Goldman Sachs's terrible, no-good week
Jul. 9th, 2009 10:44 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
womzillaGoldman Sachs is in the news a lot this month, and it's about time. Matt Taibbi's sweeping article "The Bubble Machine", describing Goldman Sachs's position inflating every American economic bubble of the last twenty years, is in the current Rolling Stone, and it's a great introduction to the company. It's also available on the Internet.
Then on Friday (July 3), a Russian-born programmer was arrested for stealing vast amounts of the source code for the Goldman Sachs program trading systems . It's not clear to me how much of the code Sergey Aleynikov had himself written, though apparently it's built from his ideas.
This in turn has lead to a thread of discussion about the possibility that Goldman Sachs has possibly been frontrunning* pretty much every trade on the New York Stock Exchange (NYSE). There's info on this DailyKos diary, with links to and from everywhere.
Frontrunning is one of the simplest scams in stock trading. Here's an exaggerated example. Let's say Microsoft is currently trading at 26.75. If you try to buy a million shares, the price will go up while you're executing the trade--you might get the first 100K at 26.75, then 200K at 26.76, then 50K at 26.77, and so forth; and by the time you're done a few seconds later, it'll be up to 26.80 and you might have paid an average of 26.7887 per share. If I know about your trade and buy a hundred thousand shares one-tenth of a second before you start to buy your million, I can buy all mine at 26.75. I can then sell it back to you at 26.76, making a quick penny-per-share for $1000--not much money, true, but it only took me one-tenth of a second, and had no risk. If I do this ALL DAY LONG with EVERY STOCK, I can make hundreds of millions of dollars. And if I get caught--oh, sorry, getting caught is for peasants.
No, actually, frontrunning is one of the things that FINRA and the SEC take really seriously. If this is true, and Goldman Sachs has been caught, there will be many people going to jail. Frontrunning is not just theft, it's the type of theft that destroys confidence in markets. (One of the amusing sidelights of the Madoff ponzi scheme is that apparently everyone on Wall Street assumed Bernard Madoff was a crook, but with few exceptions, they all assumed that his "hedge fund" was frontrunning orders. Turns out that he was a different, lower-tech kind of crook.)
There are a few additional points worth mentioning. First is that Zero Hedge has been making a lot of noise about the end of NYSE's daily program trading report (DPTR), because the DPTR was one of the best sources of visibility into the high-volume trading that allows companies to make $100 million per day on less than a penny per share. It's possible that the discontinuation of the DPTR is part of a conspiracy to hide Goldman Sachs from the world, but I don't think so--at least, not directly. I dealt with the DPTR at my department until it was handed off to a different department, so I have been paying attention to it for a while. Shutting down the DPTR has been in the works for at least 3 years, and it kept getting delayed; if Goldman (and Morgan Stanley) really were pushing NYSE to stop the DPTR, I don't think it would have taken them so long to succeed.
I will also say that there are a lot of technical errors in the Kos diary linked above--for instance, conflating an Indication message for an Advertisement message. This is pretty comparable to mistaking Before for After--an indication is a statement that you want to trade a stock, and an advertisement is a statement that you have just traded a stock. They're linked, but the diary seems to think they're identical. That said, the scheme outlined (reading the electronic order messages before they're passed to the Exchange) is technologically feasible, if audacious, and would indeed work exactly as described, especially if you have access to the vast amounts of liquidity and computing power Goldman Sachs has. (They trade about 1.6 billion-with-a-b shares a day on the NYSE.)
If this is proven true, as I said, it will lead to a lot of prison sentences. It could destroy Goldman Sachs--and if this is true, it bloody well should. It could also destroy the NYSE, which, admittedly, is in the process of making itself obsolete anyway.
Then on Friday (July 3), a Russian-born programmer was arrested for stealing vast amounts of the source code for the Goldman Sachs program trading systems . It's not clear to me how much of the code Sergey Aleynikov had himself written, though apparently it's built from his ideas.
This in turn has lead to a thread of discussion about the possibility that Goldman Sachs has possibly been frontrunning* pretty much every trade on the New York Stock Exchange (NYSE). There's info on this DailyKos diary, with links to and from everywhere.
Frontrunning is one of the simplest scams in stock trading. Here's an exaggerated example. Let's say Microsoft is currently trading at 26.75. If you try to buy a million shares, the price will go up while you're executing the trade--you might get the first 100K at 26.75, then 200K at 26.76, then 50K at 26.77, and so forth; and by the time you're done a few seconds later, it'll be up to 26.80 and you might have paid an average of 26.7887 per share. If I know about your trade and buy a hundred thousand shares one-tenth of a second before you start to buy your million, I can buy all mine at 26.75. I can then sell it back to you at 26.76, making a quick penny-per-share for $1000--not much money, true, but it only took me one-tenth of a second, and had no risk. If I do this ALL DAY LONG with EVERY STOCK, I can make hundreds of millions of dollars. And if I get caught--oh, sorry, getting caught is for peasants.
No, actually, frontrunning is one of the things that FINRA and the SEC take really seriously. If this is true, and Goldman Sachs has been caught, there will be many people going to jail. Frontrunning is not just theft, it's the type of theft that destroys confidence in markets. (One of the amusing sidelights of the Madoff ponzi scheme is that apparently everyone on Wall Street assumed Bernard Madoff was a crook, but with few exceptions, they all assumed that his "hedge fund" was frontrunning orders. Turns out that he was a different, lower-tech kind of crook.)
There are a few additional points worth mentioning. First is that Zero Hedge has been making a lot of noise about the end of NYSE's daily program trading report (DPTR), because the DPTR was one of the best sources of visibility into the high-volume trading that allows companies to make $100 million per day on less than a penny per share. It's possible that the discontinuation of the DPTR is part of a conspiracy to hide Goldman Sachs from the world, but I don't think so--at least, not directly. I dealt with the DPTR at my department until it was handed off to a different department, so I have been paying attention to it for a while. Shutting down the DPTR has been in the works for at least 3 years, and it kept getting delayed; if Goldman (and Morgan Stanley) really were pushing NYSE to stop the DPTR, I don't think it would have taken them so long to succeed.
I will also say that there are a lot of technical errors in the Kos diary linked above--for instance, conflating an Indication message for an Advertisement message. This is pretty comparable to mistaking Before for After--an indication is a statement that you want to trade a stock, and an advertisement is a statement that you have just traded a stock. They're linked, but the diary seems to think they're identical. That said, the scheme outlined (reading the electronic order messages before they're passed to the Exchange) is technologically feasible, if audacious, and would indeed work exactly as described, especially if you have access to the vast amounts of liquidity and computing power Goldman Sachs has. (They trade about 1.6 billion-with-a-b shares a day on the NYSE.)
If this is proven true, as I said, it will lead to a lot of prison sentences. It could destroy Goldman Sachs--and if this is true, it bloody well should. It could also destroy the NYSE, which, admittedly, is in the process of making itself obsolete anyway.
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no subject
Date: 2009-07-10 09:44 pm (UTC)no subject
Date: 2009-07-11 03:08 pm (UTC)btw, the comments on that diary are full of people insisting that frontrunning is impossible to explain in simple terms that someone's elderly parent/grandparent could understand, yet you did just that. thanks! though I have to point out, my 78 year old dad is still sharp as a tack and reads math and physics texts for fun, so I'm the one that needed the simple explanation, not him.
no subject
Date: 2009-07-11 04:23 pm (UTC)