Streetwise for Sunday July 19, 2009

Streetwise for Sunday July 19, 2009

 

 

Streetwise

 

Lauren Rudd

 

Sunday, July 19, 2009

 

 

Where Are All The Customers' Yachts

 

  

 

“There is an old joke that Wall Street has a river at one end and a grave yard at the other. Yet, this is strikingly incomplete. It omits the kindergarten in the middle.” Fred Schwed, Jr.

 

There was some perverse amusement on Wall Street recently amid the outcry over the antics of one Sergey Aleynikov, a Wall Street quant who left Goldman Sachs for greener pastures and a fourfold increase in salary. In happenstance, as he was cleaning out his desk he somehow included a copy of Goldman’s high-frequency trading software.

 

Such an infraction might have been over looked had it not been for the countless hours and millions of dollars Goldman spent developing the software, designed to detect large order positions ahead of their execution. In other words, the software enabled Goldman to essentially engage in high-tech front running.

 

Front-running, or trading ahead of executing a customer’s order, is a prohibited activity. However, Goldman was not actually front running its own customers so the activity is not illegal per se. Furthermore, Goldman is one of the shrewdest risk takers on Wall Street. The firm searches out risk and underwrites trades that are viewed with envy by its more conservative brethren, which is why Goldman just posted second quarter earnings of more than $2.7 billion?

 

What was amusing was a statement by the prosecutor in the case in which he told the court that bail should be denied because it is not known exactly what happened to the software and that in the wrong hands, “It could lead to unfair manipulation of the markets.”

 

Let’s see if I understand that statement correctly. In Goldman’s hands the manipulation is not unfair. It is unfair only if it is being orchestrated by others.

 

Do not misunderstand me; I am in no way condoning the alleged theft and I am not denigrating Goldman for developing the software, or even demeaning high-frequency trading as a technique to take advantage of market inefficiencies. As Harry Truman often said, “If you don't like the heat, get out of the kitchen.”

 

However, last week a writer in Barron’s, a bastion of financial idolatry, penned the profound thought that successful brokers all seem to have nice cars but only a few investors do. He then proceeded to add the astute observation that there is no lack of pundits offering up ineffectual advice to the investing public.

 

I do not wish to castigate the writer but his statements are a poor parody of the classic book, “Where Are the Customer’s Yachts,” by Fred Schwed, Jr., published in 1940 and updated in 1955. And since Barron’s is published by Dow Jones, the same organization that brings us the hallowed Wall Street Journal, please allow me to paraphrase the following Journal quote from Schwed’s book, an illustration of how far we have come in giving investment advice.

 

“During the slow rise from the April lows, the action of the market was regarded in the nature of a technical recovery, with little thought of the imminence of dynamic action. Resistance, as expected, was encountered just below 140 for the Dow; but after a one-day decline, volume dwindled and the market presently appears to be in somewhat of a consolidation.”

 

The plain and unfortunate truth of the matter is that most investors do not have yachts...or even rowboats. The primary reason is a penchant to be swayed by tales comprised of fool’s gold.

 

Kermit Long told the story of the two men who were walking along a crowded sidewalk. Suddenly one exclaimed, listen to the lovely sound of that cricket. The other commented he heard nothing. Furthermore, he asked his companion, how was it possible to detect the sound of a cricket amid the din of the city?

 

The first man, a zoologist, had trained himself to listen to the voices of nature. But rather than try to explain, he simply took a coin from his pocket and dropped it on the sidewalk, whereupon a dozen people began looking around. “We hear,” he said, “what we listen for.”