U.S. "Stock Market Is Rigged"

Courtesy of: CBS and 60 Minutes

Steve Kroft reports on a new book from Michael Lewis, "Flash Boys," that reveals how a group of unlikely characters discovered how some high speed traders work the stock market to their advantage.

 U.S. stock ownership is at a record low and less than half of Americans trust banks and financial services. And in the last two weeks, the New York attorney general and the Commodities Futures Trading Commission in Washington have both launched investigations into high-frequency computerized stock trading that now controls more than half the market.

How Brokers Became Bookies

The Insidious Transformation of Markets into Casinos

By ELLEN BROWN

July 14, 2010

Courtesy Of "CounterPunch"

“You all are the house, you're the bookie. [Your clients] are booking their bets with you. I don't know why we need to dress it up. It's a bet.”

- Senator Claire McCaskill, Senate Subcommittee investigating Goldman Sachs (Washington Post, April 27, 2010)

Ever since December 2008, the Federal Reserve has held short-term interest rates near zero. This was not only to try to stimulate the housing and credit markets but also to allow the federal government to increase its debt levels without increasing the interest tab picked up by the taxpayers. The total public U.S. debt increased by nearly 50% from 2006 to the end of 2009 (from about $8.5 trillion to $12.3 trillion), but the interest bill on the debt actually dropped (from $406 billion to $383 billion), because of this reduction in interest rates.

One of the dire unintended consequences of that maneuver, however, was that municipal governments across the country have been saddled with very costly bad derivatives bets. They were persuaded by their Wall Street advisers to buy credit default swaps to protect their loans against interest rates shooting up. Instead, rates proceeded to drop through the floor, a wholly unforeseeable and unnatural market condition caused by rate manipulations by the Fed. Instead of the banks bearing the losses in return for premiums paid by municipal governments, the governments have had to pay massive sums to the banks – to the point of bankrupting at least one city (Montgomery, Alabama).

Another unintended consequence of the plunge in interest rates has been that “savers” have been forced to become “speculators” or gamblers. When interest rates on safe corporate bonds were around 8%, a couple could aim for saving half a million dollars in their working careers and count on reaping $40,000 yearly in investment income, a sum that, along with social security, could make for a comfortable retirement. But very low interest rates on bonds have forced these once-prudent savers into the riskier and less predictable stock market, and the collapse of the stock market has forced them into even more speculative ventures in the form of derivatives, a glorified form of gambling. Pension funds, which have binding pension contracts entered into when interest was at much higher levels, need an 8% investment return to meet their commitments. In today’s market, they cannot make that sort of return without taking on higher risk, which means taking major losses when the risks materialize.

Derivatives are basically just bets. Like at a racetrack, you don’t need to own the thing you’re betting on in order to play. Derivative casinos have opened up on virtually anything that can go up or down or have a variable future outcome. You can bet on the price of tea in China, the success or failure of a movie, whether a country will default on its debt, or whether a particular piece of legislation will pass. The global market in derivative trades is now well over a quadrillion dollars – that’s a thousand trillion – and it is eating up resources that were at one time invested in productive enterprises. Why risk lending money to a corporation or buying its stock, when you can reap a better return betting on whether the stock will rise or fall?

The shift from investing to gambling means that not only are investors making very little of their money available to companies to produce goods and services, but the parties on one side of every speculative trade now have an interest in seeing the object of the bet fail, whether a company, a movie, a politician, or a country. Worse, high-speed program traders can actually manipulate the market so that the thing bet on is more likely to fail. Not only has the market become a casino, but the casino is rigged.

High frequency traders – a field led by Goldman Sachs -- use computer algorithms to automatically bet huge sums of money on minor shifts in price. These bets send signals to the market that can themselves cause the price of assets to shoot up or tumble down. By placing high-volume trades, the largest speculative traders can thus intentionally “fix” prices in any direction they want.

“Prediction” Markets

Casinos for betting on what something will do in the future have been elevated to the status of “prediction” markets, and they can cover a broad range of issues. MIT’s Technology Review launched a futures market for technological innovations, in order to bet on upcoming developments. The NewsFutures and TradeSports Exchanges enable people to wager on matters such as whether Tiger Woods will take another lover, or whether Bin Laden will be found in Afghanistan.

A 2008 conference of sports leaders in Auckland, New Zealand, featured Mark Davies, head of a sport betting exchange called Betfair. Davies observed that these betting exchanges, while clearly gambling forums, are little different from the trading done by financial firms such as JPMorgan. He said:

“I used to trade bonds at JPMorgan, and I can tell you that what our customers do is exactly the same as what I used to do in my previous life, with the single exception that where I had to pour over balance sheets and income statements, they pour over form and team-sheets.”

The online news outlet Slate monitors various prediction markets to provide readers with up-to-date information on the potential outcomes of political races. Two of the markets covered are the Iowa Electronic Markets and Intrade. Slate claims that these political casinos are consistently better at forecasting winners than pre-election polls. Participants bet real money 24 hours a day on the outcomes of a range of issues, including political races. Newsfutures and Casualobserver are similar, smaller exchanges.

Besides shifting the emphasis to gambling (“Why Vote When You Can Bet?” says Slate’s “Guide to All Political Markets”), prediction markets, like the stock market, can be rigged so that they actually affect outcomes. This became evident, for example, in 2008, when the John McCain campaign used the InTrade market to shift perception of his chances of winning. A supporter was able to single-handedly manipulate the price of McCain’s contract, causing it to move up in the market and prompting some mainstream media to report it as evidence that McCain was gaining in popularity.

Betting on Terrorism

The destructive potential of prediction markets became particularly apparent in one sponsored by the Pentagon, called the “policy analysis market” (PAM) or “terror futures market.” PAM was an attempt to use the predictive power of markets to forecast political events tied to the Middle East, including terrorist attacks. According to the New York Times, the PAM would have allowed trading of futures on political developments including terrorist attacks, coups d’état, and assassinations. The exchange was shut down a day after it launched, after commentators pointed out that the system made it far too easy to make money with terror attacks.

At a July 28, 2003 press conference Senators Byron L. Dorgan (DND) and Ron Wyden(DOR) spoke out against the exchange. Wyden stated, “The idea of a federal betting parlor on atrocities and terrorism is ridiculous and it's grotesque,” while Dorgan called it “useless, offensive and unbelievably stupid”.

“This appears to encourage terrorists to participate, either to profit from their terrorist activities or to bet against them in order to mislead U.S. intelligence authorities,” they said in a letter to Admiral John Poindexter, the director of the Terrorism Information Awareness Office, which developed the idea. A week after the exchange closed, Poindexter offered his resignation.

Carbon Credit Trading

A massive new derivatives market that could be highly destructive economically is the trading platform called Carbon Credit Trading, which is on its way to dwarfing world oil trade. The program would allow trading in “carbon allowances” (permitting companies to emit greenhouse gases) and in “carbon offsets” (allowing companies to emit beyond their allowance if they invest in emission-reducing projects elsewhere). It would also allow trading in carbon derivatives; for example, futures contracts to deliver a certain number of allowances at an agreed price and time.

Robert Shapiro, former undersecretary of commerce in the Clinton administration and a cofounder of the U.S. Climate Task Force, has warned, “We are on the verge of creating a new trillion-dollar market in financial assets that will be securitized, derivatized, and speculated by Wall Street like the mortgage-backed securities market.”

Eoin O’Carroll cautioned in the Christian Science Monitor:

“Many critics are pointing out that this new market for carbon derivatives could, without effective oversight, usher in another Wall Street free-for-all just like the one that precipitated the implosion of the global economy. . . . Just as the inability of homeowners to make good on their subprime mortgages ended up pulling the rug out from under the credit market, carbon offsets that are based on shaky greenhouse-gas mitigation projects could cause the carbon market to tank, with implications for the broader economy.”

The proposed form of cap and trade has not yet been passed in the U.S., but a new market in which traders can speculate on the future of allowances and offsets has already been launched. The largest players in the carbon credit trading market include firms such as Morgan Stanley, Barclays Capital, Fortis, Deutsche Bank, Rabobank, BNP Paribas, Sumitomo, Kommunalkredit, Credit Suisse, Merrill Lynch and Cantor Fitzgerald. Last year, the financial services industry had 130 lobbyists working on climate issues, compared to almost none in 2003. The lobbyists represented companies such as Goldman Sachs and JPMorgan Chase.

Billionaire financier George Soros says cap-and-trade will be easy for speculators to rig. “The system can be gamed,” he said last July at a London School of Economics seminar. “That’s why financial types like me like it — because there are financial opportunities.”

Time to Board Up the Casinos and Rethink Our Social Safety Net?

Our forebears considered gambling to be immoral and made it a crime. As the Industrial Revolution and the ascendance of capital changed religious mores, gambling gradually gained acceptance, but even within that permissive paradigm, derivative trading was originally considered an illegal form of gambling. Perhaps it is time to reinstate the gambling laws, board up the derivatives casinos, and return the stock market to what it was designed to be: a means of funneling the capital of investors into productive businesses.

Short of banning derivatives altogether, the derivatives business could be slowed up considerably by imposing a Tobin tax, a small tax on every financial trade. “Financial products” are virtually the only products left on the planet that are not currently subject to a sales tax; and at over a quadrillion dollars in trades annually, the market is huge.

A larger issue is how to ensure adequate retirement income for the population without forcing people into gambling with their life savings to supplement their meager social security checks. It may be time to rethink not only our banking and financial structure but the entire social umbrella that our Founding Fathers called the Common Wealth. The genius of Social Security was its recognition of the basic economic truth that real “security” rests on the ability of a society to provide for and take care of those who, because of age, health or economic conditions, cannot take care of themselves.

Deficit hawks cry that we cannot afford more spending; but according to Richard Cook, a former U.S. Treasury Department official, the government could print and spend several trillion new dollars into the money supply without causing price inflation. Writing in Global Research in April 2007, he noted that the U.S. Gross Domestic Product in 2006 came to $12.98 trillion, while the total national income came to only $10.23 trillion; and at least 10 percent of that income was reinvested rather than spent on goods and services. Total available purchasing power was thus only about $9.21 trillion, or $3.77 trillion less than the collective price of goods and services sold. Where did consumers get the extra $3.77 trillion? They had to borrow it, and they borrowed it from banks that created it with accounting entries on their books. If the government had replaced this bank-created money with debt-free government-created money, the total money supply would have remained unchanged. That means a whopping $3.77 trillion in new government-issued money could have been fed into the economy in 2006 without inflating prices. Different proposals have been made concerning how this money should be distributed, but at least some of it could be used to provide adequate social security checks, relieving the pressure to gamble with our savings.

The Federal Reserve has funneled $4.6 trillion to Wall Street in bailout money, most of it generated via “quantitative easing” (in effect, printing money); yet hyperinflation has not resulted. To the contrary, what we have today is Depression-style deflation. The M3 money supply shrank in the last year by 5.5 percent, and the rate at which it is shrinking is accelerating. The explanation for this anomaly is that the Fed’s $4.6 trillion added by quantitative easing fell far short of the estimated $10 trillion needed to “reflate” the money supply after the “shadow lenders” disappeared. When these investors discovered that the “triple-A” mortgage-backed securities they had been purchasing from Wall Street were actually very risky investments, they exited the market, credit dried up, and the money supply (which today consists almost entirely of credit or debt) collapsed.

The only viable way to reflate a collapsed money supply is to put more money into it; and creating the national money supply is the sovereign right of governments, not of banks. If the government wants to remain sovereign, it needs to reassert that right.

Ellen Brown is the author of Web of Debt: the Shocking Truth About Our Money System and How We Can Break Free. She can be reached through her website.  

More Red Flags For The Economy

By Mike Whitney

July 05, 2010

Courtesy Of "Information Clearing House"

Bonds are signaling that the recovery is in trouble. The yield on the 10-year Treasury (2.97 percent) has fallen to levels not seen since the peak of the crisis while the yield on the two-year note has dropped to historic lows. This is a sign of extreme pessimism. Investors are scared and moving into liquid assets. Their long-term expectations have grown dimmer while their confidence has begun to wane. Economist John Maynard Keynes examined the issue of confidence in his masterpiece "The General Theory of Employment, Interest and Money". He says:

"The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention.

The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast — on how highly we rate the likelihood of our best forecast turning out quite wrong."

Volatility, high unemployment, and a collapsing housing market are eroding investor confidence and adding to the gloominess. Economists who make their projections on the data alone, should revisit Keynes. Businesses and households have started to hoard and the cycle of deleveraging is still in its early stages. The winding down of the Fed's liquidity programs comes at the same time as Obama's fiscal stimulus begins to run out. Bank reserves are not getting into the hands of the people who will spend them and increase economic activity. These things all indicate a generalized tightening in the money supply. Soon, incomes will begin to contract and the CPI will turn from disinflation to deflation. Aggregate demand will weaken as households and consumers hunker down and increase personal savings. The financial crisis may be over, but the Depression has just begun. Here's how Nobel prize winner Paul Krugman sums it up:

"We are now, I fear, in the early stages of a third depression....And this third depression will be primarily a failure of policy. Around the world ... governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending. ... After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.


I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times." ("The Third Depression", Paul Krugman, New York Times)


More than 8 million jobs have been lost since the beginning of the crisis, and yet, President Barack Obama has made no attempt to initiate a second stimulus. Government spending must increase to make up for the slack in demand and to increase capacity. That means larger budget deficits until households have patched their balance sheets and can again spend at pre-crisis levels. Belt-tightening should wait until the economy is stronger. Withdrawing stimulus now, while the economy is still weak, will crimp spending, collapse state tax revenues and increase unemployment. Here's an excerpt from an article by James K. Galbraith which helps to explain what's needed to get back on track:

"The only way to reduce a deficit caused by unemployment is to reduce unemployment. And this must be done with a substantial component of private financing, which is to say by bank credit, if the public deficit is going to be reduced. This is a fact of accounting. It is not a matter of theory or ideology; it is merely a fact. The only way to grow out of our deficit is to cure the financial crisis.

To cure the financial crisis would require two comprehensive measures. The first is debt restructuring for the entire household sector, to restore private borrowing power. The second is a reconstruction of the banking system, effectively purging the toxic assets from bank balance sheets and also reforming the bank personnel and compensation and other practices that produced the financial crisis in the first place. To repeat: this is the only way to generate deficit-reducing, privately-funded growth and employment.

To be clear: unemployment can be cured without private-sector financing, if public deficits are large enough — as was done during World War II. But if the objective is to reduce public deficits, for whatever reason, then a large contribution from private credit is essential.

One more time: without private credit, deficit reduction plans through fiscal austerity, now or in the future, will fail. They cannot succeed." (James K. Galbraith, "Why the Fiscal Commission does not serve the American People", New Deal 2.0)

The economy cannot grow without private sector credit expansion. But the banks are constrained by toxic assets and a lack of creditworthy applicants. On the other hand, deleveraging households and consumers are less willing to borrow at any rate. Retirement age "boomers" have lost nearly $12 trillion in net wealth since the crisis began and must hunker-down and save for the years ahead. They are no longer in a position to spend freely anticipating their home equity will rise 10% or 15% per year creating a cushion for the future. In fact, bond yields indicate that retail investors have lost faith in both the housing and equities markets. These people have moved their savings into low-yielding, risk adverse assets-- US Treasuries. Here's what Keynes said on the topic:

"Our desire to hold Money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future.... The significance of this characteristic of money has usually been overlooked; and in so far as it has been noticed, the essential nature of the phenomenon has been misdescribed. For what has attracted attention has been the quantity of money which has been hoarded... supposed to have a direct proportionate effect on the price level through affecting the velocity of circulation. But the quantity of hoards can only be altered either if the total quantity of money is changed or if the quantity of current money income (I speak broadly) is changed; whereas fluctuations in the degree of confidence are capable of... modifying... the premium which has to be offered to induce people not to hoard. And changes in... liquidity preference... affect, not [consumer] prices, but the rate of interest...." (John Maynard Keyne, "1937 Quarterly Journal of Economics")

So, hoarding reduces spending which leads to economic contraction. But behavior can be altered by changing incentives, raising incomes or restoring confidence. Keynes was less sanguine about merely increasing the money supply which he compared to "trying to get fat by buying a larger belt". The point is to increase consumption, which means that money has to get in the hands of the people who will spend it to grow the economy. Bank reserves alone won't do the trick.

Presently--according to data collected by the Federal Reserve-- companies are hoarding capital due to the lack of investment opportunities. High unemployment has led to falling demand which is stifling investment. As households continue to deleverage, many companies will opt to pay down debt rather than seek new investments (as they did in Japan) This will further reduce economic activity and deepen the slump. The government must increase the deficits to offset cuts in state and private sector spending and to avoid another excruciating cycle of debt deflation.

The economy is at a tipping point. CPI is is slipping from disinflation to outright deflation. Unemployment has flattened out at 9.5%, but 650,000 discouraged workers have stopped looking for work altogether which will add to the slowdown. The cash-strapped states are laying off workers in droves. The rate of underemployment has soared to 16.5%. There are 6 applicants for every new job created. Conservatives believe that the ongoing crisis creates a unique opportunity to crush the labor movement and to force down wages. GOP senators and congressmen have quashed a bill that would extend unemployment benefits to over a million workers. Apart from the gratuitous cruelty of the action, their obstructionism only adds to deflationary pressures.

Nomura economist David Resler says that congress's action will have an immediate and damaging effect on the economy and could trim GDP by 0.2 percentage point this quarter and by 0.4 point in the period from July through September. (Bloomberg) Republicans are precipitating a crisis to garner support in the upcoming midterm elections, but they may not fully grasp the knock-on effects of their vote on their constituents. Here's a clip from economist Steven Keen on Naked Capitalism:

"The final debt-driven collapse, in which both wages and profitability plunge, gives the lie to the neoclassical perception that crises are caused by wages being too high, and the solution to the crisis is to reduce wages.

What their blinkered ignorance of the role of the finance sector obscures is that the essential class conflict in financial capitalism is not between workers and capitalists, but between financial and industrial capital. The rising level of debt directly leads to a falling worker share of GDP, while leaving industrial capital’s share unaffected until the final collapse drives it too into oblivion." (Steve Keen's Scary Minsky Model, Yves Smith, Naked Capitalism)

The FOMC's June statement was a real stunner. The economy is losing-ground in nearly every area. Household spending, business spending, bank lending and housing are all either beginning to slow or falling sharply. The Commerce Dept. revised its first quarter estimate of GDP from 3.0% to 2.7% due to lower than expected consumer spending. The recovery is largely a mirage created by inventory adjustments and fiscal stimulus. 46 of the 50 states are mired in huge deficits that will require substantial cuts to balance. That will be a drag on activity going forward. This is from Bloomberg News:

"States face a cumulative budget gap of $127.4 billion as 46 prepare for the start of their fiscal year on July 1, according to a report this month by the National Governors Association and the National Association of State Budget Officers. They will have to fill that hole largely on their own, as aid from the federal government under programs including President Barack Obama’s $787 billion stimulus package starts to wind down.


State and local governments will have to dismiss 162,000 workers if Congress fails to extend about $24 billion of Medicaid payments, Lawrence Mishel, president of the Economic Policy Institute in Washington, said during the governors’ call. Payrolls have already registered 11 straight months of year- over-year declines, the longest stretch of continuous drops since 1983, based on Labor Department data." (Bloomberg)

State budget cutting will swell the unemployment lines and slow consumer spending. With fiscal stimulus quickly running out and the deficit hawks pushing for greater austerity, the Fed will be forced to intervene in the 4th quarter resuming its quantitative easing bond purchasing program to pump more liquidity into the financial system. The recovery is not self sustaining.

In Europe, the scenario is much the same only worse. ECB head Jean-Claude Trichet has been preaching austerity while conducting a massive stealth bank bailout, providing limitless funds in exchange for dodgy collateral, overnight deposits for wary banks that no longer trust the repo market, and bond purchases of sovereign debt that is vastly overpriced given the fiscal position of the issuers. Germany is calling for additional belt tightening across the eurozone as a hedge against fictitious inflation. German policymakers don't see that their trade surpluses translate into deficits in the Club Med states, or that their solutions will only exacerbate existing imbalances, increase the deficits, and put the EU on course for another contraction. Here's an excerpt from the Wall Street Journal:

"Germany’s unwillingness to accept higher domestic levels of inflation in order to alleviate the burden of debt elsewhere in the euro zone ultimately constrains the European Central Bank in how much it can do on the monetary side....

... governments already nursing fragile financial sectors are being forced into some of the most severe austerity programs ever planned in modern developed economies at a time of rigid monetary policy.

If policy goes through as planned, a severe depression is almost certain to follow across peripheral euro-zone countries and a significant downturn elsewhere across the continent. Even European countries with power over their own monetary policy are bound to suffer from a euro-zone slump." ("Euro-Zone Policy Sets Stage for Depression", Allen Mattick, Wall Street Journal)

After Lehman Bros. collapsed in September 2008, the world was pulled back from the brink of depression by an activist Federal Reserve that (arbitrarily) assumed the authority of congress and conducted a massive rescue operation that provided unlimited liquidity and government support for teetering financial institutions. And, while the Fed's uneven treatment of Wall Street has been widely criticized, (the banks have been allowed to carry on much as they had before) the precipitous slide into the abyss was halted. Now, the congress seems eager to reverse that achievement for fleeting political gain.

It's important to understand the process so we can settle on a remedy. Economist Bradford DeLong explains what's going on with the economy and why it would be a mistake to count on the so-called "self correcting" powers of the market rather than government intervention. (additional fiscal stimulus) Here's an excerpt from DeLong's blog "Grasping Reality With Both Hands":

In our normal, microeconomic world it is not a big deal when excess demand emerges in one market and excess supply emerges in another.....But in macroeconomics things are different. The excess supply is economy-wide--throughout all commodity markets, producing supply in excess of demand for goods, services, labor, and capacity. Producers and entrepreneurs respond to an aggregate demand shortfall just as individual producers respond to a particular shortfall of demand for their products: they hold sales to liquidate inventories, they cut prices, they cut wages to try to preserve margins, they fire workers.

Thus workers fall into unemployment from the excess supply in the goods and services industries....

Wages should then fall. And when wages fall higher profits should induce employers to expand production even without any increase in spending. Eventually wages should fall low enough that the economy returns to full employment and to normal levels of production and capacity utilization even without any increase in asset supplies. Or will it? Falling wages means that households have even less money. Some of them will default on their loans. Some banks will find that their reserves are no longer large enough to provide an ample cushion because of these loan defaults........

Relying on nominal deflation of wages to restore full employment runs the risk of creating yet another shock of excess demand in finance and excess supply in goods and services to deepen the depression. The hoped-for cure's first effect is to worsen the disease.

We trust the market to take care of a microeconomic excess-demand excess-supply situation in a few industries in a productive way in a short period of time. Do we trust the market to do the same way to a macroeconomic imbalance, to quickly resolve a depression in a productive way without help? No, we do not. Rather than relying on economy-wide deflation to eventually restore balance, we should pursue other alternatives." ("Microeconomic and Macroeconomic Excess Supply", J. Bradford DeLong, Grasping Reality With Both Hands)

True, in some perverse sense, the market is "self correcting", but in this case, it would take years if not decades of high unemployment, overcapacity, dwindling investment and social unrest. Are we ready for that? The preferable solution is to plug the regulatory holes that allow financial institutions to speculate in massively- leveraged instruments that have implicit government guarantees (CDS, MBS, CDO), and to promote income growth so the supply/demand balance that is essential to economic growth is restored. The way out of this mess is more jobs and higher pay. And that will take public mobilization and whopping big deficits.