Computerized Front-Running: How a Computer Program Designed to Save the Free Market Turned Into a Monster

Ellen Brown is the author of Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free. She can be reached through her website.



Market commentators are fond of talking about “free market capitalism,” but according to Wall Street commentator Max Keiser, it is no more.  It has morphed into what his TV co-host Stacy Herbert calls “rigged market capitalism”: all markets today are subject to manipulation for private gain.

Keiser isn’t just speculating about this.  He claims to have invented one of the most widely used programs for doing the rigging.  Not that that’s what he meant to invent.  His patented program was designed to take the manipulation out of markets.  It would do this by matching buyers with sellers automatically, eliminating “front running” – brokers buying or selling ahead of large orders coming in from their clients.  The computer program was intended to remove the conflict of interest that exists when brokers who match buyers with sellers are also selling from their own accounts.  But the program fell into the wrong hands and became the prototype for automated trading programs that actually facilitate front running.

Also called High Frequency Trading (HFT) or “black box trading,” automated program trading uses high-speed computers governed by complex algorithms (instructions to the computer) to analyze data and transact orders in massive quantities at very high speeds.  Like the poker player peeking in a mirror to see his opponent’s cards, HFT allows the program trader to peek at major incoming orders and jump in front of them to skim profits off the top.  And these large institutional orders are our money — our pension funds, mutual funds, and 401Ks.

When “market making” (matching buyers with sellers) was done strictly by human brokers on the floor of the stock exchange, manipulations and front running were considered an acceptable (if morally dubious) price to pay for continuously “liquid” markets.  But front running by computer, using complex trading programs, is an entirely different species of fraud.  A minor flaw in the system has morphed into a monster.  Keiser maintains that computerized front running with HFT has become the principal business of Wall Street and the primary force driving most of the volume on exchanges, contributing not only to a large portion of trading profits but to the manipulation of markets for economic and political ends.

The “Virtual Specialist”: the Prototype for High Frequency Trading

Until recently, most market making was done by brokers called “specialists,” those people you see on the floor of the New York Stock Exchange haggling over the price of stocks.  The job of the specialist originated over a century ago, when the need was recognized for a system for continuous trading.  That meant trading even when there was no “real” buyer or seller waiting to take the other side of the trade.

Read moreComputerized Front-Running: How a Computer Program Designed to Save the Free Market Turned Into a Monster

US: Death-Spiral Intercept

Well well well…. ( The origins of the next crisis – William White, the former chief economist at the Bank of International Settlements (BIS) gave an important speech at George Soros’ Inaugural Institute of New Economic Thinking (INET) conference in Cambridge.):

In essence, White was saying: “it’s the debt, stupid.”  When aggregate debt levels build up across business cycles, economists focused on managing within business cycles miss the key ingredient that leads to systemic crisis. It should be expected that politicians or private sector participants worried about the day-to-day exhibit short-termism. But White says it is particularly troubling that economists and their models exhibit the same tendency because it means there is no long-term oriented systemic counterweight guiding the economy.

This short-termism that White refers to is what I call the asset-based economic model. And, quite frankly, it works – especially when interest rates are declining as they have over the past quarter century. The problem, however, is that you reach a critical state when the accumulation of debt and the misallocation of resources is so large that the same old policies just don’t work anymore. And that’s when the next crisis occurs.

It seems that Mr. Harrison has it figured out.  He goes on to spend a lot of digital ink on the periphery of the bottom line, which is that we continue to think of debt in terms of service costs (indeed, you’ll hear Bernanke talk about it, but never about the actual gross financial system debt outstanding.)

When you boil all this down, however, you get to the following chart (trendline added by moi):


You can see what’s going on here – each “crisis” leads to lower lows and lower highs.

This presents two problems:

Read moreUS: Death-Spiral Intercept

When The Gun Is In YOUR Mouth…. (CDS / Merkel)

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suddenly politicians “get religion” about making damn sure it has no bullets in it:

“We’re of the opinion that a quick implementation of actions in the area of CDS has to happen,” Merkel said. Citing “ongoing speculation against euro-region countries,” she called for the “fastest possible” implementation of new rules. Europe must “do everything to avoid unhealthy speculation,” said Juncker, who heads the euro-area finance ministers group.

Where ‘ya been Angie?

Oh, and you too Papandreou:

“Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system,” Papandreou said yesterday in a speech in Washington.

And, of course, Sarkozy.

Note that I’ve been calling for these things to be either exchange-traded with central counterparty “blinding” (on purpose) as is the case with the regulated option and futures markets or be torn up since The Ticker began publication.

Why?  Because it is my position and remains so that unless you have this sort of market these contracts are all a scam.

They are a scam because:

Read moreWhen The Gun Is In YOUR Mouth…. (CDS / Merkel)

Federal Reserve Inflicts Maximum Pain By Changing Terms In Front of OpEx AGAIN


This is a load of crap folks:

For release at 4:30 p.m. EDT

We just made sure that anyone who was long into Options Expiration – which is tomorrow – especially on index options which cannot be hedged or traded now, is screwed.  Just like in August of 2007 when we did the opposite.

The Federal Reserve Board on Thursday announced that in light of continued improvement in financial market conditions it had unanimously approved several modifications to the terms of its discount window lending programs.

Of course we couldn’t wait until Friday after the close when it wouldn’t hose people – instead, we timed this for maximum pain.

Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve’s lending facilities. The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy, which remains about as it was at the January meeting of the Federal Open Market Committee (FOMC). At that meeting, the Committee left its target range for the federal funds rate at 0 to 1/4 percent and said it anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

We gave no warning either.  Ha ha.  You did wear your titanium plate in your pants, right?

The changes to the discount window facilities include Board approval of requests by the boards of directors of the 12 Federal Reserve Banks to increase the primary credit rate (generally referred to as the discount rate) from 1/2 percent to 3/4 percent. This action is effective on February 19.

That’s “right now”, in case you didn’t figure it out yet.

In addition, the Board announced that, effective on March 18, the typical maximum maturity for primary credit loans will be shortened to overnight. Primary credit is provided by Reserve Banks on a fully secured basis to depository institutions that are in generally sound condition as a backup source of funds. Finally, the Board announced that it had raised the minimum bid rate for the Term Auction Facility (TAF) by 1/4 percentage point to 1/2 percent. The final TAF auction will be on March 8, 2010.

This is something we did warn about, and in addition we’re giving notice.  See?  Hope you don’t get a margin call in the morning – BOOYA!

Easing the terms of primary credit was one of the Federal Reserve’s first responses to the financial crisis. On August 17, 2007, the Federal Reserve reduced the spread of the primary credit rate over the FOMC’s target for the federal funds rate to 1/2 percentage point, from 1 percentage point, and lengthened the typical maximum maturity from overnight to 30 days. On December 12, 2007, the Federal Reserve created the TAF to further improve the access of depository institutions to term funding. On March 16, 2008, the Federal Reserve lowered the spread of the primary credit rate over the target federal funds rate to 1/4 percentage point and extended the maximum maturity of primary credit loans to 90 days.

Read moreFederal Reserve Inflicts Maximum Pain By Changing Terms In Front of OpEx AGAIN

FDIC “Tells Banks” To Quit Cooking The Books! ROFL!

Oh My God.

I write two Tickers on The FDIC and banks’ refusal to take their marks, and gee, you’d think someone over there might have read them!

SAN FRANCISCO (MarketWatch) — The Federal Deposit Insurance Corp. said late Monday that banks should recognize losses on home loans promptly and warned that failure to do so could delay efforts to mitigate the financial impact.

Institutions must analyze the collectibility of the loans they hold for investment at least every quarter, the FDIC said in a statement on its Web site.

Banks then have to keep an appropriate allowance for loan and lease losses, covering estimated credit losses on individually evaluated loans that are deemed to be impaired, and on groups of loans with similar risk characteristics, the regulator said.


That’s just too much.

Let me put it in simple English, Ms. Bair.  Here ‘ya go, in formal letter format:

From: The Tickerguy
To: Ms. Sheila Bair, FDIC Chairwoman
Regarding: Your FDIC Statement Nonsense

Dear Ms. Bair;

You know full well that essentially every bank in the nation, including the largest ones that went through the so-called “Stress Tests”, have been intentionally mis-marking loans “held for investment” at or near par even when there is essentially no chance these loans will be satisfied in full, and that this practice has been going on since the housing crisis began.

These include defaulted loans; there are literally millions of Americans that are living rent-free, right now, because their lender has sent out a NOD and then done nothing else, despite never paying another penny toward their mortgage.

Why is the bank doing this?

That’s not hard to figure out.

If the banks foreclose and sell the property then the sale price becomes the indisputable mark to market on that paper, and avoiding that mark is absolutely critical or these banks would be forced to recognize their own insolvency.

Thus we have people who live in their houses for more than a year with nothing more than a NOD in the mailbox, we have people who have had their homes foreclosed upon and then the bank has refused to perfect title (leading to stories in the media of foreclosed owners being chased for neglected upkeep, code violations and similar) and we have banks that have made a practice of bidding themselves in the foreclosure auction for the full mortgage amount, which of course is dramatically more than anyone else will pay for it.  They wind up “owning” their own foreclosure but the paper remains marked at the full mortgage amount, since that’s what they bid, even though there’s not a snowball’s chance in Hell that any real buyer would pay anything close to that amount (evidenced by the lack of bids at or above that amount at the auction!)

I have repeatedly stated (and shown my work) that there was likely $3 trillion in total “bad paper” in the banking system in residential mortgages alone.

We know for a fact that recovery is running in the neighborhood of 40% (including both first and second lines) from those loans that have been followed through from default to recovery. We know for a fact that bid lists of defaulted second lines circulate all the time and trade literally at a few pennies on the dollar; thus, a second line behind a defaulted first loan is essentially worth zero.

We also know that about $1 trillion in bad loans have been written down thus far, which means there is two trillion more to go, and then we get to talk about commercial real estate where “extend and pretend” has even become part of the vernacular of the trade!

Ms. Bair, this sort of misdirection is the worst sort of tripe.  You have two banks with self-identified negative Tier Capital Ratios, a circumstance that is never supposed to happen, but it has.

You have a third identified bank that had its last real chance for a rescue evaporate Friday and it reported, at the same time, a quarterly loss of more than five times its market capitalization.

All three of these institutions should have been seized LAST FRIDAY, but there’s a problem with doing that, isn’t there Ms. Bair?  It’s this table here showing how much money you have left in your insurance fund, and the average loss for a seized institution:

The last line in particular shows a paltry $8.26 billion dollars left.  Now since the FDIC thinks its cute to be somewhat secret about exactly how much money it has (and what of that is committed) we don’t have hard numbers, but this was a “best guess” sent to me the other night – and it looks about right.

So exactly how do you intend to close those three (and the other few hundred similarly-situated) banks and make sure Granny gets her $20,000 life savings back?  With your good looks?  Yes, I know, you have a potential $500 billion credit line from Treasury, but that line isn’t funded and in order to do so Turbo Tax Timmy would have to go auction off another $500 billion in Treasuries, and there might be a tiny problem with doing that, given the insane rate of issuance already taking place.

Read moreFDIC “Tells Banks” To Quit Cooking The Books! ROFL!

Collapse of government due to spending into bankruptcy or “only” a currency crisis?

Both. The US will default on its debt and the dollar will be destroyed.

Looks like what I have warned all along may be coming to pass sooner than even some of the most bearish investors expected.

It may be not tomorrow but it is coming … and it is soon coming to other countries (UK) too.

Now what people? Land of the poor and home of the slaves? Wake up America!

Ben Bernanke: This financial crisis may be worse than the Great Depression

The Greatest Depression is here.

Uh Oh…. (GDP Interpretation)

I have a very disturbing pattern here on a few charts today….


The dollar is getting trashed.


10 year bond futures are skyrocketing (yield collapsing); the yield gapped under a “must hold” trendline this morning and has continued down since.


What is this all telling us?

It appears to be that traders in the FX market (who by the way tend to be smarter than the average equity or bond trader) have deduced that the entire “improvement” in 2Q GDP came from government spending.

Well that’s not hard to figure out – it did.

They also appear to be making a bet that the US Government will attempt to continue this, along with The Fed monetizing the debt through its buyback programs to destruction of both the government and currency.

This is not positive for our economy. At all.

But this is the meme today – traders are piling into bonds expecting more Fed buybacks, they are shorting dollars like crazy, and Gold is of course reacting to these two facts.

This is a “collapse of government due to spending into bankruptcy” play folks, or at minimum “currency crisis around the corner.”

Right or wrong this is the trade being put on in size; the dollar selling in particular is especially pernicious and troublesome – that chart is essentially straight down since the GDP release this morning.

Read moreCollapse of government due to spending into bankruptcy or “only” a currency crisis?