Felix Salmon

Bite-sized video

Felix Salmon
May 7, 2010 21:55 UTC

I’m experimenting with adding a bit of video to this here blog, do you think it’s a good idea? Here’s a couple of bite-sized snacks I recorded this afternoon: the first one’s on why it’s a good idea to get out of the stock market right now, and the second one’s on Greece, and how it’s a harbinger of other sovereign debt crises to come.


I love it. I just hope it doesn’t slow you down.

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El-Erian on Greece and its consequences

Felix Salmon
May 7, 2010 17:37 UTC

Mohamed El-Erian is fast becoming the biggest and most important bear in the world when it comes to the consequences of the Greece crisis:

Since Greece is part of a general phenomenon of bloated public finance and higher systemic risk, we should also expect a generalised and volatile step-increase in risk premia around the world. Capital will thus be more selective in terms of destination, as it opts for liquidity over returns and for safe government bonds over equities…

For the next few days, we should worry about cascading disruptions in the European banking system as interbank activities are undermined by renewed uncertainties about each institution’s exposures to peripheral European names.

Mohamed’s talking his book, to a certain extent, here: the more volatile that the world of investment becomes, the more important it is to have smart professionals like the folks at Pimco running your money. Buy-and-hold is a strategy which worked very well for much of the past 50 years or so, but it’s far from obvious that it will continue to work going forwards. And besides, a lot of the tail-risk hedging that Pimco can do is simply impossible for retail investors: how would you hedge the risk of cascading disruptions in the European banking system?

If we’re about to see people move their savings from equities into bonds as stocks become just too volatile to hold for someone with a normal risk appetite, then it’s worth asking serious questions about the best way to invest in bonds, which always need to be actively managed, if only because they have maturity dates. Given that the biggest risks to the bond market are the ones surrounding sovereign default, El-Erian’s drumbeat of op-eds on Greece might well help his company get mandates from investors who want to park their money with a company thinking seriously and presciently on such matters.

Especially since it looks as though, at least until now, he’s been pretty accurate.

Update: Just to be clear, when I say that El-Erian is talking his book, I don’t mean that he’s short Greece, or anything like that. I don’t think he is. I just mean that he increases his assets under management, and makes money, when the world gets complicated. And so it’s in his interest to point out just how complicated the world is getting.


Trouble with El is, he’s not just pointing out how complicated the world has gotten: he’s taking a fork-tongued approach to the public sector and glossing over after the fact how Greece got the patsas kicked out of it – and by whom.

It’s rather superficial and indecently early to write Greece off as something that “just happens” but that’s what El’s up to here. Otherwise, as many self-fulfilling prophecies go, El’ll probably appear right, especially after his IMF cohorts have finished wrecking the joint. But nobody who really matters will applaud.

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Deconstructing the crash

Felix Salmon
May 7, 2010 14:25 UTC

Bloomberg’s Nina Mehta and Chris Nagi have an excellent explanation of the role of fragmented exchanges in yesterday’s market crash. The upshot is that something which was meant to make trading safer in fact made it more dangerous, just like portfolio insurance in 1987. And the background is the way in which the big two exchanges just aren’t as big as they used to be, at least on a relative basis:

Increasing automation and competition have reduced the NYSE and Nasdaq’s volume in securities they list from as much as 80 percent in the last decade. Now, less than 30 percent of trading in their companies takes place on their networks as orders are dispersed to as many as 50 competing venues, almost all of them fully electronic.

They thought they could turn this bug into a feature, but it turned out to be a real bug after all:

Rapid-fire orders trigger what the NYSE calls liquidity replenishment points, or LRPs, shifting the market into auctions. While the system is designed to restore order on the Big Board, trading is so fast during times of panic that orders routed past the exchange may swamp other venues and exhaust buy orders, said Angel at Georgetown.

Conceptually it’s a bit of a stretch to hope that in extremis, if the NYSE runs out of liquidity, then the smaller electronic exchanges will be able to provide it. But that’s the idea behind LRPs. With any luck, in the wake of yesterday’s chaos, the whole LRP system will be revisited.

Meanwhile, Kid Dynamite is on fire right now, with three posts getting to the real nub of the Crash of 2:45. He started good, pouring cold water on the “fat finger” hypothesis; that skepticism is holding up, even in the face of an anonymous “official” in the NYT talking about “a huge, anomalous, unexplained surge in selling”. He then got better, noting where the big correlations were (think the yen carry trade), and blaming not humans with fat fingers but rather algorithms which break during tail events.

And then this morning he explains why it’s a really bad idea to bail out those algos by rescinding the craziest trades from yesterday:

Merkel’s point is simple and accurate: if buyers who step in later see their trades canceled, it removes all incentive for them to step in – and then you don’t get the bounce back that we saw! Think about how much havoc it causes a trader who astutely bought cheap stock, then sold it out at a profit. He’s now short! …

If anyone wants to defend the decision to cancel the trades, I’m all ears – but your argument needs to be better than “HEY ITS NOT FAIR THE COMPUTERS RIPPED ME OFF AND MY STOP ORDER GOT EXECUTED AT A PENNY WTF OMG *$XYS !^^!@&!*#” If you don’t understand that this can happen with a stop order, don’t use stop orders.

There’s a very sensible idea going around that a simple way to deal with nearly all of these problems, at a single stroke, would be to implement a tiny tax on financial transactions. Historically, people have complained that such a tax harms liquidity, which is true. But the fact is that it harms the bad kind of liquidity — the liquidity which dries up to zero just when you need it most. Liquidity, if it’s spread across multiple electronic exchanges and can disappear in a microsecond, does very little actual good, and in fact does harm during tail events like this. Let’s tax it, and raise some money for the public fisc at the same time as slowing down markets and making them think before doing a trade.


Incidentally, if I look at the S&P 500 on Thursday with Bollinger bands, the 2:30-2:45 period doesn’t look especially different qualitatively from earlier in the day, where the market was bouncing off new lows that were descending in an accelerating way. The liquidity collapse from market fragmentation presumably exacerbated what was going on; beyond that, it looks like a bunch of trades based on technical analysis could well have driven the market to the point where that amplifier kicked in.

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Jobs come back, along with unemployment

Felix Salmon
May 7, 2010 13:34 UTC

The payrolls report this morning was good: it feels churlish to throw cold water on the news that 290,000 more people are working now than a month ago.

But. Keep an eye on those unemployment rates. The headline figure is back up at 9.9%, the highest it’s been this year. The U-6 underemployment rate is a gruesome 17.1%. And U-4, which is total unemployed plus discouraged workers, has hit a new high of 10.6%.

If we’re going to have sustained GDP growth, it’s going to have to come from those figures falling back to acceptable levels: without that happening, we can have a little bit of a rebound, but none of the long-term consumer demand that’s necessary. And yet they’re all going the wrong way: up, rather than down. That’s devastating for the economy, and not only because rising unemployment is a sure-fire way to increase mortgage delinquencies, with all the ugly financial and fiscal consequences that entails.

Underneath it all, there’s a glimmer of a silver lining to the unemployment figures: they come from an increase in the labor force, which means that people are actually bothering to look for work again. Remember though that 6.7 million people have now been unemployed for more than six months — 46% of the total unemployment figure. We’ll literally never find jobs for all of them: many will never be employed again. Which is the real underlying tragedy of this recession, and of the jobless recovery.


High corporate profits do not mean jobs are on the horizon. It just means that companies have finally jettison enough people and sales have gone up a little which means they can do without repeating those mistakes of the past. The real problems are with the rest of the world and its not looking good. We do not have enough domestic product manufacturing and that accounts for retail sales rebounding yet jobs not rebounding. Too much made in other places. Too much debt with States and local governments will just create another wave of underemployed and unemployed too.

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Felix Salmon
May 7, 2010 06:04 UTC

Update on tape revelations of stormy Copenhagen leader smackdown — now with Obama Admin response — NYT

Freddie Asks for $10.6 Billion — WSJ

Were 16 billion E-mini S&P 500 futures really sold in 2 minutes this afternoon? — CNBC

Barry’s looking pretty smart right around now — Ritholtz

“I survived the crash of 2:45 p.m.” t-shirts for sale — Zazzle

Mega Millions Winner is a journalist! — SCPR

Why is the FTC nosing around Apple & not Wall Street? Because the Federal Trade Commission Act explicitly excludes banks — Reich

How a market crashes

Felix Salmon
May 6, 2010 20:30 UTC

How can the market go, on a random Thursday afternoon, completely insane? The story which is emerging centers on old, boring Procter & Gamble, as can be seen in the PG chart from this afternoon.

pgtips.tiff Look at the volume chart: what you see here is a big block of shares trading in P&G at around 2:30, followed by another huge block right before the market crashed. And then, nothing. The two big blocks were probably sell orders, which were big enough to blow through all the bids in the market. As Henry Blodget says, “for a few minutes, buyers just disappeared”.

It’s worth noting here that none of this data is particularly reliable: the Nasdaq is reportedly confirming that there were technical problems with the P&G quote, and there are persistent rumors of a “fat finger” trade as well, which I’m not sure that I believe.

If the market were rational, it could cope without difficulty with such things. There’s no bid on P&G right now? Fine, wait five minutes and see if you can get a bid then. But there were stop-loss orders on P&G, which meant forced selling into a no-bid market, and if these trades really happened, then a couple of people who are surely going to celebrate tonight were in the right place at the right time and bought up a small amount of the stock in the high 40s.

In any case, whether the trades actually happened or not, they were reported to the exchanges, and were immediately reflected in the Dow, which remember is an average and not an index. If P&G is off 14 points, and the Dow’s divisor is 0.132319125, then that one trade in itself wipes 100 points off the Dow in a matter of seconds.

The timing of that 100-point fall could not have been worse: stocks had started selling off about five minutes earlier, and so the 100-point drop came into a market which was already getting jittery and panicked. The velocity and severity of that drop in the Dow immediately triggered stop-loss selling in the market more generally, which then started feeding on itself: even as P&G’s share price was recovering, bids were falling away rapidly in the other 29 Dow components, and at one point the Dow was down just a hair short of 1,000 points on the day.

But the fact is that none of these numbers are all that meaningful: what we were seeing was traders flailing around in a context of limited information and liquidity, trying to get a grip on what was or wasn’t going on. There was always the possibility, after all, that the sellers knew something they didn’t, and that stocks were actually falling for a reason. So it took a few minutes for the market to realize that it was all just market volatility — and therefore a great buying opportunity for any trader.

It’s been a very impressive day to learn how the stock-market sausage is made: I think we just saw the largest intraday fall, in point terms, that has ever happened. But the bigger lesson is that in the short term, any market can fail temporarily. The question is whether the jitters from this afternoon are going to mean increased volatility and risk aversion going forwards. My feeling is that, yes, they both will and should.


The stock market crash on Thursday afternoon took financial Web sites down with it, as people hurried online to make trades and check their investments. Yahoo Finance, Fidelity.com, and Google Finance are among the sites that people complained were unavailable or slow for a period during the afternoon. This has definitely affected the e-commerce marketplace, which has become the virtual main street of the world. Providing a quick and convenient way of exchanging goods and services both regionally and globally, e-commerce has boomed. The stock market crash has caused much volatility in the marketplace.


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Volatility returns

Felix Salmon
May 6, 2010 19:25 UTC

Ah, volatility. Suddenly, at 2:30pm this afternoon, the US stock market decided it was going to fall off a cliff, and the Dow promptly proceeded to drop about 700 points in the space of mere minutes, before bouncing back up. This is pure market craziness: if any journalist tries to blame “worries about Greece” or anything like that, ignore them — insofar as there’s a simple explanation, it’s probably something to do with a dodgy feed on Procter & Gamble’s stock price, which fed directly into the Dow, and caused a brief spell of utter panic.

I suspect that this is only the beginning of a new era of volatility. Markets are a bit like volcanoes, or earthquakes: they’re inherently unpredictable, but if they’re quiet for a while, the magnitude of the next big event is likely to be that much bigger. The trigger for this particular move could have been anything; the lesson to learn is that given the complexity of contemporary financial markets, correlations can pop up anywhere, and a relatively small uptick in something like Portugese CDS spreads can combine with a glitch somewhere in the equity markets to get magnified into an event which wipes out hundreds of billions of dollars in capitalization in the blink of an eye. Or maybe it was the UK election, or a butterfly flapping its wings in Kuala Lumpur: there’s no way of ever knowing.

To take a little bit of a step back, Dow 10,000 is something which most people would have thought absolutely wonderful if you’d asked them at any point in the first half of last year: there’s a lot of room to fall. As the world has been releveraging for the past year, equity valuations have been increasingly predicated on the sustainability of a rapidly-growing debt pile. The stock-market collapse of 2008 was a delayed reaction to the credit crunch of 2007, and similarly now we might see equity valuations be marked down as the world of credit becomes very dicey all over again. Alternatively, the incredible rapidity of this afternoon’s rebound might reassure investors that the market is self-correcting and pretty safe.

But that would be the wrong conclusion to draw from this episode, I think. My feeling is that we’re going to have a turbulent journey into a world where risk assets all price off each other in highly complex and unpredictable ways: a radical change from the old world where credit instruments traded at a spread to governments, while stock investors took solace in the low spreads and high liquidity of commercial paper. In the new world, devastating correlations can appear out of nowhere — and then disappear again just as quickly. And anybody who wants to stay in the market is going to need a very strong stomach.


You’d need a strong stomach and absolutely no sense of smell to write today’s event off as an accident. It appears to have been redistribution of wealth by “other” means.

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The Goldman Wells puzzle

Felix Salmon
May 6, 2010 13:38 UTC

I can understand the trading-desk mentality which went into the Abacus deal. What puzzles me more is Goldman’s incredible secrecy when it came to disclosure that it had received a Wells notice:

The Financial Industry Regulatory Authority also has opened an investigation into Goldman’s failure to report the Wells Notice that it received in September regarding trader Fabrice Tourre, a person familiar with the matter said on Wednesday.

Goldman was required to report the notice – which signals the likelihood of SEC charges – within 30 days of receiving it, but did not disclose it to FINRA until this week, the source said.

This seems to me to be a no-brainer of a disclosure, since there’s no way the firm is going to make any more money if it doesn’t disclose the notice. But not only did Goldman fail to make any SEC disclosure of the notice, it didn’t even inform Finra, despite industry requirements. Even after the SEC suit came and the importance of transparency in all dealings was abundantly clear, Goldman’s top lawyer Greg Palm refused to say on the firm’s earnings call whether the bank had received any more of these things.

It seems to me that there are two possibilities here. Either Wells notices are very rare beasts at Goldman, in which case such an unusual event with such large potential repercussions would seem to clearly mandate disclosure. Or otherwise Goldman receives them quite regularly, and they normally amount to nothing, in which case a steady drip of disclosures at the SEC would soon be discounted by the market as business-as-usual.

Either way, Finra and Goldman’s shareholders deserve to know when the bank is being investigated by the SEC. Is there any colorable reason at all for the bank to hide such things from its owners and regulators?


There is no general duty to disclose material information. You have to disclose (1) if a line item of an SEC report, etc. requires it, (2) you are trading in the security or (3) it would render statements misleading not to disclose.

I believe public companies generally disclose and GS should have disclosed here.

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Felix Salmon
May 6, 2010 06:35 UTC

Goldman’s outside directors got an average of $298,000 each in 2008. How much would a non-executive chairman make? — Reuters

Spiral Jedi (Video) — Star Wars Modern

Truly geektastically wonderful: xkcd’s Color Survey Results — xkcd

Me, in the BNN studio, wearing the salmon suit — BNN

BBC announces a goal of doubling monthly ‘click-throughs’ to external sites — Nieman Lab

The Nevermind baby works for Shepard Fairey — Kottke

I’ll buy a ticket to Grant Achatz’s new restaurant — Kottke

Me, interviewing Richard Florida in Toronto — Rotman


when are ya gonna come to chicago? i’d totally join you at NEXT.

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