You have got to be kidding me!!!

“Regulators Clamping Down on High Speed Stock Trades”.

It’s the regulators and regulation that caused this problem in the first place. One need not go too far back in time to a place called Irrational Exuberance. A fantasy land of never ending money making by blind monkeys on Main Street circa 1990s. Yes, the same blind monkeys that are currently protesting today, without knowledge, across business districts and Wall Street. Yes, the same blind monkeys who were part of a collective of odd lot self-aggrandizing sycophants that believed they could compete in a world of traders by throwing darts while blindfolded at the broad side of a barn. Sure they could do no wrong.

The 90’s. The Roaring 90’s. Where have I heard that before? It’s the same insanity as the Roaring 20’s which lead us straight to the Great Depression. It was a period and decade of increased consumer spending and economic growth fed by supply side economic policy. It should sound familiar to most but we have short term memory and a lack of knowledge of history. Not to digress into the pattern of vomit and waves, but the facts are facts. And the Roaring 20’s were exactly the Roaring 90’s.

Irrational exuberance indeed. In my article “Black Hole Sun”, I describe the failures of Federal Reserve Chairman Alan Greenspan in continuing ad naseum, a monetary policy that extended globalization, increased American debt as a percentage of GDP, did nothing to tighten and upend the moral hazard that awaited blind monkeys and that which wiped out two trillion in net worth and pension from 2000 to 2002. The list goes on as a result of poor decision making.

And it is just that. Poor decision making by the so-called experts. Experts like Alan Greenspan, and Arthur Levitt, who were appointed, not elected, by our political intelligencia, who themselves have admittedly, next to no clue about the importance of a balanced think tank or the ability to judge a so-called experts' acumen and more importantly, follow through. One need only look at the Supreme Court blunders made by U.S. Presidents to get a glimpse of the head slapping cry of “Did he/she just decide to…” Yes, they all did. Including, Ret. Justice David Souter.

Expert Analysis is Anal at Best

All of the so-called experts who have put their “oh-no” idealistic mark on failure have also failed to admit their mistakes. It is as important a phenomenon as the mistake in letting a leading administrative or monetary expert in the hen house without additional oversight. The reason, as we all know, that it is a bigger mistake to let a failed policy go un-reformed as it leads to the long term damage we see in today's marketplace. In the world of finance, adverse selection can become a mutating virus that starts with one rule and completely goes unbound, tearing asunder an entire market or eco-system. Regulation ATS did just that. Laissez-faire economic policy (supply side on heroin) did just that. Failed oversight by the only authority other than Congress to rectify a poor choice, did nothing.

All in the name of the Roaring 90’s, globalization and fear of inflation.

Get to the Point in a Flash

In December 2009, I wrote, in the article “Gone In Sixty-Milliseconds or Less*” that,

“To give rise to the phenomenon of high-frequency trading, otherwise known as “flash trading”, one need look no further back to the future during the Arthur Levitt administration of the Securities and Exchange Commission and the information age Executive Branch of the Clinton/Gore administration. Just prior to the birth of Regulation FD, along the same ideology of protecting the investment community and another market popping pin, Regulation ATS was a congenital twin to FD, born and giving life to modern day velociraptors– fast moving, spread snapping machines called ECNs (Electronic Communication Networks). The birth of ECNs and the regulation that spawned this ideal was born by the same administration attempting to provide a parallel cure to a two headed monster. Selective Disclosure was certainly unfair and the margin of profit to information potentially unlimited. Yet, in reviewing this solution for narrowing “unfair” spreads and measured profits on risk-taking for traders, Regulation ATS, has instead, lead to an unlimited and unfair margin that can never be closed by investors. Prior to Regulation ATS, fixed spreads of .0612 to upwards of .25 made the efficiency of a trade and the risk to carry far more expectant and therefore, more rational in a supply-demand driven market.  After being routed off the playing field for ten straight years, the individual investor’s ability to compete in a day-trade based and short-term risk modeled market begged for a return of a thousand shares buy/sell of Intel ‘up or down a teeny’”.

In the mid 90’s towards the rising peak of a mountain of irrational exuberance, blind monkeys throwing darts at winning trades like Cisco going from 10 to 75 and other rocket ships were the lemmings of Main Street. It fanned the flames of lemming mania and cliff diving that drew in the rest of middle class America in your friendly neighborhood of foreclosure. Yes, that America, that once had a love affair with belonging to and imbibing at the luxury lounge called the New York Stock Exchange and Wall Street.

Finally, the middle class ship came in and docked at Pier 17 and the individual investor had the opportunity to come aboard the good ship lollipop and ride the crest of a wave. It became painfully obvious that the odd lot had power and the top trading firms and their so-called proprietary traders had an army of competition. Nothing made sense, including Amazon.com. The power of mass was in full force and effect. And so it went, in the mid to late Roaring 90’s, fostered by the salty dehydrating preservative of idealism, former SEC Commissioner Arthur Levitt, decided that all of the nouveau riche on Main Street needed a champion of the ‘steenth.  

“Unfair spreads and pricing”, cried Levitt. Traders were making illicit spreads like a sixteenth of a dollar per share of stock purchased or sold. That spread is between the bid (what a trader is willing to pay to buy from the marketplace) and the ask (what a trader is willing to pay to purchase from the marketplace) of a stock price. That’s the equivalent of $.0625 or one half of an eight ($.125), that’s twelve and one half cents. The eights and sixteenths of a dollar were the charge of the regulators and Arthur Levitt to provide individual investors with a fair shake at getting best price on their trades through a regulatory scheme called Regulation ATS, born to merge off floor trading competition through machines and merged with decimalization, right down to the penny or fraction thereof.

It scared the daylights out of the big firms and their proprietary trading desks as they were no longer interested in making good on 1,000 share lots for the risk premium of even a thirty-second (1/32, not half a minute) or $.03125, half of a ‘steenth. Who benefitted? ECNs; big trading firms like Knight and the outgrowth to the birth of today’s dark pools and flash trading megaliths. Back in the Roaring 90’s, the regulatory argument was that the spread that was captured by the “market makers” and traders of the open outcry pits across America, was “unfair”. It breached the hull of “just and equitable principles of trade.” Right. Sure. Another idealistic bomb shot straight up and just like the Hindenburg, straight down. As for “just and equitable”, go try making that unfair spread argument to a sports bookie who takes in a portion of over 20,000,000 Americans’ bets on any given Sunday. When the market has certainty on the supply and demand side without fear of huge swings and such, it has less fear of participation, hence normalized supply and demand mechanics are at work, hence and perhaps a more normalized wealth accumulation effect without the elements of over-crowding out?

One need not see the outgrowth of man vs. machine as also having given birth to what Jeffery Sachs, noted economist from Columbia University confirmed today on Maria Bartiromo’s Wall Street Journal Report and that is that the percent of income share of the top 1% earners in America is 23% versus a historical average of 9%. I’ve mentioned this fact many times in the past year and it is a fact that comes out of adverse selection. Adverse selection has its roots in poor policy and administration. Poor policy and idealistic administration are externalities that have long range and damaging effects. Worse if they are compounded by poor congressional oversight, failure to correct abhorrent pronouncements and derisive regulatory schemes, and of course fruitless trillion dollar war boondoggles. Put them altogether and you have the worst parade of horribles since the Great Depression.

Spreads of Certainty for the Masses

Try walking into a bar and telling a guy who just finished a ten hour shift in a steel mill…

Oh, sorry about that. By count I believe we only have one steel mill left in the U.S. called Nucor and run by the brilliant American CEO, Dan DiMicco (but that’s another story for another day). Let’s try this.. Back to the guy who finished a ten hour shift stocking shelves at Walmart. Try telling that guy he shouldn’t drink that third cold beer on a hot summer day. Or better yet, how much of his hard earned money should go to the bartender for pouring out such fine libation and relief. That’s an example of sheer unadulterated opinionated interference. Try telling someone what’s good for them or not. See where it gets you. Try walking into a Best Buy and tell some woman on line at the check out counter that she shouldn’t pay $299 for Playstation3 for her son’s or daughter’s special birthday. Explain to them the virtues of cheap labor as she overpays for trans-shipping and price fraud. Get the picture? Try telling America about the evil spreads that men make or care to spend on what men make in order to keep a market efficient through human intervention or inefficiency. Do it today after the ether wears off and the average investor can understand what regulation gave us. Proselytize 1998’s story today. Do it and I bet they’ll string you up right quick.

I pause to think, if Werner Heisenberg were still alive he’d probably decry our failure to let our faults be the catalyst of fault tolerance and, ironically, the reduction of uncertainty. His theory on uncertainty is complex, yet very simple… “the more precisely one property is measured, the less precisely the other can be controlled, determined, or known.” So, let’s now say that the overcrowding of trading on the floor of the global stock exchanges and commodities pits are precisely measured by perfect machines and trading algorithms that have taken out human imperfection and replaced it with preciseness. How’s that working out lately?

In other words, its our imperfection(s) which makes us perfect and I dare say, probably keeps uncertainty out of the range of birthing black swans (severe market crashes). It’s our differences that make us the same and allows us to talk to one another, negotiate with one another (standing post on a trading floor with open outcry), and, at times, be on the right or wrong end of a skewed benefit of a bargain.  But that’s what makes it a horse race and the cost of betting in it. That’s risk. That’s Wall Street. That’s the whole concept behind investing… risk. Whether it’s a stock or a football game, risk is placing a bet in an attempt to gain from taking that risk.

Thus, in that human interaction filled with minor imperfections lay the true art of a “just and equitable” trade. In that imperfection is the principle that completes the “just and equitable principles of trade”. Beyond that, there is the principle of being human.  That man vs. machine is a losing battle fought on the ideal of protecting us from ourselves. I think Dr. Heisenberg may agree that we are human and our imperfections are the balancing beams to uncertainty. It took machines and an adversely selected market born from over regulation to cause the outgrowth of the most uncertain and most volatile capital market in the history of modern man. At the apex of exhausting risk and “unfair” pricing, the mountain of perfection has crashed on us, not once (2000-2002 tech crash), not twice (2008-2009 total crash), but three times (May 6, 2010 – for no good reason but a fat finger).

When machines manage the over concentration of wealth, the movements in the market can be death defying. What once was an army of blind monkeys, who could care less if a sloth ate a banana from a bunch, are no longer. Where are these market participants who were such the main concern of Arthur Levitt in 1998? Many have been camping outside the NYSE for the last 22 days. Many of the sloths (the market makers and floor traders) are working at Walmart today. We’ve lost touch with our ability to understand the unreasonableness of a proposition that is painted on the walls of sheer regulatory idealism and demagoguery.

The United States is said to have the most progressive and satiable capital markets in the world. Yet the volume of risk trading and investing from individuals who were sovereign to make their own blindfold decisions in the 90s (by reasoning of right or wrong – intuitive or fundamental or otherwise) has disappeared. Hence, the regulations born to make it safer did nothing of the sort. It has just kept Main Street where it is today… camped on Wall Street like the starving ready to bash in the Bastille.

And with that sovereignty has lost its virtue, such as trading one’s own stock brokerage account without fear of the machines born from irreverent regulation caused to interfere with a human to human, Party A to Party B transaction. It is long gone. And perhaps too, will be a quick clip and a slip of a blackjack bottle opener or the cling of a glass to a tap for a cold one. We keep going at this rate of denial and even bars may some day soon will soon be dispensing Norm’s brew from chilled automotons.

So lift your glasses to the architects of adverse selection. Here’s to Arthur, Harvey, Chris and Mary. You’ve all done a great job protecting against the former masters of the universe who gave a solid quote of 1,000 shares of anything for the risk of the spread. None have reversed the mistakes of the past and given Wall Street, the capital markets and investor confidence what it lacks and needs more than anything, the human thinking element.

“There can be no argument that machines evolve faster than man. Yet it is mankind’s imperfections that run aground the highest and best use of improving productivity for but for the want of yacht fleets to a single water skier. And thus is the game of Oligopoly, to further develop tools and use them to whatever advantage suits the Darwin resolve. Given the ultimate weapon of performance, survival of the fittest knows no bounds to equitable trade or fair market competition. The abuses uncovered in the latest Wall Street scandal – flash trading – has pointed directly to behemoths the likes of Goldman Sachs who continue to break with the very regulation that has been used to stifle smaller competition. For what is a speeding ticket to the Governor’s son?”

Dean Petkanas, Gone in Sixty Milliseconds or Less*, December 16, 2009