Posted by Shyam Moondra
It's a well-known fact that increased volatility in stock and commodity markets is primarily due to manipulation by investment banks and hedge funds through their frantic computerized trading. Jim Cramer, a TV business commentator, once posted a video on his website explaining how he, as a former hedge fund manager, used to throw $25 millions or so and move a particular stock up or down as he wished. The investment banks and hedge funds short sell a stock to push it down (often spread false rumors about the targeted company to aid the process of bringing it down) while also trading in options. Then just before the monthly options are to expire, they start covering their short positions and push the stock up. In the process, they may lose some money in trading stocks but they make proportionately more money in options and thus come out ahead. Sometimes they move a particular stock up or down to make the options they wrote worthless and thus pocket the premium the buyers paid. They repeat the process every month in many targeted stocks and make money at the expense of small investors. Some of these big players also use what is known as "pump-and-dump" strategy in which they take substantial long position in a company, usually a lesser-known small-cap company, and then publish inflated views or research reports about those companies that help move the stock price up ("pumping"), enabling them to sell their holding at a profit ("dumping"). Some times these big players also use their research departments to make money in their trades. As an example, Goldman Sachs' research department was touting that oil was headed to $200 per barrel while at the same time they reportedly held long positions in oil. It's also reported that some investment banks were selling mortgage-based securities to others while at the same time they were short selling those securities.
The stock markets were created to help companies raise capital so that they could build new factories and hire more workers and the stock prices moved based on the companies' fundamentals. Now the markets move up and down in a yo-yo fashion without any underlying change in fundamentals. The increased volatility caused by manipulation in the markets has turned the markets into gambling casinos, hurting our overall economic system.
We urgently need new regulations to stop market manipulation by the investment banks and hedge funds. The government could take a number of actions such as:
- Ban naked short selling, limit short positions to 1% of outstanding shares at any given point in time and reinstate the "up tick" rule for short selling.
- Regulate hedge funds like any other mutual fund. Their CEOs and other officers must pay taxes at the regular rates as opposed to at the capital gains rate as they do now.
- Investment banks and hedge funds must be required to hold stocks they buy for a certain specified period before they can sell those stocks.
- Change the margin rules so investment banks and hedge funds are limited to leverage of no more than 10:1 (in the recent past they have had leverages of up to 40:1).
- The investment banks must not be allowed to own research business. Currently, they have arm's length relationship between their trading and research departments which is not enough.
- Pass tough laws to discourage "pumping-and-dumping" so that big players can't make money at the expense of unsuspecting small investors.
- Strengthen SEC resources to investigate and enforce the laws vigorously to stop market manipulation. The CEOs of the companies that are found to violate any of the new regulations must be given mandatory jail terms and their companies must be fined heavily to discourage them from manipulating the markets.
- Change the tax laws to stop investment banks and hedge funds from escaping from paying their fair share of income taxes. In a recent quarter, Goldman Sachs paid only 10% in taxes because they executed their trades through a complex web of off-shore subsidiaries and hedge funds that made it possible for them to reduce their tax levies. It's time we close all these tax loopholes.
