Defense May Be the Best Offense in the Financial Markets

Individual investors largely sat out the most recent bull market, and the wisdom of the crowd seems to have been vindicated. The Euro zone is the latest debt-fueled asset bubble to pop. The 16 nations that use the Euro are being forced by skittish creditors to deleverage. Since the European Central Bank won't deliberately weaken the Euro (and may be quietly supporting it through sovereign debt purchases in the secondary market), Euro bloc governments have to cut spending. Some may even have to restructure their debt (although none will admit to that). The U.K., with Europe's largest economy outside the Euro bloc, is also retrenching.

In Asia, China is trying to rein in overheated asset markets. North Korea's bellicosity frightens cash into bank accounts. The war in Afghanistan grinds on, with no clear end in sight. Although Asia's emerging economies (i.e., excluding stagnant Japan) are in growth mode, they are too small a bunch of ponies to pull the huge, lumbering wagon that is the combination of the European and North American economies. (China, India, South Korea and the other emerging economies in Asia combined barely total a quarter of Europe and the U.S. together.)

More Sisyphean than the Afghanistan war is the British Petroleum oil spill in the Gulf of Mexico. Nothing has stopped the outflow. Even though yet another temporary fix is being attempted, there is apparently no hope of a permanent solution until August. The amount spilled is in dispute, but there's no doubt it's a lot. Oil is not only spreading throughout the Gulf states, but may come up the East Coast of the U.S. in the Gulf stream. At some point, the spill will discernibly slow U.S. economic growth, and that point could be close.

That said, the U.S. economy keeps growing, at a moderate rate that has pretty much been imputed in stock market valuations. More moderately good news won't revive the bull. There's no indication of a large economic stimulus in the future. With the recession over from a statistical standpoint, and populism surging from sea to shining sea, there isn't enough political support for another spendapalooza by the U.S. government. The Fed can't lower interest rates below the zero level where they now are, and may have to soon begin selling off some of the trillions of dollars of mortgage-backed assets it reluctantly holds.

All in all, this may be a good time for investors to play defense. Be cautious about putting new cash into the market. Ease back on equity exposure if you're losing sleep over downside risk. Since stocks are no higher than they were in 1999 (or 1997 if you consider inflation), there isn't a strong argument that you need always need a large proportion of your portfolio in stocks.

Cash has a beauty that becomes luminescent in uncertain times. Fraidy cats who kept their money in passbook savings during the last decade proved more perspicacious than most professional money managers and most stock market investors. Intelligent and rational people can look at the stock market and reasonably opine it's a looney bin.

That's not to say that stocks need be shunned like a carrier of typhoid. Defense can serve as the foundation for offense. Build up cash and keep it ready for use. If stock values fall to attractive levels, consider buying. Don't think you can time the market perfectly. But with a lot of conventional investment wisdom upended by the volatility of today's big bank, big investor centric market (i.e., the market being of big money, by big money and for big money), it's hard to contend that market timing should be counted as a cardinal sin.

Like all else, however, sin in moderation. Invest only a small proportion of your available cash at a time. Think in terms of cost averaging, not hitting a home run. If the market continues to look attractive, infuse more cash bit by bit. Don't get discouraged if the market declines again. Use the further decline as an opportunity to feed a little more cash into the market. Unless civilization ends (and the combined military strength of North Korea, Iran, al Queda and the Taliban can't end civilization; the recklessness and greed of bankers presents a greater risk), your investments will become profitable eventually.

Banks Get Murkier

Just as an incipient credit crunch lurks in Europe's weeds, the financial condition of major banks is getting murkier. Spain's credit crisis is mostly a matter of banks being overleveraged (its government isn't in bad fiscal shape, compared to many Western nations). Some Spanish banks may not be marking their real estate assets to market. Spain's government is merging banks rather than liquidating them, which might obscure rather than illuminate the financial weaknesses of the banking sector (kind of like the way grocery stores mix good string beans in with the crappy ones to make lazy shoppers buy some, well, crap).

In the U.S., Citigroup and Bank of America have admitted to misclassifying in financial reports repo transactions (which are loans) as asset sales. This echoes the infamous Repo 105 strategem used by Lehman Brothers to reduce reported leverage levels. Both Citi and B of A claim the amounts were immaterial and that the misclassifications were errors. Nevertheless, billions of dollars of transactions were involved, and a curious investor might wonder, in light of the magnitude involved, how sound the banks' internal controls were.

U.S. banks continue to benefit from accounting rule changes made by regulators last year under political pressure from Congress, which loosened requirements to mark assets to market. It's possible that the major U.S. banks hold hundreds of billions of dollars worth of hinky assets that are carried at valuations above market prices. With residential real estate wobbly and commercial real estate falling, the banks can't continue indefinitely to wear rose-tinted glasses when compiling their financial statements.

One reason why the stock market goes on volatility frenzies is that investors are ambushed by surprises. The sovereign debt crisis began with Greece 'fessing up last fall to having a lot more debt than it had previously acknowledged. Things went downhill from there as it became clearer that various EU members had debt problems. Spanish and other European banks are having trouble selling or rolling over commercial paper in the U.S. Credit default swaps protecting against defaults on bank debt have been rising in price. While many failures contributed to the current problems, a failure of proper accounting was among the most important.

"Garbage in, garbage out" is a time-honored axiom from computer science. It also applies to the financial markets. Bad or inadequate information results in poor pricing. When the truth comes out, abrupt shifts in valuation can be expected. When bank accounting goes hinky, the soundness of the financial system can be endangered. Taxpayers must then gird themselves for more bailouts. Bank regulators don't always encourage transparency, in the fear that the truth will spark runs on troubled institutions. But in today's computerized, Internet-connected world, there are no secrets. At least, not for long, and when the word belatedly gets out, the run is all the more panicked. Full, fair and timely accounting and disclosure by banks, nations and other debtors is essential to a healthy financial system. Such should be a primary goal of financial regulatory reform in the U.S., Europe and elsewhere. Expediency, however, militates in the other direction. Sunshine is the best disinfectant, but human frailty the greatest source of continued infection.

How Liquidity Can Be Bad for Investors

It is axiomatic among finance professionals that liquid investments are preferred for individual investors, especially those that aren't wealthy. It's easier to buy and sell liquid stocks and bonds. Information about them is easier to get. They tend to have readily ascertainable values.

But these qualities, especially the ease of buying and selling, make liquid investments the focus of computerized trading. Computers can observe prices, and buy or sell stocks, all in milliseconds. Their great speed allows them to profit from holding stocks for just a moment. It's not unusual for a computerized trading system to complete a purchase and sale of a stock in ten seconds or less.

All this frenzied computerized activity requires highly liquid markets. The program has to be able to trade quickly at or very near, the prices the computer observes. Otherwise, the algorithm (i.e., the mathematical formula) on which the program is based won't work well, and, horror of horrors, money could be lost.

So the banks, hedge funds and other institutional investors deploying computer-driven trading strategies have come to dominate the markets for the most liquid investments. Over half the trading in the stock markets today is computer-driven. The small investor, who thoughtfully researches investments before timorously buying a couple hundred shares, is playing on an interstate filled with tractor trailers. For little apparent reason other than a deluge of lickety split orders spewed out by immensely powerful computer systems, investors can lose 10% or more in a matter of minutes. This happened during the flash crash on May 6, 2010. It could happen again.

The markets for the most liquid of stocks and bonds are beginning to look like commodities markets, where positions are bought and sold for momentary profit, and where the big, powerful traders garner almost all the profits. The Model T version of investing--buying and holding--is taking on a distinct resemblance to the Tin Lizzy.

The stock markets have always favored the big firms and large investors. Small investors (a/k/a chumps) have always been at a disadvantage. But there once was, or at least seemed to be, something in it for Mom and Pop. Today, however, the stock market, unadjusted for inflation, is trading about where it stood in April 1999. That's 11 years ago. Factor in inflation, and we're back to mid-1997, 13 years ago. Either way, that's a long time with no gains. The Moms and Pops who put faith in CDs and money markets came out ahead.

Individual investors have largely stayed out of the most recent bull market. The last few weeks' volatility will only reinforce their skittishness. They know that, should they ever get the urge to go back into stocks, they'll never beat a computer to the punch. Why put your hard-earned savings into a market where you're behind the competition and have no hope of catching up?

High tech traders argue that computerized trading adds liquidity to the market and therefore is beneficial. They overlook that fact that long term buy and hold investors (so-called "natural" investors in market parlance) are the true fount of liquidity. Drive them out, and the market, and we, will be poorer for it.

Republican Losses in the Primaries

More than is generally recognized, the Republicans may have been the biggest losers recently. Their mainstream candidates have had a rough time. Senator Robert Bennett of Utah was ousted at a GOP state convention, in favor of a Tea Party candidate. In Kentucky, the choice of the state GOP establishment was beaten in a primary by Tea Partier Rand Paul. Arlen Specter, a former Republican Senator from Pennsylvania, felt so uncertain about his re-election prospects in a Republican primary that he switched to the Democratic Party, but then lost to an upstart Democratic Congressman, Joe Sestak.

It seems that mainstream Republicans are an endangered species. Mitt Romney, a frequent leader in the early polling for the 2012 Republican Presidential nomination, endorsed the losing Bob Bennett. He must be furiously re-working his candidacy, perhaps to include a well-televised caribou hunt in Alaska.

The Democrats have their share of problems with upstarts. A longstanding Congressman from West Virginia, Alan Mollohan, was defeated in a primary by a state senator. Senator Blanche Lincoln of Arkansas will face Arkansas' lieutenant governor, Bill Halter, in a runoff. But the Dems also won a special election in Pennsylvania to replace the late John Murtha. Democrat Mark Critz beat Tea Partier Tim Burns.

Political insurgencies today aren't always about one party versus the other. They're often about newcomers challenging incumbents. And the challengers that win tend to be the more extreme. That's what is surely giving the GOP establishment nightmares. Presidential elections are decided by winning over moderate voters. Extremists may take control of parties. But they don't win Presidential elections.

Lyndon Johnson, may he rest in peace, must be smiling now. He was elected in 1964 by a landslide when the Republican nomination was seized by Barry Goldwater's insurgency. Goldwater, may he rest in peace, mellowed as he grew older and is probably frowning now. Barack Obama is the presumptive Democratic nominee for the 2012 Presidential election, and he'll have a good chance for a second term if extremists succeed in their efforts to take over the Republican Party.

A Proposal for Reform: No More Managed Money in the Synthetic Derivatives Market

Synthetic derivatives are having their 15 minutes of fame. It began with the SEC's lawsuit against Goldman Sachs, which featured the world's best known synthetic CDO, ABACUS 2007-AC1. Goldman allegedly structured this deal in a way that favored the short side investor, John Paulson & Co., without telling the long side investors about Paulson's involvment in choosing the collateral. Now, the financial press reports that Morgan Stanley is under SEC investigation for creating synthetic CDOs called "Baldwin" and "ABSpoke" in a way that supposedly favored the short side, and then itself investing in the short side. If the reports about Morgan Stanley are true, its conduct would arguably be worse than Goldman's, which did not include a proprietary bet against its long side customers. Other major Wall Street banks are also reportedly under investigation for structuring similar transactions and then taking the short side.

Enough already. Synthetic CDOs are pure bets, like sports bets. Unlike "real" CDOs, which can be connected to substantive economic activity, synthetic CDOs have no socially redeeming value. Yet, they can cause billions of dollars of losses. One solution would be to ban them outright. However, investors might simply go to offshore markets, where transactions would be even less visible and regulated than they are now.

A better idea would be to protect the money we really care about: managed money. Institutions holding or investing money for others shouldn't be allowed to transact or invest in synthetic CDOs or other synthetic derivatives. That would include broker-dealers, mutual funds, pension funds, banks and credit unions, insurance companies, investment advisers, trust companies and other fiduciaries, financial advisers who manage funds for clients, and anyone else who holds or invests money for others. The prohibition would not only apply to direct transactions and investments in synthetic derivatives, but also indirect transactions and investments through parent corporations, subsidiaries or other affiliates or agents. We wouldn't allow money managers to book or invest in sports bets. Why let them bet or make book in synthetic derivatives, which are analytically indistinguishable from sports bets? One advantage of taking the managed money approach is that the prohibition would extend to offshore markets as well as the U.S. market.

An exception could be made for independent hedge funds and other independent entities that receive no government subsidies, bailouts, or benefits (like deposit insurance) and whose investors are limited to individuals meeting the definition of accredited investors (i.e., those with net worths of $1 million or more, or who make more than $200,000 a year ($300,000 for married couples)) and institutions that aren't themselves prohibited from transacting or investing in synthetic derivatives (remember, no indirect transacting or investing). That would amount to a rather small universe of gamblers, but the point is to protect managed money.

Of course, Wall Street would howl in protest over such a proposal, as the lost profits could seriously impact bonuses. Tant pis, as the French would put it. Whatever Goldman Sachs and other big banks might say about their conduct not being illegal, none of them have made a coherent case why synthetic derivatives are good or socially beneficial. Only the most money-obsessed parents would want their children to grow up to sell synthetic derivatives. Plenty of derivatives contracts have made the trek to Boot Hill (such as the once popular portfolio insurance). The synthetic derivative has had plenty of opportunity to demonstrate its value to society, and has failed abysmally. R.I.P.

Still Searching for the Seven Cities of Gold

Suddenly, gold has become the hot new investment, reaching over $1,200 an ounce (in dollar terms) for the first time. Does this make gold a good investment? Consider history.

For the Spain of the 1500s, the New World was a fantastic tale of unimaginable wealth come true. In 1519, Hernan Cortes conquered the Aztecs, securing astonishing amounts of gold and silver, as well as vast territories. Next, Francisco Pizarro and his brothers conquered the larger Inca Empire with even fewer men than accompanied Cortes. Unfathomable amounts of gold and silver flowed to Spain, which had grown in the space of 50 years from a medium sized European kingdom to the enormous Spanish Empire.

As vast fleets of galleons transported gold and other wealth to Spain, inflation set in on the Iberian peninsula. Gold wasn't a magical store of value and wealth. Nevertheless, the Spanish Empire dedicated itself to obtaining as much gold and silver as possible, through conquest and then mining. Latin America, a region with tremendous amounts of natural resources, wasn't developed in the way of North America. By the end of the 19th Century, North America was an industrial powerhouse. The Spanish Empire was bankrupt.

Gold isn't a productive asset. Its only value lies in what it can be exchanged for--i.e., what other people think it's worth. In times of distress, it has value. With the Euro in decline from the sovereign debt crisis in Western Europe, the dollar wavering because of the financial crisis and recession in the United States, and the absence of any strong currency in wide circulation in Asia, gold has by default become popular.

Gold doesn't produce prosperity. It can be a good short term trading play, if your timing is right. But the value of gold is affected by innumerable variables--economic, political, cultural, commercial and industrial (there are a few industrial uses for gold)--and its price trends are notoriously difficult to predict. Gold has done poorly as a long term investment--adjusted for inflation, today's prices are not gold's all time peak (that would be the 1981 price of almost $600 an ounce, which translates to about $1,400 an ounce today). In the last 35 years, the stock market has done about twice as well as gold.

People become wealthy by working, earning, saving and investing, not by speculating in gold. Countries become prosperous by industrializing and strengthening their manufacturing abilities. The Spaniards who searched for the legendary Seven Cities of Gold (or Seven Cities of Cibola) roamed through vast areas of what are now the plains of the United States. They didn't find any gold, and they didn't recognize that the dry grasslands through which they marched would some day become part of the wealthiest nation in the world. They were searching for the wrong thing, and so are today's investors who think they've found a panacea in gold.

Contours of an SEC Settlement with Goldman Sachs

Settlement talks between the SEC and Goldman Sachs are reportedly ongoing. The parties are supposedly far apart; but that wouldn't be surprising for the early go 'rounds. Both sides have strong incentives to settle and they're likely to make progress. It would be interesting to speculate what a settlement might look like. We have no inside information from either side. Experience tells us that the settlement will probably contain certain features.

Undertakings to Change Business Practices. Goldman will undertake to change the ways in which it handles derivatives transactions. It's already begun a review of business practices in this area, and will formalize that review in the SEC settlement. The settlement will outline in general terms the changes that SEC expects, and will probably require Goldman to hire an independent consultant to review the changes it proposes. The consultant will report to the SEC staff, which will have an opportunity to object to proposed changes. These undertakings may take months or over a year to finalize, but this element of the settlement will probably be one of the least controversial because both sides see the need for change.

Court Order Against Future Violations. Goldman will agree to an injunction or other court order that would be equivalent to an injunction, which will prohibit it from future violations of certain specified provisions of law. Injunctions are standard requirements for SEC settlements, and Goldman won't seriously argue against one. It will try to limit the scope of the injunction as much as possible, probably to subsections (2) and (3) of Section 17(a) of the Securities Acts of 1933. These particular subsections are viewed by aficionados of the securities laws as the least harsh among the SEC's antifraud weapons (because one can violate them without acting intentionally). The SEC staff will negotiate for a broader injunction, that would also cover the more well-known rule 10b-5, the most expansive antifraud provision in the SEC's arsenal. Where the parties will come out isn't entirely predictable, but the end result isn't likely to be a show-stopper, one way or the other, for the broader investing public.

Money. Goldman will pay out money, probably in the form of disgorgement (i.e., a return of the compensation and gains it received in connection with its allegedly illegal conduct) and civil monetary penalties.

The disgorgement in this case would be comparatively small. Goldman supposedly was paid by John Paulson & Co. $15 million for structuring the ABACUS 2007-AC1 deal. The SEC would expect that amount to be paid out as disgorgement. Goldman claims it suffered a $90 million loss investing in the deal, but the SEC is unlikely to agree that Goldman can offset this investment loss against its structuring fee, because allowing Goldman to offset an investment loss against unlawfully obtained earnings makes for poor public policy. (Think of it this way: if a bank robber steals $5,000 and then loses it in the stock market, should the bank robber be excused from reimbursing the bank $5,000?) Goldman probably won't argue hard about giving up the $15 million in compensation. After all, this is a firm that makes billions per quarter.

Civil monetary penalties are, in cases involving fraud charges, de rigueur from the SEC's standpoint. Goldman probably won't argue vigorously against paying any penalty, but will try to limit the amount. The penalty is determined by a statutory formula: for each fraud violation by a corporate defendant, the penalty is the greater of $650,000 or the defendant's gross pecuniary gain from the violation. Goldman's gross pecuniary gain would likely be the $15 million it received in fees for structuring the deal. The number of violations would be the subject of intense debate. Goldman would probably contend that it engaged in one violation (failure to disclose in connection with the deal), or else, two violations (failures to disclose to the two injured investors, ACA Capital Holdings and IKB). The SEC staff would likely assert that each act by Goldman that involved a failure to disclose was a separate violation. Under this point of view, each communication by Goldman or one of its employees that involved a failure to disclose would constitute a separate violation giving rise to a $650,000 penalty. The SEC staff would count not only communications with actual investors (ACA Capital Holdings and IKB) but also communications with potential investors, since attempted frauds are treated by the agency (and courts) as violations of law. The number of acts falling within the SEC staff's likely point of view is unclear. About a dozen are specified in the SEC's charging document (the Complaint), but it's probable that the Complaint doesn't itemize all acts that the SEC staff would regard as separate violations.

If the SEC staff can point to 100 violations, the penalty would be $65 million. If there are 200 violations, the penalty would be $130 million. Considering that the investors allegedly lost almost $1 billion, the SEC staff will be looking for as large a number as possible. Money collected in the form of civil penalties can be returned to injured investors, through a vehicle called a "fair fund." Perhaps the best case for the SEC would be a fair fund that would reimburse the investors for all of their losses. But it is unclear that the evidence would support a civil monetary penalty anywhere close to the amount of investor losses in this case.

As we write, the investors haven't actually sued Goldman. They might be having conversations with Goldman about reimbursement, but even that isn't certain. Goldman, from a tactical standpoint, would probably want to settle with the SEC for as little as possible, and then negotiate any demands of the investors down to a separate settlement of cents on the dollar. The SEC staff might consider the approach taken in an enforcement case almost 17 years ago against Prudential Securities, Inc. Prudential was accused of defrauding hundreds of thousands of investors in limited partnerships, and agreed in its settlement with the SEC to establish a court supervised claims resolution process. In this way, numerous investors were able to recover their losses even though the SEC didn't have the means to provide such relief through its standard legal tools. The SEC staff might seek Goldman's agreement to such a claims resolution process.

Money is probably one of the issues on which the SEC and Goldman are far apart. Only time will tell whether and how this gap can be bridged.

Fabrice Tourre. Goldman would certainly want the litigation to end with its settlement, in order to stanch the flow of negative publicity. That would require a disposition of the case as against Fabrice Tourre, the Goldman executive who is also a defendant. Press reports have not indicated that Tourre is participating in the settlement talks. The defendants would be unrealistic if they expect the SEC to simply drop Tourre from the case. The agency's allegations have made him the poster child for bad conduct in the derivatives market and the Commission would surely feel obliged to pursue him if he didn't settle. The SEC probably would want a settlement with Tourre to include, among other things, his being barred from the U.S. securities industry for at least a few years. Such a sanction would imperil Tourre's career in finance (in the U.S. and other countries, since no foreign securities regulator would want Tourre chatting up its country's citizens if he's barred in the U.S.). So Tourre would face substantial personal consequences from a settlement, and might well choose to fight. Goldman has many reputational reasons to extract itself from the case quickly, and may simply choose to live with the continuation of the case against Tourre.

Did the EU Agree on a Bailout or a Press Release?

In an effort to prevent more market panic over sovereign debt problems, the European Union's finance chiefs held an emergency conference in Brussels today. As Asian stock markets commenced trading, the EU began issuing press releases trumpeting a rescue package, which may be valued as high as 750 billion Euros (or close to $1 trillion). Asian markets have risen on the news, and U.S. stock market futures are up 2% to 3% as we write. However, there may be less to the EU's "bazooka" than meets the eye.

The central element of the bailout is a 440 billion Euro (approximately $560 billion) "special purpose vehicle" that evidently will lend to weaker EU nations or guarantee their debt. Participation in the SPV is voluntary and each participating EU member is responsible for only a pro rata share of the SPV's obligations. In other words, there's no certainty that all EU members will participate in the SPV, and its claimed 440 billion Euro capacity may turn out to be considerably less if grouchy EU members like Germany don't participate. The SPV will expire after three years (so longer term sovereign debt may continue to present an unresolved problem). Why would a voluntary measure be the centerpiece of the bailout? Because there's no established mechanism in the EU's governance structure for assistance to distressed members.

It will evidently take weeks, at a minimum, for the SPV to be created, funded and ready to roll. A lot can happen in weeks. Perhaps as an interim measure, the European Central Bank announced that it was prepared to begin buying sovereign and private debt in the secondary markets, something it's been avoiding as part of its overall anti-inflationary stance. The ECB said it would conduct "specific operations" to re-absorb the liquidity injected through these secondary market purchases. It's unclear how the ECB would do that. One way might be to sell good bonds it holds. But that could result in the ECB buying a lot of stinky sovereign and private debt while parting with its good assets. Who then would recapitalize the ECB?

Another potential result of ECB secondary market debt purchases is that it could end up buying debt bought by hedge funds and other speculators for cents on the Euro. It's likely that speculative traders have not only bet on the Euro falling, but may also have bought up distressed Euro-denominated debt to cover the possibility that the Euro makes a comeback. The EU's electorates would probably be displeased, to say the least, if the ECB ends up providing a profitable put to speculators.

The IMF has supposedly lined up to charge with the SPV into the valley, cannon to the right, cannon to the left, and cannon in front of them, offering as much as 220 billion Euros to SPV borrowers. But IMF loans come with strings attached, and there's no certainty that borrower nations will agree to the tough terms the IMF typically seeks. Greece has struggled mightily to achieve the political will needed to accede to the IMF's terms. Citizens of other debtor nations may have trouble seeing why they should make sacrifices for the stability of the Euro (and its consequent benefits for Germany and other wealthy EU nations).

Politics in the wealthier nations are also a complicating factor. Germany's ruling Christian Democratic Union lost a regional election today, weakening its ability to secure German participation in the Big Bailout. The U.K., which was standing on the sidelines because it hasn't adopted the Euro, may be headed for a mostly Tory-oriented coalition after last week's inconclusive election. In that circumstance, Britain will likely fortify the coasts of Kent and Sussex against an invasion of Continental financial flu, rather than be drawn into the bailout frenzy.

The need for a definitive resolution to the EU's problems couldn't be clearer. But EU continues to be hamstrung by the fact that, simply stated, it isn't truly a union.

The Complexities of Computerized Stock Trading: We Told You So

Life gives you very few chances to say "we told you so." So you take the opportunities you get. It appears that today's abrupt 998 intraday point plunge in the Dow (which partially recovered to close down 347) was the result of computerized stock trading programs selling so fast they tripped over each other, and then interpreted the resulting mess as a signal to sell more. Things snowballed. See the explanation from the New York Stock Exchange. http://www.bloomberg.com/apps/news?pid=20601087&sid=aETiygQQ8Y3g&pos=1.

This is a problem we predicted last fall. http://blogger.uncleleosden.com/2009/10/computerized-stock-trading-grave-new.html. Nothing's been done since then, by the exchanges and other markets, big banks and other securities firms, FINRA, or the SEC. The NYSE announced it will cancel trades that were more than 60% above or below the 2:40 p.m. Eastern Time price. It appears that if you make a truly big mistake in the stock markets, you get a second chance. And when you buy stocks at a really cheap price, you can be punished for being astute. When computer programs are inadequate to spot a pile of dog doo on the sidewalk and rush to buy it, they (and the well-capitalized hedge funds and broker-dealers that use them) shouldn't be let off the hook. Make them pay the price of their mistakes and they'll fix their computer programs. Give them a bailout, and what incentive would they have to prevent this from happening in the future?

Too bad all those millions of folks whose 401(k) accounts got clobbered in 2008 didn't get a second chance.

Avoiding Garnishment of Social Security Benefits: Direct Express

As the Dow Jones Industrial Average falls hundreds of points today in a panic over the European sovereign debt crisis, life goes on. Some people have worse problems. One is the garnishment of Social Security benefits.

Garnishment is a legal process for creditors to get a court order requiring your bank to give them the funds in your bank account(s) to repay your debts. Garnishment sounds harsh, but you're obligated to pay your debts, unless they've been discharged in bankruptcy or otherwise resolved. Creditors should have the means to obtain what you lawfully owe.

Social Security benefits are by law exempt from garnishment (except for limited situations such as taxes owed the IRS, child support or alimony). The idea is that beneficiaries should get the money so many need to survive when they're retired or disabled. But banks have frequently failed to protect Social Security benefits from garnishment, often because of the difficulty of separating Social Security funds from other funds in customer accounts (money, after all, is fungible). Some Social Security beneficiaries were able to protect their benefits by cashing their checks and living off the banking grid. But this involved obvious problems with high check cashing fees, the question of how to keep cash safe, more high fees for money orders when cash payments aren't accepted, and so on.

The check cashing way of life is ending. New enrollees for Social Security benefits can no longer get checks in the mail. Their benefits must be paid electronically. Existing beneficiaries will have to go electronic by March 1, 2013. So how can legally exempt funds be protected from garnishment? The Treasury Dept. is issuing regulations that would require banks to analyze accounts and hold back certain amounts from garnishment orders, and so on. But what are the chances the banks won't screw it up? Hint: don't bet your benefits on it.

An alternative would be a debit card called Direct Express. Direct Express is a debit card that is credited with your Social Security benefits each month. It bears the Mastercard logo and is administered by Comerica Bank in Dallas. Direct Express can be used like any debit card. Since acceptance of debit cards is now widespread, it's pretty convenient. You can get cash at ATMs (watch out for fees) or by going to banks that handle Mastercard cash withdrawals. If you need a check, you can use Direct Express to buy money orders at the Post Office, or you can transfer the funds to a bank checking account (although then you might be at risk of garnishment). For more details about Direct Express, go to http://www.usdirectexpress.com.

Direct Express isn't connected to a traditional bank account. Since Direct Express would only contain Social Security benefits, it shouldn't be subject to garnishment (except in certain limited circumstances permitted by law, such as for taxes owed the IRS, child support or alimony). Of course, you should pay your debts and that would include voluntarily using Social Security benefits for repayment if you can afford it. But if you're not sure you want to rely on a bank to protect your benefits from garnishment, consider Direct Express.

Now, go back to worrying about the European sovereign debt crisis.