Monday, July 05, 2010

Wall Street's War of the Machines

Happy July 5, the nation's official "commercial" Independence Day holiday. Making things even more festive today, Washington DC's traditionally oppressive heat and humidity aside, is the fact that Wall Street is on holiday as well. Sadly, unless there's a nice surprise, it's likely to resume its current Long March down to new lows tomorrow when trading opens at 9:30am.

We've opined many times before on two items that are massively contributing to this mess, aside from the Obama Administration's systematic destruction of capitalism as we know it. The first, which we'll again visit in detail soon, is the ongoing nonsolution to relentless short-selling: the socalled Uptick Rule which was scuttled in the waning months of the Bush Administration--just in time to ensure that certain already stressed banking institutions had no alternative other than being flushed down the toilet bowl of history. There's a sort of "fix" in for this in terms of circuit breakers. But it won't be at all effective during the next flush downward which we'll see probably sooner rather than later.

We have to keep in mind, though, that the absence of the original uptick rule isn't exactly what CAUSED the current Wall Street mess. It merely aided and abetted it. My reasoning in arguing for its return intact is that there's no reason for anyone to help profiteering mischief makers transform a very bad situation into a worse one.

What is currently proving far more damaging however, are the existence in the investment community of so-called "dark pools"--private stock transactions of considerable size that are not reported on the tape and thus hidden from the average investor and, arguably, many mutual fund managers; and socalled "flash trading" or "high speed trading" wherein computer programs, linked to market movements, trade mass quantities of many, many stocks, often within milleseconds, generating massive profits via tiny, incremental moves.

None of this stuff, from dark pools, to short sales, to high speed trading, has been addressed in the currently pending "FinReg" legislation. Presumably, they will be addressed by rulemaking bodies after this amazingly flawed legislation is passed.

Problem in the first place is that regulators, who are never really responsible to voters, are bureaucrats at heart. It will take a long time to get them appointed, installed, and working, and a longer time to start creating, considering, and implementing rules.

Problem is in the second place that we can't count on them to create rules to shelter the average investor--only the wealthy high-speed traders who've turned investing into the stock market into the kind of game better suited for playing on your kid's Wii or Xbox.

Problem is in the third place is that it's actually decision time not for the Government but for Wall Street. The Street and its various exchanges are at an important crossroads. Currently, the average investor, whether running his or her own portfolio or participating via mutual funds or retirement accounts (like 401ks), has largely dropped out of the market entirely, preferring to stay in cash.

The reason why is simple: it's now abundantly clear that the system, always game-able, has become fatally so for any investor who doesn't have supercomputing power doing the trading for him. The 30-somethings and their machines now control 70% of daily trading on Wall Street (Wall Street Journal figures, can't link due to subscription wall). Since no one else, statistically speaking, is trading besides hedge funds (a bunch of which are probably using these same whiz kids and their algorithms), the exchanges love these traders and are now depending almost entirely on them for business. Were any rules put in place to either ban or restrain high speed trading, Wall Street exchanges and trading firms for that matter would lose a huge chunk of their business and profitability with no guarantee that the little guy would come back to the market to make up for the difference.

We are at a crossroads here. Follow me on this. Social Security is now well-known to be a slow-speed train wreck. The current administration and Congress are on a path to destroy what's left of the national budget and our healthcare infrastructure to boot. Meanwhile, Defined Benefit pension plans have pretty much gone by the boards, replaced by often self-directed 401(k) programs, most of which went in the tank in 2008, were briefly revived last year, and are now gurgling down the toilet once again.

In other words, the whole socalled social safety net is not just frayed, it's broken. The current solutions, stated or quietly undeclared, are to let retirees drift into poverty like they used to, force anyone over, say, 55 to join them (since, once laid off, they will never be hired in any great numbers again), and let them die, sooner rather than later, when the government determines they're no longer cost effective.

Hey, guys and gals, this ain't what we signed up for, saved in our 401(k)s for, and got docked 5-ish percent every year for FICA taxes for, is it?

We don't have much time to get this fixed. But a good way to begin is for the Feds and for Wall Street to get serious for once and for all and decide on their business model going forward. To wit: Do we just put a painful end to the myth of investible 401(k)s, declare an end to personal investing, and turn Wall Street into an elaborate video game for bored, overpaid young oligarchs from good families and Ivy League schools? Or do we put these punks out of business, make them do real work in a steel mill for a change, and get Wall Street back to its original game of raising capital for business and maintaining capital markets for businesses and investors to grow and prosper. In other words, is Wall Street so addicted to its high commission structures that it no longer cares that it's abandoned its primary purpose, ceding it to the video gamers? Or is Wall Street going to get serious and get America back on the road to prosperity.

Washington is currently getting an F in this regard. If Wall Street caves in permanently to the video-gamers and their automated trading machines, capitalism is dead and gone, leaving us to start over again with no capital, no hope, and no future since there won't be anything left to manufacture or buy.

I'm not trying to be silly or alarmist here. But the Street--and ultimately, the boneheads in Washington as well--are at a Decision Point. And I'm no longer sure they have the knowledge, the intellect, or the gumption to do the right thing, since I'm also no longer sure they have any active gray matter at all.