K.O. Katsuyama

The poll at CNBC showed public opinion strongly favoring Brad Katsuyama over HFT whore Bill O’Brien. Now, it turns out that O’Brien actually lied about how his BATS exchange works. New York’s Attorney General has required him to print a retraction in the Wall Street Journal. In the video, you see Katsuyama catch him out, while the crowd cheers – literally, a cheering crowd on the floor of the New York Stock Exchange.

“You want to do this? Let’s do this,” Katsuyama said in response to O’Brien’s prodding.

The beauty of Katsuyama’s idea is that, since the SEC won’t act, he will provide a market solution. Katsuyama has invented an HFT free exchange, called IEX. If you are tired of getting scammed, you can switch. Already, two leading brokers have switched to his exchange – and the book only came out on Monday. One, Interactive Brokers, is the ne plus ultra of trading platforms. We expect investors to flee BATS like the fall of Saigon.

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The HFT Tobin Tax

flash-boys-jkt_1Michael Lewis has made a splash with his latest book, Flash Boys, and his declaration that the stock market is rigged. Jeremiah is shocked – shocked! Cue Claude Rains. Wall Street has been in various stages of denial about High Frequency Trading (HFT) since the flash crash. Those not in denial include Charlie Munger, Mark Cuban, Eric Hunsader, and Brad Katsuyama.

“It [HFT] is legalized front-running. I think it’s basically evil …” Charlie Munger

Of all the ink spilled since the 60 Minutes piece, we like the Vanity Fair review best. For sheer entertainment, you should watch the head of BATS come unglued on CNBC. Mainstream broker Charles Schwab is here.

Here is a quick guide to how HFT works. Let’s say you want to buy 100 shares of Exxon for your retirement fund, at $98.50 per share. An HFT bot detects your order and runs in front of it, buying the shares for $98.50. Then, it spams the exchange with bogus orders for $98.51. Your broker’s system, much slower, blindly buys the shares for $98.51. A second later, they’re back to $98.50.

In the old days, this was called “painting the tape.” It has been illegal since 1934. No one has been prosecuted, though, because supposedly the SEC can’t detect it. Some people say this is a cost of doing business, a small price to pay for added liquidity and smaller spreads. Research debunking all of that starts here, on Nanex. Jeremiah is reconsidering his views on the death penalty.

It is true that if you’re going to hold your Exxon until retirement, the extra penny doesn’t matter much. It’s just like a little tax. That’s the funny part.

Socialists at the IMF have been clamoring for a financial transactions tax, named for economist James Tobin. This would be a win-win from their perspective, funding bankrupt governments, and punishing capitalism. So, far no one has noticed the irony. There is already a tax on financial transactions.

See also: Bob Pisani

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Better Left Alone

Nassim Nicholas TalebTo date, Jeremiah has been mildly in favor of genetically modified foods. He believes in the science but, as we read here, he is suspicious of the motives. This is a good framework for such issues. You look at the science, and then you look at who profits.

Now, we have a new paper from Nassim Taleb that questions the science. Taleb, author of The Black Swan, is the world’s foremost authority on analyzing risk. His concern is not with the biology. It is clear that, having created a new organism, scientists can reliably check whether it’s safe to eat.

Top-down modifications to the system are categorically and statistically different from bottom up ones. There is no comparison between selective breeding and … arbitrarily taking a gene from one organism and putting it into another.

Professor Taleb’s concern has to do with the probability of a genetically modified organism having some unforeseen impact on its ecosystem. Here, we are talking about a unique event in a complex system – Taleb’s home turf – with a nonzero probability of something going wrong.

Taleb draws a parallel with his work in the stock market. A trader can survive many small losses, but a trader who bets the farm will sooner or later go bust. This is not risk management, but a completely different problem – called “risk of ruin” in the business. Nature produces organisms that are safe, because each mutation is small and reversible (in the population), and other organisms have time to adapt.

This is a good way to define what “natural” means, without the hype. Taleb recommends leaving natural systems alone, whether they’re ecosystems or financial systems. In this interview, he says that governments should not intervene in financial crises. It’s nice to find someone with a consistent basis for his beliefs – even if it’s advanced statistics.

See also:
Is Nassim Taleb Right About GMOs?

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New Fed Bashing Hero

AudreyHepburnJeremy Grantham gave an insightful interview to Fortune magazine, which they have subtitled “Fed bashers have a new hero.” Business Week picked up the story, calling Grantham a “noted gloomster.” This is what passes for analysis in journalism today. Everything is ad hominem and partisan. If you have actually read Grantham’s (expensive) published research, you know that he is rigorous, objective, and precise. When he says that stocks are overvalued, this is based on solid analysis of corporate earnings – documented elsewhere by his colleague James Montier. Temperamentally, Grantham is bullish on America, but he is not in business to make overpriced investments.

“The only ones who have really benefited from QE are hedge fund managers.” – Jeremy Grantham

A related headline is, “Grantham calls Yellen ignorant.” What he actually said was, “either she is ignorant of the markets, or else she is cynical about manipulating them.” Congress had asked the Fed Chair if markets were overvalued, which is not her area of expertise. The Fed studiously avoids pricing stocks, gold, or Bitcoin. They look instead at employment, yields, and consumer prices. Financial analysts, obviously, feel the Fed should also study the markets.

The New York Times presents this roundup of Fed bashers. The Times is married to Paul Krugman’s idea that printing money somehow helps the common man – dogma long past its sell-by date. Opinions are more varied than the tabloids let on, and the consensus is much as Jeremiah has presented. The Fed was right to step in with the first round of quantitative easing, but now it has gone too far. Easy money has created a variety of perverse incentives and moral hazards.

Speaking of moral hazards, look at the list of Fed critics – Gundlach, Grantham, Einhorn, Hunt, Chanos, Spitznagel, and Druckenmiller. The Times says they’re all wet – and a minority. So, what does the rest of Wall Street have to say? Not a damned thing. They’re taking the money.

See also:
Inflation at Tiffany’s

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Filed under Economy, Finance

Paging Garry Kasparov

You know how, when you have two pieces and a pawn tied up attacking Q5, you can simplify the position by making an exchange? Alternatively, you can keep the pressure on and extend the attack to some of the defending pieces. That’s called “playing for complication.” It favors the stronger player, the one with greater mental stamina and determination. Let’s review the game so far.

“We are certain that the revolutions in Georgia and Ukraine are shaping the new wave of liberty in Europe”

  • In 2004, Ukraine’s orange revolution aligns that nation with the West, but it remains politically divided. For ten years, the West fails to consolidate this position, mainly because the EU is stupid and shortsighted.
  • In 2008, during the Beijing Olympics, Russia invades Georgia on a pretext, retaining South Ossetia and Abkhazia. This is some prime Black Sea coastline.
  • In 2013, Russia protests the installation of an antimissile defense system in Poland, and America backs down. Only during the Cold War were defensive systems considered “destabilizing,” a parallel the State Department chooses not to notice.
  • Also in 2013, revolution threatens the Assad regime in Syria. America makes vague threats about military intervention, and then allows President Putin to handle the removal of chemical weapons from that nation. This procedure keeps Assad alive and in power.

Having rescued Bashar al-Assad from an ugly death, like fellow dictators Saddam Hussein and Muammar Qaddafi, Russia needs no treaty to guarantee its ongoing control of Syria. Likewise, having seized Crimea by force, Putin can easily keep Ukraine unsettled enough to prevent its ever recovering, rearming, or joining NATO. He can afford to let these positions simmer – the “complication” described above.

Russia has said it will not allow use of force to be considered, even in the event that Syria fails to properly comply with the conditions.

Do not think, as John Kerry does, that this is a crude game played only with tanks. The Kremlin knows how to fight with trade and diplomacy, too. By extending his front southwards into Syria, Putin gains yet more control over Europe’s gas supply, and he will soon ink a Yuan denominated oil contract with China. He also holds the spoiler vote on sanctions for Iran, which nation was the ostensible reason for missile defense in Poland.


This game is complicated and dangerous, and millions of lives hang in the balance. Our State Department has not had the brainpower to play at this level since the glory days of Brzezinski and Kissinger.  They are doing “pivots,” “resets,” and handing out plum posts to campaign donors. John Kerry is an embarrassment. Victoria Nuland is an embarrassment. The Kremlin insults our people with impunity. It’s time to get serious.

See also: Transcript of Leaked Nuland Phone Call

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Filed under Foreign Policy

The People’s Ice Cream

Dear Citizen,

This year, instead of shipping your carton of ice cream, we are sending the enclosed voucher.  This is a cost saving measure, over strong opposition from the International Brotherhood of Ice Cream Shippers.  The central government costs quite a bit, and I take seriously my job of reducing that cost.

Your ice cream distribution is the result of a sarcastic remark I made during the last election.  The central government, you see, does not have any money at all except what we collect in taxes.  If you think this ice cream is free, you’re wrong.  Any government is always a net cost to its people.

Perhaps you expect to gain at the expense of your fellow taxpayers.  If so, I admire your optimism.  While we may take ten dollars from the rich and use four of them to buy you two dollars worth of ice cream, do not be too smug.  A government that will “rob from the rich” will soon rob from everyone.

Your ice cream voucher is backed by the full faith and credit of the central government.  All vendors are required to honor it.  Please remember to fill out the voter registration card on the back.

Your Leader,


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Take the Deal

Kevyn Orr has made a good deal for Detroit, and it’s surprising people are hostile to it.  Contrast The Economist with the local newspaper.  The latter is focused entirely on the workers’ demands, as if Detroit is hardwired for UAW negotiations.  The rules in bankruptcy are a little different, and this attitude could lead to negative outcomes for the city.

Even if the actual return to the pensioners is lower than the figures being thrown around, it is still vastly more than they would get …If the pensioners reject the grand bargain … I don’t think Judge Rhodes is going to be sympathetic.

Mr. Orr, the administrator, is asking for minimal reductions in city salaries and pension benefits – with no deadline pressure, as would be his prerogative – and meanwhile asking bondholders to take twenty cents on the dollar.  An 80% haircut!  That’s worse than Greece.  Orr is also trying to protect Detroit’s art collection by moving it off the books.


Some people feel there is a moral obligation to pay back your debts – or at least a legal one.  Media pressure is not going to make a judge overlook these obligations.  GO bonds are supposed to be paid from ongoing tax proceeds – as they say, “full faith and credit.”  Some bonds even claim specific revenues, like the water works, and they have strong covenants.

Municipal bonds will be harder to sell after Detroit, making finances tighter for all the other struggling cities in America.  Politicians should never have been allowed to make these pie in the sky pension deals in the first place.

It’s a beautiful museum, by the way.  We note the irony that its main gallery was painted by Diego Rivera, a communist.

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