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Thursday, March 20, 2008

It's Time Wall Street Answered to Main Street

Ever since the Curbstone Brokers traded stocks outside the NYSE in the 1800s, its always been a dog-eat-dog world on Wall Street. In today’s market where thousands of hedge funds managed by glorified day traders are answering to sophisticated investors craving alpha, eating one’s own is as common as it ever was.

And today the financial press is full of articles covering investigations into whether false rumors spread by short sellers caused catastrophic damage to major financial institutions...sometimes the very same institutions that executed their trades. Bear Stearns stock price has been on a roller coaster ride and extremely aggressive put options are being investigated by the SEC:

Betting on a 57% decrease in Bear Stearns stock in nine days is very unusual, Todd Salamone of Schaeffers Investment Research told the Wall Street Journal. The Wall Street Journal claims that over 25,000 of such contracts as of last Thursday. The insinuation is the traders were manipulating the market either through insider trading or spreading false rumors.

It’s not illegal for traders to talk amongst themselves, but it is if the information is knowingly false. Regulators will have a hard time proving their case especially because well-lawyered hedge fund managers can expertly operate on the edges of legality.

The persistence of rumors however, should not be remembered as the only reason for Bear Stearns’ collapse. More likely, Bear Stearns is a case of managerial hubris, an utter failure to manage risk multiplied by unreasonable leverage and a culture of greed perpetuated from the top down. How else to explain the firm’s bulls-eye position among the myriad of Wall Street scandals of the past 20 years?

Bear Stearns is a scandal. Market manipulation by hedge funds is a scandal. In my mind, the potential intersection of the two underscores the need for regulatory consolidation, which Barney Frank (D-MA) has put on the table. It remains to be seen what shape the regulatory landscape may take given Wall Streets highly paid and effective lobbyist. But our current system of self-regulation, the light-touch of the SEC and forcing competitors to play by different rules has proven ineffective. The wave of greed on Wall Street and its tornado effect on Main Street is too strong for such a hands-off approach.

Consolidation may only be half the solution. The corporate scandals of Enron, WorldCom, etc. and the criminal trials in their aftermath sent a message to board members and CEOs alike: accounting fraud will not be tolerated. Thorough federal investigations should be next for Wall Street and if wrongdoing is found, perpetrators should be prosecuted to the fullest extent of the law.

The message would be clear: Wall Street exists for Main Street, not the other way around.

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