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A New Enron in the Stock MarketBy Jeff ClarkTuesday, May 11, 2010 Imagine winning the lottery twice in the same week.
Imagine picking the exact finishing order of all the horses in the Kentucky Derby... five years in a row.
Now, imagine you're Goldman Sachs.
The illustrious Wall Street firm that seems to beat all the odds did it again last quarter. Goldman traders were profitable in 63 out of 63 trading days. Not one losing day in the bunch. This amazing feat follows on the heels of the 61-out-of-63 record for the quarter ended December 31, 2009.
Daily profits for the firm ranged anywhere from $25 million to well over $100 million. Indeed, Goldman traders rang up over $100 million in profits for 35 of the 63 trading days.
Now, it is entirely possible Goldman traders are THAT good. Maybe they can have a perfect batting average and they can hit homeruns more than 50% of the time. It's also possible I could be struck by lightning while being attacked by both a great white shark and a lion at the same time.
Possible, but not likely.
What's really going on here? Allow me to speculate...
Like Michael Milken's old firm, Drexel Burnham, ruled the junk- bond market in the 1980s, and like Enron controlled the electricity market in 2000, Goldman has cornered the stock market today.
Everyone follows what Goldman is doing. If Goldman's computers are buying, you better be buying. If they're selling, you sell, too. It's like a playground game of follow-the-leader. Everything goes along fine as long as the kid in the front of the line doesn't do anything that could hurt the little guy at the back.
Like your mom used to say, "It's all fun and games until somebody loses an eye."
Eyes were popping out everywhere last week.
The computer algorithm trading programs, which are largely responsible for Goldman's odds-defying profit streak, went nuts. They kicked off sell programs that wiped out nearly 10% of the stock market's value in 10 minutes. Then they executed buy programs that pumped prices back up to more reasonable levels.
"No harm done," the Wall Street big wigs will likely argue. After all, as of this morning, stocks are right back where they were before last Thursday's shenanigans.
The problem, though, is the little guy got hurt.
There was nothing wrong with junk bonds in the 1980s. The market gave low-quality firms access to capital, and investors received a reasonable return for the risk. But the leader went too far and the little guy got hurt. Drexel Burnham went bankrupt, and Michael Milken went to prison.
There was nothing wrong with trading energy contracts in 2000. It allowed states with excess electricity to sell to other states that were energy deficient. But the leader went too far and nearly bankrupted several states. Enron went under and CEO Ken Lay was surely headed to prison (he passed away before his trial).
There's nothing inherently wrong with algorithmic computer trading programs. They provide liquidity and increased volume on the exchanges. But last week, the leader went too far.
There's no doubt Goldman, and many other big Wall Street firms, made gobs of money during last week's volatile sessions. Normally, there's nothing wrong with that.
This time, though, Goldman profited at the expense of the little guy.
Goldman CEO Lloyd Blankfein should be a little nervous today.
Best regards and good trading,
Jeff Clark
Further Reading:
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Fears erased overnight... Volatility Index drops more than 25% as $1 trillion European rescue package is approved.
European banks win big... Barclay's (UK) and Banco Santander (Spain) rally double-digits.
Gold prices pull back... but big gold mining fund GDX pushes higher.
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