Friday, November 26, 2010
The game ends when the kid who owns the football gets called home for dinner.
That's the rule we followed as kids on the playground. It's the same rule we better follow today on Wall Street.
You can't play football without a ball. And you can't trade without liquidity.
The kids who've provided liquidity to the market for most of the past year just got called home.
The FBI raided the offices of several prominent hedge funds earlier this week. It's claiming the hedge funds engaged in insider trading, front running, and a variety of other abuses that gave them an edge over the investing public.
We all know this stuff happens on Wall Street. And we all know nothing is ever going to come from these allegations.
What is going to happen, though, is the hedge funds that provided liquidity to the stock market are going to take their ball and go home. They're not going to cheat when we've tripled the number of referees on the field and all the new refs are charged with watching each of their players. And if the hedge funds can't cheat, they can't make the oversized returns that justify the enormous quarterly bonuses.
So for the next few months, or until the end of the FBI investigation, hedge fund portfolio managers are home for dinner. Without the liquidity the hedge funds provide, the stock market is likely to be especially volatile.
The public might cheer the FBI's attempt to level the playing field. After all, once you kick the cheaters out of the game, you get a more honest score. That should be a good thing. Somehow, though, I suspect the investing public isn't quite prepared for such honesty.
An honest market doesn't have the Fed propping up asset prices. It doesn't have firms like Goldman Sachs making money on 100% of its trading activities. And it doesn't have algorithmic trading programs restricting the daily range of the S&P 500 to just two or three points.
An honest market rises and falls.
For most of this year, while the hedge funds have engaged in activities the FBI considers illegal, investors have enjoyed the rise. It'll be interesting to see if their enjoyment continues through the end of the year.
Best regards and good trading,
Jeff has worked in many different areas of finance, giving him a unique perspective into Wall Street and Washington D.C.'s ways. When the Fed announced it was monetizing debt, Jeff wrote, "It's a big deal because the Fed is basically using its Visa card to make its MasterCard payment."
And last week, Jeff wrote about the looming liquidity crisis, telling readers, "The Fed has lost control of the bus, and the passengers are waking up just in time to watch it drive off the cliff."
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