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Bill Black: Technical traders love volatility; Obama raising big money on Wall St.

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. One of the characteristics of the current economic crisis that doesn’t get talked about all that much is just how much money there is to be made in a downturn. There are players, big players, that take advantage of crisis. Now joining us to talk about all of that is Bill Black. Bill is an associate professor of economics and law at the University of Missouri-Kansas City. He’s also the author of The Best Way to Rob a Bank Is to Own One. And he now joins us from Kansas City. Thanks for joining us again, Bill.


JAY: So what a lot of the big players do, investment banks and commodity traders and such, it may not be technically fraud, although I know you argue much of what happened in the ’08 crisis was actual fraud, but a lot of what goes on may not be actual fraud, because there’s no regulations yet to actually make any of this illegal. But talk a little bit about how volatility makes you money if you’re big enough.

BLACK: Well, for technical reasons, almost all options are maximized in value if you get lots of volatility. And so technical traders really like volatility if they’re involved in options, and most of these plays are done in options. The most obvious way that people are–I’ve often heard about is shorting a security.

JAY: So explain this for people who don’t understand options and shorting and all of this.

BLACK: Well, an option is, as the name implies, something that you have the right to take possession of but not the obligation to do so. And so there’s more chance that that option will be valuable to exercise if whatever I’m betting on is bouncing around a lot, because I can wait till it bounces in the right direction, and then I can exercise my option right there. So that’s the human explanation of how options and volatility work. Shorting is I’m going to buy this security at some date in the future, and so I’m betting that it’s going to fall in value between now and then, I want to prompt the–you know, increase the chances that it will actually fall in value. So I will engage in speculative attacks on it, designed to cause it to fall in value, I’ll spread rumors in the press and such, and I’ll get people coordinated in our behavior. And then what’s really changed in the modern era is two things. One, extraordinary leverage. So in the old days it took a lot of money. If you–you know, the famous ones of people my age were the Hunt brothers trying to corner silver prices and such. Well, that took among the wealthiest group of individuals in the world. But now a 26-year-old trader with extreme leverage can buy enough using financial derivatives to move world prices. So it’s that combination of leverage and derivatives that is–changed the world into a vastly more dangerous world. And then we have to remember what happened in 2000 with the passage of the Commodity Futures Modernization Act of 2000. You should oppose any bill that has the word modernization in it, because it’s always a disaster–supposedly we’re smarter than we were in the past. So the setting there was that the head, Brooksley Born, of the Commodity Futures Trading Commission was thinking ahead of time, before the disaster had hit, and she said credit default swaps have the potential to be a disaster; we should have regulations in place to protect against them. And this unleashed–pick your cliche about firestorms in Washington, DC, in which the Clinton administration worked with Alan Greenspan and Phil Gramm, the great anti-regulator, to pass a law in very short order that not only blocked that particular regulation that Brooksley Born was proposing but actually said: the Commodity Futures Trading Commission, we are removing your statutory authority to regulate credit default swaps at all. It also created a regulatory black hole in energy trading derivatives, which Enron, with Wendy Gramm, Phil’s wife, on the board of directors, promptly exploited to create the California energy crisis, which was not an energy crisis, was complete manipulation of prices, plus the actions of a cartel, to just ruin a state economy and risk people’s lives by causing energy blackouts. So that bill, that became law. Brooksley Born was just turned into roadkill by these political forces. And the amazing thing is, after it actually did produce not one but two crises, California and the current crisis, Dodd-Frank bill didn’t repeal it. So we still are in a situation where we have very limited authority. And what has arisen in the last five years that has now made it even worse is hypervelocity trading. And this is believed to have caused the flash crash of roughly a year ago when there was a massive loss of Dow Jones value in five minutes.

JAY: Yeah, I was talking–I interviewed recently, actually, Bart Chilton from the commission, an interview we’re going to be running in the near future, and he was saying that of the 35,000 employees at a big bank–and I know the big bank is Goldman, although he didn’t name it–of 35,000 employees, 1,000 are PhDs and mathematicians working on algorithms for this kind of flash trading.

BLACK: Yeah. And by the way, that’s one of the reasons why the US is far or less competitive in making real constructive goods. Remember we have this shortage in math and science? Well, on top of that shortage, we divert the math and science experts we have to destroying value by creating these kinds of algorithms. By the way, Kansas City area is the heart of a couple of these really massive hypervelocity trading. Out here we do 25 percent of the trades of the entire nation. Nobody knows this. And a relatively small Kansas firm that is located a mile from where I’m speaking is the one believed to have triggered the flash crash with a large but not extraordinarily large trade. Now, you want to talk about financial terrorism, yes, this is financial terrorism, but it also is going to become real financial terrorism, because if with [incompr.] $41 billion trade you can cause the US economy to go into disaster, think what the People’s Republic of China, with its math experts, what it could do if it gets upset and decides that it wants to actually attack the US economy.

JAY: Now, the other thing I’ve been told is–in terms of volatility and profitability, is that it’s in these big tanks or these big dips [that] the big, big players, even if they get hurt in the short run, they can always sustain these big hits. So you may have the odd roadkill like Lehman Brothers, but the majority of the big players survive. And then they survive where their competition, especially the medium-sized and smaller competition, can’t survive and get wiped out. So these big dips are–lead to more and more monopolization, more consolidation. Is this part of the issue?

BLACK: That’s part of the issue. But the bigger part of the issue is they cause really gigantic movements that are disastrous, and they can’t survive those. But what’s different is these are what we call the systemically dangerous institutions. It’s the big 20, roughly, in the United States. This is where the administration–and it’s not just this administration; prior administrations as well believe that if a single one of those massive financial institutions fails, the entire financial system globally is at risk of failing. And so they get bailed out. And so things are not symmetrical. And you’re right: the result of all of this is the medium-sized players are crushed, even the large players are crushed, and you get economic dominance, which allows even greater ability to manipulate, but you also get political dominance. And that’s why we’re getting no real reforms out of these things, because big finance is the largest single contributor to both parties. Now, much has been made about how Obama is supposedly persona non grata in the financial community. In fact, Obama, both in absolute dollar terms and in percentage terms, is getting far more money from finance right now as he tries to create his billion dollar war chest than he got in the last general election. So once you get this kind of power–this is why Citicorp referred to the United States economy as a plutocracy, a government of the wealthy by the wealthy.

JAY: Thanks for joining us, Bill.

BLACK: Thank you.

JAY: And thank you for joining us on The Real News Network.

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William K. Black, author of The Best Way to Rob a Bank is to Own One, teaches economics and law at the University of Missouri Kansas City (UMKC). He was the Executive Director of the Institute for Fraud Prevention from 2005-2007. He has taught previously at the LBJ School of Public Affairs at the University of Texas at Austin and at Santa Clara University, where he was also the distinguished scholar in residence for insurance law and a visiting scholar at the Markkula Center for Applied Ethics.

Black was litigation director of the Federal Home Loan Bank Board, deputy director of the FSLIC, SVP and general counsel of the Federal Home Loan Bank of San Francisco, and senior deputy chief counsel, Office of Thrift Supervision. He was deputy director of the National Commission on Financial Institution Reform, Recovery and Enforcement.

Black developed the concept of "control fraud" frauds in which the CEO or head of state uses the entity as a "weapon." Control frauds cause greater financial losses than all other forms of property crime combined. He recently helped the World Bank develop anti-corruption initiatives and served as an expert for OFHEO in its enforcement action against Fannie Mae's former senior management.