Thursday, August 7, 2008

Market Manipulation

As many of you know, I have a strong hunch that Wall Street insiders and speculators are responsible for many of our recent bubbles (they manipulate the market and make a killing at the expense of the "ignorant masses").

This recent revelation by Reuters does little to quell my conspiracy theory leanings....

"A quiet data revision that has boosted by nearly 25 percent the number of oil futures contracts U.S. regulators think are held by speculators is raising eyebrows in the energy trading community. The revision means that speculators controlled 48 percent of the open interest in NYMEX crude oil futures and options as of July 15, compared with just over 38 percent under the previous classification.......The big shift is all the more surprising, oil traders and analysts said, since the CFTC apparently reclassified only one unidentified oil trader at the same time as the data revision."

I am quickly losing confidence that our free market society provides equal benefits to all involved. U.S. regulations and over site are out of date, and too disjointed to properly monitor the market and ensure that it is free of manipulation. Those with connections and resources routinely increase their wealth, while those without are left to foot the bill for the market's excessive risk taking.

11 comments:

Patient Renter said...
This comment has been removed by the author.
Paul said...

There has been no evidence of a decline in available oil supplies, yet prices have gone up dramatically. If not speculators driving it up, someone please tell me what it is. CFTC and industry insiders self-serving comments to the contrary have not led me to conclude otherwise. But, all of us have a similar opportunity to join the speculation by being long in oil (or short) via ETFs, ETNs, mutual funds, etc.

Patient Renter said...

Yea, watching this all unfold is pretty sad, but I guess it's to be expected. I'd just mention something that my favorite economists point out a lot - what we have isn't a free market and I think it's kinda a red herring to attack the idea of a free market in favor of regulation.

As you said, those with connections and resources routinely increase their wealth - and you're right. But such favoritism isn't a sign of free markets at work, it's a sign of corruption. One example of built in government favoritism is how the Federal Reserve lends money first to "special" banks and now to Wall Street firms (why can't I borrow from the Fed?). Another example would be government bailouts - companies who know they stand to be bailed out benefit by being able to operate with greater risk.

Anyways, IMO, we should be attacking the system of favoritism and corruption, not the idea that a market can work without heavy regulation.

Buying Time said...

Having worked in several quasi deregulated industries, I am a huge fan of "market design."

I believe a well designed market with the right checks, balances, transparency, and incentives, can more or less function without heavy government involvement.

Finding that right balance can be tough, not to mention that favoritism and corruption can easily destroy that balance.

smf said...

Remember, this period (as I have stated before) will be eventually known as the 'Global Asset Bubble' period.

When many financials 10X their investment in commodities in the last 3 years, it was easy to figure out that we are indeed in a bubble.

And notice how the oil price came up since the bubble burst?

G Spot1 said...

While I agree about Wall Street and bubbles, I tend not to believe it is market manipulation causing them. This gives too much credit to the speculators, and greatly overestimates their intelligence.

My feeling is that the recent bubbles over the past decade have been driven more by pure speculation and groupthink. People jump on the latest bandwagon. There is so much money looking for good investments these days that these bubbles can inflate incredibly quickly (Check out NPR's This American Life episode called "The Global Pool of Money"). Calling it manipulation tends to credit the speculators for having control over what they are doing. But this isn't an energy market where the speculators own the supply (e.g., Enron). This is just big money chasing the next big thing. From internet stocks to mortgage back securities to commodities. And because they are foolish and can't control these markets, as soon as the bubble bursts all hell breaks loose, just like we are seeing now.

I do agree stongly with your last statement. We can't continue privatizing gains and socializing losses. If we are going to bail them out it is far past time to put controls in place to keep all this from happening in the first place.

Buying Time said...

"privatizing gains and socializing losses"

Now if I were the cynical type...I would make a comment about the sizable campaign contributions that the financial industry makes to politicians. I starkly remember a WSJ graphic where the amount easily eclipsed the contributions from the next 5 largest industries.

Patient Renter said...

If we are going to bail them out it is far past time to put controls in place to keep all this from happening in the first place.

Instead of putting into place all kinds of rules and regulations to prevent a situation where we "have to" bail someone out, wouldn't it be better to just say we're not going to bail you out, and let people/companies be responsible for themselves? Seems a lot easier and a lot less costly (regulation has enforcement cost) to me.

Buying Time said...

I actually found the WSJ article I mentioned above (but can't get a link to it). On April 2, 2008 they ran an article on who the business donors are supporting.

The graphic, supplied by the center for reponsive politics, showed that Finance contributed around 40mil to the three candidates (this was when Hilary was still around). The next closest industry was healthcare, their total stood at around 9 mil, and of course construction was the next in line (the data focused on typical Republican industries)

G Spot1 said...

"wouldn't it be better to just say we're not going to bail you out, and let people/companies be responsible for themselves?"

It's a good point, but I disagree for two main reasons. First, letting the actors be responsible for themselves is unlikely to prevent the bubble from bursting and causing the related fallout. There are many reasons why that is likely true, including the actor's overestimation of their speculative abilities and underestimation of the consequences, as well as the fact that while a company may fail, those responsible for the company's failure are unlikely to suffer. Indeed, history has shown they are likely to get a bonus or, at worst, a gold plated severance package. Sure, in some cases jail may be a consequence, but many of these people aren't committing fraud, just taking enormous risks. Bad business is not illegal.

Second, the fallout from burst bubbles has severe consequences for the economy as a whole. It would be great in theory to watch the chips fall where they may, like one big morality play. The problem is that many innocent people are severely affected by this and, indeed, the entire economy could be dragged down in the process. There simply are some entities that are too big to (let) fail. I'm a pragmatist in this respect, I suppose, but I think it is better than the alternative.

So the only way out of the cycle as I see it is to put in place rules to prevent the bubbles from getting so big.

Patient Renter said...

letting the actors be responsible for themselves is unlikely to prevent the bubble from bursting

Ultimately, nothing can stop a bubble from bursting, but making entities responsible for themselves helps prevent bubbles in the first place.

It would be great in theory to watch the chips fall where they may, like one big morality play. The problem is that many innocent people are severely affected by this and, indeed, the entire economy could be dragged down in the process

There simply are some entities that are too big to (let) fail

Nobody likes to see the economy getting hammered and people losing their jobs, but you have to see the big picture and think long, long term. By subsidizing risk, we encourage behavior that causes bubbles and market turmoil. And ultimately by bailing out companies with public debt, we are setting ourselves up for an even greater fall later on.

Would you invest in a company that threw around money as foolishly as the US government does, giving it away to all sorts of private entities without getting anything in return? Of course not, nobody would, and eventually nobody will. That's the problem we face. One day nobody will want our debt or our dollars anymore, and at that point everything seizes.

Preventing "too big to fail" companies from going down is like paying off one credit with another, at a higher interest rate. It doesn't solve anything, it just makes the problem worse and postpones the eventual day of reconning when our credit card is maxed out and nobody will give us a new one.