When the big banks crashed our economy, froze credit markets, and put the entire global economy on the brink, our government responded by giving the very banks that caused the problem a near limitless supply of free money. The number of bank executives in jail for financial crimes related to bilking the American public out of billions of dollars is exactly zero — and the obscene bonuses have continued to flow, albeit with a bit less fanfare.
Given that history, it should come as a surprise to no one that big banks continue to find ways to pad their own margins at the expense of everyone else. “Too big to fail” has evolved into “too big to regulate” — and here are some of the bad behaviors that have found new life, funded by nearly zero-percent interest taxpayer money.
If you think the government manipulates currency, they are mere amateurs compared to the quantitative sharks in the financial industry. Banks such as RBS, Lloyds, JPMorgan Chase, and Citigroup have either been fined by the Fed or are under investigation for manipulating the currency markets by quietly sharing pending orders from large customers. Instead of competing fairly in an open market, the big players applied the basics of game theory to the currency market and cooperated as a functional cartel, to rig the market and then exploit it individually.
Management at the big banks, like Captain Renault in Casablanca, were shocked, shocked to discover there were abuses of currency trading going on in their bank. All the same you’re not seeing any of them lining up to give back the winnings.
High Speed Trading
Imagine every time your 401(k) plan sent an order in to buy more stock for your portfolio, that a string of financial institutions all lined up to tack on a small fee for that order. While each institution may only extract a few pennies on each trade, the aggregate over time adds up to tens of millions of dollars in extra fees. The trades happen too fast for the hands of a human being on a keyboard, and are instead carried out by computers located on super-fast data backbone systems. Computers now account for 70% of all securities trades, with some high speed traders clicking off over 1,000 trades a minute.
Interestingly, the high speed traders don’t even have to make the actual trades. Many times these computerized traders can put an order in, then cancel it before the actual execution. Only if they happen to get in front of your trade can they bump the price a few pennies and actually execute the trades. You hardly notice because it was all so fast. Surprisingly this cheap chisel is still legal.
Imagine you have something to sell, like a portable hot dog cart that you see on the sidewalk outside of office buildings. Instead of just selling the hot dog cart, you buy a whole bunch of hot dog carts with money you borrow from the Federal Reserve, lease them to a management company to run for you, and bundle them up together in a security called HOTDOGZ. You then sell investors shares of HOTDOGZ, which earns them a future slice of the earnings from the leasing of all of those hot dog carts. Only it’s not just shares of HOTDOGZ that investors can trade, it’s other derivatives, like futures. Investors can make bets on the future of the hot dog business, buy purchases, puts, and calls, and trade those abstract elements besides the actual shares of HOTDOGZ.
Most of the time those “customers” for derivatives are actually other banks. RBS buys from Citigroup, Citigroup buys from JPMorgan Chase, which then turns around and sell the shares to their investment customers. Big banks and investment houses are on the phone with one another all day, each scratching the back of the other, providing a collective cartel market for these sometimes shabby collections of investments. Now you have a somewhat simplistic idea of how the derivatives market works.
If you’re thinking a convoluted process like that would be rife for abuse, you would be correct. It was, in fact, this very market, flooded with derivative investments based on subprime mortgages, that caused the economy to nearly collapse in 2008/2009. But the government passed laws to end those abuses, right? Yes and no; banks were saddled with additional capital requirements, money to cover the bills if these investment instruments went bad. The hilarious part is banks get that reserve cash from the Federal Reserve, and by extension the taxpayers, at 0.25% interest.
That’s why banks and investment houses have been howling like a gut-shot wild hog at the idea of the Fed raising interest rates. If they lose the free money gravy train, it’s going to raise the cost of running the derivatives casino. Instead of cleaning up their act, they’ve been lobbying your elected representatives to loosen up the capital requirements so they can keep their gambling habit.
The more things change, the more things stay the same in the cloistered world of big money investment houses.