Posted by Shyam Moondra
Over the last few decades, the economists have variably characterized the financial markets as random, efficient, and rational. However, in the last ten years, with the emergence of computerized day trading by investment banks and hedge funds and increased trading in derivatives, the true characterization of the markets today would be "manipulated."
It's a well-known fact that today's 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 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 as was done in the case of Bear Stearns and Lehman Brothers) 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 unsuspecting 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"). Often, investment banks issue a positive research report to pump-up a stock so that their best clients can dump the stock, or issue a bad report on a stock to push it down so that their best clients can buy that stock. Some times these big players use their research departments to make money in the trades for their own accounts. 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 investment banks and hedge funds call the above trading practices as "investment strategies" and deny that they are engaged in unlawful manipulation. The fact is that if a market player can make a stock or commodity move in a certain direction at will, then that's manipulation.
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 up or down based on the companies' fundamentals. Now the markets move up or down in a yo-yo fashion without any change in underlying fundamentals. The increased volatility caused by manipulation in the markets has turned the markets into gambling casinos, hurting the free-market 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 minimum period before they can sell those stocks. Or, as Louis Gerstner, the former CEO of IBM, has suggested, short-term gains should be taxed at a hefty rate of 80%, which will discourage day trading and thus reduce volatility.
· 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).
· Impose a limit on how much options trading investment banks and hedge funds can do in any given stock.
· 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 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 offshore subsidiaries and hedge funds that made it possible for them to reduce their tax levies. It's time we close all these tax loopholes.
· Put restrictions on how much commodities investors can buy. It's believed that the recent sharp oil price increase was not because of imbalances in demand and supply but was driven by speculators.
