Eugene Linden
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Matt Taibbi, a journalist whose writing I admire, has joined the throng decrying the hypocrisy of pundits who write on the pages of the Washington Post (owned by a billionaire) that if billionaire Elon Musk buys Twitter it will be a threat to democracy. This is too glib. The problem isn’t b...



Fire & Flood
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Afterword to the softbound edition.

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The Future In Plain Sight
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Silent Partners
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Affluence and Discontent
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Wall Street is the undertaker beetle of statistics: the markets voraciously consume, digest and then forget the numbers churned out by the keepers of vital economic statistics each week. Every now and then, however, a statistic pops up that gives pause to this number munching machine because the number points to deep and scary forces gathering beneath the surface. That happened Jan. 9, when the U.S. Labor Department announced that non-farm payrolls only increased by 1,000 jobs in Dec. despite robust economic growth, and it was underscored March 5, when the Feb. payroll number came in at 21,000, a small fraction of the 130,000 new jobs predicted by economists and the 300,000 estimated by the White House. After three months of anemic numbers amid a supposedly robust recovery, even the most Panglossian cheerleaders recognize that consumers canít spend if they donít have jobs. Much has been written about outsourcing, but the real threat of these stunning numbers is that they may set in motion a cascade of events that could become seriously destabilizing in the coming years. A jobless recovery that enriches shareholders, but bypasses Americaís debt-burdened employed will exacerbate the wealth gap between rich and poor. This gap was perceived as a problem at the end of World War II, and despite more than 50 years of unprecedented global economic expansion it has only widened, both in the U.S. and in the developing world. In my 1998 book, The Future in Plain Sight, I made the wage gap one of my clues to future instability because the gap is written in the DNA of the way we now do business, and because it is unsustainable. The few can only hold onto their gains with the consent of the many, and at some point those not sharing in those gains will realize that a significant portion the enormous wealth created for the fortunate few in recent years has come out of their future prospects. Back in 1997, I expected that this realization to take a long time to gain traction with workers, but a few more months of payroll numbers such as those released last week, and this ďahaĒ moment might arrive within a year. Thatís when trouble will really begin. The labor department figures have prompted a flood of explanations. Some caution that the payroll number may miss significant numbers of self-employed, while different pundits have mentioned technologically driven efficiency improvements, cautious businesses that make people work harder rather than hire as business improves, and the movement of jobs overseas. This last point is the real problem Any U.S. business can now draw on an unlimited pool of cheap skilled labor for nearly any business need that does not involve face-to-face encounters. This not only fosters recoveries without jobs, it also puts a cap on wage demands by those lucky enough to still hold a job. The executives making decisions to outsource to low wage employees have their own problems. The digital connections that gives Amalgamated Cup access to cheap programmers in Bangalore also gives competitors in China and elsewhere access to Amalgamated Cupís markets at home. If a networked global economy has put a cap on wages, it has also put a cap on the prices a business can charge for their goods. Thanks to the Internet everything and everyone is in danger of becoming a commodity. Both businesses and labor would like to set up barriers to low-priced competitors, but there really is no easy way out of this self-destructive system. If the gap continues to widen and the economy turns down, there will be an ever -growing constituency for protectionist measures and other restraints that could lead us into a disastrous spiral of trade wars. On the other hand, any measures such as government guarantees, safety nets, or other programs offered by politicians trying to capitalize on class resentments would spook the deficit-conscious bond markets, and could easily cause a collapse of the dollar. Because of U.S. dependence on trade and because trillions of dollars in dollar-denominated assets are held overseas, U.S. economic policy is now hostage to the opinions of foreigners, our military might notwithstanding. Is there a solution? Maybe. A massive public works project that did not expand the deficit would help; something like a massive clean energy program or nationwide high-speed rail network financed by new taxes on pollution and fossil fuels. A more progressive tax system would help as well. Both seem inconceivable since the Bush administration wants to spend public works dollars on Mars not earth, and Congress that has just enacted tax breaks that exacerbate the wealth gap. Still, if this jobless recovery stalls, and populist resentments find a voice, I suspect that the few might give up a bit to the many in order to hold onto the rest. The South African tycoon Harry Oppenheimer once remarked, ďIf they donít eat, we canít sleep.Ē He was talking about racial apartheid, but the remark might well apply to economic apartheid as well.

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Short Take

HOW THE OPTIONS TAIL HAS COME TO WAG THE MARKET DOG: A Simple English Language Explanation of How Structural Changes in the Stock Markets Contribute to Whipsaw Movements in Prices.

Lately a string of violent price movements and reversals in the equity markets make it look like the markets are having a nervous breakdown. The last day of trading in April 2022 saw a 939 point drop in the Dow. The day before that, the Dow rose about 625 points, and two days before that it fell over 800 points. The very next week, after two quiet days, the Dow rose over 900 points after the Fed announced its biggest rate hike in 22 years (ordinarily a big negative for the markets), and then, the next day, fell over 1000 points (more on this later).  There have been plenty of headlines – about the Ukraine Invasion, inflation, the threat of a Fed caused recession, supply chain disruptions – to justify increased uncertainty, but the amplitude of the moves (and the sudden reversals) suggest something more may be at work. Here follows an effort to explain in simple language the significant changes in the market that have contributed to this volatility.


“This time it’s different” is perhaps the most dangerous phrase in finance as usually it’s uttered by market cheerleaders just before a bubble bursts. That said, markets do change, and those changes have their impacts. One change in the markets has been the shift from intermediaries (such as brokers) to direct electronic trading, a shift that has made the markets somewhat frictionless, and allowed computer driven funds to do high speed trading. This shift began a couple of decades ago. Today’s markets can move faster than a human can react.


Another shift has been the degree to which passive investing through index funds and algorithmic trading through various quant funds have come to eclipse retail investing and dominate trading. A consequence of this is that to some degree it has mooted individual stock picking because when investors move in or out of index funds, the managers have to buy or sell the stocks held on a pro rata basis and not on individual merit. This change too has been developing over recent decades.


A more recent and consequential shift, however, has been the explosion in the sale of derivatives, particularly options (the right to buy or sell a stock or index at a specified price on or before a specific date). Between 2019 and the end of 2021, the volume of call options (the right to buy a stock at a specified price on or before a particular date) has roughly doubled. During times of volatility, more and more retail and institutional investors now buy calls or puts rather than the stocks. 


Today, trading in options has reached a scale that it affects market moves. A critical factor is the role of the dealers who write options and account for a significant percentage of the options issued. Dealers have been happy to accommodate the growth in option trading by selling calls or puts. This however, makes them essentially short what they have just sold. Normally, this doesn't matter as most options expire out of the money and worthless, leaving the happy dealer to book the premium. Being short options, however, does begin to matter more and more as an option both moves closer to being in the money and closer to expiration. 


This situation is more likely to occur when markets make large and fast moves, situations such as we have today given the pile of major uncertainties. Such moves force dealers to hedge their exposure. 


Here’s how it works. If, for instance, a dealer has sold puts on an index or a stock, as a put comes closer to being in the money (and closer to expiration), the dealer will hedge his short (writing the put) by selling the underlying stock. This has the combined effect of protecting the dealer -- he's hedged his potential losses – while accelerating the downward pressure on the price. In other words, this hedging is pro-cyclical, meaning that the hedging will accelerate a price move in a particular direction.


Traders look at crucial second derivatives of stock prices, referred to by the Greek letters delta and gamma to determine exposure to such squeezes. As an option moves closer to in the money it's delta -- it's price movement relative to the price movement of the underlying, and its gamma -- the rate of change of the delta relative to a one point move in the underlying, both rise. The closer to both the strike price and expiration date, the more the dealer is forced to hedge. The result is what’s called a gamma squeeze. Once the overhang of gamma exposure has been cleared, however, the selling or buying pressure abates, and gamma may flip, with new positioning and hedging done in the opposite direction. The result can be a whipsaw in the larger markets. This same phenomenon can happen with indexes and futures.


How do we know that the hedging of option positioning are contributing to violent price changes and reversals in the market? While not conclusive, perhaps the strongest evidence is that large lopsided agglomerations of options at or near the money have been coincident with surprising market moves as expiration dates approach. In fact, some market players use this data to reposition investments, in effect shifting investment strategy from individual companies to the technical structure of the markets. This is what Warren Buffett was referring to when, at his recent annual meeting, he decried the explosion of options and other Wall Street fads as reducing companies to “poker chips” in a casino.


The week of the May Fed meeting gave us a real-time example of how a market move that looks insane on the surface reflects the underlying positioning in various derivatives. To set the stage: ordinarily, given debt burdens and the threat of recession, the markets would be expected to react badly to a Fed tightening cycle that is accelerated by the biggest rate hike in 22 years. On Wednesday, however, market indices began to soar on Wednesday when Fed Chairman Powell, one half hour after the Fed announced it 50 basis point raise, suggested that the Fed was not considering larger 75 basis point hikes during this tightening cycle. Traders interpreted this as taking the most hawkish scenario off the table. Up to that point, institutions were extremely bearish in their positioning, heavily weighted to puts on indexes and stocks, and also positioned for future rises in volatility in the markets. Right after Powell made his comments, investors started hedging and unwinding this positioning, and all the pro-cyclical elements entailed in this repositioning kicked in. By the end of the day, the technical pressures producing the squeeze had largely abated, setting the stage for a renewed, procyclical push downward the next day, as the negative aspects of the tightening cycle (and other economic headwinds) came to the fore. 


What these violent moves in the market are telling us is that while in the broader sense, this time is not different --the overall sine wave of the market is still that bubbles build and burst -- how the present bubble is bursting may be following a different dynamic than previous episodes. The changes since the great financial crisis-- the rise to dominance of passive trading through indexes and algorithmic trading through various quant strategies – reduced the friction in the markets as well as the value of picking individual companies. Now, the more recent explosion of option issuance, further accelerates market moves, and leads to unpredictable reversals that have to do with option positioning rather than fundamentals such as earnings, politics, or the state of the economy. 


The tail (the options and other derivatives markets) now wags the dog (the equities markets).



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