Monthly Archives: October 2015

Barclays Gets Washed Up in Dark Pools and High Frequency Trading

By Barry Elias | Friday, 30 Oct 2015 07:02 AM

Barclays Bank seems like it is next in line to settle with the authorities regarding its dark pool operations.

In recent years, the Securities and Exchange Commission (SEC) and the New York State Attorney General (NYSAG) have focused on the disruptive nature of dark pools and high frequency trading: especially when used in tandem, as the authorities allege to be the case with Barclays Bank. The SEC and NYSAG claim Barclays misled its clients into believing high frequency traders would be less active in their LX dark pool trading venue.

Dark pools are essentially private, anonymous, off-exchange and opaque venues that permit the trading of exchange-listed securities. This structure helps camouflage the trading strategies of large financial institutions, such as mutual funds, pension funds, hedge funds, and insurance funds to afford them optimal profits or minimal losses. These venues are lightly regulated, require less public disclosure, do not carry the same protective margin requirements as the public exchange marketplaces, and allow banks to forego paying fees to exchanges for trade execution.

Dark pool trading as a percentage of total trading volume more than tripled from 4 percent in early 2008 to nearly 14 percent by the end of 2011, according to Rosenblatt Securities. Haoxiang Zhu, a financial economist at the MIT Sloan School of Management and the author of a new paper in the Review of Financial Studies, cites a study in which 71 percent of financial professionals believe dark pools are “somewhat” or “very” problematic in establishing stock prices.

Despite denying any wrongdoing and fighting this case, Barclays is in serious discussions to pay a fine of $65 million.

Thus far, two firms have agreed to pay fines related to this activity: $14 million by UBS Group and $20.3 million by Investment Technology Group, which has admitted to wrongdoing in its case. A third, Credit Suisse, has a planned agreement to pay an $85 million fine.

To evade recent proposals that would regulate and undermine dark pool trading, some U.S. banks are conducting their derivative trades through non-U.S. subsidiaries that do not have explicit guarantees from the U.S. parent.

The SEC and other regulatory bodies need to keep the playing field level for all, and where possible, prosecute individuals as a more effect deterrent.

© 2015 Newsmax Finance. All rights reserved.

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Why Economists Fail

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By Barry Elias | Friday, 23 Oct 2015 07:24 AM

I attended a presentation this past week at Cooper Union College in Manhattan by an economist promoting his new book.

I was rather aghast to hear him say: “No one” predicted the global economic crisis and experts did not foresee how slow the recovery would be.

Following the collapse of Bear Stearns on March 17, 2008, I divested most of my family’s investment portfolio from the market when the Dow Jones Industrial Average hovered near 12,000. By September of that year, the Dow reached its nadir – around 6,500.

At that time, I expected the unemployment rate to double from 5 percent to 10 percent, which it did. I also suggested the global recovery may take a decade or two to return to robust growth, since the crisis was the result of financial mismanagement that spanned several decades.

Further, on May 6, 2010, the day of the infamous “Flash Crash,” my article entitled “Why I Divested From the Dow” was published: About six hours later, the Dow had plummeted about 1,000 points.

The Cambridge-educated economist that I alluded to earlier is Adair Turner, the chairman of the Institute for New Economic Thinking; a member of the United Kingdom’s Financial Policy Committee: and the former chairman of the Financial Services Authority (FSA) until its abolition at the end of March 2013.

The FSA was an independent regulatory body for the financial services industry in the United Kingdom (U.K.) between 2001 and 2013. It was appointed by the Treasury and funded entirely by fees charged to financial firms.

Due to the apparent regulatory failure of banks during the financial crisis, the U.K. government abolished and replaced the “failed” FSA on April 1, 2013 with two new agencies: the Financial Conduct Authority (FCA) and the Prudential Regulation Authority of the Bank of England, in an effort to strengthen England’s financial system with a more forward-looking perspective.

While the FSA under Turner’s leadership presided over the near-total collapse of several major financial institutions, including the merger of Lloyds Bank with ailing HBOS in September 2008, Turner claimed in February 2009, as well as today, that other global regulatory authorities also failed to predict the economic collapse. He did not apologize for the actions of the FSA, and believes the intellectual failure was the result of a focus on processes and procedures, in lieu of the larger economic landscape.

Economists ought to take note of that admission and view the world with greater breadth and depth, especially before proposing public policy prescriptions that may have implications for many decades to come.

In his new book, Turner argues most credit formation is not necessary for economic development. He suggests excess credit drives real estate booms and wealth inequality, which then lead to financial crises and depression. Turner believes banks need to increase capital and reduce real estate lending, and debt needs to be taxed as a form of “economic pollution.” I wholeheartedly agree with the premise and prescriptions presented.

Income inequality is self-reinforcing, since wealthier households consume a smaller percentage of their income, and savings tend to be invested in short-term, speculative, and arbitraged financial assets. This dynamic undermines employment and economic growth for the masses as compared with direct investment. Favorable tax rates on investment income, especially for hedge fund managers, perpetuates this viscous cycle.

Since 1970, financial firms expanded credit among themselves and households seeking real estate, because it involved a simple and secure business model: real estate collateral valuations were more predictable as compared with the assessment of an entrepreneurial endeavor. This methodology permitted the excessive refinancing of existing assets, and less on the creation of new ones.

Financial firm credit skyrocketed from 10 percent of GDP in 1970 to 125 percent in 2008, while that for household credit rose from 40 percent to about 90 percent, which included toxic subprime mortgages. (During the same period, federal government debt as a share of GDP increased from 35 percent to 60 percent, and that for non-financial corporate debt rose slightly, from 35 percent to 40 percent.)

The financial firms essentially transferred wealth among themselves and others instead of creating new wealth. This led to less optimal employment and income growth for the masses, since direct investment in business endeavors was on the wane. Instead, financial products that were derived from preexisting assets exploded, and wealth and income inequality grew.

The net worth of the financial sector was negative from 1996 through 2007, reaching a nadir of negative $1.46 trillion in April 2007. Quantitative easing by the Federal Reserve following the financial crisis put the financial industry in positive territory, but it turned negative at the end of 2013, and by of June of 2015 it stood at negative $809 billion.

Why was the financial industry protected so well?

Some suggest a significant number of economists with keen academic and think-credentials regularly accept funding from corporations to provide “objective” analyses that actually promote corporate objectives and defy evidence and logic.

Let’s keep the economists honest and forward-looking, shall we?

© 2015 Newsmax Finance. All rights reserved.

Too Big to Jail Is Being Tested by US LIBOR Trial

Friday, 16 Oct 2015 07:27 AM

Dollar banknotes, handcuffs and judge's gavel isolated on white

Financial behemoths have paid handsome penalties to settle criminal and civil charges related to manipulation of the LIBOR. Now American citizens may be in jeopardy, thereby disrupting the implication that bank employees are “too big to jail.”

In recent years, more than $5 billion have been ponied up by several financial institutions for these transgressions: $2.5 billion from Deutsch Bank, $1.5 billion from UBS, $450 million from Barclays, and $325 million from Rabobank. Other perpetrators include Citigroup, The Royal Bank of Scotland, JP Morgan, Lloyds, and ICAP.

LIBOR, or the London Interbank Offered Rate, is the interest rate paid by banks to borrow funds from other banks. It represents the average lending rate offered by the 16 participating banks. These offers are submitted daily to the British Bankers’ Association for five currencies and 7 borrowing periods, spanning overnight to one year loans. Other lenders, including financial institutions, mortgage banks, and credit card companies set their rates relative to these. It is estimated that $350 trillion of derivatives and other financial products are based on the LIBOR.

The Justice Department issued a memo last month that prioritizes the investigation of employees for financial malfeasance before seeking settlement with corporations. In an important test for U.S. prosecutors, two Rabobank employees are now being tried in a Manhattan federal court for manipulating LIBOR in order to benefit other Rabobank traders’ trading positions that were tied to the LIBOR. The traders on trial are Anthony Conti, a senior U.S. dollar trader, and Anthony Allen, a former global head of liquidity and finance, and supervisor of Rabobank’s Libor submitters, including Mr. Conti. They are alleged to have conspired to rig the rate on or about May 2006 through early 2011.

Thirteen individuals have been charged thus far in the U.S. in relation to the LIBOR investigation. While several defendants have pleaded guilty, including three other former Rabobank traders, none have gone to trial yet. Six former brokers accused of rigging LIBOR are currently on trial in the U.K. This comes on the heels of Tom Hayes’ conviction in London several months ago. He was a former UBS and Citigroup trader sentenced to 14 years for LIBOR manipulation.

Former Federal Reserve Chairman Ben Bernanke believes some Wall Street executives deserve jail time for their roles in the financial crisis, since individuals, not abstract firms, committed these crimes. He lays the blame with the Department of Justice and others who are responsible for enforcing the laws of our country.

Wide swaths of the political spectrum are extremely dismayed with the way the financial industry operates. In the recent debate, democratic presidential candidate Bernie Sanders claimed the banking business model is one predicated on “fraud.” And republican presidential candidate Donald Trump believes too many in the financial industry do not pay their fair share of taxes.

The maximum tax rate for capital gains on financial products is 23.8 percent, while that for ordinary income is 39.6 percent. Further, unlike ordinary income, capital gains are not subjected to social security taxes of 12.4 percent, which is shared equally by the employee and employer.

The only effective deterrent to financial misdeeds is the possibility of personal punishment.

© 2015 Newsmax Finance. All rights reserved.

Bankers Battle Banks

By Barry Elias | Friday, 09 Oct 2015 07:27 AM

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Bank profit margins are expected to decline at an accelerating pace over the next five years as bankers team up with technology firms to provide more cost-effective products and services.

Technological competition is expected to reduce profits from non-mortgage retail lending, such as car loans and credit cards, by 60 percent and revenues by 40 percent over the next ten years. Profits and revenues for mortgages, wealth management, small and medium-sized lending, and payments processing are also slated to fall between 35 and 10 percent, and earnings on some financial products may decline by nearly two-thirds, according to McKinsey & Company, a global management consulting firm.

Technology firms are focusing on the most lucrative segments of bank portfolios, especially those that involve customer relations. This will return banks to their roots as a utility: one that manages balance sheet assets and liabilities. McKinsey says banks generated $1.75 trillion of revenues in 2014 from origination and sales activities, earning a 22 percent return on equity, compared with $2.1 trillion of revenue and only a 6 percent return on equity for managing balance sheet net interest.

McKinsey calculates banks earned a record $1 trillion last year with a 9.5 percent return on equity. Nearly two-thirds of banks in developed markets and a third of those in emerging markets earned a return on equity below the cost of equity, causing their equity prices to fall below book value.

McKinsey expects this rate of return to plummet rapidly as bankers continue to enter technological finance as advisors, investors, board members, and company executives, such as former JP Morgan executive Blythe Masters, who is the current Chief Executive Officer of Digital Asset Holdings, a start-up that provides ledger and settlement services for digital and mainstream assets.

Thirteen more banks are now collaborating with R3CEV, a New York based start-up to develop a private, distributed ledger system for financial institutions, bringing the total to twenty-two financial institutions. In contrast, the bitcoin blockchain platform permits access to all and is secured by a digital token.

These 13 banks are: Citigroup, Bank of America, Morgan Stanley, HSBC, Bank of New York Mellon, Deutsche Bank, Mitsubishi UFJ Financial Group, Commerzbank, National Australia Bank, Royal Bank of Canada, SEB, Société Générale and Toronto-Dominion Bank.

Nasdaq is also using the blockchain to set up a private share trading platform with Chain, a start-up that has received funding from Nasdaq, Citi Ventures and Visa.

The bitcoin blockchain methodology ensures more timely, efficient, cost-effective and secure asset ownership transfer. This will be especially useful for the syndicated loan market, where settlement can take 20 or more days to finalize.

The New York State Department of Financial Services recently approved two firms to operate Bitcoin exchanges: Gemini, founded by Cameron and Tyler Winkelvoss, and ItBit. The Wicklevoss brothers are also working on a bitcoin-backed exchange-traded fund, which is expected to trade on the Nasdaq exchange and awaits regulatory approval.

Banks are beginning to brace for the coming seismic shifts of the financial terrain.

© 2015 Newsmax Finance. All rights reserved.

Treasury Market-Rigging Further Disrupts the Middle Class

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By Barry Elias | Friday, 02 Oct 2015 06:48 AM

The U.S. Department of Justice and the New York State Department of Financial Services are looking into possible manipulation of the U.S. Treasury market by banks and brokers that serve as primary dealers to underwrite government debt.

To date, 23 lawsuits have been filed, with 2 more coming soon, that allege collusion by these institutions to enhance their profits at the expense of their investor clients. More than half of the cases brought forth thus far have been on behalf of pension funds, which predominantly serve the middle class.

The allegations claim the dealers inflated the price of newly issued Treasury securities that they sold to investors and lowered the price for securities they purchased from the U.S. Treasury. If accurate, this raises the cost of issuing Treasury security debt to taxpayers.

These cases include a comparable price analysis that was used in the market manipulation trials over the Libor — the London Interbank Offered Rate and the benchmark interest rate for lending between banks — and the currency markets, which resulted in more than $5.6 billion in penalties from six banks.

Gregory Asciolla, a partner at the law firm Labaton Sucharow, which is the lead counsel in two cases that involve the State-Boston Retirement System and Arkansas Teacher Retirement System, claims the auction and pre-auction market — also known as “when issued” — are “rigged.”

The Cleveland Bakers and Teamsters Pension Fund alleges the price was reduced in 69 percent of the auctions for securities in the secondary market — or those already in circulation. This analysis included data between 2007 and 2015.

Declining comment are the U.S. Treasury, The Federal Reserve Bank, and primary dealers contacted by The Financial Times.

Once again, high powered financial institutions continue to prosper at the expense of the middle class.

© 2015 Newsmax Finance. All rights reserved.