Mortgages and Contract Innovation

In which Prof. Cochrane points out that the US mortgage market is an extremly artificial construct that exposes banks to trememdous risk, leading to the only entity being able to finance it being the US government. And of course, the effects on ever increasing housing prices and stunted innovation that comes from Fannie Mae and Freddy Mac.

Regulations around government debt lead to crisis

Put briefly

By much favoring banks holding “safe” government debt and residential mortgages (demand-carbs) than loans to “risky” small businesses and entrepreneurs (supply-proteins), way too much debt has been generated against a weakly obese not muscular economy. Of course, in the process, bureaucracy autocracies were empowered, and houses transformed from home into valuable investment assets.

Kodak-con

Normally I wouldn't post this on a finance blog but I picked this up on Only VIX, one of my favorite finance Blogger blogs. The big picture doesn't look good.

On the corporate side of the con, we have Kodak Chairman and CEO Jim Continenza, who picked up 3 million shares and cheap options over the past 4-6 months. It’s Kodak board member George Karfunkel of the private equity and banking Zyskind-Karfunkel family, with his 6.4 million shares. It’s Kodak board member Philippe Katz, who owns about 4.3 million shares through at least five shell companies. Of these shares, they were also each granted tens of thousands of shares in Kodak just over the past 60 days.

And so on. It's good for insiders, good for politicians, terrible for everyone else.

The end of the exchanges

As NYSE passes its regulatory power to FINRA, the meaning of the word "exchange" loses relevance.

It was announced a month ago, on May 4, and was greeted without much fanfare: The New York Stock Exchange will delegate to FINRA responsibility for performing market surveillance and enforcement over trading on the NYSE.

To comply with the niceties of the Securities Exchange Act of 1934, the NYSE will retain responsibility for making sure that FINRA is doing its job. Lawyers will prepare appropriate procedures to demonstrate that this oversight function is being carried out properly. But, I very much doubt that anyone believes this will amount to anything more than window dressing. The NYSE's oversight role will be mainly perfunctory.

Maker-taker mostly takes

The maker-taker model deployed by exchanges and ECNs benefits neither liquidity providers nor liquidity takers. Worst of all, it distorts stock prices.

That's the conclusion of a new study by a trio of academics, including two former chief economists at the Securities and Exchange Commission.

Oops. Good thing everyone and their grandmothers converted to it.

Federal Reserve pump and hold

"The Working Group on Financial Markets, also know as the Plunge Protection Team, was created by Ronald Reagan to prevent a repeat of the Wall Street meltdown of October 1987. Its members include the Secretary of the Treasury, the Chairman of the Federal Reserve, the Chairman of the SEC and the Chairman of the Commodity Futures Trading Commission. Recently, (2007) the team has been put on high alert because of increased market volatility and, what Hank Paulson calls, the systemic risk posed by hedge funds and derivatives....

Ambrose Evans-Pritchard of the UK Telegraph notes, "Secretary of the Treasury Hank Paulson has called for the PPT to meet with greater frequency and set up a command centre at the US Treasury that will track global markets and serve as an operations base in the next crisis. The top brass will meet every six weeks, combining the heads of Treasury, Federal Reserve, Securities and Exchange Commission (SEC), and key exchanges."

This suggests that the PPT could, in fact, be the driving-force behind the ongoing stock market rally.

Why "Old GM" is trading at more than zero

Reg NMS 2?

Some thoughts on what's going on in the world of dark pools vs displayed markets. I tend to be partial to displayed markets with public information and what have you, perhaps the SEC is moving in a similar direction.

High frequency trading

I tend to be against this sort of stuff as I think smart people could be better used. This article presents a defense of the practice and also points out how silly the people who oppose it sound.

My awakening began when I read a recent Times column by Nobel laureate Paul Krugman, who commented that much of today's trading is a "socially useless" activity, as opposed to a higher calling, like say, writing opinion pieces. He ripped apart traders for the crime of making money "mainly by outsmarting other investors, rather than by directing resources to where they're needed."

. . . .

But I became a little worried when I realized how low the professor sets the bar for non-public information. He's not talking about Gordon Gekko learning about the impending takeover at Blue Star Airlines. Far from that, Dr. Krugman first cites high-frequency traders, who by processing public information faster than the next trader, are damaging society.

The implicit argument is that since not everyone has "superfast" computers, the information that high-frequency traders are reading from the public tape is still essentially non-public until everyone has had time to read and digest it. It's a good point--why should a trader have an advantage over his competition just because his broker splurged on a nitrogen-cooled, tungsten-coated nanochip processor? Shouldn't algorithm providers be polite and wait until the old-school broker with the paper ticker tape and the Atari 800 catches up?

My prediction is that the Obama administrations next push will be to require all computers which interact with market centers to be Atari 800s. My vintage computing hobby will finally be vindicated and I will be able to sell my equipment for tens of thousands of dollars.

Morality and Markets

The management teams and bankers involved in the recent deals told us that the buyside players are changing. Many of the hedge funds and fast money players are gone, heralding a return of the long-term investor. This is important for the newly public company because it gives them the ability to create a better shareholder base aligned with their strategic objectives.

And this is in line with markets as a positive force:

My last point is something we often forget to think about. The IPO is an important job engine for our economy. These two companies employ about 2,000 employees. Bridgepoint didn't exist five years ago. Rosetta Stone had 10mm in revenue five years ago. Both companies create jobs, provide for families and create wealth.