Chicago residents grew up to the sound of local early morning radio rundowns of pork belly futures and other exchange traded commodities. Every trick in the book from manipulation of soybeans to silver has played out in Chicago's trading pits. Every market professional I've talked to in Chicago since Thursday is of the same opinion. It makes no difference whether human beings or computers are front running and manipulating trades. The gyrations in the market last week have the look and feel of classic market manipulation.
If you want to manipulate a market, deregulate it as much as possible. Then make it as "dark," and fast as possible. Make it hard for outsiders to view your trades as they get done, and make it even harder for anyone to figure out why you are trading. Get as much monopoly power as possible over the market. Get funding at the cheapest possible rate. The best possible rate is the near zero cost funding available from the Federal Reserve.
Next, get your "men" stationed in the most influential positions at the exchanges. Make sure your cronies have shock and awe market dominance through, say, High Frequency Trading algorithms that now make up the majority of stock trades.
Then, make sure you have advance information of major market-moving events. A bailout announcement by the European Union would do nicely. A few days before the announcement, "bang" the market. Pound down the value so you can monetize put options and other bearish instruments. Trigger customers' stop-loss orders, and pick up bargains at their expense. Then cash-in again when the market pops up on bailout news.
To paraphrase Paul Erdman's 1975 tongue-in-cheek observation: "The lack of discretion in financial and political circles these days is appalling."
Meanwhile, take the heat off of yourself by leaking "fat finger" rumors to CNBC, since they can be relied up on to repeat as gospel any self-serving news you throw at them. Did someone type billions? It should have been millions. If we want to rescue the market from the Jaws of future disasters, we have to recognize that "this was no boating (or typing) accident." The system itself is flawed.
(See also: "How to Corner the Gold Market," TSF, March 30, 2010)
The NYSE was supposed to provide market liquidity. Trading safeguards are no good unless they are system-wide. The current and former heads of the NYSE, billed as the "best and the brightest," i.e., the most connected, should be asked a few questions about High Frequency Trading and "liquidity" providers. Our mega-bank trading desks that control most of the volume on the exchanges should be called in for an accounting and justification of their trading activities. Trading patterns during last week's debacle and over the last year should be examined.
Unfortunately, as others have observed before, the SEC is both largely incompetent and captured. They are learning to crawl in the space age. Moreover, the next stop for SEC officials seems to always be a highly paid influential job at a law firm, fund, or other entity that heavily relies on Wall Street for revenues. Financial reform requires radical overhaul of our "regulators."
As for Wall Street mega-bank reform, Congress seems disinclined to break up our Too-Big-To-Fail banks, define proprietary trading, or sever Goldman Sachs, Morgan Stanley, and proprietary trading at large banks from the Federal Reserve's, i.e., taxpayers' heavy subsidies. (See also: "Goldman Sachs: Spinning Gold," Huffington Post, April 7, 2010.)
If everyone wants to stick to the story of "woe is us, we had no idea things could go this wrong," then fine. No one is in control; no one is in charge; and no one can competently regulate our current system. This is a compelling argument for immediate radical financial reform.
Update May 11, 2010: The Wall Street Journal published an article suggesting that a trade by Universa crashed the market. Nassim Taleb, author of "The Black Swan," with a second edition just coming out today, advises the hedge fund.
The WSJ article misleads the public about an important event. This trade did not crash the market. The other side of Universa's trade would have been "delta hedged," meaning the futures contracts required to hedge the trade would have been meaningless to the market, or one could have bought offsetting puts or an options spread trade to hedge. This trade was immaterial to the events on Thursday. The transaction is immaterial and was not responsible for the market move.
The put options would expire worthless if the S&P were just above the strike in June. According to the WSJ article, the strike appears to be 800, but the article is a bit vague. Assuming the strike is 800, the contracts would only make some money at expiration if the S&P were below that, and the contracts would only make $4 billion if the S&P went to zero. Even on a high volatility day like last Thursday, Universa could have made money on the price of the put options, but even if it cashed out at the top of the market, it would only have made around $25 million after investing $7.5 million, and again, that is if Universa were lucky enough to sell at the highest level for the options for the day.
See also: "Nassim Taleb Kills $20 Billion Mythical Swan, WSJ Crashes Credibility, "Huffington Post, May 11, 2010.
Janet Tavakoli's book on the causes of the global financial meltdown and how to fix it is Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street.