Market Leverage

[JK]

FWIW -

When you and I buy and trade Stocks, we generally have two options on how to manage our purchase. Either we pay for the entire cost of the block of Stock we want to buy in cash, or we can buy it on credit. To purchase it with credit is called buying on the MARGIN. Federal rules from the SEC restrict and limit private purchasers/traders from borrowing no more than 50% of the Stock purchase price. This Margin Limit Rule was created at a direct result of the Stock Market Crash of 1929 that lend the World into the Great Depression.

To reiterate, you and I are restricted from over leveraging our stock purchases/trades (buying on the margin) to fifty cents on the dollar.

Why do people buy on the margin?

It allows them to double their profit, when their Stock value moves up. For example if your buy your Stock at $100/share and the price moves up by $10 to $110/share, you have "made" $10, or a 10% return on your investment.

However, if you only invested $50 and borrowed $50 dollars from your broker to make the purchase, you "made" a 20% return on your $50 investment (the same $10).

Simply put, using other peoples' money (by trading on the margin), leverages your profits when your Stock portfolio increases in value.

Furthermore, the SEC instituted the 50% margin rule to limit public speculation in the Stock Market.

Unfortunately, these restrictions are not binding on "Professional" Investment Bankers.

Specifically, Bear Stearns, Lehman Bros., and the other US Investment Banks established trading postions that leveraged their assets, on an average, of 30 to 1, per Bloomberg/SEC reports.

In short, American Investment Banks on put 3 cents down on each dollar traded, and the rest of the 97 cents, used to finance and establish their worldwide trading positions, were bought on credit.

Put another way, these "Professionals" were speculating/gambling for all they were worth, and not clearly not investing.

And when their "bets" went bad, the American taxpayer was put on the hook, to bail them out, to the tune of $700.0B+, in a blink of an eye.

In summary, the direct cause of the recent Worldwide Market meltdown was due to rampant over leveraging and speculation, through investment vehicles that are known as Derivatives.

J.K. :wow

[kahuhna]

Nice synopsis of why we need an overhaul of our financial system.
Let's not forget the selling job done on the public to institute the hedge funds that are merely a form of super shorting.The temporary ban on regular short selling is nothing short of a joke. These transactions, although they have a very long history, have no place in our system. Since our market runs on rumor, speculation and inside information, hedging and short selling are contrary to the public's best interest.
I find it very interesting that CDs(or precious metals) are about the only "safe" investment. Even the money markets are tainted in this scenario.
My upcoming mortgage will be with an outfit that doesn't sell them, so they can be packaged and sold to foreign investors.

[JK]

Nice synopsis of why we need an overhaul of our financial system.
Let's not forget the selling job done on the public to institute the hedge funds that are merely a form of super shorting.The temporary ban on regular short selling is nothing short of a joke. These transactions, although they have a very long history, have no place in our system. Since our market runs on rumor, speculation and inside information, hedging and short selling are contrary to the public's best interest.
I find it very interesting that CDs(or precious metals) are about the only "safe" investment. Even the money markets are tainted in this scenario.
My upcoming mortgage will be with an outfit that doesn't sell them, so they can be packaged and sold to foreign investors.

From puts and calls, to options and futures, buying long and selling short, these trading tools and strategies are what make computer trading programs and hedge funds work and turn a tidy profit in normal times.

Whether covered or naked, these Market Makers not only have real-time tickers, but they also "see" how trades are stacking up in the que.

By restricting/prohibiting "short" trades to EVERYBODY BUT MARKET MAKERS, it's just another way of skimming the till by widening the spread.

J.K. :wow

[kahuhna]

J.K.,
I am eager to see what shakes out with this bailout. What do you think ought to change after the government covers for their gross mistakes (and profit taking)?

I never begrudge anyone for the money they make honestly. But this mess has pointed out to the world that capitalism in its present state has serious issues.

[JK]

J.K.,
I am eager to see what shakes out with this bailout. What do you think ought to change after the government covers for their gross mistakes (and profit taking)?

I never begrudge anyone for the money they make honestly. But this mess has pointed out to the world that capitalism in its present state has serious issues.

It might be a little esoteric for some on the Forum, but the mechanism that the Fed's using to recapitalize the U.S. banking system is the skimming of the spread between T-Bills and overnight lending rate.

For the Market Makers for the Stocks listed on the NYSE and Nasdq, it's allowing them to sell short, thus broadening the spread from bid to ask. Again, it allows them to milk the spread.

Finally, the move to re-invent/transform "Investment Banks" into "Holding Houses/Banks" facilitates the process under the cover of smoke and mirrors.

They did during the RTC bailout of the S&Ls, and they'll do it again, now. :hug

In short, Politicians/Feds are shifting public monies into private hands, but keeping the process off the books, so as to avoid taxpayer outrage.


J.K. :wow

[jdmetzger]

I read this interesting story from Time, this morning regarding the bailouts.

How We Became the United States of France (http://www.time.com/time/nation/article/0,8599,1843168,00.html?cnn=yes).

[JK]

I read this interesting story from Time, this morning regarding the bailouts.

How We Became the United States of France (http://www.time.com/time/nation/article/0,8599,1843168,00.html?cnn=yes).

The Economist usually has the most in depth analysis, but you don't need an MBA to understand the radical shift and transformation undergone by the US Financial Sector (Insurance/Banking/Equity Trading), last week.

The FACT that it wasn't debated or discussed outside of the green eye-shade group, to rubberstamp a QUADRUPPLING of our National debt ($500.0B to $2.0T, not counting unfunded mandates), boggles the mind and bugs out the eyes. :hungover


J.K. :wow

[sjbmw]

The true heart of the disease is moral hazard, and it was born in 1913, and emboldened in 1933 with the confiscation of US citizens gold, and the stake in the heart was 1971, when the USA declared bankruptcy.

It's been a credit based economy ever since, backed by military might, the rest of the world has been paying their empire tax through US Treasuries and currency pegs, but it's not too much different that what Kenyans, Congolese, Indians (and what is Pakistan) paid to the British empire via direct tax until the mid 1900's.

Since the "banksters" know that the Federal Reserve will bail out their losses, (the Fed's true mission since 1913), all the regulation in the world is not going to manufacture financial virtue. Sarbanes Oxley was passed to do this remember?
SOX is MIA, so much for regulation....

Only a free market, and the prospect of real losses, keeps business honest.
And some businesses will fail, that is the health of the free market.

If these firms know that the Fed will fire up the printing press and cover them (while our savings get destroyed by inflation) why should they even bother with prudent business practices?

The politicians are just window dressing, the bankers are the culprits.
But when the bankers become the politicians, look out.
No one can steal wealth as fast as a banker with official power.

Paulson was chairman of Goldman Sachs before he was Treasury Secretary, and next year, he will return to GS..... think he has YOUR pension in mind?

Perhaps millions of Americans need an Alpo diet, to wake up....

[JK]

The true heart of the disease is moral hazard, and it was born in 1913, and emboldened in 1933 with the confiscation of US citizens gold, and the stake in the heart was 1971, when the USA declared bankruptcy.

It's been a credit based economy ever since, backed by military might, the rest of the world has been paying their empire tax through US Treasuries and currency pegs, but it's not too much different that what Kenyans, Congolese, Indians (and what is Pakistan) paid to the British empire via direct tax until the mid 1900's.

Since the "banksters" know that the Federal Reserve will bail out their losses, (the Fed's true mission since 1913), all the regulation in the world is not going to manufacture financial virtue. Sarbanes Oxley was passed to do this remember?
SOX is MIA, so much for regulation....

Only a free market, and the prospect of real losses, keeps business honest.
And some businesses will fail, that is the health of the free market.

If these firms know that the Fed will fire up the printing press and cover them (while our savings get destroyed by inflation) why should they even bother with prudent business practices?

The politicians are just window dressing, the bankers are the culprits.
But when the bankers become the politicians, look out.
No one can steal wealth as fast as a banker with official power.

Paulson was chairman of Goldman Sachs before he was Treasury Secretary, and next year, he will return to GS..... think he has YOUR pension in mind?

Perhaps millions of Americans need an Alpo diet, to wake up....

Prudent Bankers don't leverage the same collateral to establish multiple trading positions. Only speculators "betting" on a sure thing do. The sure thing was computer driven trading programs/market monitors, that rigged the outcomes and "guaranteed" the success of their trading strategies.

Unfortunately, once credit to finance their trades dried up, and the true risk involved with derivative trading vehicles were expose, did the recent Market meltdown come crashing down.

By providing only 3 cents of collateral for each dollar borrowed, it didn't take much to take down Bear Stearns and Lehman Bros. AIG was far behind. Likewise, JP Morgan was forced this weekend to change stripes and seek the safety of the Fed by declaring itself and Holding Bank.

Simply said, $700.0B is only a down-payment. Expect the final cost (to the American taxpayer) to approach $2.0T once the dust and smoke settles.

IMHO

J.K. :wow

[sjbmw]

Fractional Reserve lending has been around for a long time.

OTC derivatives are the same thing, but on steroids.

As investor money starts to run from the dollar into tangible assets like oil metals and commodities, those left holding the dollar bag will end up short.

This bailout will be Wiemar Republic size.