The Insider’s Tale
The ‘foreclosure-gate’ scandal, discussed here last week, rumbles steadily on, with new revelations emerging daily. Yet the full extent of this mess is quite unclear. We can be certain that it will not be a minor matter, since the big banks are estimating their potential losses in the tens of billions of dollars.
Obviously, no-one believes this line. Rather, the operating assumption is that the true loss figures will prove to be many times higher – in other words, this ‘Return of Sub-prime Mortgage Mess’ horror movie will follow the same story line as its hugely successful predecessor and move from ‘contained’ to ‘out-of-control’ to totally disastrous. But no-one knows just how big the losses might be and whether they do indeed, as many independent analysts claim, represent another systemic crisis.
The fact that no-one believes what the banks – or the government, for that matter – say in the most official and public way, is the nub of the whole issue. As discussed repeatedly in this column, the essence of the mega-crisis that is still unfolding is the collapse of confidence on the part of the general public in the financial system and the governmental system that supposedly oversees it.
I have also noted that one of the most important manifestations of this crisis of confidence is the way in which stock markets are behaving. This has little to do with the way prices on those markets are moving – which is what most people associate stock markets with – but rather how the markets themselves are functioning or, more correctly, malfunctioning.
In that context, it is more than useful to bring to the attention of the wider public an extraordinary speech made last week at the annual general assembly of World Federation of Exchanges. The speaker is not a regulator or even an exchange official, but rather the chairman and CEO of Interactive Brokers Group, a leading global firm engaged in brokerage and market making on more than 100 exchanges. Thomas Peterffy’s concerns about exchanges are therefore neither theoretical nor altruistic. He actually understands that his own and his firm’s well-being in anything beyond the short-term demands that the markets function properly.
He begins by comparing the old days – say, 15-20 years ago – when “all the transactions had to take place on centralized exchanges with basic rules of fair trade”, so that “customers could be reasonably sure there was a limit to the amount for which their brokers could fleece them”. However, “we cannot make that claim today” – because the move from physical to electronic exchanges and the accompanying ‘robotisation’ of trading has led to fragmentation (there are many competing exchanges and brokers can route customer’s orders to any of them), whilst large firms with massive computing power can create distortions in the trading of individual securities or in entire markets. The result: “what we have today is a complete mess.”
Peterffy gets to the heart of the problem, under the heading “The Crisis of Trust”: “It is not so much that the public does not trust their brokers. They do not trust the markets, the exchanges and the regulators either. And why should they, given our showing in the past few years?…I must confess to you that I was an ardent proponent of bringing technology to trading and brokerage. Unfortunately, I only saw the good sides…I did not see the forces of fragmentation and the opportunity for people to use technology to keep to the letter but avoid the spirit of the rules – creating the current crisis. It is vitally important that we bring an end to this crisis of trust before it spreads any further; that we bring back order, fair dealing and trust in the marketplace.”
Peterffy sensibly begins that effort by identifying “the root of the problem” which he correctly defines as “as always, short-sighted greed on the part of the brokers”. That is the root of the problem on markets, where brokers are key players. In the banks, the root of the problem is short-sighted greed on the part of the bankers. And so on for insurance, pension-fund management and every other area of the financial services industry. And this poisonous root is allowed to spread by the absence of a regulatory framework both empowered and motivated to enforce rules that constrain the very human tendency to short-sighted greed.
The good news is that the crisis is now so severe that insiders like Peterffy feel they have no choice but to talk about it in public and demand tough solutions that they know will be opposed by their own peers and colleagues. But Peterffy is a representative of the private sector, whereas the public sector, all the way up to the most senior level, is still engaged in a vain effort to persuade the public that a) all is well and b) whatever isn’t can be made so by pursuing the policies currently in force. Then they wonder why no-one believes them and are shocked to find that confidence in them keeps ebbing to new lows.