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FMX | Connect – www.fmxconnect.com - (Reported 5/19/2010)

We read a Bloomberg article today that dissected the poor performance of Goldman’s trade recommendations to their clients.  (Emphasis ours)

 

 

 

Seven of the investment bank’s nine “recommended top trades for 2010” have been money losers for investors who followed the New York-based firm’s advice, according to data compiled by Bloomberg from a Goldman Sachs research note sent yesterday. Full article

We thought it was appropriate to dig up a previous guest post in our Commodity Intelligence series dealing with the moral hazards of flow trading.  Flow Trading 101

Several things are clear to us as we read today’s articles on the Goldman Sach’s bash du jour

1.       Flow Traders do not listen to their research department advice.

·         To have a perfect 63 “up” trading days last quarter, they would have to not heed the advice of their own research department even once. At least not in any meaningful way that would have impacted their daily P &L.

·         If they did put on those recommendations, it was implemented in a minuscule way so they could say to clients “we are long this ourselves” as part of the sales pitch. 

·         If they did have the positions on, they had hedged the risk, so that the inventory was there in name only.

 

2.       Broker-Dealer Research is conflicted at its core

·         Research may be good or bad, but all research issued by execution forms is designed to do one thing above all others, that is to facilitate client order flow.

·         No Chinese wall is high enough to prevent even the most ethical analyst from succumbing to implicit firm pressures to create actionable research for client business.

·         Cited as proof: research is given away to clients. It is a loss leader to generate Broker-Dealer fees.

 

3.       Hate the player if you must, but hate the game more.

·         Goldman Sachs isn’t the problem. They are just the best flow traders out there. The other banks are equally conflicted and staffed by worse traders.

·         Our society operates under the illusion that we can legislate morality.  The problem is that conflicts of interest enable good people to make bad decisions under duress. And they enable less than perfect people to game poor Market Structure.

·         As long as Market Structure permits conflicts of interest, then we are relying on ethics of the individual to self-police the system. The bigger the system, the less reliable the individual policeman (anonymity in numbers) as personal responsibility hides under the skirt of corporate culture.

·         The CFTC and SEC simply cannot oversee this effectively with their limited resources. These banking entities police themselves. The government asks the regulatory oversight to go door to door checking trading cards, when what needs to be done is regulate top down, and not expect ground forces to catch everything. Lock your car doors, a criminal will get in any time he wants, but don’t lock them and you invite even the most moral person to steal your ipod.

 

4.       Only by dividing Principal and Agency services will you begin to solve the problem.

·         Broker- Dealers will continue to serve themselves at the expense of their clients in dark pools, OTC, or on exchanges. Moral hazards must be minimized, not worked around

·         Regulate OTC broker-dealers or move dark- pools onto hybrid exchanges are the only solutions. Or just live with it, it has been going on for 50 years already. The press is just getting around to noticing it because it sells papers now and the Gov’t needs a scapegoat to obscure its own paid-off enabling hand.

 

Think about the statistical probability of a trading firm making money every single day for 3 months. Now think about two trading firms doing it in the same time period. Where is your Brownian motion, efficient market, random walk, god now? 

Related Posts: Flow Trading 101,    Goldman Sachs and the Moral Hazard of the Broker- Dealer Model

 

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