nearly $120 billion over the past five years, according to CBO forecasts and Department of Education budget documents. The CBO estimates that the government will generate $184 billion in profit for new loans made this fiscal year through 2023.”

Given these enormous profits, it would seem that income based debt forgiveness would be the least the government could do for the students it is now profiting from. Of course, the government can’t be too generous to students—banks have to come first:

But let’s just be clear on exactly who is a drain on the federal budget, and who is a source of gains. Income-based repayment and some forms of income-based debt forgiveness are the least that the government (and more specifically, the elite whose declining taxes are the main reason for austerity) can do for Generation Debt.

X-Posted: Balkinization.

The Locust and the Bee

LocustBeeFables have been in the politico-economic air of late. The FT’s Martin Wolf considered the locust part of a master metaphor for the future of the global economy. He concluded that “the financial crisis was the product of an unstable interaction between ants (excess savers), grasshoppers (excess borrowers) and locusts (the financial sector that intermediated between the two).”

Now Geoff Mulgan has entered the fray with the excellent book The Locust and the Bee: Predators and Creators in Capitalism’s Future. As Mulgan observes,

If you want to make money, you can choose between two fundamentally different strategies. One is to create genuinely new value by bringing resources together in ways that serve people’s wants and needs. The other is to seize value through predation, taking resources, money, or time from others, whether they like it or not.

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Gilchrist on “The Special Problem of Banks and Crime”

Law professors are beginning to get to grips with the massive amount of wrongdoing at American financial institutions. Here’s part of the abstract for Gregory M. Gilchrist’s article on “The Special Problem of Banks and Crime:”

Federal prosecutors face increasing criticism for their failure to indict large banks and bankers for serious criminal conduct, including allowing violent drug cartels to launder hundreds of millions of dollars, willfully conducting business with rogue nations and terrorists, and manipulating the LIBOR to defraud investors. This Essay argues that the non-prosecution of banks is often justified by proper consideration of externalities and that the non-prosecution of bankers is often justified by lack of evidence. Nevertheless, the result is that extremely serious criminal conduct is penalized by mere fines and negotiated terms of probation, and this introduces deterrence and expressive costs to the legal system.

The idea that “non-prosecution of bankers is often justified by lack of evidence” is particularly interesting in a post-fusion center, post-PRISM world. If robbery suspects are demanding NSA phone records for exoneration, how soon might authorities consult them to finger paladins of peculation?

This is part of a series on crime and scandal at financial institutions. Prior posts include:
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Big Rig? Libor & Beyond

BankstersTo inaugurate a series of posts about scandals and crime in the financial sector, I wanted to highlight John Lanchester’s work in the London Review of Books on “banks’ barely believable behaviour.” He mentions the still unwinding Libor scandal up front:

Libor is the single most important number in international financial markets, used as a reference point throughout the global financial system. It is a range of interbank lending rates, set after consultation between the British Bankers’ Association and two hundred and fifty-odd participating banks. During the daily process, each bank is asked the rate at which it could borrow money from other banks, ‘unsecured’ i.e. backed only by its own creditworthiness rather than by specific collateral. The question is, in effect: what would your credit be like today, if you had to ask? . . . .

It seems bizarre that something so central to the global markets – $360 trillion of deals are pinned to Libor – should have such a strong element of invention or guesswork. The potential for abuse is immediately apparent. As Donald MacKenzie prophetically said, ‘the obvious risk to the integrity of the calculation is that a bank on a Libor panel might make a manipulative input, trying to move Libor up or down so as to influence interest rates or the value of its swaps portfolio.’ Surprise! After the crisis, when investigators were taking an energetic interest in Libor, it turned out that that was exactly what had been happening, not just at one or two banks but across an entire swath of the industry.

Lanchester only brings up LIBOR as the opening act for what he considers a far deeper scandal in Britain—PPI. And guess what—it’s not just LIBOR where we’re seeing these concerns about privileged access to information turning into profit. Here are some other “rigging” scandals of recent vintage:
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