Prop Trading

While in the US speculators and speculators alone are blamed for surging oil prices, in China we get an example of precisely what happens when speculators get caught on the wrong side of the trade. "Farmers across China are suffering from unmarketable vegetables since the arrival of spring, hurt by an increase in output following speculation last year’s surge in demand would continue in 2011... Many farmers blamed oversupply as the main reason for the poor market. Due to climate factors, leaf vegetables from northern and southern China came onto the market almost at the same time, making the supply much higher than last year...Speculators also played a major role in the price collapse, as they dumped vegetables that they had been hoarding onto the market." That's a new one: so speculators are now to blame for a plunge in prices? Of course, the "speculators" themselves merely took their losses, some went out of business, and the PBoC did not rescue any of them. This way the more incompetent of them are now out of business. In the US, on the other hand, where we are now urgently holding our breath for an ES margin hike to hit the tape any second now from the Globex because the silver bubble has now moved back to the S&P ("where it belongs" - unnamed Fed official), all those who would have placed idiotic bets either way would be promptly bailed out by the Fed, especially if they were the prop trading operation of a TBTF toxic laden monstrosity (here's looking at you mother Merrill). Does one see an issue here?

Somewhat ironically, up until the Texas Instruments news hit, NYSE market volume today was 3.2 billion shares. This is on par with the lowest non-holiday market volume since just before the market crash in September 2008. It seems not even algos and robots care to trade this market anymore. Any banks that may have been hoping to make some commission-based profits on a mythical jump in trading this uear will have to shelve such plans and continue to rely on the only proven money-making model: massively leveraged prop trading.

In an eerie recreation of the events that transpired during last year's flash crash, among the reasons for the spectacularly wide spreads during yesterday's dramatic yen surge (which was more than just a selloff of in the USDJPY but virtually all carry pairs as we pointed out previously) is that various brokers pulled away their entire market making in the currency. While the full list is those who turned the machines off is still unknown, one company is. According to Dow Jones, "Barclays Capital pulled yen prices off its Barx dealing system for a short period Wednesday, as the Japanese currency fizzed to its strongest levels on record, a person familiar with the situation said Thursday." The reason: "to protect themselves during hectic trading conditions" - but why, remember there is no more prop trading on Wall Street (wink wink). And had others followed suit in Barclays footsteps and withdrawn markets due to a stop loss triggered wipe out in the FX market, compounded by fundamental uncertainty, it is easy to see how the yen may well have surged far, far higher. Luckily, it did not happen this time, although the USDJPY is trading at all all time lows today. On the other hand, if the market, despite trillions in capital injected by the central planners is so jittery it can take out all bids in what is supposedly to be the world's most liquid market on literally a moment's notice, we wonder just what will happen if and when Bernanke announces the end of QE3 and we have a repeat crisis...

Now that silver continues hitting nominal high after high (except of course for the record price hit during the Hunt Bros period), and there is a very distinct possibility we may see an unprecedented melt up in the price of silver to over triple digits for a variety of previously discussed factors, here is a post we produced a year earlier, courtesy of a "deep insider" which dissects with exquisite detail the nuances of silver market manipulation, which in retrospect may have been just a little early. Considering that every single trope mentioned is now in play (even the unmasking of Buffett's unbelievable PM bashing hypocrisy when he himself was one of the people who utilized blatant silver market manipulation for his own purposes when it suited him back in 1997 to send silver soaring), we believe readers should re-read this post in its entirety as it presents a walk-thru for the mechanics, and strategy, of the ongoing unprecedented move higher in the shiny metal.

A topic which we anticipated last summer, and which has come to shocking and rapid fruition ever since the beginning of the year with the self-immolation of a Tunisian protester, resulting in a tsunami of violent revolutionary uprisings across the developing world, has been the question of whether and to what degree Bernanke's monetary policies are responsible for what is becoming an indirect wave of suppressionary genocide (today alone, between Libya, Yemen and Bahrain over 500 people have been killed). And while Zero Hedge is far less ambivalent about the underlying cause of the surge in anger (in most of the affected countries, the bulk of their population has to spend well over half of its income on food and energy), and when people who already have nothing, see whatever little they have left taken away as well, they see no downside in violent revolution, there are some more moderate views. Below we present one, courtesy of reader Chindit13.

Ever since Zero Hedge's advent just over two years ago, one of the most improper things we claimed happened routinely on Wall Street, was that the big banks' prop traders would consistently, and completely against regulations, populate their massive trading floors with both flow and prop traders, who often sat side by side, within earshot and front run the big clients' orders. Some may recall that point #8 of our follow up query to Goldman's Lucas van Praag in December 2009 was precisely a request to get the seating chart together with assigned responsibilities of all Goldman traders. To wit: "we are still hoping to get a seating chart of Goldman's trading floor (via legitimate channels) which clearly discloses flow and prop traders' seats in order to disclose to the general public that flow and prop traders do not share the same information flow, especially that emanating from core clients who tend to move markets the second they announce their trading axes to Goldman's flow traders." The reason we bring it up is that once again we seem to have been just a year ahead of the curve. In a just announced settlement, the SEC has fined Merrill, and supposedly its insolvent Bank of Calcutta taxpayer funded holdco, $10 million for doing precisely this! From Bloomberg: "The SEC found that Merrill operated a proprietary trading desk from 2003 to 2005 on the firm’s main equity-trading floor in New York, where market makers received and executed customer orders. While Merrill told clients their order information would be used on a need-to-know basis, proprietary traders got information and used it to place trades on Merrill’s behalf after executing the customer orders, according to the statement"...... So, does everyone finally understand how Goldman's (et al) prop group has no trading loss day (at near 50% margins) every single day year after year now?

After last week we actually saw some volume participation for the first time in 2011, today the no-volume meltup has resumed. The chart below shows the relative to average volume in the ES. Which ironically shows the Catch 22 the banks find themselves in: the higher they run up the market, the less participation there is, the less trading volume, the lower commissions, and the lower the profits from the traditionally biggest contributors to bank P&L over the past 2 years: flow and prop trading (as confirmed recently by Goldman, Morgan Stanley, JPM, Jefferies and everyone else). Which simply means that banks will have to increasingly rely on the Treasury curve trade (and of course, fudged accounting) to make their bottom line. This would work if consumers had actually stopped deleveraging. Which they haven't. Meaning simply that banks will need to make all their trading profits on market distributions and other crashes that see volume spike. But that as we now know, is contrary to the Fed's third mandate. A curious bind indeed.

Congratulations to Jeff Immelt - the uberhead of the soon to be former head propaganda financial station has been appointed to chair the White House's job panel. That said, we wonder just whose leg he had to hump to get that particular job: after all any small business job CEO in America is infinitely more qualified than Immelt to create jobs (unless the jobs in question are 1,000 prop trading positions at Goldman Sachs - since we are rubbing it in in Volcker's face why not go all the way). Dow Jones has created a brief compilation of Immelt's simply tragic job creation track record:

[Immelt] runs a big company, but Immelt has shown more skill at cutting jobs, frankly, than creating. GE finished 2009 with 18,000 fewer US workers than it had at the end of 2008, and US headcount is down 31,000 since Immelt's first full year in 2002. During his tenure, GE workers based in the US as a percentage of total employees has fallen to 44% from 52%.

Uh, Crickets???

Goldman reported Q4 numbers today and they were ugly. While earnings were in line with expectations (bank EPS has become completely irrelevant as the FASB now affords banks with a practically infinite array of options to game the bottom line), the revenues were more difficult to fudge. And now that the firm finally spreads its revenues in the new method which breaks out Prop (and FICC from Equities as part of client flow), we can see just why prop trading is so critical to the firm. The traditional golden goose for the firm: Fixed Income, Currency and Commodities trading on a flow basis was abysmal, plunging from $2,687 million to $1,636 million sequentially, and from $3,129 million in Q4 2009. As the chart below shows, this number peaked at $6,017 million in Q1 2010. Combined, total revenues by all segments came at a five quarter low with FICC posting the lowest contribution since 2009. Yet the one segment which did post an increase was Prop Trading, also known as Investing and Lending, which increased from $1,797 million to $1,988 million. And as we noted previously, the margins in this group are by far the highest, averaging just under 50%, confirming why as Bloomberg noted earlier, attempts to reintegrate prop into Wall Street trading are ramping up big now that Volcker is gone. But the number everyone is waiting for is comp, which was $2,253 million in Q4 (unlike the negative number posted in Q4 2009 when the outcry against banker bonuses was apparently louder). This was a 26.1% comp margin, and brought the year total to $15,376 or a 39.3% margin on total revenues of $39,161. Based on "total staff at period end" of 35,700 this comes to precisely $430,700 per employee. Surely this is admirable compensation for a Fed-backstopped hedge fund job well done.

• Define irony: Goldman among four underwriters picked to manage AIG share sale (Reuters)
• Prop trading is baaaack: Volcker Rule Should Require Sign-Off by Bank CEOs, Panel Says (Bloomberg)
• Wells Fargo Misses Profit Estimates as Mortgage Banking Weakens (Bloomberg)
• Asia to See Soaring Prices in 2011 (Reuters)
• Chinese Premier stresses stabilizing food prices, housing market in 1st quarter (Xinhua)
• China and U.S. Set to Square Off (WSJ)
• China Needs Urgent Guidance on Euro Debt Risk, Yu Yongding Says (Bloomberg)
• Gerova Hires Investigator in Bid to Refute Critical Report (NYT)... stock plunges again (report posted here first)
• José Sócrates reportedly begged for help last week as Portugal became the latest eurozone country tipped for a bailout (Guardian)
• European banks face tougher stress tests (Irish Times)

The fact that the unveiling of Facebook was done with so much noise and fanfare by GS, a firm that never does anything rash you understand, suggests that there was a need to divert attention from the issue of valuation.

Over a year ago we attempted to deconstruct Goldman's prop trading activity using scraps of data from the tax returns of the Goldman Sachs Foundation. The reason we did that, is that up until today, the firm had never disclosed the non-client aspect of its trading, instead dumping all related revenues and profits in the umbrella "Trading and Principal Investments." That is no longer the case, as starting today the firm will break down its client facing and prop ("Investing and Lending") revenue and profit streams. The reason for our long-term fascination with Goldman prop trading, which is nothing less than a glorified hedge fund, and has no client flow focus whatsoever (presuambly), is that we had always claimed it accounts for a substantial portion of the firm's if not top, then certainly bottom line. After all it was Lucan van Praag who told us directly, that prop trading contributions to Goldman were really de minimis, a response which we took extremely skeptically as the margins associated with a modest revenue amount may well be huge and thus result in a substantial pre tax net income benefit to the firm. Today Goldman also published an 8-K that did a pro forma breakdown of its earnings. To our great surprise, we were correct in assuming that Goldman prop has been the dynamo behind the firm's profitability in 2010.

For nearly two years Zero Hedge (and others) have badgered Goldman Sachs for being purposefully opaque in its reporting structure to not allow any transparency in the split between flow and prop trading revenues, instead lumping everything into the ubiquitous "Trading and Principal Investments" segment of which FICC (fixed income, currency, commodity) has always been the dominant vertical for the taxpayer sponsored hedge fund. This is about to change. In a just released 67 page report titled Report of the Business Standards Committee, Goldman announces that going forward this key trading group will now be split into two separate segments: "Institutional Client Services" and "Investing & Lending" which will provide much more detail on how the firm determines its trading revenue, and will allow objective, third party analysts to determine just how much risk the firm takes on from both a principal (taxpayer funded) and agent (dumb mutual fund money) capacity, something which should have been the case long ago, and which we railed about for two years now. We are happy that our railing on this most important topic has been met with success.

Poor President Obama may be left without a single non-Wall Street based advisor in no time. After his trusty sidekick Robert Gibbs announced earlier he is bailing from the Titanic, Reuters has just reported that Paul Volcker, the only man in the past 30 years to have to deal with the problem of pernicious inflation, is about to take a hike too. While his role was simple: head of the White House advisory panel, he did at least attempt to do some things while there, namely take down prop trading. Of course, he failed, as all prop traders are now merely masked as flow traders, and even worse, are sitting smack in the middle of order flow, knowing full well who is buying what, and allowed to build or reduce securities inventories at will with full inside knowledge. But at least he tried. Unfortunately, Volcker's (hyper)inflation fighting skills will be needed again very soon, alas by then America will only have the deranged madman of a genocidal Rudy von Havenstein reincarnation to fall back on. Hopefully it can enjoy the gross lie that is the "wealth effect" before it becomes the "poverty effect."

One of the recurring topics on Zero Hedge since inception has been that Goldman's flow/prop operations, simply by dint of their massive, monopolistic size, allow the firm to manipulate various securities, among which equities, structured products, and especially CDS. And while the firm has migrated to a more wholesale market manipulation paradigm when it comes to equities due to the far smaller bid/ask spreads, requiring the need for Goldman to become either an SLP on the NYSE, or to create market manipulating algorithms, such as that it is currently accusing Sergey Aleynikov of stealing, where the firm has always excelled has been in the far thinner, and far more profitable, courtesy of wide bid/ask margins, CDS market. Today, we get confirmation from Senator Carl Levin, to whom it appears Goldman has the same trophy value as SAC to the New York District Attorney and Federal Task Force, that Goldman was engaged in precisely the kind of CDS manipulation we have previously alleged the company was involved with.