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August 7, 2012

First NYT's Sorkin & Now Reuters' Felix Salmon Battle Better Markets

As the old saying goes, we must be doing something right to get criticized by Andrew Ross Sorkin in the NYT and by the Reuters blogger Felix Salmon in the same day.  (We’ve already responded to Andrew here.)

We like Felix and think he often says things that are thought provoking, but his column today is ad hominem, over the top and just plain wrong in many ways.  Too bad.  It’s self-discrediting.

Because we draft and file comment letters and court filings, meet with regulators and other policy makers, research and publish studies, among lots of other things, we don’t have time to respond to everything columnists have to say – that alone could be a full time job for lots of people and we prefer to work on getting financial reform in place, making the financial system stronger and safer, thereby less prone to crisis and failure and less likely to require taxpayer funded bailouts.

But, a few egregious statements in this particular column merit a response.

First, Felix totally overlooks the fact that some of the biggest banks in the world knowingly committed multiple very serious crimes by rigging the Libor rate.  Criminal conduct should not be so easily excused or ignored, particularly by those in the financial industry.  If criminal conduct isn’t prosecuted, crime is incentivized and there’ll be lots more of it.  That’s bad for the markets, for society and, frankly, for everyone.

Second, he ignores that the multi-year Libor rate-rigging conspiracy by the world’s biggest banks had two distinct parts.  One was to manipulate the rate up or down so that the bank could be in the money on its derivatives book, which is just illegally ripping off counterparties pure and simple.  The other one was to lower Libor to present a false picture to the market of the bank’s true weak financial condition during the 2007-2009 financial crisis, which was a fraud on the market, shareholders and others. 

Third, he doesn’t appear to know how Libor based swaps work and, therefore, is just dead wrong that no one was harmed by the banks rigging the Libor rate.  Many municipalities, cities, counties, states and others — like hospitals — were ripped off as a result of the Libor based swaps they have with the banks manipulating Libor. 

The interest rate swaps have worked against many governmental entities because the variable leg often was tied to Libor.  The cities, for example, typically agreed to pay the banks a fixed rate, and the banks agreed to pay the cities a variable rate based on Libor.  As the banks manipulated Libor down, the swaps turned against the cities and net payments from the cities to the banks increased.  There is no legitimate dispute that manipulating the Liborrate down clearly cost these governmental entities a lot of money.  And, yes, those governmental entities could have and likely would have spent that money on other things like services and personnel like firefighters and teachers.

Fourth, he misunderstood what Better Markets President and CEO Dennis Kelleher said on the TV show Viewpoint with Eliot Spitzer last night.  Mr. Kelleher distinguished between high speed trading (really high speed market making) and predatory high frequency trading (HFT).  Maybe not the most precise way to talk about these activities, but not too far off the mark for a general audience.  It was the later practice not the former that Mr. Kelleher said rips off small investors, frequently referred to in the market as dumb money.  (Not mentioned was that, because shops like Knight pay for order flow from retail brokers and pick off what they want, there are fewer natural buyers and sellers in the market and only professional or toxic retail flow actually gets to the market.)

Felix also sees HFT as nothing but a force for good.  If that were true, there wouldn’t be any spraying, spoofing, stuffing, pinging and other purely predatory actions that serve no purpose other than to rip off other traders.  He also apparently continues to believe, as he said on the Viewpoint TV show last night and again in his column today, that HFT provides liquidity.  This is what the predatory HFT crowd asserts every time someone suggests they should be regulated. 

However, a mountain of non-industry research has established that HFT is a liquidity taker, not a liquidity provider and, unlike real market makers, HFT exits the market during times of stress.  I won’t belabor those points here, but all anyone has to do is glance at the data and academic research Themis Trading has accumulated (available at their website) or visit Nanex’s website and see what HFT really does. 

Finally, as for his anti-regulation stance, he sounds like Wall Street and the pro-too big to fail crowd that never met a regulation they liked.  Those anti-regulatory views prevailed prior to and led to the financial crisis of 2007-2009 and the ongoing economic crisis.  Throwing out the financial transaction tax as the only appropriate response, as he did in his column, is just silly and ignores a myriad of other reasonable and modest options for addressing some of the egregious HFT conflicts of interest, market disfunctions and rampant predatory conduct that pose genuine threats to the US capital markets.  That’s too long a subject for this post, but we’ll write more on that at another time. 



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