Thursday, January 21, 2010

Obama's Bank Proposal: Back to Good (or Bad) Old Days?

President Obama launched a fresh attack on the nation's large banks today, as anticipated, in which he is proposing a ban on the banks' proprietary trading and investment in hedge funds. The tongues are wagging that it was Paul Volcker, not Timmy Geithner, who was standing next to Obama.

Paul Volcker was the chairman of the Federal Reserve from 1979 to 1987.

Options started to be publicly traded in 1973, with the creation of the Chicago Board of Option Exchange (CBOE) and the Option Clearing Corporation (OCC). "For the first time, the general public is able to trade call options under the performance guarantee of the OCC and the liquidity provided by the market maker system." (

Put options were introduced in 1977.

Hedge funds, the first of which is said to have been created in 1948 by Alfred Jones, operated under the radar until late 1980s. The industry's explosive growth came in 1990s and 2000s. One of the most successful hedge funds to date, John Paulson's Paulson & Co., Inc. was founded in 1994.

Individual investors and traders started to use discount brokers when the Internet became widely accessible and easier to use with the graphic user interface - Internet browsers (Mosaic, quickly followed by Netscape) running on Windows 3.1, in mid 1990s.

Financial markets with fully electronic execution and similar electronic communication networks developed in the late 1980s and 1990s, the birth of the current quant (or algo) trading.

Algo trading and high frequency trading have been used increasingly since 2007 both by buy side (eg. mutual funds, pension funds, investor-driven institutional investors) and sell side (eg. market makers, hedge funds). Currently, 70 to 80% of the stock trading volume in the U.S. is attributable to the algo/high frequency trading.

Direct Edge, which rules in high frequency trading and flash trading, was founded in 2005. Its current owners are ICE, Knight Capital, Citadel, Goldman Sachs, and J.P. Morgan Chase. SEC's call to ban flash trading has gone nowhere.

No offense to Mr. Volcker, but I have this feeling that he just wants everything financial to be back to when he was the Fed chairman, back to what he knew best. I don't know what will happen to these big banks targeted by Obama, but I don't think small retail investors and traders necessarily want to see the return of the 70s and 80s.

The whole idea of "punishing the banks" into smaller, lower-risk entities also fits well with other financial proposals that have surfaced under the Obama administration. These proposals have emphasis on safety or security, low risk, but are likely to end up with high cost to the taxpayers.

Stuffing at least part of 401K and IRA with special Treasury bonds that would serve as "annuities" is one such proposal. The government wants to make sure that our retirement investment is safe. These days I wouldn't call U.S. Treasury bonds safe, but again, this "safety" is not for us; it is for the government who will be able to thus secure the captive buyers of its $1 trillion-plus debt year after year.

Another one is the trading tax being proposed by an Oregon Democrat and supported by the labor union. It is supposed to somehow reduce the risk by discouraging investors from buying and selling securities, but all it would do is to raise the cost of trades by several hundred percent for ordinary investors.

Outside the financial proposals, how about the whole-body scan at the nation's airports so that the passengers are safe? Equivalent of taking off everything you have on you, without actually taking anything off. But if you have nothing to hide, why would you protest? By the way these scanners are pricey, and one of the manufacturers is represented by the former Homeland Security chief Michael Chertoff.

The government will do whatever they want to do, because they can. Just don't get suckered into their antics simply because they say "it is to protect the American taxpayers." They always say that.


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