If you can't beat 'em (or manipulate 'em), then don't join 'em.
That's the new Wall Street mantra, as evidenced by happenings in the "price fixing" world.
Talk about irony. "Fixing" or "fix" are Wall Street terms used to describe how benchmarks are priced on hundreds of instruments, from the Libor and other foreign currency exchange rates to gold, silver, and swaps.
In all fairness, "fix" didn't start out as a Wall Street term.
It's been around, but Wall Street eagerly joined 'em.
Now, join me as I tell you all about this fix we're in...
Price Fixing's Downfall
Most stocks trade on exchanges, and their prices are determined by those trades, and so the closing price of a stock is generally the last price at which it traded. On the other hand, benchmarks (not including stock-market benchmarks) are "fixed."
Take the Libor, for example - it's fixed. The London Interbank Offered Rate is actually a series of interest-rate benchmarks in different currencies for different durations.
The Libor is the most widely used interest-rate benchmark in the world. Interest rates on all kinds of loans are based on Libor plus some additional "spread" above the base Libor rate.
But Libor itself isn't determined on any exchange, or where loans are traded over the counter, or necessarily by any actual transactions. Libor is fixed by a fixing panel.
That means the select, small panel of bankers who trade Libor (interest-rate traders) get together, through computers (for some instruments, sometimes by phone), and fix, which means determine or price, benchmarks. Those benchmarks are then used for valuation purposes, including pricing trade blotters and balance sheet assets, for loan pricing, and to trade against.
While the methodologies used to determine fixes are different, in all cases where benchmarks are fixed by panels, the input of the bankers is what results in the output.
But here's where things get a little... funny.
When panels are convened to determine the fixed price of an instrument, and the panelists also make markets, hold as assets, and/or trade those instruments, panel participants may have an agenda in determining price outcomes.
Say, for example, you're on a panel that determines the price of silver. Maybe your boss comes to you and says, "We have stockpiled silver, and the quarter is coming to an end. We need the price of silver to be as high as you can make it because the value of silver will impact our quarterly earnings."
Or, say you're a trader who has a big short position in silver, it's almost the end of your fiscal year and your bonus will be determined as of the last trading day this week. Because you're short silver, if you manipulate the price of silver down (by influencing the panel's outcome), you'll get a bigger bonus.
The problem with these panels is that they can and have manipulated benchmarks they are charged with determining, presumably in a fair and honest manner.
Big banks responsible for fixing Libor were regularly manipulating rates. So far, a group of them have paid more than $6 billion in fines for their dirty work.
Member banks of panels that determine fixings on foreign currency exchange rates have manipulated them and will end up paying billions of dollars in fines to settle those charges. And there are other ongoing investigations where regulators are looking at other instruments whose prices are determined by panels.
Well, now that the big banks are subject to huge fines for their manipulations, they are packing up their panel positions and closing shop.
That's right. Banks that got away with manipulation for years and probably decades - and got caught - are getting out of the business of being on panels.
Several big banks, including Deutsche Bank AG (NYSE: DB), JPMorgan Chase & Co. (NYSE: JPM), UBS AG (NYSE: UBS), and Citigroup Inc. (NYSE: C), have looked at the cost of those fines and dropped out of panels.
I guess the old saying works in reverse: "If you can't beat and cheat 'em, leave 'em."
How's that for a slap in the face?
These banks obviously feel that they can't be honest, or that they can't control the greed of their traders or higher-ups, who all like their big, fat bonuses, to any degree that they can stop the manipulation that's become part of the fabric of the soiled cloth they've woven. Because they can't make money cheating, they're packing up their knitting needles.
First Comes Silver
I say good riddance to you lying, cheating, manipulating bonus junkies.
It's high time we replace panels of poseurs with transparent, real-world, market-based inputs. We've had the technology for years now. The old system is antiquated, and the only reason it's still so predominant is that it's so easily manipulated.
Silver was the first to get a makeover. Gone is the 117-year-old London Silver Fixing Market and its panel pricing methodology.
It was killed off in the middle of August this year when a new system for determining the silver fix was implemented. The new fix, the London Bullion Market Association Silver Price, is determined by actual transactions. And where there aren't enough transactions, meaning 300,000 ounces of silver trading hands, an algorithm takes over that looks at price and volume transactions and comes up with a dirty-hands-off, free-market fix.
In case you're wondering why silver went that route, it was because Deutsche Bank, one of the three panel members who "fixed" silver (I used quotes there, because, well, you figure it out), very publicly pulled out of the panel.
Why did they pull out? Who knows?
Maybe they were just tired of getting caught up, or caught, in the price fixing game.
More from Shah Gilani: Once again, the Fed is demonstrating that it's not us that it's here to protect. All of this is revealed in the secret Goldman Sachs tapes...
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.