By Pam Martens and Russ Martens: July 1, 2019 ~
The current fragmented, opaque, and deeply conflicted structure of the U.S. stock market as well as the structure of the giant Wall Street banks that interact in every imaginable way with capital formation in America, is not in the public interest, the national interest or in the interest of capitalism itself.
Let’s start with the structure of the stock market. Those quaint video clips that you see on television of traders mulling about on the floor of the New York Stock Exchange at 11 Wall Street in Manhattan, as executives from some new company that just listed its shares ring the bell to begin stock trading, is meant to lull the public into a sense of confidence that humans are still in charge and looking out for your retirement investments in your 401(k) or public pension plan.
But 11 Wall Street is no longer the epicenter of stock trading in the United States. The truth is, there is no epicenter but rather a sprawling, opaque global network of Dark Pools owned by the big Wall Street banks trading stocks in darkness; the same Wall Street banks trading stocks in a system known as “internalization”; and more than a dozen stock exchanges, the names of which are unknown to the average American.
In a June 3 speech by Brett Redfearn, the Director of the Division of Trading and Markets at the Securities and Exchange Commission (who is, himself, legally ensnarled in this mess of a market), he described the U.S. market as follows: there are 13 stock exchanges that “collectively execute around 63 percent of volume in U.S. listed stocks but “no single exchange has even a 20 percent market share.” Then there are 32 Dark Pools, also known as “Alternative Trading Systems (ATSs)” which Redfearn politely describe as allowing “their participants to interact in a more discreet fashion.” In fact, the SEC and other regulators have repeatedly charged these secretive Dark Pools, which are owned by the biggest banks on Wall Street, with gaming the system. (See related articles below.) And yet, the Dark Pools continue to flourish under the nose of the SEC.
While television serves up those quaint men in trader jackets on the floor of the New York Stock Exchange like a comfort blanket to disarm the psyche of the American people, Redfearn goes on in his speech to describe where the real action is taking place:
“Instead of a trading floor in Manhattan, the locus of exchange trading is now largely in suburban data centers in places like Mahwah, Secaucus, and Carteret, New Jersey. These data centers contain rows and rows of server racks, and vital trading advantages can go to those trading firms that have their machines ‘co-located’ in these racks. In addition, exchanges now sell a spectrum of data products and connectivity services in their data centers that have helped fuel a low-latency arms race. These include proprietary data products with expansive trading information, as well as low-latency connectivity services, such as 40 Gb cross-connects and microwave transmission of data among geographically dispersed data centers. These data products and connectivity services can shave crucial microseconds off of the latencies of competing brokers and trading firms.”
Add high-frequency traders and algorithms and artificial intelligence software to this mess and it’s easy to see that the iconic American stock market has been replaced with a Frankenstein’s monster version of stock trading.
At a Senate Banking Subcommittee hearing in June of 2014, Senator Elizabeth Warren explained who benefits from this high-speed arms race and opaque, fragmented trading venues. Warren stated:
“For me the term high frequency trading seems wrong. You know this isn’t trading. Traders have good days and bad days. Some days they make good trades and they make lots of money and some days they have bad trades and they lose a lot of money. But high frequency traders have only good days.
“In its recent IPO filing, the high frequency trading firm, Virtu, reported that it had been trading for 1,238 days and it had made money on 1,237 of those days…The question is that high frequency trading firms aren’t making money by taking on risks. They’re making money by charging a very small fee to investors. And the question is whether they’re charging that fee in return for providing a valuable service or they’re charging that fee by just skimming a little money off the top of every trade…
“High frequency trading reminds me a little of the scam in Office Space. You know, you take just a little bit of money from every trade in the hope that no one will complain. But taking a little bit of money from zillions of trades adds up to billions of dollars in profits for these high frequency traders and billions of dollars in losses for our retirement funds and our mutual funds and everybody else in the market place. It also means a tilt in the playing field for those who don’t have the information or have the access to the speed or big enough to play in this game.”
This fragmented mess of darkness for stock trading incentivized by pure greed, must return to the original concept of what a stock exchange’s function must be: a vehicle for the fair, efficient and orderly share price discovery process and capital allocation to worthy industries in America that will innovate to keep America competitive and will thrive and grow to create good-paying jobs for our nation’s citizens.
Regulation needs to be tightened on all the stock exchanges and the Dark Pools and internalizers need to be outlawed. The ability of the stock exchanges to charge over $150,000 a month to offer high-speed co-location computer services and faster data feeds to those with deep pockets also needs to be outlawed. Existing law is adequate to do just that since the stock exchanges are not allowed to discriminate against market participants.
The Wall Street banks are a bigger, darker and more conflicted mess than the stock trading platforms. More importantly, they are exponentially more dangerous — as the world realized in 2008 when they blew up the U.S. housing market, the U.S. economy, and the stock market.
Under one roof, Wall Street banks are now allowed to perform the following functions: the investment bank is allowed to put corporate mergers together or underwrite a new stock offering and collect millions of dollars in fees. Then the same bank’s research analyst frequently puts out a buy rating on the stock. That buy rating is then communicated to the thousands of retail stockbrokers (today known as financial advisors) that reside in the same bank’s brokerage firm, which feel intimidated into calling up their retail clients and suggesting they act on that “buy” recommendation. That same bank holding company is also allowed to own a giant commercial bank which holds upwards of one trillion dollars in deposits, the bulk of which are Federally-insured and backstopped by the U.S. taxpayer. Under existing law, some of those Federally-insured deposits can be used as gambling casino chips and used to make trades in high-risk derivatives.
Today, the Federally-insured commercial banks of four of the largest Wall Street firms are sitting on a powder-keg of $177 trillion in notional amount (face amount) of derivatives. That breaks down as follows as of March 31, 2019 according to the regulator of national banks, the Office of the Comptroller of the Currency: JPMorgan Chase has $59 trillion; Citibank has $51 trillion; Goldman Sachs Bank USA has $47 trillion; and Bank of America has $20 trillion. (See Table 3 in the Appendix of the OCC report here.)
No Federal regulator and no Congressional committee can explain why these four Federally-insured banks need to have $177 trillion in derivatives and why it is that they control 89 percent of all derivatives held by all 5,362 Federally-insured banks in the country. When it comes to Congress, it has not even asked the question, despite the fact that derivatives played a key role in blowing up the U.S. financial system in 2008 and four years later blew a $6.2 billion hole in depositors’ money at JPMorgan Chase. (See Looking Back on JPMorgan’s London Whale Saga.)
The late Senator John McCain, the ranking Republican member of the Senate’s Permanent Subcommittee on Investigations which formally probed the London Whale matter, issued this written statement in 2013:
“This investigation into the so-called ‘Whale Trades’ at JPMorgan has revealed startling failures at an institution that touts itself as an expert in risk management and prides itself on its ‘fortress balance sheet.’ The investigation has also shed light on the complex and volatile world of synthetic credit derivatives. In a matter of months, JPMorgan was able to vastly increase its exposure to risk while dodging oversight by federal regulators. The trades ultimately cost the bank billions of dollars and its shareholders value.
“These losses came to light not because of admirable risk management strategies at JPMorgan or because of effective oversight by diligent regulators. Instead, these losses came to light because they were so damaging that they shook the market, and so damning that they caught the attention of the press. Following the revelation that these huge trades were coming from JPMorgan’s London Office, the bank’s losses continued to grow. By the end of the year, the total losses stood at a staggering $6.2 billion dollars.”
Senator Carl Levin, the Chair of the Committee issued this written statement:
“The bets were made by traders in the London office of the U.S. banking giant JPMorgan Chase. Their trades—meaning their bets—grew so large that they roiled the $27 trillion credit derivatives market, singlehandedly affected global prices, and finally attracted a media storm aimed at finding out who was behind them. That is when the media unmasked JPMorgan’s Chief Investment Office (CIO), which, until then, had been known for making conservative investments with bank deposits. At first, JPMorgan’s Chief Executive Officer (CEO) Jamie Dimon claimed the April media reports about the whale trades were a ‘tempest in a teapot.’ But a month later, the bank admitted the truth: That their credit derivative bets had gone south, producing not only losses that eventually exceeded $6 billion, but also exposing a litany of risk management problems at what had been considered one of America’s safest banks.
“JPMorgan Chase is the largest financial holding company in the United States. It is also the largest derivatives dealer in the world and the largest single participant in world credit derivatives markets. It has consistently portrayed itself as a risk management expert with a ‘fortress balance sheet’ that ensures taxpayers have nothing to fear from its extensive dealing in risky derivatives. But that reassuring portrayal of the bank was shattered when whale trade losses shocked the investing public, not only with the magnitude of the losses, but because the financial risk had been largely unknown to bank regulators…”
Despite the Federal Reserve’s illusion of performing annual stress tests on these Wall Street mega banks and its reassurances to the public that another 2008 cannot happen today, the banks continue to be fined for serial fleecing of the public both here and abroad.
There is no benefit to the American people of having brokerage firms, investment banks and Federally-insured commercial banks all owned by one bank holding company. The United States prospered and there was no financial implosion of Wall Street or the U.S. financial system for the 66 years (from 1933 to 1999) when these combinations were against the law under the Glass-Steagall Act. But just nine years after Glass-Steagall was repealed in 1999, Wall Street’s deeply conflicted and corrupt Frankenstein model blew up, causing the greatest economic collapse since the 1929 stock market crash and ensuing Great Depression.
A 21st Century America needs retail brokerage firms where financial advisors are salaried and given bonuses at the end of the year based on the performance of their clients’ investment portfolios. Currently, brokers receive commissions based on how much money they make for the firm.
A 21st Century America needs Federally-insured banks that are completely disentangled from high-risk gambles on Wall Street, where Mom and Pop savers can feel secure to put their life savings.
A 21st Century America needs Wall Street investment banks that return to the partnership structure so that partners are putting their own money at risk in the deals instead of today’s heads I win, tails you lose mentality.
America needs regulators we can trust instead of people waiting to collect their six-figure paycheck on Wall Street as they move through the revolving door. This can be easily accomplished by putting a five-year ban on a regulator taking a job on Wall Street after serving in a Federal oversight position.
And, finally, the idea that these Wall Street banks can trade the shares of their own bank with no accountability to regulators in their own Dark Pools is simply insane. (See related article below.) It is the final stage of greed gone berserk that typically comes in the leadup to an epic crash.
Congress knows that the current structure of Wall Street is dragging down America, widening wealth inequality, harming the nation’s competitiveness, diverting critical capital allocation to the wrong areas based on conflicted motives, and destroying trust in our once respected markets. But Congress will not act until there is a groundswell of demands from their constituents. It will take a much more deeply engaged America to prevent another financial catastrophe and restructure Wall Street into an enlightened model.