What Business is Wall Street In?
blogmaverick.com
blogmaverick.com
The biggest wins and losses in day trading will come from exotic derivatives simply by their nature: they're highly leveraged bets. Those firms that create the vehicles to make those bets aren't "hackers", they're "Vegas". You ask for a bet against the housing market or for cattle, they set up a structure to let you make that bet, and you play the odds -- and you might beat the other betters in the market over the short term, but it's the house (taking its percentage off the top) that always wins long term. Mark Cuban is right to be uncomfortable playing that game.
Meanwhile, people like Warren Buffet continue to look for healthy companies that are underpriced and buy into them for the long term. Day-to-day the market might be driven by short-term bets, but over the course of 3 decades it's still driven by the fundamental health of companies. If anything, those who care about "the performance of specific companies and their returns" benefit from the fact that occasionally, as a result of day traders' bets, healthy companies' stocks get sold at bargain prices.
If you try to play Vegas' game, you'll probably get burned. But if you stand back, watch the game, and buy when their game creates a bargain price on good long-term stocks, you stand to get very solid returns.
Why? There are oodles of people doing the same thing, who have access to better information, have more experience, have better search/screening systems, and so on. To me it just seems like you're going to be the 'greater fool', unless you really go at it more or less as a job, with the associated time commitments.
If you're playing the short-term investment game, all of those things matter hugely. It's a zero-sum game. In order to make money at it, you have to have a better system than the rest of the people playing -- just like making money on sports betting.
They don't matter nearly so much in the long term. Long-term investing isn't zero-sum; economies can grow, and your goal is to own a growing piece of the economy. There are oodles of people playing the long-term game, but the market is big enough that even I, with my relatively limited information, can make good solid investments.
Consider this a corollary to "the market can stay irrational longer than you can stay solvent". The market can offer irrational bargains to such a degree that even once those with better information have had their fill, there's some left over for people like me.
"Around 3 p.m., the selling pressure abated. Just as swiftly as the market fell, it recovered ground. One factor behind the swift recovery, traders say, were funds that use computers and formulas to sniff out bargains in the market. These funds swooped in on hundreds of cheap stocks, helping push the market higher."
It really sounds to me like you have to have insider information, or something close, to have a good chance of getting something on the cheap, because otherwise the price is going to get pushed up again by people with better and faster research tools.
More specifically, Wall Street's obsession with the big score makes stocks very dangerous and volatile which means that if you try investing based on a company's intrinsic value, the stock you buy can easily swing down for reasons that are completely unrelated to the company value but have to do with some traders or trading algorithms trying to outsmart each other.
Now if you are Buffet you probably have enough cash reserves to ride out any such swings, but most people need to rely on the money in their stock holdings, so they cannot afford the new found volatility of Wall Street, so many people are just moving out of the market all together.
Now I have to say that I am not sure if this argument is right, but that is his argument.
If you need to rely on the money from the sale of your stock holdings, you're not a Warren Buffet type of value investor. If you're looking for income from your holdings (dividends and such), the volatility of Wall Street's stock pricing algorithms is not an issue.
For those who are nearing retirement and counting on the sale of stock holdings, make sure you have an appropriate stock-bond-short term reserve mix in your portfolio so that you can ride out market swings. Moving out of the market altogether is unnecessary. If you do move out of the market in desperation (like people did in March of last year, selling for whatever they could get), you're providing us value investors the "irrational bargains" I mentioned in my reply to davidw.
But in his defense, I don't think he even mentioned "exotic derivatives". Exotics are just derivatives that aren't "vanilla" (standard put or call options, etc). They don't have to be any more leveraged than a standard call option or a futures contract.
>If you try to play Vegas' game, you'll probably get burned. But if you stand back, watch the game, and buy when their game creates a bargain price on good long-term stocks, you stand to get very solid returns.
When a stock is dropping a lot (like it happened the other day with several stocks), you usually can't tell if it's really a "bargain". In hindsight it's easy to say that some stocks were a bargain a few days ago, but at that moment it would be risky to buy them. It could be that the companies were really in trouble.
For instance, even as Lehman stock was dropping, some people were buying it. Another example: this year, Japan Airlines (JAL) went bankrupt. It had been in trouble for some time, but as usual for airline companies, the government was propping it and most people didn't believe it could go down.
If you read http://en.wikipedia.org/wiki/Reminiscences_of_a_Stock_Operat... you will notice that people like Warren Buffet have always been in the minority, as much as people hate to admit it, there is always that element of speculation in their investing.
The problem, according to Mark Cuban(and I will agree here), that there has been too much emphasis on the creating leveraged bets, and skimming in HFT, and not enough emphasis on capital creation for companies new(read - startups) and old.
Is it to enact hard to enforce ambiguous anti hacking laws, while at the same time individually patching each exploit with unrelated fixes?
Or is it to step back and analyze why a system has so much hackable complexity, and seek to fix the overarching issues that create security vulnerabilities?
I would much rather see fundamental suggestions about how to optimize the market for fairness from the ground up rather than patchwork fixes like the dollar a trade tax, or the 5 year tax break.
Guess what? That just means that the market has gotten more efficient so that you can't arbitrage it anymore. If you can't make money, that your problem. If the quants made the market so irrational then why aren't you profitable arbitraging it?
All technologies improve the average case at the expense of making the worst case worse. Cars versus walking for example. Average case: get to where you are going faster, worst case: horrible accident. The question is not whether financial innovation introduces systemic risk but whether the benefits out-weigh the costs. The consensus amongst academic is that yes, this is the case.
Funny that Cuban wasn't complaining about traders when they were driving up tech stocks in the dot-com bubble that eventually helped him land his giant payout in Yahoo stock. Or the traders that took said Yahoo stock off of him when he wanted to divest himself (aka liquidity).
Tax breaks for long-term investors? Well VC and PE firms are "long-term investors" and they already have a pretty sweet deal on carried interest. That didn't stop them from rampant speculation in the tech bubble, or buying companies at outrageous debt multiples in the credit bubble. Imagine how much more it would have gone on if they didn't have to factor tax into their return calculations? I bet Mark would love to get all his future speculative VC investment payouts tax free. I don't know of a major tax regime that doesn't treat short-term trading revenue as income as opposed to capital gains. Tax breaks for "real long-term investment"? Yes, it's called a 401k or pension plan. If you're really a long-term investor a 10% algo glitch (4% actual down day) shouldn't even register for you. You shouldn't even be looking at the market on more than an annual basis.
"The market has changed over the last 3 years" and is driven by macro issues? Yes we've been through a severe global recession driven by the bursting of a global credit bubble. Of course macro issues have dominated and volatility has been extremely high.
(The wider) Wall Street's business is not and never was purely raising capital for companies. In the 20s were market volumes way less than capital raised as a proportion? I doubt it, but even if so it sure didn't prevent the Great Crash. Why does government need to further incentivise capital raising, that already brings in some of the highest possible fees (on individual transactions) to investment banks of any "traditional" activity (equity and debt underwriting, M&A, market making), i.e. excluding principal business and super exotic trades. He also says that companies never go public anymore, yet global IPO volumes are the highest in a decade (http://www.efinancialnews.com/story/2010-03-26/global-ipo-q1).
The only point I really agree with is leverage - it fuels the growth of bubbles, and exacerbates their bursting (or causes it when taken away in some cases). Most of the major bubbles/crashes in the past 100 years were either caused by excessive leverage (credit bubble, LTCM, various debt and currency crises) or had leverage as a major feature in their bursting and the speed and volatility of the movements (dot-com, Great Crash, credit bubble). The possible exception to this is '87 (to a large extent computer-driven, arguably) although again leverage played a big role.
Finally, the major, unforeseen crashes have typically come about due to opaque, illiquid and/or highly leveraged situations (AIG, LTCM, CDS on CDOs, day traders buying tech stocks on margin etc). High-frequency traders only trade in the most liquid instruments, so ironically they are the ones trading on exchange, transparently and with exchange-set collateral and trading rules. Certainly illegal activities such as real front-running should be stamped out. Possibly things like flash orders too. A level playing field should be ensured. But he should worry more about the stuff going on off exchange than in the public markets.
Your point is taken though.
Admittedly this is a bit pedantic, and I know the popular use of the term has come to imply black hat, but this is Hacker News!
I'm glad I'm not the only one who somehow says and types the exact opposite to what I meant to say.
Mark means there is a maximum amount of moral hazard -- the brokers have completely different interests than the principals. If there were zero moral hazard, that would be a good thing.
well I'm sorry, but that also applies to VC/angel funded startups game nowadays, which Cuban participates in.
Has it not become painfully clear that the financial system has come to dominate the economy to a greater extent than the value it provides? http://en.wikipedia.org/wiki/File:NYUGDPFinancialShare.jpg And that this has been driven by the interests of those who profit personally from such a configuration, in opposition to the interests of society as a whole? http://www.thisamericanlife.org/radio-archives/episode/405/i.... I'd say those statements are hardly controversial to anyone without a vested interest in the status quo.
I grant that "hedging risk" and that other standby, "ensuring liquidity", do have value, just not to justify the existing system. The liquidity argument in particular comes off as ironic in light of the fact that trillions of public dollars provided to the financial sector in the name of opening liquidity to the general economy did no such thing.
In any case, since you feel the financial sector is too large, what do you believe is the proper size of the financial sector?
To turn to your other point, I certainly respect what you're saying, but once again there's this problem of reductio ad absurdum: forces leading straight to financial meltdown can hardly be representative of a proper system. What you're saying sounds dangerously close to "the system worked". Or perhaps, "the system just didn't follow its own logic consistently enough".