James Pethokoukis

Politics and policy from inside Washington

Are US regulators blowing it … again

May 7, 2010 19:10 UTC

Karen Shaw Petrou at Federal Financial Analytics asks a good question:

Last Friday, we outlined the systemic-risk implications of the growing EU crisis. In the days that followed, LIBOR spreads tightened, funding dried up and our fears only rose. So, we were a bit surprised to hear a senior U.S. bank regulator tell a radio audience Thursday morning not to bother their heads about any prospects that the European crisis could wash ashore. That was, of course, followed in a few hours by a classic systemic-risk crisis on the exchanges. Was the U.S. regulator keeping the game-face on so as not to scare the children? Or, more worryingly, are U.S. regulators still unprepared for another bout of systemic risk, whistling in the dark much as they did when they told us that subprime-mortgage risk couldn’t spill over?


A computer glitch, a fat finger is that the best analysis we can do? Though I doubt we can trace the transactions if they went through “dark pools” yesterday’s situation looks a lot like a program trading variation with sell and cancel orders to create massive liquidity then intiating buys on a variation of the following example of a gaming strategy:

Savvy traders can use information about your order to manipulate prices in their favor. Some of the most common gaming scenarios include:

Gaming by manipulating the stock price. This scenario is explained with the following sequence of actions:
Figure 3. Gaming with Fishing
How gaming happens: 1) The Information Leak (Fishing)- By selling a few small lots, a gamer determines that a passive buyer has placed a standing order in a stock 2) The Exploratory Maneuver – The gamer buys the stock rapidly in the displayed market and succeeds in moving the stock up. 3) The Hit – After moving the stock, the gamer sends a large sell order to the dark pool and sells at substantially higher prices than the price he started buying at in the displayed market. 4) The Reversion – In less then two minutes it is all over. Prices revert as the gamer stops supporting the market.

Dark pools are lucrative, and can be anonymous trades.
U.S. regulators are observers and will have a difficult time regulating what the “insiders” already know and have succesfully kept quiet. It feels like I sat down at the high stakes table in Vegas, not investing with firms that are concerned with my volatility objectives or financial goals.
See the following for a simple description of “dark pools”.
http://www.itg.com/news_events/papers/IT GResearch_Toxic_Dark_Pool_070208.pdf

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Greece and the 2010 US elections

May 7, 2010 18:39 UTC

The  290k increase in jobs is great news for the WH and congressional Democrats. The rising unemployment rate, from 9.7% to 9.9%, is not. Yes, it reflect workers moving back into the workforce, but it is still a lousy headline number. So, too, the rise in the broad U-6 unemployment number to 17.1%. The good news also gets drowned out by the big drop in the stock market and trouble with EU sovereign debt. Even if Greece’s problems do not metastasize, they still provide unsettling headlines for U.S. voters. Like something is still not right in the world. Then, of course, you still have the moribund U.S. housing market and all that evaporated net wealth. Stronger growth may be enough to keep Republicans from capturing the House and Senate, but big gains nonetheless.


The Euro would be much more tenable if it was the currency of only core Europe. The situation is not terribly different than many other European experiments with empire — too much, too fast.

In this case, I predict that rather than the weaker participants leaving the Eurozone, the stronger participants will. This is a case of Spain and Portugal needing the Euro more than Germany and Finland.

While this is all very easy to talk about, the implementation will be frightening.

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US debt woes could explode in just three years

May 7, 2010 18:35 UTC

The great Jed Graham over at Investor’s Business Daily writes an important piece on America’s debt problems. It is not a long-term or intermediate-term issue, it is a short-term issue:

In the wake of the financial crisis and recession, Moody’s Investors Service has brought new transparency to its sovereign ratings analysis — so much so that 2018 lights up as the year the U.S. could be in line for a downgrade if Congressional Budget Office projections hold.

The key data point in Moody’s view is the size of federal interest payments on the public debt as a percentage of tax revenue. For the U.S., debt service of 18%-20% of federal revenue is the outer limit of AAA-territory, Moody’s managing director Pierre Cailleteau confirmed in an e-mail.

Under the Obama budget, interest would top 18% of revenue in 2018 and 20% in 2020, CBO projects.

But under more adverse scenarios than the CBO considered, including higher interest rates, Moody’s projects that debt service could hit 22.4% of revenue by 2013.