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MAY 13, 2010 12:30AM

Things you may not know about the economy

Rate: 12 Flag

The last week has been filled with historic developments in the world economy, but it's easy to lose their significance when one is bombarded by the 100 ring circus of 21st Century capitalism.  When you're dealing with the world stock and bond markets, or the political machinations of Washington,DC or Europe it's easy to get lost in the billions of details.  Nevertheless, a few of the political and economic developments of late appear to me to be particularly significant in Wall Street, Washington, and Europe.

WALL STREET

The unprecedented 1000 point intraday drop in the Dow Jones Industrial Average has certainly been in the news.  And it's fairly interesting that to date, no one has found any easy explanation for the mysterious swan dive and instant recovery that manifested itself.

I may be wrong, but I remember a statistic to the effect that 70% of all the volume of trading on the various big boards in NYC is done by institutions on a regular basis lately.  And much of that volume is done with limited human intervention in the form of program trading.  Big firms from Goldman Sachs to Wells Fargo have computer operations established capable of making trades based on .oo1 of a cent.  These microscopic trades mean back and forth operations that can take place hundreds of times a second.  Since there are no commissions for market makers, these trades are free, and 99.9% of the time they make money.  Just look at the fact that all of the big banks have had positive, money making days trading for 61 working days in a row.

This infallability has been cobbled together by PhDs in mathematics and geniuses in computer programming, who are behind what people traditionally think as the boys in the pinstripe suits.  The problem is that the stock market, being what it is, has had two events in the last two years that should statistically happen only once every 100,000 years.  The first statistical anomaly was triggered by the collapse of Lehman Brothers in September, 2008.  The second was last week's flash crash.  All the math in the world cannot account for this kind of behavior.  As such, the stock markets can be seen as being similar to nuclear power plants or modern offshore drilling platforms.  They're incredibly reliable, until something really rare and bad happens.

WALL ST. IMPLICATIONS

This so far unexplained behavior of the market last week should put more political power into the Angelides Commission, which is responsible for examining the 2008 crash.  As such it should pave the way for more substantial reforms of the world of Wall St. in the future.  In the immediate future, this will put more wind in the sails of the Dodd legislation and the proposals put forward by President Obama on financial re-regulation.

More interestingly, this meltdown that wasn't is leaving even hardened apologists for Wall Street privately admitting that perhaps program trading is a bull in the china shop of finance.  This may strengthen the legislation put forward by Sen. Charles Schuemer of New York to ban program trading.  And it may put wind in the sales of the  few like Rep. Peter De Fazio who are calling for a 0.1%  tax on all stock all stock and bond transactions. Any eventual limitation or banning of program trading on Wall Street would mean profound changes from the way business is currently being done.

WASHINGTON, DC:  SANDERS -PAUL

But beyond this is yesterday's passage out of the US Senate of the Sanders Amendment.  Similar to legislation successfully passed out of the House under the leadership of Rep. Ron Paul, both pieces of legislation require a historic, first-time ever audit of Federal Reserve Board functions. I anticipate that a conference committee will hash out any differences between the House and Senate versions with veto-proof majorities eventually, giving President Obama no choice but to go along with the program or else.

IMPLICATIONS OF SANDERS-PAUL

While there will be many people spotlighted in a GAO audit once it comes out (Hank Paulson, Alan Greenspan, and Ben Bernacke in particular), the real person who should be sweating is none other than US Secretary of the Treasury, Timothy Geithner.  Geithner, who was Fed Reserve Governor of New York at the time of the economic meltdown was the man most responsible for monitoring all of the shenanigans on Wall Street from the continued blessing of financial sausage made from liars' loans to the pawning off of toxic CDOs on unsuspecting pension funds and other investors.

Geithner is also the man who admittedly made a series of inconsistent calls on financial triage.  He was the midwife that got Bear Stearns to liquidate a $70 per share stock for $2 a share, and he was the man who told Hank Paulson that nothing could  legally be done to save Lehman Brothers, and yet  the US Government almost immediately turned around and said that institutions like AIG, Merrill Lynch, and others could be saved through government intervention.

A dispassionate audit report from the Governmental Accountability Office may eventually supply plenty of kindling wood for the eventual burning of the current US Secretary of the Treasury.

THE EUROPEAN UNION

A similar about face in policy direction took place last week with Claude Trichet, head of the European Central Bank.  Up until last week Monsieur Trichet adamantly refused to offer the ECB's services to the Greek government, saying firmly that it was the responsibility of individual governments in the EU to keep their fiscal houses in order.  The fevered and secret meeting of EU finance ministers and other major Western world finance powers on May 8th through 10th produced a massive 750B Euro relief package that has been incorrectly dubbed Le Tarp.

Like the TARP and the Federal Reserve/Treasury, this package represents a radical departure from historic policy by providing a safety net for the immediate budgetary shortfalls of Greece, Spain, Portugal, Italy, and Ireland (also known as the PIIGS)  should the need arise.  And the ECB has opened up a window to buy the PIIGS securities on the open market to support their fiscal stability should the need arise.  This complicated plan also calls for the 19 members of the European Union to pony up any additional monies to cover the PIIGS defecits through their own budgets.  In other words, a run on the PIIGS means greater budget defecits for everyone in the European Union, as well as the United Kingdom, Canada, and Japan.

With even less coverage, the US Federal Reserve has put forward a minimum of $50B in its own funny money as loan guarantees through the backdoor of the International Monetary Fund.  Should it be activated, the bill in a bank run could impose as large a cost as $125B to the US Treasury.  This is because the United States government represents roughly 40% of financial participation of the IMF, and the IMF has committed 250B Euros to be set in play should the EU countries be threatened with default.

IMPLICATIONS

While Teabaggers may rage at the hanky panky of the Federal Reserve in this, actually for  the time being there appears to be very little to fear about such a committment being activated.  The financial markets were overjoyed, as seen by the 400 point rise in the Dow on May 10th.  There is general consensus in the financial community that the European financial crisis has been put to rest for the time being.  Any money that the IMF (and therefore the Fed commits) is like having a piece of heavy artillery.  It doesn't mean that this money will be spent.  That would happen only in the event that financial anarchy was let loose, requiring the firing of the big guns.

However, there are more disturbing long term trends in Europe that still hang over us like a thundercloud, and that is the populist reaction to the financial pain that will surely be inflicted on the PIIGS.  The European Central Bank and the IMF have both ladled out  the same bitter prescription for the PIIGS, and their citizens may choke when they try to down the medicine.  With the IMF's heavy hand of destroying countries ( historically including Somalia and Yugoslavia) based on a program of cutting pensions, social services, denationalizing industries,  lowering tarriffs that protect fragile local industries, cutting government employees, raising taxes and interest rates while a mini-depression is going on -- all of this reeks very strongly of the same kind of medicine that Herbert Hoover prescribed in 1930 and 1931.  And it may very well induce the same result in the PIIGS.

On top of this, wealthy European countries like Germany, Finland, and the Netherlands have elements that are chafing at the thought of having to go into defecit conditions to bail out their profligate Mediterranean brothers and Ireland.  The protesters in Athens may very well provide the talking points for the wealthier classes of Berlin and Amsterdam as they seek payback against German and Dutch government leaders who signed off on the EU emergency package.  At the very least, the structure of the European Union may be challenged in the next 18 months, and along with it the concept of the Euro.

The world markets have yet to see what this continentwide discontent will produce in this area.

-------------------

For regular readers of my column, you'll see that my first prediction about the events of 2010 was 100% wrong.  My idea of a gradual slippage of Spain and Portugal into trouble was a pipe dream.  The very few people in power who actually knew what was going on were not forthcoming in their private statements to the press and punditocracy. I think there was this concept about not wanting to scare the horses.

Unfortunately the horses, in the form of Greek, Spanish, and Portugese bond yields were already whinnying in outright fear when the EU had its series of  round the clock meetings, finally coming up with its complicated plan only hours before the markets in Asia were set to open.  Had the EU not taken action the way it did, it is most likely that there would have been yet another meltdown rivalling the meltdown on Wall St. in 2008.  Yes, we came that close to another financial nuclear disaster.

This demonstrates not only the difficulty of trying to predict the future, but the conspiratorial power of those few people who know all of the facts. Thank you, Monsieur Trichet.

 

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So what you're saying is, the world's economic stability is based on some computers trading imaginary money every day, billions moving through the world of 1s and zeros!!

**evil thought comes into the mind of Tink** Thank you kind sir, I'm off to destroy the world...oops, I mean, sell cookies for my daughter's girl scouts, yeah, that's it. What do you mean, I don't have any children?

None that you know of!! ~teeheehee~

RATED
Uhhh...the thing behind the world of trading is this ancient tome...GAAP...The Big Book of Generally Accepted Accounting Principles. I call it the Big Book Of Accounting Spells. I did a database transition for a big financial house some years ago, and those peeeple with that book! What a lot of hooey! You can't make the generally accepted crapola in that book fit into the logic of a database.

But, hey, what Tink said! hacketyhackhack...I mean those luscious thin mint girl scout cookies, gotta get some!! xox
Oh, and ONL...don't upon fear of death in hell every question the keepers of the ancient GAAP Book any questions regarding the lacki of logic in it. They will thump it and stare at you as if you are unwashed! xox
so were you in favor of the notorious original US bailout in sep2008? if so, how can you argue this one is different?
I mean, these people have something called Triple Witching Friday! What's up with my last comment? Those accountants are trying to get me! xox
wow, robin may be an IT geek. Im in luv
vzn...I was on the usenet before it was the internet...geek...yeah....like born to the line or something. I was a C programmer for 17 years...defense...I like long walks on the beach and a hot Perl poem...xox
vzn,
The EU is substantially different from the TARP, TALF, Freddie Mac, Fannie Mae, AIG stuff in a number of significant ways.

First, we're talking about the propping up of sovereign nations instead of mostly private corporations, even though profligacy and mismanagement are common to both at least for Greece. The situations in all the other countries have different causes of financial malaise, some of which stretch decades or even centuries back in history.

Secondly, the ECB is a much weaker institution than the US Federal Reserve or Treasury Department. The Fed has had a history of intervening historically, be it Mexico or Long Term Capital Management. All of this is done through the New York Fed's close working relations with the banks. Because of this, the EU had to get agreement not by phone with a few bankers, but through an unprecedented and prolonged negotiating session that had never taken place in history.

Thirdly, the 19 EU countries can be seen as a just barely contained herd of cats in this situation, making it much easier for any deal to fall apart politically than the TARP. Because the US has at least some standard operating procedures, it's easy to make the bailout stick compared to the EU.

Fourthly, the EU had to literally invent the financial gizmo from scratch with the provision that the 19 member countries (and associated auxillaries like the US, Great Britain, Japan, and Canada) would sign off on the plan.

All in all, this makes for a much more tentative, delicate, and failure prone situation than September, 2008. Because we did TARP didn't mean that we were in danger of abolishing the dollar. Unfortunately, there is still some risk (although small at this time )of the whole EU deal unraveling like a bad golf ball -- thus destroying the Euro and the EU.
Thanks for the great post. I think the government goes to great lengths to confuse the public about what's really going down with the US economy. You have really done a great job at demystifying the subject in ordinary language that is easy to understand. The only hope we have of reform is for people to understand what's really going on.
I have been studying the market with impunity in the past year, and I have to say that this post sums a lot. R
All of this reminds me of the farmer who told me he had a dog worth $10 Million Dollars - but he would sell it to me for $25K because he needed the money. When I asked to see this prized hound, he brought out an old beagle that had seen better days. I told him I'd need proof that the dog was worth $1o Million. He showed me a receipt of payment recording the sale of one $10 Million dollar dog in exchange for two $5 Million Dollar cats.
...as to brokers, did you hear the one about the guy who treks into the Amazon forest and offers to pay the natives $5 for every monkey they bring him? The natives start to comb the jungle for monkeys and they sell them to the guy for $5 each. In a week's time, the natives have cleared the jungle of monkeys and each native has made a small fortune. The guy tells them that he has to leave, but he is going to keep the monkeys in a cage in the village and his assistant will take care of the monkeys until the guy returns in a few weeks with the expectation that the jungle will, by then, have more monkeys to capture. And then he announces that when he returns, he will pay $25 for every monkey. The day after he leaves, his assistant puts a sign up on the monkey cage that reads "Monkeys for Sale $10 each". All the monkeys are sold in a few hours. The assistant leaves and neither man is ever seen again.....
I have the same problem with math. Too many numbers.
I feel like an ostrict who kept his head buried to long.
Great summary. I disagree on what the end will be for Geithner in the audit, but I enjoyed reading this and thinking about everything you have to say. Thanks.
My parents long ago taught me to stay away from that evil thing called the stock market. So I don't give a damn what it does!
Yes I know you will think that is childish. But I really don't give a damn. Us little people will survive one way or the other.
Hopefully, somebody will some day do to Goldman Sachs what was done in 2001 to Cantor Fitzgerald.
Robin is right about GAAP. Numbers are what you make of them. Look at the clean bill of health Enron got from its auditors until everything went south. And the same thing may happen with the GAO audit and the report of the Angelides Commission.

Unfortunately, Token Tarheel may be onto something. It's entirely possible that the flash crash could be put in the same basket as, "Who shot JFK?"

The Feral Conservative has of course revealed the flim-flam nature of Wall St through his jokes. Same as it ever was.

Actually, Saturn and I may both be right. Given the time frames necessary to put out a GAO report on a subject as big and complex as this, and given that even the youngest Cabinet members eventually tire of the 18 hour day, 7 day week work days -- we can see a replacement for Secretary Geithner with certainty before the end of the Obama administration. And Tim Geithner's retirement would have absolutely nothing to do with his term as NY Fed Governor! ;)

Jon, Goldman Sachs is an easy villian, too easy. Given the controlled anarachy of world capitalism with its extremely comples interactions between big businesses and governments, GS is only one of dozens of guilty players. And if you were to line up and shoot all of the employees of Goldman today, market dynamics guarantee that there would be immediate replacements.
Hey, ONL...yep...I think numbers can be manipulated any ole way people want...great piece, here...congrats on the cover!!! xox
with computers and glass fiber communication, it is possible to monitor business and financial activity now.

there is no need for unpleasant surprises. business done in public might be slow and boring, but it would be difficult for corruption and incompetence to ruin the economy.

it would also be difficult to get rich through insider knowledge and shady use of public assets. in short, continuing to allow politicians to run nations the way their progenitors, the bandits and invaders did, is no longer necessary and visibly counter productive for ordinary people.

i wonder if they will ever wise up...
Funny you should mention that, Al. Why if we eliminated the entire financial structure because we had to (there being no other choice), then the world economy would go back to the 19th Century where people solely invested for dividends and interest. Capital gains wouldn't mean a thing, and we'd be on the gold standard.

Don't laugh. It could happen. If anyone has any doubts about my paragraph, I would urge you to read the entire book (take notes!) entitled The Great Wave by David Hackett Fischer.
nice work, but kinda weak on the opinion. I did like the part about kindling wood for a geithner bonfire.
two economists you might try reading
a) stiglitz. & his critique of the IMF
b) john hudson. he talks about the IMF loans as the "proboscis of a parasite"
also try
c) "confessions of an economic hit man" by perkins
and congrats on the EP
-- 70% of all the volume of trading on the various big boards in NYC is done by institutions on a regular basis lately.

Likely higher. The 70% is the computer generated trades.

I agree with your general tenor. All of these machinations have been "trickle down" attempts to return to a level of income equity which last occurred during MonicaMan's administration.

Once again: It's the Distribution, Stupid. The real problem is that this works only be isolating one's economy from the rest of the globe in a Mercantilist way. That may not be possible. Unless we convince the rest of the globe we really will nuke 'em if they don't co-operate. It's not a co-incidence that the post war pleasantness derived from that threat. The global monetary system was controlled by the Dollar. Americans, many anyway, got an otherwise unwarranted comfortable lifestyle.
Already years ago I started to think that we others should build a tall fence round the American continent. To let somebody come out once in a year to tell if some people are still alive there. Most OS people could come on the other side of the fence before the construction would be ready. (Kyle Dykman is a bordering case. Maybe she could move to Island.)

All that crazy stock market capitalism should be banned on this side of the fence. On the other side they could do what they wanted. We wouldn't see their stock markets behind that black fence painted by tar.
The NYSE used to be run by humans. It used to use a technique called open outcry, where someone would bid on a stock, and someone would accept that bid, and then a transaction would take place. Back in those ancient days around the turn of the century, you wouldn't have had these computerized programs making trades in a fraction of a second.

There are a lot of benefits to electronic trading, but one of the things that we lost when open outcry went the way of the dodo is the interaction of humans with each other. Humans are not quick enough to see a fraction of a cent difference and trade on it. Machines are. And for all the talk of insider information that has nothing to do with it. That's great if you want to trade with humans, but with machines, before you can use that information, they've already made a trade.

What happens is that the machines buy something, and then they see it ticked up a penny. So they sell. And then they wait for it to fall a penny or two, and then they buy. And then it goes up a penny and they sell.

They're only making pennies but when you do this thousands of times a day, it adds up. There's nothing illegal or shady about it.

Is it rigged for the big money guys? Yes and no. The small investor can't play this game because he doesn't have the capital to do so. But the thing I've got on my side is an ability to not have to justify my returns to anyone but myself and the ability to move the needle with much smaller profits than a big player needs.
I appreciate Tony's defense of program trading. An argument can be made that such a thing benefits the efficient market theory. Unfortunately this does give the big boys a huge comparative advantage as opposed to us peons. And it highlights the growing nature of income inequality in this country and the world.

Just as you have market faith, I have faith in the concepts of a just and equitable society, and program trading does nothing more than concentrate wealth into speculative, non-productive investments. I will not bore you with the Marxist ruminations about what happens to societies when there is an overconcentration of wealth because we can see the effects of that every day in our society.

To end this note, I will refer you to Eisenhower Communism. Under the appartchik Ike we had a top income tax bracket of 90% along with a gross national product that doubled from 1945 to 1960, and in the process Ike put in some tchotskes like the interstate highway system. You don't see that kind of growth today
Old new, I'm neutral on program trading. I'm just explaining what's going on.

Another thing to remember is that small investors can play, too. The problem is that we have to pay commissions. Even if it's a tiny amount per share, when you're talking thousands of trades per day, it doesn't work. You've got to have direct access, like a market maker, and you've got to have enough capital to make money on a trade where the profit is a penny or two.