Kevin Drum

Goldman's Billions

| Fri Jul. 24, 2009 12:59 AM EDT

Earlier this month Matthew Goldstein of Reuters broke the story of Sergey Aleynikov, a naturalized Russian immigrant who's been charged with stealing trade secrets from Goldman Sachs.  The secret in question was computer code.  In particular, according to the feds, it was 32 megabytes of code that Aleynikov encrypted and uploaded to a UK-owned website in Germany prior to leaving Goldman to go work for a competitor at a much, much higher salary.

And what did this incredibly valuable code do?  Answer: it ran Goldman's high frequency trading operation, and it's drawn attention to the shadowy but wildly lucrative HFT trading sector.

Basically, HFT relies on speed.  Traders buy and sell stock thousands of times a second and their profits rely on being able make their trades slightly before ordinary traders make theirs.  Speed is so important that a key component of HFT — aside from fast computers, big pipes, and rocket science code — is colocation of their servers.  That is, they set up their operations physically close to stock exchange data centers so that trading data has less distance to travel before it gets to them.  A few milliseconds in reduced latency time makes all the difference.  And that's not all: you'll be unsurprised to learn that there's a regulatory loophole that provides HFT traders with yet another advantage over ordinary schmoes. The New York Times provides an example today of how it all works:

It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: the hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors’ upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.

Tyler Durden has been all over this for a while and estimates that HFT might account for as much as a quarter of Goldman's total earnings.  And here I always thought that fixed income trading was where all the money was. Live and learn.

Anyway, HFT has turned into an arms race, but it's an arms race that only the elite are allowed to play.  You and I just get to foot the bill, a tenth of a cent at a time.  Sound familiar?

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MoJo Mix: 23 July 2009

| Thu Jul. 23, 2009 6:11 PM EDT

Hey, Laura again. Kevin's usually optimistic about health care reform on odd-numbered days, but the news out of Congress is none too cheery at the moment, as you know. So, consider these 4 story recommendations your reform news chasers for the week:

1) Apocalypse Ciao: When the economic Rapture comes, will collapsitarians be the chosen ones?

2) Hippie, put your clothes on. California doesn't want to see your naughty bits at the beach anymore.

3) A zombie meme returns: Vaccines still don't cause autism. But you wouldn't know it from the comments on this article.

4) The Going Galt movement protests Obama with a collective shrug.

And what the heck, 5) A video of Amy Poehler hearting on Mother Jones with Sarah Silverman and a few other very funny ladies.

Laura McClure hosts podcasts, writes the MoJo Mix, and is the new media editor at Mother Jones. Read her investigative feature on lifehacking gurus in the latest issue of Mother Jones.

Global Warming Charlatanism

| Thu Jul. 23, 2009 4:57 PM EDT

Ezra Klein is puzzled:

I've gotten a bunch of requests for a response to George Will's assertion that “If you’re 29, there has been no global warming for your entire adult life.” I'm actually puzzled enough by that comment to not really know how to respond.

Sigh.  Here's the deal: Will is being cute.  If you're 29, you became an adult in 1998, and average global temperatures last year were lower than they were in 1998. So: no global warming in your adult lifetime.

In case you've missed it, this is the new favorite talking point from the chucklehead denialist set.  The earth is actually cooling!  But as about a thousand serious climate researchers have pointed out, it's not true.  Global temps have been trending up for over a century, but in any particular year they can spike up and down quite a bit.  In 1998 they spiked up far above the trend line and last year they spiked below the trend line.  So 2008 was cooler than 1998.

Of course, you can prove anything you want if you cherry pick your starting and ending points carefully enough.  For example: The year 2000 was below the trend line and 2005 was above it.  Temps were up 0.4°C in only five years!  The seas will be boiling by 2050!

This is idiotic, and only deliberate charlatans who think they have an especially gullible audience bother with it.  It's the trend line that matters, and the trend line has been going up for decades right along with rising CO2 concentrations.  Listen to the climatologists, not the charlatans.

Is the Geithner Plan Working?

| Thu Jul. 23, 2009 3:16 PM EDT

As I mentioned last night, big banks are handing out big paychecks again.  Matt Yglesias says this is all part of the plan:

The Obama administration didn’t want large financial institutions to fail. They also didn’t want to try to get congress to appropriate funds on the scale that would be needed to take the banks over, clean house, and recapitalize them publicly. What they came up with was a strategy of implicit and explicit guarantees designed to allow financial institutions to recapitalize themselves through profits. And big profits mean big paychecks. This is an ugly solution to the problem, but for whatever it’s worth it’s working.

That's true.  The idea that banks could be safely recapitalized via earnings was explicitly part of the Obama/Geithner plan.  And maybe this was safer than pessimists like me thought, since the two weakest banks, Citi and Bank of America, had already received massive federal guarantees on their toxic assets in addition to their TARP money.

Still and all, I'd caution that it's only working so far. The Geithner plan leaves the banking sector fairly weak, and while this is OK as long as things continue to improve, it could yet become a big problem if there's another shock and things take a turn for the worse.  So let's hope there aren't any more shocks.

Chart of the Day

| Thu Jul. 23, 2009 1:27 PM EDT

Maybe you know this, maybe you don't, but generally speaking you can't sue your credit card company if you have a dispute with them.  The fine print in your contract says that all disputes have to be resolved by an arbitrator.  And not just any arbitrator: it has to be one chosen by the credit card company.  Probably one with a record of siding against the consumer 99.8% of the time.

But those days may be ending thanks to Lori Swanson, the attorney general of Minnesota.  She sued one of the two biggest arbitration outfits in the country last week and they caved almost immediately.  Within days they announced they'd no longer be taking new cases.

So what was Swanson's complaint?  Simple: it turns out the National Arbitration Forum had affiliated itself with a debt collection conglomerate, something that might have made them just a wee bit less than perfectly neutral in consumer debt disputes.  The affiliation was done through a chain of intermediaries to try and keep everything on the QT, but it was still there.  The chart on the right shows how it worked.  Here's the explanation from the court filing:

Accretive, Agora, Axiant, the Forum, and Mann Bracken form a complex web of companies that compose some of the largest debt collectors and arbitrators of consumer credit card debt in the country.

....In June 2006, principals of Accretive, LLC met in Minnesota with Edward Anderson and Michael Kelly, officers of the National Arbitration Forum....Among other things, Accretive promised the Forum that it could provide it with “[i]ntroduction to legal collections individuals” and stated that “we believe Accretive would be a great partner to help NAF become a billion dollar company.”

....Under the proposal, Cline’s company — Accretive, LLC — would acquire a 40 percent ownership interest in the Forum and the right to appoint two members to its board of directors. Accretive promised to play an “active role in landing new customers.”

....The Forum — aided by principals of Accretive — thereafter went to great lengths to concoct an elaborate corporate structure that conceals — but does not legitimize — the affiliations that undermine its claims of independence and neutrality. For example, for most of its existence, defendant NAF, Inc. operated as a standalone company. As part of the transaction between the Forum and Accretive, both companies created new companies that would conceal the affiliation between them. The Forum formed Forthright, and Accretive formed Agora. As a result, at no time is Accretive publicly disclosed as an owner of the Forum....In fact, the three defendants — NAF, Inc., NAF, LLC, and Forthright — effectively operate as one enterprise.

Italics mine.  Basically, a guy named J. Michael Cline, who owned a bunch of debt collection companies, put together a plan to secretly buy a stake in NAF.  Result: synergy!  NAF rules against the consumer and one of Cline's companies collects the debt.

There's plenty more like that if you plow through the rest of the complaint.  And needless to say, NAF claims that nothing shady was going on at all: their rulings would have continued to be completely fair and neutral regardless of who their partners were.  You can decide for yourself if you believe them.

UPDATE: There are two big arbitration outfits, NAF and the American Arbitration Association, and both have stopped taking new cases.  However, Swanson's office didn't sue AAA.  They only sued NAF.  The post has been corrected to reflect this.

California's Great Irony

| Thu Jul. 23, 2009 11:40 AM EDT

In the LA Times today, Harold Meyerson echoes a common complaint about California's two-thirds rule for approving tax increases and budget resolutions:

The most basic principle of any democracy is that of majority rule, with minority rights running a clear but close second. Simple though this precept may be, California seems to have gotten it backward. The budget deal that emerged from Sacramento on Monday was the result of minority rule — the consequence of a state Constitution that vests more power in the minority party than the constitution of just about any other state.

....Californians need to amend their state Constitution, in convention if need be, to end the practice of minority rule. Democracy — not to mention the future of the state — depends on it.

I agree, but I wonder if Republicans ever stop to think about how badly these rules have hurt them too?  Don't get me wrong: for various reasons, California would probably be a blue state these days regardless of whether we had a two-thirds rule or not.  But the fact is that Californians, like most people, are generally unfriendly to tax increases.  And yet they keep voting for Democrats anyway.  Why?

Well, why not?  Everyone knows the two-thirds rule will keep them from raising taxes, so if you like them for other reasons there's no reason not to vote for them.

But what if they could boost tax rates?  Then, basically, their bluff would be called.  They'd have to either raise taxes, thus pissing off a lot of people and giving Republicans a great campaign issue, or they'd have to leave taxes alone and take responsibility for cutting services.  There would be no Republicans to blame it on.  And guess what?  That might make Democrats quite a bit less popular.

Now, it's unlikely that anything could turn the California legislature over to the GOP in the near future, but in the past 25 years California has had only one Democratic governor — and we recalled him after five years in office.  We're not all that unfriendly to Republicans.  If Democrats had the power to raise taxes — and actually did it — we might become even less unfriendly toward the GOP.

In other words, even though the two-thirds rule is the only thing that currently gives Republicans any influence at all in Sacramento, repealing it might be their only long-term hope of ever taking back the California legislature.  Ironic, isn't it?

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Where are the Witnesses?

| Thu Jul. 23, 2009 11:14 AM EDT

Question about Henry Louis Gates' encounter last week with Cambridge's finest: what's up with the witnesses?  The initial reports suggested there were half a dozen onlookers, but I haven't heard anything further about this.  It's hard to believe that no one has managed to round up at least a couple of them since Thursday.  Like, say, the neighbor who took this picture.  Have I just missed something?  Did I read the initial reports incorrectly?  Or what?

Anybody know?

Business and Healthcare

| Thu Jul. 23, 2009 10:14 AM EDT

Yesterday a reader emailed to ask whether the business community was supporting or opposing healthcare reform.  Well, as the Washington Post notes, the Chamber of Commerce recently came out against it while Wal-Mart has come out in favor:

Less noted has been the diversity of opinion among small and medium-size businesses. Many agree with the Chamber that a public insurance option would undermine the private insurance market and that requiring companies to provide coverage would impair job growth. Others say the current system is so broken that they are assessing whether to support the reform plans.

The wait-and-see approach that many businesses are taking — alternately skeptical and hopeful — is a further sign that the alliances that previously scuttled health-care reform may be scrambled this time around, not just in the health-care industry but also in the business world at large. President Obama and congressional Democrats face formidable obstacles to their reform efforts, but one factor in their favor is businesspeople who may not be as inclined as they were in the past to bring grass-roots pressure against reform.

This is probably about as good as we could have hoped for.  When the bullets finally start flying, it was always unlikely that either big or small businesses would be enthusiastically in favor of healthcare reform.  It's just not in their DNA, and the web of allies and lobbyists they're part of naturally works to keep them skeptical.  Still, the mere fact that they're divided, not rabidly opposed, demonstrates just how far things have come since 1994.  Whether that's enough to help deliver a few Republican and Blue Dog votes is hard to say, but at least it probably won't cost us any.

Ka-Ching!

| Thu Jul. 23, 2009 12:55 AM EDT

I'm glad to see that things are back to normal:

Wall Street, helped by improving profits, is on track to pay employees as much as, or even more than, it did in the pre-crisis days. So far this year, the top six U.S. banks have set aside $74 billion to pay their employees, up from $60 billion in the corresponding period last year.

....Some analysts and investors had especially sharp words for Wall Street rival Morgan Stanley, which reported Wednesday that it had set aside $6 billion so far this year for compensation expenses even as it recorded its third straight quarterly loss. In reporting its second-quarter results, Morgan Stanley said it lost $1.26 billion, after accounting for one-time charges including an $850 million expense related to paying the government back after its bailout. Still, the company set aside $3.9 billion in compensation expenses, representing 72 percent of its revenue for the quarter.

As long as bankers are paid obscene salaries and bonuses, all is right with the world.  I'm sure we'll all rest easier tonight knowing this.

Press Conference Liveblogging

| Wed Jul. 22, 2009 7:30 PM EDT

Half an hour into tonight's press conference Barack Obama has answered a grand total of three questions.  This is not a good performance.  He really needs to pick up the pace and make his answers crisper and more comprehensible.

UPDATE: Aside from the rambling nature of his replies, I don't think Obama has been good on substance either.  His opening statement had a little bit of good stuff about healthcare security, but he's spent the vast bulk of his time on deficits and cost cutting.  That's just not a good sales job.

UPDATE 2: All done.  I'm curious to hear what other people thought, but this really struck me as nowhere near his usual performance.  Obama avoided giving direct answers, rambled a lot, kept interrupting himself with asides, and didn't explain things in terms that ordinary viewers were likely to understand.  He's supposed to be the communicator-in-chief, but I wouldn't be surprised if a lot of people came away more confused than they were when they tuned in.  Bottom line: There were bits and pieces that were fine, but overall I'd give it a C-.  Other comments?