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>Oh, poor “Demonized Algos” !!!

Demonised ‘algos’ push the surge in FX trading

By Jennifer Hughes, Senior Markets Correspondent
Published: September 1 2010 00:04 | Last updated: September 1 2010 00:04

Since the infamous stock market “flash crash” of May 6, high-frequency, or algorithmic, trading has been unwillingly dragged into the political and regulatory limelight.
forex-trading-graphicSo far, however, attention has focused on the role of these high-speed traders in the equity market. Outside the glare of that publicity, it is less well known that on May 7, FX trading volumes reached records, straining the plumbing of these markets.
Some participants argue these strains were partially caused by algorithmic, or algo, traders.
Exactly how much of this can be attributed to algo trading is unclear. However, there is no question that high-frequency traders are a fast-increasing force in FX markets, which is sparking a fierce debate as to their value to the market.
On Tuesday, the Bank for International Settlements reported that average daily turnover in the FX market has jumped 20 per cent in the past three years to $4,000bn a day. Its survey was taken in April, so missed the May spike, which related to the eurozone sovereign debt crisis.
The BIS-reported gains were led by a near 50 per cent leap in spot trading – deals for immediate delivery – to $1,500bn a day. This jump was powered by increased activity from “other financial institutions”, a group that includes hedge funds, pension funds, some banks, mutual funds, insurance companies and central banks. This will also include algos.
While all categories of “other” could have increased their trading, it is likely a significant proportion was driven by algo traders, who favour the deep, liquid spot markets and particularly currency pairs such as eurodollar and dollar-yen, which between them account for 42 per cent of all currency trading.
The question for the FX market is whether high-frequency dealers improve the market by adding liquidity, or whether they are instead merely price takers who contribute little.
“Algos have been demonised, but they’re an important part of the growth story,” says David Rutter chief executive of Icap Electronic Broking, which runs EBS, the main FX interbank trading platform. “What we’ve found is that they add pressure at each price point so that instead of getting big price gaps on shocking news, trade is more orderly.
“With FX, there are a lot of other flows such as global trade, so there is good underlying liquidity that the algos can enhance.”
Algos initially appeared in FX markets almost a decade ago, attracted by the deep liquidity and increasing use of electronic trading. They were generally welcomed, particularly by banks looking to build their prime brokerage businesses. However many banks soon grew disenchanted when they found the fast-moving shops were profiting from banks’ own slow systems by exploiting brief, tiny price differences between rival platforms.
Some banks went as far as ejecting offenders from their platforms but banks’ views have since become more nuanced. They have generally reached an accommodation, helped by technological improvements which make it easier to monitor client dealings and offer client-specific prices.
“The facts are that algos have made the markets more efficient and have helped ensure there’s one virtual price,” says Jeff Feig, global head of G10 FX at Citigroup. “They do cause banks to be smarter and we’ve had to work harder to be more efficient, but that’s ultimately to the advantage of the end user.
“I think that to some extent, algos have pushed banks and the result has been enhanced transparency and increased liquidity.”
Algos mean many different things in the FX market. While high-frequency traders are the best known – typified by one senior banker as “five smart guys in a room in New Jersey,” – banks are increasingly adept at developing their own algorithms to make their internal FX deals more efficient. These “internalisation” trades too will have provided a boost to the BIS numbers.
Most players say algos are now a fact of life in currency markets.
Unlike the equity market, which is split into hundreds of stocks, they believe the FX world’s focus on a relatively small number of currency pairs means it would be far harder for a single group of participants to move the market significantly, intentionally or otherwise, as some watchers fear happened during the “flash crash”.
“Also trading can happen anywhere there’s an electronic execution system and a volatile market,” says Alan Bozian a former FX banker and now chief executive of CLS Bank, the FX settlement system. “The question is, which markets adapt well and I don’t think it’s necessarily the stock market.”
FX markets have proved generally good at adapting. Systems such as CLS, introduced years before the financial crisis, have helped minimise settlement risk and since May, participants have been working again to improve their processing systems to cope with increased volume.
Significantly, for a market that is very much built around a hub of big banks, the BIS report showed that, for the first time, interaction of the main banks with “other” financial institutions overtook trading between themselves.
This could be a pointer to the market of the future, where banks are likely to remain the hub, but as much for their trade processing abilities as for their liquidity.
This would allow the winners to build profitable volume without taking on huge trading risks – suiting the current regulatory mood.
“The banks want to continue being the price providers, but they’re getting much more interested in the infrastructure and improving that,” says Mr Bozian. This evolution is likely to apply to high-frequency trading too.
Mr Rutter believes algos are only in their “late teens” in terms of development. “The early algo trading was about super-fast dealing and chasing inefficiencies. That’s largely gone,” he says.
“Now its about math and science being thrown at the market – there’s a rich pool of data and I think we’ll see algos evolve so its not just about milliseconds, but about longer-term predictive math.”

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Goldman Backs Oil, Copper, Gold, Maintains `Overweight’ Commodities Call

Commodities demand from emerging markets and limited growth in supplies will help to support prices toward the end of the year, according to Goldman Sachs Group Inc., which backed oil, gold, copper, zinc and platinum.
The bank reiterated an “overweight” recommendation on commodities, analysts led by Allison Nathan and Jeffrey Currie wrote in a report. Goldman pared its 12-month forecast for the S&P GSCI Enhanced Total Returns Index to a 19 percent gain from 21.6 after recent gains in agricultural commodities and metals.
Commodities last week had the worst weekly performance in six after the Federal Reserve said the recovery is weakening and European industrial output fell, stoking concern that there may be a double-dip recession. Reports also showed China’s retail sales and new lending grew in July at a slower pace than June.
“We are not overly optimistic about commodities prices in the second half,” Ni Xiaolei, a trader at Donghai Futures Co., said from Jiangsu today. “‘We saw a very sharp ascent in commodity prices last month, which will be hard to sustain as global macroeconomic data emerges weaker than expected.’’
Goldman’s commodity ‘‘overweight’’ call was maintained even as the bank has been paring forecasts for U.S. and Japanese economic growth for next year. Ed McKelvey, Goldman’s senior U.S. economist in New York, has also said that the chance the U.S. may tumble back into recession is as high as 30 percent.
Gold, Crude
Gold, which surged to a record $1,265.30 an ounce in June amid concern sovereign-debt levels in Europe may be excessive, traded at $1,29.60 at 2:11 p.m. in Singapore, 11 percent higher this year. Goldman forecast a rise to $1,260 in three months and to $1,300 in six. New York crude futures were at $75.86 a barrel, 4.4 percent lower over 2010. Goldman’s report put them at $92 a barrel in three months.
‘‘The current softness in economic data, combined with increasingly mixed signals from the underlying commodity markets, is likely to continue to generate choppy commodity-price action in the near term,” the Goldman analysts wrote in the Aug. 13 report. Still, “high and rising emerging-market demand levels against limited supply growth in key commodities are likely to increasingly tighten balances,” they wrote.
Japan’s economy expanded at an annualized 0.4 percent in the three months to June 30, the Cabinet Office said today. That’s the slowest pace in three quarters. U.S. industrial production figures are due for release tomorrow, the same day as data on investor confidence in Germany.
Chinese Demand
Commodity prices may advance into the end of the year on evidence of increased oil demand in China, a decline in crude stockpiles in Europe and the U.S., and further falls in metals inventories, the report said.
“We expect upside to be greatest for crude oil, copper, zinc, platinum and gold,” it said. “Improved data will likely be required to sustain rising prices.”
Goldman Sachs last week backed gold to resume a rally and climb to a record $1,300 an ounce within six months on renewed investor interest. The precious metal, which has risen for nine years to last year, may also climb in 2011, the report said.
A ban on wheat exports by Russia helped to drive futures to $8.68 a bushel earlier this month, the highest price in almost two years. The country is battling reduced grains production amid the worst drought in at least 50 years.
‘Sharp Gains’
“Commodity returns rose over the past month led by sharp gains in the agricultural complex owing to weather-related supply shocks in wheat,” according to the Goldman report.
Zinc, trading today at $2,080 a metric ton, has fallen 19 percent this year, making it the worst performer on the London Metal Exchange. Goldman’s analysts forecast that the metal may climb to $2,121 a ton in six months, according to the report.
Copper rose 1.3 percent to $7,246.50 a metric ton, paring this year’s loss to 1.7 percent, while platinum gained 0.8 percent to $1,535.75 an ounce, 5 percent stronger this year. Goldman forecast copper at $7,925 a ton in six months.
Japan will grow 1.4 percent in 2011, compared with an earlier forecast of 1.7 percent, Goldman’s Tokyo-based senior economist Chiwoong Lee said in a report dated Aug. 7. The week before that Goldman lowered its projection for U.S. growth for the same year to 1.9 percent from 2.5 percent.
To contact the reporter on this story: Glenys Sim in Singapore at Gsim4@bloomberg.net

Goldman Backs Oil, Copper, Gold, Maintains `Overweight’ Commodities Call – Bloomberg

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Goldman Sachs Lost Money on 10 Days in Second Quarter

Goldman Sachs Group Inc., the bank that makes the most revenue trading stocks and bonds, lost money in that business on 10 days in the second quarter, ending a three-month streak of loss-free days at the start of the year.

Losses on Goldman Sachs’s trading desks exceeded $100 million on three days during the period that ended on June 30, according to a filingtoday by the New York-based company with the U.S. Securities and Exchange Commission. The firm also disclosed that trading losses surpassed its value-at-risk estimate, a measure of potential losses, on two days.

Trading results across Wall Street firms declined after Goldman Sachs and its biggest rivals posted perfect results, with no losing days, in the first quarter. Goldman Sachs’s $5.61 billion in second-quarter trading revenue exceeded all of its Wall Street competitors. The bank, overseen by Chairman and Chief Executive Officer Lloyd Blankfein, relied on trading for 71 percent of its revenue in the first half of the year, down from 80 percent a year earlier.

Today’s filing also shows that the firm’s traders generated more than $100 million on 17 days during the quarter. Of the 65 days in the quarter, Goldman Sachs traders made money on 55 days, or 85 percent of the time.

Morgan Stanley said separately today it lost money on 11 days during the second quarter. The losses never exceeded $75 million daily, and never surpassed the firm’s value-at-risk estimate. Morgan Stanley’s traders made more than $175 million on one day, the firm said in an SEC filing today.

Goldman Sachs agreed last month to pay $550 million to settle a fraud lawsuit filed by the SEC over Goldman Sachs’s 2007 sale of a mortgage-linked investment. In the settlement, a record for the SEC and a Wall Street firm, Goldman Sachs said it made a “mistake” by failing to disclose that a hedge fund that helped construct the investment was also planning to bet against it.

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net

Goldman Sachs Lost Money on 10 Days in Second Quarter – Bloomberg

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Goldman Sachs Will Settle Fraud Case for $550 Million

FINANCIAL SERVICES, GOLDMAN SACHS, SEC, SETTLEMENT,
CNBC staff and wire reports
| 15 Jul 2010 | 07:43 PM ET
Goldman Sachs agreed Thursday to pay a record $550 million to settle civil claims it misled investors about a subprime mortgage product it sold in 2007, resolving a major public relations nightmare for the Wall Street financial giant.
The settlement, first reported by CNBC, sent Goldman shares up sharply in after-hours trading.(Click here for an after-hours quote)
“This is a very favorable outcome for investors,” said Bill Fitzpatrick, equity analyst for Optique Capital Management.
“The dollar amount wasn’t really going to be the issue, particularly if it was under a billion dollars and this has put some closure around what was a black eye for Goldman Sachs.”
“They pay $550 million and they get an $800 million pop in their stock price—they got off easy,” said Kevin Caron, a market strategist at Stifel, Nicolaus & Co in Florham Park, New Jersey.
The settlement came on the same day that the financial overhaul bill won final approval in the Senate, imposing the stiffest restrictions on banks and Wall Street since the Great Depression.
The deal calls for Goldman to pay the Securities and Exchange Commission fines of $300 million. The rest of the money will go to compensate those who lost money on their investments.
CNBC understands that the SEC was originally looking for a settlement near $750 million dollars and that management change within Goldman was not on the table during the negotiations. Goldman’s response over the complaint would have been due on Monday.
The fine was the largest against a financial company in SEC history. Goldman earned $3.3 billion in the first quarter of this year. It earned $13.4 billion in 2009.
The settlement also requires Goldman to review how it sells complex financial mortgage investments. Goldman acknowledged in a court filing that its marketing materials for the deal at the center of the charges omitted key information for buyers.
But Goldman did not admit any legal wrongdoing.
The investments were crafted with input from a Goldman client who was betting on them to fail. The securities cost investors close to $1 billion while helping a Goldman client—hedge fund billionaire John Paulson—capitalize on the housing bust.
The civil charges the SEC filed April 16 were the most significant legal action related to the mortgage meltdown that pushed the country into recession.
The SEC said its case continues against Fabrice Tourre, a Goldman vice president accused of shepherding the deal.
“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” said Robert Khuzami, the SEC’s enforcement director.
The settlement is subject to approval by a federal judge in New York’s Southern District.
The Justice Department opened a criminal investigation of Goldman over the transactions in the spring, following a criminal referral by the SEC. Executives of the firm were grilled and publicly rebuked by senators at a politically charged hearing.
Of the $550 million Goldman agreed to pay, $250 million will go to the two big losers in the deal. German bank IKB Deutsche Industriebank will get $150 million. Royal Bank of Scotland, which bought ABN AMRO Bank, will receive $100 million.
Goldman will pay back $15 million in fees it collected for managing the deal. The remaining $535 million is considered a civil penalty.
Paulson was not charged by the SEC.
—The AP and Reuters contributed to this report.

© 2010 CNBC.com

Goldman Sachs Agrees to Settle Fraud Case for $550 Million – CNBC

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April 20, 2010

How Paulson created toxic debt

Special to Globe and Mail Update

An excerpt from Wall St. Journal reporter Greg Zuckerman’s book on the collapse of the subprime mortgage market

Excerpted from The Greatest Trade Ever by Greg Zuckerman.
Also read a Q&A with the author: Author Zuckerman on Goldman case [http://www.theglobeandmail.com/report-on-business/author-zuckerman-on-goldman-case/article1538691]
John Paulson, focused on creating a huge trade, soon took a controversial step that would lead to some resentment for his role in indirectly contributing to more toxic debt for investors.
Paulson and Pellegrini were eager to find ways to expand their wager against risky mortgages; accumulating it in the market sometimes proved a slow process. So they made appointments with bankers at Bear Stearns, Deutsche Bank, Goldman Sachs, and other firms to ask if they would create CDOs that Paulson & Co. could essentially bet against.
Paulson’s team would pick a hundred or so mortgage bonds for the CDOs, the bankers would keep some of the selections and replace others, and then the bankers would take the CDOs to ratings companies to be rated. Paulson would buy CDS insurance on the mortgage debt and the investment banks would find clients with bullish views on mortgages to take the other side of the trades. This way, Paulson could buy protection on $1-billion or so of mortgage debt in one fell swoop.
Paulson and his team were open with the banks they met with to propose the idea.
“We want to ramp it up,” Pellegrini told a group of Bear Stearns bankers, explaining his idea.
Paulson and Pellegrini believed the debt backing the CDOs would blow up. But Pellegrini argued to his boss that they should offer to buy the riskiest slices of these CDOs, the so-called equity pieces that would get hit first if problems resulted. These pieces had such high yields that they could help pay the cost of buying protection on the rest of the CDOs, Pellegrini said, even though the equity slices likely would become worthless over time, as the debt backing the CDO fell in value.
And if their analysis proved wrong and the CDOs held up, at least the equity investment would lead to profits, Pellegrini said.
“We’re willing to buy the equity if you allow us to short the rest,”
Pellegrini told one banker.
To try to protect themselves, the Paulson team made sure at least one of the CDOs was a “triggerless” deal, or a CDO crafted to be more protective of these equity slices by making other pieces of the CDO more likely to take early hits. Paulson’s goal was to make the equity piece a bit safer, but this step made the other parts of the triggerless CDO even more dangerous for anyone with the gumption to buy them.
He and Paulson didn’t think there was anything wrong with working with various bankers to create more toxic investments. Paulson told his own clients what he was up to and they supported him, considering it an ingenious way to grow the trade by finding more debt to short. After all, those who would buy the pieces of any CDO likely would be hedge funds, banks, pension plans, or other sophisticated investors, not momand- pop investors. And if these investors didn’t purchase the newly created CDOs, they’d likely buy another similar product since there were more than $350-billion of CDOs at the time.
However, at least one banker smelled trouble and rejected the idea.
Paulson didn’t come out and say it, but the banker suspected that Paulson would push for combustible mortgages and debt to go into any CDO, making it more likely that it would go up in flames. Some of those likely to buy the CDO slices were endowments and pension plans, not just deep-pocketed hedge funds, adding to the wariness.
Scott Eichel, a senior Bear Stearns trader, was among those at the investment bank who sat through a meeting with Paulson but later turned down the idea. He worried that Paulson would want especially ugly mortgages for the CDOs, like a bettor asking a football owner to bench a star quarterback to improve the odds of his wager against the team.
Either way, he felt it would look improper.
“On the one hand, we’d be selling the deals” to investors, without telling them that a bearish hedge fund was the impetus for the transaction, Eichel told a colleague; on the other, Bear Stearns would be helping Paulson wager against the deals.
“We had three meetings with John, we were working on a trade together,” says Eichel. “He had a bearish view and was very open about what he wanted to do, he was more up front than most of them.
“But it didn’t pass the ethics standards; it was a reputation issue, and it didn’t pass our moral compass. We didn’t think we should sell deals that someone was shorting on the other side,” Eichel says.
For his part, Paulson says that investment banks like Bear Stearns didn’t need to worry about including only risky debt for the CDOs because “it was a negotiation; we threw out some names, they threw out some names, but the bankers ultimately picked the collateral. We didn’t create any securities, we never sold the securities to investors. . . . We always thought they were bad loans.”
Besides, every time he bought subprime-mortgage protection, someone had to be found to sell it to him, Paulson notes, so these big CDOs were no different.
Indeed, other bankers, including those at Deutsche Bank and Goldman Sachs, didn’t see anything wrong with Paulson’s request and agreed to work with his team. Paulson & Co. eventually bet against a handful of CDOs with a value of about $5-billion.
Paulson didn’t sell any of these products to investors. Some investors were even consulted as the mortgage debt was picked for the CDOs to make sure it would appeal to them. And these deals were among the easiest for an investor to analyze, if they so chose, because they were “unmanaged”
CDOs, or those in which the collateral was chosen at the outset and not adjusted later on like other CDOs. It wasn’t his fault that others were willing to roll the dice.
A few other hedge funds also worked with banks to create CDOs of their own that these funds could short-so Paulson wasn’t doing anything new. Nor did Paulson’s moves create more troubled mortgages or saddle borrowers with additional losses-the deals were CDOs composed of CDS contracts, rather than actual mortgage bonds.
“We provided the collateral” for the CDOs, Paulson acknowledges.
“But the deals weren’t created for us, we just facilitated it; we proposed recent vintages of mortgages” to the banks.
But some investors later would complain that they wouldn’t have purchased the CDO investments had they known that some of the collateral behind them was chosen by Paulson and that he would be shorting it. Others argued that Paulson’s actions indirectly led to more dangerous CDO investments, resulting in billions of dollars of additional losses for those who owned the CDO slices when the market finally cratered.
In truth, Paulson and Pellegrini still were unsure if their growing trade would ever pan out.
They thought the CDOs and other risky mortgage debt would become worthless, Paulson says. “But we still didn’t know.”
Later… Paulson & Co. had bet against about $5-billion of CDOs and made more than $4-billion from these trades-including $500-million from a single transaction-according to the firm’s investors and an employee of the firm. One of the biggest losers, however, wasn’t any investor on the other side. It was the very bank that worked with Paulson on many of the deals: Deutsche Bank. The big bank had failed to sell all of the CDO deals it constructed at Paulson’s behest and was stuck with chunks of toxic mortgages, suffering about $500-million of losses from these customized transactions, according to a senior executive of the German bank.
These were some of Paulson & Co.’s largest scores.

Excerpted from The Greatest Trade Ever by Greg Zuckerman; Broadway Books, Copyright @2009.

How Paulson created toxic debt – The Globe and Mail





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