What should be allowed on the financial markets?

[Trembling Hand]

TH what part of "collusion" don't you understand ?

Basilio. You do know that a broker the size of UBS would have 100s of different funds and trading decks and clients and prop desks all doing different things. VASTLY different. All with clear and open objectives. Thats is why they are trading both ways in all stock all the time.


When we were cavemen sitting around the camp fire at night and heard a sound in the bush we would think "**** that is a Saber tooth tiger, I'm running". That brain function whether there was a tiger there or not saved us as a species.

Unfortunately it makes us crap investors, the sound in the bush has been replaced by adverse share moves and the first thing we think about is "bloody manipulators conspiring against my well-being".

 

[basilio]

I suggest we are getting off the topic again if we try to focus purely on LNC. I suggest it is only an example of what appears to be happening to a number of stocks.

Sinner and Skyquake have reproduced graphs to show the overall market situation Vs LNC. In many ways a fair point. The market has been poor and many companies have been affected. That doesn't necessarily mean all companies at all times should follow a trend does it ? I'm sure for example others can come up with quite sound reasons why particular companies still have a strong foundation and a good outlook - despite overall sentiment.

TH you point out that UBS have hundreds of brokers all doing different things. So what is the possibility that one of those different things is a spot of market manipulation that happens to turn a good profit ? Is this impossible ? If you see what happened in the trading activities of other large investor companies absolutely not.

Were you aware of one of the biggest deals that made money from the GFC ? One investor in particular John Paulson, came to he decision that there would be a bust in companies dealing with CDS's. (Credit Default Swaps) He believed the mortgages behind theses instruments were basically junk and that they would inevitablelyfail.

So to make money on this he wanted to place a very large bet against the CDS's. At that stage there were no companies willing or able to take the bet. The story is fascinating and is worth revisiting.

But at the heart of the matter was the conduct of Goldman Sachs in helping create financial instruments that in effect would have them betting against their own clients. And you suggest this can't happen ?

Goldman Sachs investigation could put Wall Street under microscope

• SEC looking into whether Paulson deal was one-off
• Fabrice Tourre described meeting as 'surreal'
• Bank of America Merrill Lynch, RBS and Barclays among banks active in sub-prime debt

Jill Treanor
The Guardian, Monday 19 April 2010 19.28 BST
Jump to comments (3)

Wall Street's bull: other banks that could come under the SEC's spotlight for underwriting financial instruments at the height of the credit crunch include Bank of America Merrill Lynch. Photograph: Charles Rex Arbogast/AP

As Fabrice Tourre sat through a meeting on 2 February 2007, he appeared to know he was taking part in an unusual event. The Goldman Sachs executive, who is at the heart of the $1bn fraud allegations being levelled against the Wall Street firm, emailed a colleague during the meeting to describe it as "surreal".

Tourre was sitting with hedge fund managers from Paulson and financial firm ACA to discuss the makeup of a complex financial instrument that was being structured to bet on the sub-prime mortgage industry.

Tourre's email stating "I am at this aca paulson meeting, this is surreal" was a reference to the fact that both sides of the transaction were sitting in the same room to discuss the list of 90 mortgage-backed securities that would be used to make up the collaterised debt obligation (CDO) known as Abacus.

The SEC alleges that while ACA did not know that fund manager John Paulson wanted to create the instrument so that he could bet against the sub-prime mortgage market, Tourre and his employer Goldman Sachs did.

Tourre's observation that this was "surreal" is now being analysed by Wall Street and City experts to establish how common it was for investment banks to create products for hedge funds to use to bet against other clients. While Goldman is adamant it will "vigorously" contest the action, it insists it was dealing with "professional investors" who were well informed about the specialist marketplace in which they were operating.

http://www.guardian.co.uk/business/2010/apr/19/sec-questions-paulson-deal-unique
http://online.wsj.com/article/SB10001424052748703574604574499740849179448.html

 

[Trembling Hand]

basilio I'll leave you to it.



Good luck......

 

[sinner]

So to make money on this he wanted to place a very large bet against the CDS's. At that stage there were no companies willing or able to take the bet. The story is fascinating and is worth revisiting.

Aside from the idea of sticking to LNC, I am not sure you understand the trade Paulson took on.

Institutions, especially those with fixed payout costs, were reaching heavily for yield in the runup to the GFC. They were long CDOs, essentially a bet that house prices would continue to rise (because otherwise no amount of yield could justify the risk of capital loss on these assets). Yields were higher than the market average but not really reflecting of risk they were taking on because rated by the agencies as AAA (due diligence problems again from both investors and ratings agencies).

This means that brokers like Goldman Sachs, in facilitating the supply for demand of CDOs, were short CDOs against their customers longs. If their customers in aggregate are desiring to be net long, they have to be net short. It's a simple fact of accounting.

How do you hedge a short CDO position to ensure you're not exposed to any price and credit risk? You buy CDS against those CDOs.

Paulson was betting against CDOs, not CDS, two vastly different products. Being long CDS when your firm is net short CDOs, is not really a big deal. You are only really betting against your own customers if you're long CDS in a greater proportion than the firm is net short CDOs.

 

[Zedd]

You think so!!

Zedd have you ever place a trade? Seriously! This is why this subject is just totally out their. Please!!

Eloquent rebuttal as usual TH. As the quote was at least a few pages into the paper I'm assuming you read some of it. Did you make it to the conclusion:

"The results presented above show that trade-based stock-price manipulation ... is consistent with rational utility-maximizing behaviour." A fairly concise summary of my POV.

Your comment that I initially responded to suggested there was absolutely no way someone could profit from trade-based manipulation. I think this paper defines and proves that in theory it is entirely possible, especially in a market with limited information.

Is there a flaw in their peer-reviewed model? Or do acknowledge the validity of the theoretical model but disagree with it's applications to the market? Do you believe that all areas of the markets have perfect information? What about trading algorithms? IMO they're a pretty good real world example of information-seekers as defined in the model...

As to my personal background, I am neither a researcher/academic nor a trader but I have been investing for the past 15 years, probably up to a max of 10 trades a year, so very much still a hobbyist. The last 2 years I've been studying a Master of Business majoring in Applied Finance with the view to switch from my current career into finance as I think it would better suit my interests. I believe though that even with my formal education and market exposure, nothing competes with real world experience in the actual industry, something I clearly do not have.

And yet while my knowledge and experience may pale in comparison to your own is irrelevant to the fact that a mechanism exists for trade-based manipulation which none of your sarcastic comments or allusions to your level of experience negate.

 

[basilio]

Thanks sinner for the correction. I just reread the document and as you pointed out, saw my error.

They met with bankers at Bear Stearns, Deutsche Bank, DB +0.87% Goldman Sachs, and other firms to ask if they would create securities””packages of mortgages called collateralized debt obligations, or CDOs””that Paulson & Co. could wager against.

The investment banks would sell the CDOs to clients who believed the value of the mortgages would hold up. Mr. Paulson would buy CDS insurance on the CDO mortgage investments””a bet that they would fall in value. This way, Mr. Paulson could wager against $1 billion or so of mortgage debt in one fell swoop.

What it does remind of was the more complete story of how John Paulson pulled his deal. He accessed Goldman Sachs mortgage accounts and managed to handpick what he could clearly see were the most likely to fail mortgages. These were the ones he managed to get Goldman Sachs to bundle and sell to their clients as AAA rated securities.

I brought this point up to illustrate the (non existent) ethical standards of the finance industry. It also demonstrates their capacity to dream up more and more obscure financial instruments to enable people to bet against. I believe it is George Soros who has said that the financial derivatives market is a just a time bomb.

But back to the theme of this thread. Should these instruments be allowed ? What do they achieve ? What are the risks ? Given the central role that financial institutions play in keeping commerce going is it just too great a risk for all of us to allow unfettered freedom to these particularly creative and ethically challenged people ?

 

[sinner]

And yet while my knowledge and experience may pale in comparison to your own is irrelevant to the fact that a mechanism exists for trade-based manipulation which none of your sarcastic comments or allusions to your level of experience negate.

The point is that a theoretical mechanism exists, in reality, every day in the markets, it's not like that at all. Theory is very very very far away from reality. This sort of manipulation is only ever going to be remotely effective in markets where there is an expectation of liquidity, and that liquidity has been withdrawn! Everywhere else, all the time, theory is the opposite of reality.

But back to the theme of this thread. Should these instruments be allowed ? What do they achieve ? What are the risks ? Given the central role that financial institutions play in keeping commerce going is it just too great a risk for all of us to allow unfettered freedom to these particularly creative and ethically challenged people ?

I'm with TH and leave you to it at this point, as it's not so much a discussion as

 

[CanOz]

Thanks sinner for the correction. I just reread the document and as you pointed out, saw my error.



What it does remind of was the more complete story of how John Paulson pulled his deal. He accessed Goldman Sachs mortgage accounts and managed to handpick what he could clearly see were the most likely to fail mortgages. These were the ones he managed to get Goldman Sachs to bundle and sell to their clients as AAA rated securities.

I brought this point up to illustrate the (non existent) ethical standards of the finance industry. It also demonstrates their capacity to dream up more and more obscure financial instruments to enable people to bet against. I believe it is George Soros who has said that the financial derivatives market is a just a time bomb.

But back to the theme of this thread. Should these instruments be allowed ? What do they achieve ? What are the risks ? Given the central role that financial institutions play in keeping commerce going is it just too great a risk for all of us to allow unfettered freedom to these particularly creative and ethically challenged people ?

This thread has changed from a theme of market manipulation in the auction markets to market manipulation and fraud in the Banking industry....

The latter is serious and was arguably responsible for the largest transfer of wealth in history....

CanOz

 

[Zedd]

The point is that a theoretical mechanism exists, in reality ... theory is the opposite of reality.

I realise that I've bastardized your quote but it summarises what I felt it added to the discussion.

While I don't think "reality" is the correct term, I agree that trade-based manipulation is only effective under certain scenarios. Much the same as insider trading, or information-based manipulation can only occur in certain scenarios also. In a largely-efficient, well-informed market these scenarios should be rare.

Again, my initial response was putting forward a theoretical response to a question about possiblities - to me that makes sense, if you want to consider if something is possible, you first start by considering possible theories, not blindly searching through mountains of data.

I appologise if this feels like . I'm genuinely interested in responses, especially from expereinced traders or investors. Unfortunately I consider statements like 'in the real-world', without elaborating further, to hold considerably less weight than a peer-reviewed paper.

If you want to use your experience as evidence/argument than perhaps a different approach would be to explain why such manipuation couldn't possibly affect your trading strategy personally. I'm learning, slowly, about different TA methods. It seems to me that there are a number of methods that would be susceptible to trade-based manipulation.

 

[Trembling Hand]

I'm genuinely interested in responses, especially from expereinced traders or investors. Unfortunately I consider statements like 'in the real-world', without elaborating further, to hold considerably less weight than a peer-reviewed paper.

Peer review isn't worth the paper it written on if its not based on real events. The trouble with your experts is that they actually are not anywhere near experts. They actually have NO experience.

If you want to use your experience as evidence/argument than perhaps a different approach would be to explain why such manipuation couldn't possibly affect your trading strategy personally.

I actually did. With this example. here


I have today traded stuff thats , my guess, 200 times their annual wage that they get "paid" to write this crap. Virtually all has been AGAINST idiots trying to push the extremes. How much do you think your experts with their peer reviewed papers have traded? How much have they made from their "theoretical" example. I'll have a pretty good guess and say ZERO.

 

[skyQuake]

I realise that I've bastardized your quote but it summarises what I felt it added to the discussion.

While I don't think "reality" is the correct term, I agree that trade-based manipulation is only effective under certain scenarios. Much the same as insider trading, or information-based manipulation can only occur in certain scenarios also. In a largely-efficient, well-informed market these scenarios should be rare.

Again, my initial response was putting forward a theoretical response to a question about possiblities - to me that makes sense, if you want to consider if something is possible, you first start by considering possible theories, not blindly searching through mountains of data.

I appologise if this feels like . I'm genuinely interested in responses, especially from expereinced traders or investors. Unfortunately I consider statements like 'in the real-world', without elaborating further, to hold considerably less weight than a peer-reviewed paper.

If you want to use your experience as evidence/argument than perhaps a different approach would be to explain why such manipuation couldn't possibly affect your trading strategy personally. I'm learning, slowly, about different TA methods. It seems to me that there are a number of methods that would be susceptible to trade-based manipulation.

I understand where you're coming from. Ranking a peer reviewed paper above strangers on the interwebs.

However trading and investing is a field where no formal education exists, anyone competent enough aint writing papers, but making real money. Consider for example the CAPM or the Efficient Market Hypothesis which were peer reviewed.
Thus the general disregard for academia and "theory".

The reason why this particular theory fails is that 1) Most stocks are not in equilibrium. 2) The manipulator does not know who/what is behind any particular move - it could be an informed investor, or it could be passive funds, could be algos. ie. there is imperfect information, and there is generally someone bigger that knows more than the manipulator and will see his actions as free money.

Take MBN for example.



Say the manipulator took an interest at 30c. What would he do?
a)Manipulate the stock up as to fake a breakout? In hindsight it wouldn't work because there is a large insto seller that would be happy to get better prices. The manipulator's volume would be absorbed and now he has to get out, and compete with the insto seller.
b)Manipulate the stock down? First he needs to establish a short position, which means he will fight the insto for liquidity, aggravating the downmove and giving him a crappy fill. Then manipulate the stock down some more? What if it turns out the insto is actually done selling? What if the insto crosses the last dredges of its sell to some big holders who also start buying stock?
c)If he's really clever he'll try create some kind of break from the downtrend by aggressively buying. Then as punters pile on, he'll sell what he's bought and establish a short position, hopefully while the stock is still up, and hopefully his aggressive buying wasn't absorbed the insto's even more aggressive selling.

imo scenarios b) and c) the manipulator is more of a swing trader.

The hindsight that revealed the big insto trailer is the 46mil share crossing early May at 16c. That was the end of the insto selling so to speak.

 

[Zedd]

The reason why this particular theory fails is that 1) Most stocks are not in equilibrium. 2) The manipulator does not know who/what is behind any particular move - it could be an informed investor, or it could be passive funds, could be algos. ie. there is imperfect information, and there is generally someone bigger that knows more than the manipulator and will see his actions as free money.

I completely agree that there is generally someone more informed, or bigger to invalidate any attempts to manipulate. I have never once disputed that.

imo scenarios b) and c) the manipulator is more of a swing trader.

By definition if they try to change the market through a trade they're a manipulator. If at any time someone places a trade, or even makes a statement on somewhere as insignificant as a public forum, with the intention that their action causes a market reaction it's market manipulation.

I'm still a little surprised that my initial comment led to such a discussion as I assumed that everyone acknowledged it was theoretically possible but in practice rare. I personally believe there are some individuals operating on the fringes of markets profiting off pump and dump methods of very spec. stocks, but don't buy into the conspiracy that large institutions are. If you think this is paranoia so be it.

Where I thought this thread was going to go was more along the lines of unintentional market manipulation by large institutions and whether certain practices should be regulated/limited to prevent this. Kind of along the conceptual lines of breaking up banks before they get too big to fail. ie. If an institution's activities are so large, relative to the market they're operating in, that it moves the market away from it's "fundamental value" then is this against the fundamental principles of a market, is it manipulation and should something be done?

I would have thought this was an interesting question, and something that those with industry experience could weigh in on. Personally I was planning on watching that discussion from the sidelines as I don't have nearly enough understanding of the day-to-day balancing of accounts/shorts/derivatives etc. to comment.

 

[skc]

By definition if they try to change the market through a trade they're a manipulator.

Is this the right definition for market manipulation? If someone is placing a trade in the market, they are putting their capital at risk and is on the exact same level playing field as everyone else. They do not gain an unfair advantage.

They do not know beforehand that someone else will assume their action as more informed and hence follow suit.
Whether their intention is to cause a market reaction is irrelevant. If you chooses to make a decision based on the action of others - who's responsible?

Not to mention it is also impossible to police this kind of "manipulation". An insto just sold 20m shares... unless the trader documented their intention, their action is completely indifferent whether they are trying to "manipulate" the market or are just trading to sell in a hurry.

Indeed, if you are a long term investor, a market manipulator (by your definition) should be your best friend. If they push the price down irrationally you get to acquire cheap stock. If they push the price up irrationally you get to exit above fundamental value.

I agree things like deliberate false information or rumours are manipulation, as well as any false market activities (e.g. trading amongst associates). But these activities are already illegal AFAIK.

 

[Zedd]

Definition holds where the intent is to manipulate. Questionable as mentioned before as to whether unintentional reactions can be considered manipulation. You've touched on a separate issue though which is - "Is all market manipulation bad?" Similar argument with insider trading. Insider trading allows more information to be incorporated into the price so is arguably creating a more efficient market.

I think it's a question of magnitude of effect on perception and operation of the market.