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Makin' Money

How’d they do that?

Chris Farrell May 11, 2011

Have you noticed the amazing track record of the trading desks at the major banks?

The traders at the big banks are making money day after day, in up markets and down markets. Whatever happened to the efficient market, the notion that you can’t beat the market on a consistent basis? Have the traders figured out how to pierce the veil of the future? Is the game rigged?

Ed Yardeni, a long-time Wall Street economist, rightly wonders what is going on. He lists the stellar quarterly performance by the Big Banks:

(1) Bank of America, the largest bank in America, has discovered the magic formula to making sure bets. It posted a perfect quarter during the first three months of the year, according to its quarterly filing with the SEC. It was on a similar winning streak during the first and third quarters of last year.

(2) J.P. Morgan, the second largest US bank, disclosed that its trading activities recorded a net gain in every trading session for the first quarter. That’s remarkable. Even more amazing is that the bank had the same daily winning streak during the fourth quarter of last year. In fact, during all of 2010, JPM lost money during only eight days, all in the second quarter.

(3) Goldman Sachs, the fifth biggest bank, lost money on its trading desks on only one day during the first quarter, its best record since posting zero days of losses a year ago. It lost money during just 13 days in the fourth quarter.

(4) Morgan Stanley, the sixth largest US bank, posted trading losses on only three days during the first quarter, compared with 13 days in the fourth quarter. On a conference call last month, the firm’s CFO said, “Our trading results demonstrated considerable improvement and reflect continued focus and discipline.”

Yardeni is rightly suspicious. Either the banks have figured out a trading strategy the rest of us need to quickly learn or “the big banks have lots of proprietary information that they use to their advantage,” says Yardeni.

Something isn’t quite right. My guess? It’s further proof that Wall Street has become more like a casino than ever and, when it comes to gambling, the House always wins. It’s also further evidence why trading is hazardous to your wealth.

(I added this in the early afternoon after reading Jeremy Grantham’s latest newsletter.)

Jeremy Grantham, the legendary value manager, is quoted on page 637 of the Senate report on the financial crisis. I think he gets to the heart of the matter. It’s why trading profits can be so steady.

Proprietary trading by banks has become by degrees over recent years an egregious conflict of interest with their clients. Most if not all banks that prop trade now gather information from their institutional clients and exploit it. In complete contrast, 30 years ago, Goldman Sachs, for example, would never, ever have traded against its clients. How quaint that scrupulousness now seems. Indeed, from, say, 1935 to 1980, any banker who suggested such behavior would have been fired as both unprincipled and a threat to the partners’ money.

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