Banks are going to stink

Big banks, BAC, Citi, JPM, and WFC, are on all media title news on home mortgage investigation. BAC announced that they would stop all foreclosure processes until the investigation concludes. JPM had similar announcement. No banks would do that unless there is some solid.

Fault foreclosure processes were rampant in lenders because they wanted to expedite the process. Wells' practice is now on the New York Times. The then Wachovia issued loan now is found that there are other loan on the property. The buyer bought a non-clean titiled property in CA. Finally Wells refunded the buyer. Nonetheless, the practice was disclosed. Wells has not yet announced the stop of foreclosure. Given that Wells has the second largest mortgage portfolio (BAC is No. 1), it is reasonable to think Wells would do that soon.

If foreclosure investigation takes a long toll, BAC and WFC will be the two largest victim. They have to push homes out of their balance sheets really quick, as a matter of days. Recovery will slow down.

It is better to avoid these banks for now until the fog clears.

A tale of two families

Sam lived in Village West.

Sam was a big guy and started his car business long time ago. He had a family to feed. At the beginning, they didn't have much but worked hard. What they did was make cars and sold to make money. Cars they made were simple and durable. Because of these qualities, Sam's business boomed almost immediately. His kids all went to good schools. As fortune piled up, Sam gave money to his kids as Christmas gift. The kids knew their dad was rich and were spoiled. At the same time, Sam's order was so high that he decided to ask help from his friends to help him. His friends like Jeron, Brits, Franks, were all very happy to help. These guys were gifted too. They weren't as big as Sam but they could run pretty fast. They are lean and work hard too. Friend's friend gradually joined too, like Howard, Twain, Malay. They were called Sam's Gang in the business. Businesses the Gang members had were small because that was the amount they could only be able to handle. Sam's load was reduced but still took a large portion. Sam was generous and happy to make friends. The Gang was happy too as all of them were having a good time. As life improved, they sooner or later became sloppy in disciplined. Causal spending were rampant. That was fine because they would somehow ironed out the wrinkles and kept moving on.

This lasts from a long time until Oliver showed at the Gang's doorstep.

Oliver lived in Village East. He was a big guy too, almost as big as Sam, and had lots of kids to feed. He was torn by the large family and stayed at the relative poverty. He, once upon a time, had to let go some of his kids. When his oldest kids got old enough to go to school, he wasn't able to afford. So one day Oliver thought that he might ask help from the Gang. Oliver didn't get along with Sam's Gang too well because they're far way. But who else could he ask for? So he asked Jeron to see what he could help. Jeron made car windows from Sam. He needed to find materials, cheaper materials to make it. Oliver thought he could dig out rocks from mountains and shipped those materials to Jeron. This was laborious jobs. His kids got nothing to do anyway. Jeron thought it was a good idea too. The deal kicked off right way. It's fair to say Oliver did a good job. His boys worked hard and cheap. Jeron liked them so he extended offers from order and tools to Olive so that he could ship more. Slowly Oliver got back to shape. After this arrangement, Jeron was able to take some days off after years of work. Oliver's family was so big that Jeron's job was hardly enough to fill. That was where Sam came.

Sam wasn't completely unaware of Oliver's work. But he was OK as long as Jeron could handle it. As Oliver's reputation arose among the Gang, more asked Oliver to do simpler jobs. Oliver always delivered. Sam thought some jobs could be done by Oliver too. So they two hit a deal soon. Since then Oliver's boys became very busy as they had so many orders coming from the Gang. He didn't mind about it because his boys were happy to have jobs with low pay and the Gang was happy to enjoy days off. Oliver was driving his boys hard too. He didn't give them free money at all. All boys needed to work and funded Oliver. Oliver accumulated wealth very soon. At the same time, jobs shifted from the Gang to Oliver massively.

One day a crisis hit Sam hard. One of his kids messed up and couldn't pay his tuition. Sam usually paid his but this time he couldn't because this was a slow time during the year. The kid had to self support. That became a problem because out of school jobs were so scarce and he really didn't know how to make anything but play video games. Sam was distracted. A larger problem was that his order dropped because others knew he wasn't able to pay his kid's tuition. Consequently, he couldn't dispatch anymore works to the Gang and Oliver. Immediately, the Gang felt the heat and their long-time relationship ruptured.

They asked Sam to go out to look for more business. Sam said he couldn't because of family issues and asked them to look for business themselves. Oliver was the hard press because he had taken so much order along the years that all his boys were in it. The slowness hit him hard. He refused to return jobs to Sam. Sam, on the other hand, couldn't take back the jobs because he wasn't interested in and didn't know how to after years. There was really no solution except heated quarrel.

The business fell, no one was able to escape.

Finally Sam was so fed up with these and realized that there was not sufficient jobs to all of them. He had to take back jobs from the Gang and Oliver, no matter what they said, so that his kid could find one. That wasn't easy. He had to trim weights gained in years and got back to shape. It was hard to save again after easy time too. But he did it. Everything seems restarted.

Oliver also understood that he couldn't rely on Sam's Gang. He asked his kids to make new stuff like batteries that could be sold to make money. None of the Gang could produce these. That wasn't easy to develop a new market. Oliver went a long way to try and try anyway. It was a hit and miss experiment. But what else could he do?

They didn't get along for a long time since the crisis.

Learned from the Flash Crash report

SEC and CFTC detailed their findings in the 104-page report on how a single trade overshot the market on May 6, 2010. The trade was done by Overland Park, Kan's Waddell and Reed Financial Inc, a firm with $25B under management. The sell order of 75K contracts of E-mini, which mimics S&P 500, totalled about $4B, was amplified by other algorithm trading firms, including Waddell itself so that the market was precipitated down more than 1000 points in minutes.

The report is in detail on this had happened. From which, we can take a peek on these high frequency traders' algorithms.

Waddell's algorithm scheduled sell all 75K contracts of E-mini at the pace of 9% of volume. That means, the algorithm would monitor what current volume is and then put out 9% of the volume on their sell order. There is no other parameter, according to the report, such as the market has been down 30%. The algorithm would still royally send out 9% of the volume. It is not hard to image that the other HF algorithms would do similar things: if they sniff there is large volume coming, the algorithm would sell, even though decisions seconds ago were buy. So the volume spiked up momentarily. Waddell's algorithm didn't know the price was down and all other algorithms were selling, it still pumped 9% of the total volume. This formed a positive feedback loop. The huge drop occurred.

We can see that these algorithms have different trading parameters. No one except the owners knows what they would do. Had Waddell's algorithm detected price had already down 30%, would it still keep selling? Probably. Here is why:

E-mini is an index used to hedge individual holdings. One case is , when Waddell decided to sell E-mini, they had expected their holdings would rise but in case they were wrong, they sold E-mini to protect them self. If the selling were proved to be correct, i.e., they were wrong and the market down, they would profit from the sell. So the lower E-mini was priced, the more profit they would rake in. To a point lower enough, they needed to cover it back. At the same time, their individual holdings also needed to find another hedge. This ultimately says that they don't care how low price can go before they start to cover. In other words, there is no need to detect current price.

Some algorithms work against this thinking, though. The report says 6 out of 12 largest HF trading firms stepped out trading during this spiral. There is little clue why but we can guess that their algorithms stopped trading. This is like the auto "stop order" got halted somewhat. Again, there is no way to know how the algorithms were programmed.