Corbett counts off seven ways the markets are manipulated, from bots, plunge protection, insiders, shorting, and many more of the dirty tricks your money encounters one way or another when you invest.
#1 – High-frequency trading
Anyone who plays the markets knows that timing is everything. If you can sell at the start of a slide or buy at the beginning of a rally, you win. If you can't, you lose. Every second counts, or at least that's how it used to be. These days, every millisecond counts. What, you can't buy and sell stocks thousands of times per second? Well, the bots that increasingly drive the equities, futures, options and currency markets can. What, you don't think these computer algorithms are driving the market? The latest Morgan Stanley estimates show that a staggering 84% of stock trades are now done by bots. What, you can't afford to create a proprietary trading algorithm to handle your portfolio? That's the point. Only the global financial services firms can afford to play in these leagues, and they're the ones who get to benefit from what amounts to legalized front running. When it works “well” it ensures that the big boys are in front of every run up and sell off. When it doesn't work so well you get a flash crash, like the one in May 2010 that wiped out $862 billion in one frantic hour of bot-fueled selling frenzy or the recent Knight Capital fiasco where an errant bot went rogue and nearly wiped out the company. Never mind that all of this was actually predicted by some of the very people who actually helped to assemble the high-frequency trading desks in the first place, the financial talking heads will continue to scratch their heads over these market “anomalies” and reassure the mom and pop investor that their money is safe in the markets.
#2 – The Plunge Protection Team
Hardly a week went by in my regular interviews with Bob Chapman that he would fail to mention the actions of the President's Working Group on Financial Matters, aka the “plunge protection team.” Officially created by Executive Order 12631 signed off on by President Reagan in March 1988, the group was ostensibly formed to prevent a repeat of the Black Monday plunge of October 1987. Although the Washington critters and their Wall Street string-pullers will swear till they're blue in the face that they don't “manipulate” the markets, this is in fact that the group's raison d'être. According to the Executive Order itself, the group's purpose is “enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets and maintaining investor confidence.” Nice sounding platitudes, but how is this actually accomplished? Just take a look at the DJIA or the S&P 500 from 3:00 PM on a day where the markets are falling and options are expiring. You couldn't draw a straighter upward line on the graph with a ruler. In fact, on a day like February 22, 2008 you can find every market in the world from New York to Berlin to Mexico to Hong Kong take off in the exact same way at the exact same moment. Coincidence, surely.
#3 – Naked Shorting
So let's say you borrow your friend's beat up old car for the weekend. But instead of driving it around, you sell it to some chump who doesn't understand cars. By the end of the weekend, he's willing to sell it back to you for less than he paid just to get the clunker off his hands. You give it back to your friend on Monday morning and pocket the profit you made on the sale and buy back. Now think of this with stocks instead of cars. That's shorting, and as a counterbalance on the upward tendencies of most exchanges it has been a valuable check on the markets for centuries. But now imagine that instead of selling your friend's car, you sell someone a piece of paper saying that they can have your friend's car sometime in the future. The only problem being that your friend doesn't have a car. This, more or less, is naked shorting. Essentially, people are selling stocks that don't exist into the market in the hopes that the company whose non-existent shares are being sold will go out of business before anyone's the wiser, thus wiping out your obligation to produce the shares. This is a cancer on the markets, and it can be used to take down companies altogether by inflating their stock down to toilet paper. This is especially effective in taking down small companies and juniors who don't have a lot of shares floating around in the first place. It has been used to artificially keep silver prices orders of magnitude below where they should be. And in 2008, it was used to help bring down Lehman Brothers. 32.8 million shares were sold but not delivered in September, right before the company collapsed. The delivery date for the options? September 11. Four days later Lehman collapsed under $613 billion in debt, sparking a worldwide banking crisis the effects of which we are still feeling today.
#4 – Selective Enforcement
Take the case of William D. Strong of Springfield, Missouri. He was convicted this month for a real estate scam in which he sold investors on a scheme to purchase homes chosen by his investment firm, Greenleaf Companies, on the understanding that Greenleaf would pay the monthly mortgage and buy the investors out after several years. Instead, it sold the properties (which it didn't own) to buyers in the subprime market and left the investors on the hook for the mortgages, causing many of them to be foreclosed on. He is now awaiting sentencing for his crime, and rightly so. Compare this with Goldman Sachs, the multinational investment banking and financial services giant with total assets of $923 billion. After a congressional investigation found the firm guilty of having “designed, marketed, and sold CDOs in ways that created conflicts of interest with the firm’s clients and at times led to the bank’s profiting from the same products that caused substantial losses for its clients,” the report was referred to the Justice Department for potential criminal prosecution. This month, word came back: no prosecution will result from these congressionally certified frauds. This is just one of many such examples of the big boys at the top being let off easy, of course. AIG, Citibank, JP Morgan, Freddie Mac. They have all had giant investigations into their own frauds and abuses, sometimes resulting in billions of dollars of fines, but no criminal prosecutions. Often, the “big fines” that result from these investigations are a drop in the bucket compared to the money that was made. Think of the $25 billion foreclosuregate settlement. It would have taken investigators years to sort out the ultimate ownership of all of these properties, assuming it could ever be sorted out at all. Instead of pursuing the investigation, the DOJ just capped the negotiations at $25 bil and dusted their hands of the affair. And who pays in the end? Mainly the pensions and other institutional investors in mortgage backed securities. And who went to jail for this? No one. The lesson? If you're going to commit fraud, do it in a big way...and then convince the government that you're “too big to jail.”
#5 – Insider Trading
In 2008, the US government began an operation called “Perfect Hedge” that is billed as an “unprecedented crackdown” on insider trading. So far over 60 people have been charged in the investigation and over 50 convicted. The investigation is looking into ways that inside information are passed through to well-connected investors and includes probes into the “expert network” services that counsel hedge funds and mutual funds. Gallons of ink have been spilled in praise of the hardworking FBI agents and other government officials who have been investigating and prosecuting these manipulations. The problem? A new paper out from the University of Michigan last month indicates that insider trading has actually increased during this period of “unprecedented” crackdown. This will not be surprising to those who have watched the frauds and abuses of the Wall Street set becoming more and more brazen as the stakes become ever higher, but studies like this show that even if “Perfect Hedge” is doing its level best to crack down on the insider trading scourge, it's fighting an uphill battle...and losing. All indications are that insider trading is as rampant as ever, and increasing all the time.
#6 – Rate rigging
Although it seems like yesterday's news to those who have spent the last few weeks soaking up the summer sun, the financial world is still only beginning to process the long-term effects and the ramifications of the largest financial scam in history: the Libor rate-fixing scam. As we pointed out in these pages last month, hundreds of trillions of dollars of financial instruments are based on the Libor rates, and the knock-on effects of the rate rigging that these banks have engaged in are literally incalculable. For starters there are tens of trillions of dollars in mortgages, credit cards, student loans and other debts that are tied directly to the Libor rate. Fix the rate and you manipulate the market, mostly to the detriment of those homeowners, students, credit card holders and other debtors. Then there are the hundreds of trillions of dollars of derivatives that are linked to Libor. No one even knows the ultimate value of the derivatives market, but it's safe to say it's an order of magnitude larger than the GDP of the entire planet. Fix the Libor rate and this market, too, is manipulated, generally to the detriment of the pension funds and other institutional investors sitting across from the banks on their derivative deals. Now we know that Libor rates were being rigged for years, with at the very least the tacit approval of the central banks, the regulators, and all of the other players who woulda/coulda/shoulda intervened to stop it. The only question left is who knew what when...and what price will be paid. Given point #4 above, the answer is likely to be “not very much.” Of course, this is just the rate-fixing scandal that we know about. Now ask yourself how much you trust that other, similar rates at the root of the economy are arrived at through an impartial, above-board, fair and open process?
#7 – Back door trading
Richard Andrew Grove is a former enterprise software sales rep who blew the whistle on a massive Wall Street corruption scheme centering on the Sarbanes-Oxley Act of 2002. Passed in the wake of the Enron/Tyco/Worldcom accounting scandals, Sarbanes-Oxley was supposed to close accounting loopholes, toughen reporting standards, and tighten regulations to make sure scandals of this magnitude never happened again. The Act requires certain financial service companies to buy specific compliance software, software that would theoretically make it impossible for Wall Street executives to erase any data related to their transactions. Grove discovered that the software he was selling, the very government-mandated software that was supposed to stop accounting fraud from occurring, contained a backdoor that actually allowed that fraud to take place in a completely untraceable manner. He went to the SEC with the information, but instead of plugging the back door in the software, the SEC turned him away and then bought the software for their own record keeping. Why have you never heard of this remarkable story, despite Grove's attempts to work with Lowell Bergman, John Stossel and other nationally-recognized journalists to get the details of this ongoing fraud to the public? I think you know the answer by now.
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