by S. Lord

Debate has been intensifying about entitlement spending as the fallout from the financial crisis has crimped state and municipal budgets to the breaking point precisely when their tax bases have been decimated.

For many, the issue of entitlements — how large, for whom, and the fact they exist at all — has become one of the defining political questions of the time. Fox Business Network anchor Stuart Varney has been looking closely at entitlement spending, the political debate in the United States, and the overall impact on long-term economic performance, interest rates, income, etc.

Trader Daily caught up with Varney recently and asked him a few questions about what may ultimately be the most important strategic issue facing U.S. financial markets.

Trader Daily: There is an unprecedented focus on state and municipal spending right now, even to the point of firing teachers. Is this focus ultimately anti-union? Will there continue to be a backlash against what is perceived as cushy deals?

Varney: There is an anti-union backlash. It is almost inevitable. When Milwaukee fires 560 teachers in order to pay the medical bills of retired teachers, people are unhappy.

Trader Daily: Many people indirectly benefit from government entitlements but don’t know it. How much distance is between the average middle-class American and the government spending that so many of them profess to dislike?

Varney: Good point… everybody wants less government spending, but nobody wants their entitlements cut.

Trader Daily: The math on entitlements makes it pretty clear that spending has to fall and revenue has to rise. When viewed like a business, the solutions are not hard to see. Yet the political process makes progress impossible. Has the aftermath of the financial crisis made the tough decisions any easier to make?

Varney: The financial crisis makes sound policy decisions much more difficult. The panic left people angry… angry at bankers, bonuses and  bail-outs. It is very difficult to cut the safety net, while bailing out Wall Street.

Trader Daily: There are distinct shifts underway within both major political parties regarding entitlements – some more extreme than others. How is this issue changing the traditional positions of both parties?

Varney: I don’t believe there has been a significant shift in either party on entitlements. The Democrats are still the party of government and social services, and the Republicans are still the party of growth and private enterprise. There may be some fudging around the edges, but fundamental principles have not changed.

Trader Daily: Some states are more generous than others when it comes to handouts. Is there a correlation between states with more comprehensive entitlement policies and the yields they must pay on debt?

Varney: Yes, there is a difference in borrowing costs… witness Illinois right now. It refuses to make spending cuts and instead raises taxes. Result: massive borrowing requirements that will be much more expensive than, say, Texas.

Trader Daily: Looking at Treasury yields, Wall Street has not yet priced a budget breakdown to any degree. What happens when investors sense we do not have the stomach to address entitlements head on? How far are we from that point?

Varney: Wall Street has not priced in a budget break-down because it doesn’t expect it to happen. Plus, America is taking in all the hot money that is running away from Europe’s debt problem. That’s why the 10-year Treasury currently yields [under] 3%.

Trader Daily: Can the dollar remain the reserve currency if we do not get entitlement spending under control?

Varney: There is no alternative to the dollar as the world’s reserve currency, certainly not in the short term.

Trader Daily: Has the European “social economy” model been irrevocably damaged by the debt crisis there? Or can Europe find a way to keep their social net traditions while also restructuring their finances. If so, can we learn anything from the process?

Varney: Yes, as a refugee from the European “Social Model” i.e. Socialism, I can assure you that that model is broken. You just can’t afford cradle to grave security with an aging population and a very low birth rate. And I haven’t even gotten into the moral issues that Socialism poses. And yes, there is a lesson for America: don’t follow the European road!

Trader Daily: Is privatization of social spending programs a realistic alternative given the financial Armageddon that just happened? Can social security, Medicare etc. become valid candidates for some degree of private sector management?

Varney: Privatization is the ONLY way out of the mess. Only the competition of free markets and market forces can keep costs under control.

by S. Lord

Very few journalists have access of any kind to Warren Buffett, much less reside on the Oracle’s short list of media contacts. Fox Business Network‘s Liz Claman, however, has developed a rapport with Buffett that provides her with a unique perspective on one of the world’s richest men and most successful investors.

Claman scored a real coup recently when she landed an interview with Buffett, Berkshire Hathaway’s Vice Chairman Charlie Munger, and Microsoft’s Bill Gates all at the same time (see Trader Daily‘s recent article). Given her experience in financial journalism, and taking a page from the old newspaper tactic of interviewing the interviewer, we asked Claman for her thoughts on her three famous and successful subjects:

Trader Daily: Each of the three men you interviewed have been successful in very different ways. When you sit down with them together, does any common characteristic become apparent?

Claman: They are all so totally different from each other, but I would say in certain ways, Warren and Charlie were separated at birth. They both obsess over asset allocation, finding underpriced but superior companies to buy, and digging everywhere on the planet for great investment ideas. They both are unafraid to take calculated risks. However, their personalities differ greatly — Warren has an easy laugh, while Charlie is usually much more serious. Nonetheless, they’ll go down in history as one of the greatest partnerships of all time.

Gates is the outlier. Warren and Charlie would both be the first to say they don’t “create” anything, while Bill Gates is the complete opposite. With Microsoft, Bill Gates single handedly changed the world. Now he’s investing in a company that’s trying to create nuclear reactors that run cooler than those like Fukushima in Japan. They have less of a chance of melting down. He’s operating at the speed of thought.

Trader Daily: Much has been made of the differences between Mr. Buffett’s generation and Mr. Gates’. Did you observe any?

Claman: The glaring, obvious difference is that Warren is an unabashed luddite. As recently as three years ago, he told me he’d call Bill every time he needed to surf the Internet and that Bill would yell into the phone, “Click the blue ‘e’!” Buffett recently told us about a new cell phone he recently got because the one he was using was so old his daughter Susie was embarassed by it. But they get along so well because they’re both innately curious and think the same way about philanthropy.

Trader Daily: What do you think it is about Gates that Buffett admires? He could pick any number of uber-wealthy entrepreneurs to cozy up to, but he chose Gates. Why? Or do you get the sense Gates choose him?

Claman: Buffett told me about the first time he ever met Bill Gates. He expected to have a quick chat and it ended up lasting for hours. Literally. He says it was like the world around them stopped. They had an instant connection. They travel together. Years ago they took a trip to China with each other and in advance of it, Buffett says Gates printed out a map with every McDonald’s in China highlighted because he knew how much Buffett likes McDonald’s. They read each other, understand each other. It was Kismet from the day one.

Trader Daily: Charlie Munger gets short shrift from the media, yet seems to be an integral, almost equal part of Berkshire’s success. How did Gates interact with Munger relative to how he reacted with Buffett?

Claman: The prism through which Charlie looks at every issue on the planet is one with which I am fascinated. He’s unafraid to offend if he strongly believes he’s right. During our interview, he directly questioned the survivability of Greece as a member of the European Union, saying it’s a country of “low work and low achievement. Why should a bunch of (hard working) Dutch and Germans want to save them?”
He calls it like he sees it.

Trader Daily: Did you discuss the Skokol mess at all? Did any of the three react differently than you expected?

Claman: They all said they were disappointed. Charlie called it “tragic.” Warren shouldered the blame for not being more open to the media about the issue.
I would venture a guess that this case isn’t closed, and that the SEC might launch a formal investigation. Buffett told us he’ll cooperate fully but that he hasn’t been subpoenaed yet.

Trader Daily: Did you get a sense of where the three are politically? Any insights into their feelings on taxes, government spending, etc.?

Claman: Bill and Warren both said on the day of  the interview that they fully support President [Barack] Obama. Charlie and Warren are concerned about all the spending. They liked the Erskine-Bowles deficit reduction plan. None of them said they’d mind paying more taxes. In fact, when I asked Charlie directly if we should have extended the Bush tax cuts, he said, “No.”

Liz Claman of Fox Business Network sat down with a veritable trifecta of American business earlier this week when she met with Berkshire Hathaway’s  CEO Warren Buffett and Vice Chairman Charles Munger, and with Microsoft Chairman Bill Gates.

Claman focused her questions on last weekend’s shareholder meeting, the Sokol controversy, the economy and, of course, Osama Bin Laden’s demise. Trader Daily pulled together some selected excerpts (taken from a written transcript by Fox) of the interview:

Buffett on the impact terrorism had on the insurance business: “There was a lot of worry about it and of course we are in the insurance business and it got reflected in the insurance market. And I give credit to both administrations for the fact that we have gone without an attack for a long long time. [But] the big factor in insurance will be the number of catastrophes we’ve had this year. The first quarter in 2011 was probably the second worst quarter in the history of the insurance business in terms of natural catastrophes. Japan was huge, New Zealand was very large… and then Australia had floods and cyclones, there’s been a lot of activity. It cost us about $1.7 billion pre-tax in the first quarter. Usually the third quarter is the worst quarter for catastrophes – I hope this is the worst.”

Buffett on David Sokol: “Obviously people did not feel that I was expressing a sufficient degree of outrage…I personally thought that I was laying out the good things he’d done for Berkshire, which were many and substantial. The day of the press release, we made a call to the head of the enforcement division of the SEC to report…trades to the SEC. So I thought that I was giving some pretty terrible information out. But I also thought I out to say the things he done for the company. And I think it enraged some people that I said the nice things about him.”

Gates on Berkshire Hathaway’s compliance rules: “Berkshire has very good compliance rules and the fact is no compliance rules are going to stop someone from making a mistake. This is a mistake that was picked up, the penalty to Dave in terms of ending his Berkshire career is pretty significant. And there will be an immense effort to dig into that by various groups. So I don’t think anyone has gotten away with anything here. I do think the policies that Warren has always enunciated, not only do we have the letter of the law, but we need to think about how things will be perceived. I think it’s fantastic and we need to make sure that the number of mistakes are kept to a minimum.”

Would Berkshire consider spinning off its businesses in order to unlock shareholder value? “Over time, we think more value will be created per share by keeping the companies intact and adding to them. It gives us a flexibility in capital allocation that if we had a See’s Candy all by itself it would be a much less efficient operation in terms of the aggregate wealth that would be created from this group of companies.”

Munger on the same question: “That’s a no.”

Buffett on Greece: “We are not better off than a year ago in terms of the European sovereign debt situation. What you do with 17 countries tied to a common monetary incapable of issuing their own debt in their own currency? We don’t know the answer to that one yet.”


Buffett on the 2012 elections: “I do think the economy has made progress within the last year. I think we have some very important problems. One thing that’s kind of interesting [is] the deficit problem. Both sides agree on it. They may not agree on a solution, but they both put it at the top of the list. So at least you have a common recognition that something has to be done and now they are going to argue about what does get done.  I think the economy is going to continue to make progress just as I thought a year ago and if it doesn’t make enough progress each party will be blaming the other.”

Gates on President Obama & Medical Costs: “I think he’s done a lot of great things. This fiscal problem is gigantic and it’s not easy to solve because medical costs continue go up and as long as you are going to have an open checkbook on that, you either have to raise more revenue or cut other spending. So there are a lot of things you can be concerned about as they talk about these tradeoffs but at least it’s on the agenda. That’s real progress. [But] the medical costs are where you’ve got the biggest conundrum.

Buffett on healthcare costs: “We made promises to people in terms of their future medical expenses that can’t be kept if we still have the current medical system. The question is what’s going to get done about that, and to some extent you want people to move away from trying to shift the blame for that to the other party, to work on constructive solutions themselves. But that problem will not go away by itself.”

by S. Lord

Investment analyst and entrepreneur Marc Faber spoke with FOX Business Network’s Connell McShane yesterday about how international affairs are impacting his investment strategy and predictions. Faber said that  “as a result of the reconstruction work” required in Japan, he believes “Japanese shares are worthwhile to accumulate.” He goes on to predict “a rebound of the U.S. Dollar, weakness in asset markets, correction in commodities, and maybe a rebound in U.S. bonds.”

Faber also joined with other notable investors, including Warren Buffett, in seeing the Japanese earthquake as being ultimately friendly for equity prices. “The key to the performance of Japanese shares is the Japanese bond market becomes unattractive, and that the Yen, over time, weakens. I think as a result of the reconstruction work that may cost up to $300 billion U.S. dollars that obviously the government will have to monetize, will push money into equities. I think Japanese shares are worthwhile to accumulate,” he said.

In terms of asset markets in general, he added:

“I think asset markets have begun a correction. We peaked out on the S&P on Feb. 18 at 1344 and usually in April we have seasonal strength, but I think it’s likely that the S&P will not be able to make a new high and then we will have a more significant setback in May or June. I think the euro, contrary to expectations, has rallied. I think what we could see in the next few months is a rebound of the U.S. dollar, weakness in asset markets, a correction in commodities, and maybe a rebound in U.S. bonds. We live in very volatile times; a correction could be 10%, 20%. I would on any weakness accumulate gold.”

Faber’s thoughts on events in the Middle East support his thesis that interest rates will remain low for the foreseeable future. “What is happening in the Middle East is friendly for gold, oil, and other commodities. The mess in the Middle East will only increase over time. Nothing has been solved. All these things are indicating, including the earthquake in Japan, that central banks will continue to pursue expansionary monetary policy to keep interest rates artificially low,” he said.

The full interview is available here.

by S. Lord

The World Economic Forum’s annual love-in in Davos, Switzerland, is getting a lot of press this year as the world’s economies recover, and their bankers return to their pre-crisis partying ways. This year in particular, it seems there is no shortage of self-interested “pronouncements” by various businessmen and women about the challenges facing the world’s collective economy and how everything would be just fine if government regulators would just leave them alone.

It is, therefore, all the more surprising to hear the CEO of a global bank advocate for more, not less, blood in the streets, especially in this post-crisis era of industrial-strength financial sector subvention. Nonetheless, that is exactly what Barclays PLC CEO Robert Diamond did on Fox Business Network yesterday.

Echoing most of his counterparts, Diamond expressed renewed confidence that the economy is recovering. But he was blunt in his assessment that spending needs to be cut and deficits reduced, and that allowing banks fail is a good, not bad, thing:

It’s very important that we allow banks to fail. It’s very important that no taxpayer money is ever again used to bailout banks that have failed. And that’s why we are working on how we can ensure that banks are able to fail and are able to be wound down.

And in a time when every municipality in the United States is looking at how many firemen, police, teachers etc., to fire instead of how to reduce benefit spending so as to live within their means, Diamond offered an interesting perspective:

I think in particular the U.K. and Europe are probably further ahead of the U.S. in terms of focusing on the spending levels and the deficit levels. We know in Europe it was necessary because of the sovereign debt crisis.

Considering his remarks were made the same day as the report of the Financial Crisis Inquiry Commission was released, Diamond was especially candid about his own industry:

“I think every bank, every banker has made mistakes. I include myself in that. But we are a strong bank. And you know I think the U.K. and Europe are a good example. They are focused on cutting spending, cutting debt, cutting deficits. That means very clearly that we’re not going to see any growth coming from the public sector. We shouldn’t. We need to cut the spending and cut the deficits and focus on that.”

Also somewhat unique for a bank CEO were Diamond’s thoughts on the increased regulation of his industry following the crisis:

It’s good and bad. The positive is the financial system did need to be safer and sounder. Basel has come up with capital regulations, capital levels which are consistent  in the G-20. We’ve never had that before and … I felt very strongly that consistency amongst the G-20, a level playing field, is important going forward. On the other hand, it would be nice to have final certainty. There’s still some things around resolution and recovery.

It is refreshing to have the leader of a major bank like Barclays speak so candidly about what has happened, and continues to happen, in his industry. In fact, considering the reports of bankers partying in Davos like it is 2005, we’re encouraged to see a grown up look back and realize how much the banking world has changed since Lehman’s implosion.

by S. Lord

When Eric Bolling was featured on the cover of Trader Monthly in June 2005, he was already an extremely successful commodities trader. He was a regular on the magazine’s annual “Trader 100″ list of top industry players, and was named Maybach’s Man of the Year in 2007. As an original contributor to CNBC’s Fast Money series, Eric helped usher in the trader-turned-TV-personality era that has brought trading-floor action and insights directly into the living rooms of millions of people. Now a commentator for Fox Business Network and host of his own show Follow The Money, Bolling’s clear, to-the-point style has made him one of Fox’s most popular anchors.

Trader Daily caught up with Bolling recently and asked him a few questions about how he trades today, what he looks for in a good opportunity, and how trading has changed since Trader Monthly featured him on its cover back before, as a fellow trader has termed it, “the world blew up.”

Trader Daily: You were drafted by the Pittsburg Pirates but had to leave baseball due to an injury. Do you regret not playing ball? Or did the injury actually send you in a more meaningful direction?

Bolling: I lived for baseball, and focused every day on it. My baseball career was over in an instant, and I was devastated!

Trader Daily: What’s the first financial information or index you look at when your day begins? Why?

Bolling: WSJOnline.com. Not because it is a NewsCorp property, but because it is the single most important publication for a guy who needs to be on top of business, politics and markets, period!

Trader Daily: If you were going to start out as a trader today, would you start out in oil futures, as you did the first time around? Or would you focus on another commodity, market, etc.?

Bolling: Oil/energy. It is the lifeblood of our economy and the world’s economy.  In fact, oil may be the only viable world currency, not the dollar nor the Chinese yuan. So, yes — I would start and end in energy.

Trader Daily: Have automated and algorithmic trading taken anything out of futures trading?  Have they ultimately made trading easier or harder?

Bolling: Algorithmic models coupled with high-speed trade execution have made human beings obsolete. The traders of today and tomorrow are the best and brightest programmers. The downside is a clear spike in volatility in all trading markets.

Trader Daily: When you’re about to pull the trigger on a trade, does your gut still win out over everything else? Are instinct and aggressiveness still crucial characteristics to successful trading?

Bolling: In everything I do, my “gut” reigns supreme. Whether it’s an investment, a real estate purchase or running with a story for my show, I always consult my gut. As always, you can be as smart as Einstein but you have to be able to pull the trigger on a trade…or just be an analyst. (No offense to analysts).

Trader Daily: How much of a problem is the increasing correlation among markets and asset classes for traders?

Bolling: Problem? Markets evolve and good traders evolve with the markets. The Street is littered with losers who thought they were smarter or bigger than the market. Respect the market – it’s ALWAYS right.

Trader Daily: Regulators are doing a lot of talking about increased market oversight, combining the Commodity Futures Trading Commission and the Securities and Exchange Commission, etc., but will it help prevent fraud, flash crashes, etc? Is the market still the best judge & jury out there?

Bolling: The solution to curing market ills, be it manipulation, fraud, etc., is by offering SEC, CFTC, OTC [over-the-counter] regulators “whistleblower” rewards. Give those guys 10% – 20% of uncovered fraud, and see how much gets exposed.

Trader Daily: What’s it like to be sitting on the other side of the fence, observing the trading action as a commentator? Has your media career changed the way you view the markets you used to trade? How about the investors?

Bolling: Yes. I am under very strict and observed investment criteria, holding periods, selling restrictions and disclosure requirements. I don’t think it has changed my view of markets or investors, though.

Trader Daily: Loss/risk management is sometimes called the number-one key to successful trading, even more than being right on the underlying move. Do you agree?

Bolling: ABSOLUTELY- a good trader knows how to take a profit, and there are tons of them. A great trader knows how to cut a loss, and there are far fewer of those. But they are the most successful traders.

Trader Daily: A few years ago, Trader Monthly made waves by basically celebrating the hubris of the trading lifestyle. As someone who was a very visible member of the Trader 100, what would you say is the single largest difference in the trading world between then and now?

Bolling: I was proud to be on the cover back then. Now, I would turn the offer down flat. Successful investors and traders are flying below the radar. Times are tough, and to be strutting yourself while people are struggling would be absolutely tone deaf.

Trader Daily: The Federal Reserve’s stimulus plan known as QE2 has drawn vociferous criticism. What do you think are some of the unintended consequences that might come from it?

There are several. First, it could push the global “search for yield” into overdrive. Investors, disenchanted with ever-lower returns on Treasurys, plough into stocks, emerging market bonds, commodities, property, etc., driving them to bubble levels, precipitating a collapse. However, I don’t think these are likely to happen. Most of the world is still de-leveraging which makes it hard for speculators to borrow the money they need to buy these assets. Moreover, countries in which speculation is more likely, such as Asia, have remedies. They can raise domestic interest rates, allow their currencies to appreciate, and impose tougher regulatory conditions on speculative activity.

A second possible unintended consequence is that investors see the Fed printing money and conclude much higher inflation is on the way. Higher expected inflation can be self-fulfilling. Some argue that’s why gold is so high. But TIPS bonds provide a much cleaner read on inflation expectations than gold. And they are actually pointing to lower, not higher, inflation. Finally, when it comes time to reverse course, the Fed will have trouble “unprinting” all the money it printed, making it hard to raise interest rates. You never know until they try, but I’m pretty sure they can tighten monetary policy as much as they want, even with a couple trillion dollars of extra money sitting in the banking system.

Trader Daily: Observers such as PIMCO’s Bill Gross have said that stimulus may offer no way out of a classic liquidity trap. What else should the federal government be doing to dig our way out?

It’s true that monetary stimulus is not a guaranteed solution to a liquidity trap. You can print as much money as you want, but you can’t make anyone spend it. Arguably, that’s the problem we have now. The Fed has printed lots of money, but very little of it is being lent out; bank credit has been contracting. That said, a turning point is in sight. I expect a year from now, bank credit will be expanding, and we’ll conclude the Fed’s additional monetary stimulus was a success. But what if I’m wrong? If the private sector won’t spend, the public sector certainly can. The federal government could increase spending or cut taxes, and the Fed could continue to buy the bonds needed to finance either. This is Ben Bernanke’s notorious helicopter drop of money, and it’s how we paid for mobilization during World War II. But politically, this is dangerous territory. It would look like the Fed is monetizing the debt, and a Republican tilt to Congress makes it much less likely.

Trader Daily: Should the Fed’s QE plan also extend to Fannie Mae and Freddie Mac debt?

It would be pointless. Fannie Mae and Freddie Mac are now regarded as the same credit as Treasury debt, and they have no problem raising money. You could make a case for the Fed to buy Fannie and Freddie-backed mortgage-backed securities. But even there, the spread between MBS and Treasurys, adjusted for the fact that mortgages can be prepaid, has virtually disappeared. There’s little incremental benefit to buying MBS versus Treasurys, and arguably, the Fed would so dominate buying [that] liquidity in the entire MBS market could shrivel up. There may be a case for the Fed to experiment with ways of buying small business debt; there’s some evidence small business is having a lot of trouble getting credit, even with interest rates so low.

Trader Daily: How does Alan Greenspan’s handling of interest rates and inflation look with the benefit of retrospect? Did the bubbles simply move to new asset classes?

The recovery from [the] 2001 recession was unusually weak and presented the Fed with a choice: err on the side of tighter policy and risk higher unemployment and possibly deflation, or err on the side of easier monetary policy and risk inflation and/or an asset bubble. The Fed thought it was better equipped to deal with the latter type of risk than the former. Given what they knew at the time, they made the right choice. What almost no one, including the Fed, understood was just how far the leverage and speculation spread during the ensuing period, and how fragile that made our country’s largest financial institutions. This speaks badly of the Fed’s regulatory record under Mr. Greenspan. That said, many regulators failed in that period, not just at the Fed and not just in the United States. In the broader sweep, I think historians will judge Greenspan on his entire 18-year tenure, which is more flattering than his last few years.

Trader Daily: How much was the Fed to blame for the real estate bubble, as opposed to fraudulent underwriting and unrealistic homebuyers?

I don’t know how you disentangle these things. In my book, I discuss how both business cycles and crises are unavoidable features of a market economy and of human nature. We shouldn’t want an economy without bubbles and crises, because that would mean no risk taking, no entrepreneurship, and ultimately no growth. It’s become popular to blame the Fed for the real estate bubble, both because of its regulatory failings and its low interest rate policy.  But you could equally argue that the Fed’s greatest contribution to the crisis was, perversely, its prior success at bringing down inflation and unemployment and moderating the business cycle – the so-called “Great Moderation.” The Fed seemed to have made the world a less risky place, and thus people were willing to take on more debt and hold less liquidity. It’s like forest rangers being so successful at preventing fires that excess kindling accumulates on the forest floor and ensures that when a fire finally does occur, it will be truly massive.

Trader Daily: We’ve seen the recommendations of the congressional deficit commission. How has our view of budget deficits changed over the last decade? How important is its management to recovering from the current recession?

You have to distinguish between cyclical (i.e. temporary) and structural (i.e. long-lasting) budget deficits. The first type is a perfectly acceptable by-product of the business cycle. The second is a dangerous drain on the savings needed for productive investment. Governments are always tempted to expand the deficit because it’s politically popular, and they think the economy needs the boost. This is dangerous thinking: The Fed can almost always provide faster, more effective stimulus than Congress, and withdraw it without politics clouding its judgment. The exception is when the Fed is out of conventional ammunition, i.e. has lowered its interest rate target to zero. We’re in that situation now. It doesn’t happen very often — the last time was in the 1930s. So this is one of those rare times when a larger deficit might be a good thing.

Trader Daily: Inflation has been the bogeyman of the global economy for years, but now economists tell us the rate of inflation may be too low. Can one distinguish between “good inflation” and “bad inflation?”

We used to think there was no such thing as good inflation. We now think a little bit of inflation is a good thing. First, the way we measure inflation has a bit of upward bias because we’re slow to incorporate new, cheaper products and stores, so 1% measured inflation might in reality be zero. Second, wages are sticky. If an employer has to cut prices to cope with poor sales and needs a way to cut labor costs, it is more likely to lay off workers than to cut their wages. A bit of inflation means that instead of laying off workers the employer can freeze their wages, in effect imposing a real (that is, inflation-adjusted) pay cut. Third, when the economy is really a mess, like now, the Fed likes to engineer negative real interest rates, i.e. push interest rates below the inflation rate. It can’t do that if inflation is at or near zero. Fourth, people and companies take on debts with a view to how much their wages and prices will rise. If inflation turns out much lower than they expect, or actually becomes deflation, they’ll have much more trouble paying back their debts, which could lead to a cycle of rising real debt, default, and weaker economic growth. Underlying inflation is now around 1%; it would be better to get it back to around 2%.

Trader Daily: China’s currency policies are taking on central importance to the global economic regime. Is there a way for the U.S. and China to cooperate and establish some sort of rapprochement over relative currency valuations? Do trade considerations trump the consequences of competitive devaluations?

Yes. For a country like China, trade considerations have so far trumped the benefits of a flexible exchange rate and open capital markets. However, China needs to recognize that keeping its currency artificially low is creating a lot of tension with its trading partners and making it harder for the entire world to rebalance away from over-spending Americans and towards over-saving Chinese. The good news is that Treasury has so far used the right amount of carrot and stick to nudge China along, and the yuan is now rising. I’d be worried if more protectionist interests took charge of U.S.-China relations in either country, but that hasn’t happened yet.

Trader Daily: Jobs are the biggest issue from the public’s perspective, but from an economist’s point of view, are they the largest problem we’re facing?

Yes. On this issue, the public and most economists are on the same page. The unemployment rate at 9.6% is some four or five percentage points above its “natural” level. This translates into six to eight million more unemployed people than a healthy economy would otherwise have. This represents a terrible human cost and a waste of productive resources. It is also the single most important reason why our budget deficit is so large: The unemployed are not paying taxes.  If only we agreed as much on the prescription as the diagnosis. More fiscal stimulus would help bring unemployment down, but only if we have a coherent plan for eliminating the budget deficit once the recovery is entrenched, and we don’t have that yet. And while I think a Greek-style fiscal meltdown is unlikely – we control the world’s reserve currency and have a history of paying our debts – we’ve seen how badly things can spiral out of control when investor confidence evaporates. There’s also some concern that when the government spends money, the public spends less to prepare for higher taxes later on. Personally, I don’t think that’s going on; but the risk cannot be dismissed out of hand.

By Vince Chiofolo

Some of the truly prosperous players on Wall Street began their careers with the help of ivy-league degrees. Others used high-level contacts and strong prospects. And then there are those like CME Group’s legendary S&P 500 trader Larry Levin, who had none of the above, and by way of hard work, dedication, and will to survive, achieved legendary success.

The history behind the CME veteran is one which demonstrates that persistence and passion could turn an entry-level position – like his $3.35 per-hour job as a Lind-Waldock runner in the late 1980s – into a lucrative trading career. Eventually, Levin averaged 2,500 to 3,000 S&P contracts per day.

Levin’s career began in 1989 as he witnessed brokers and traders amassing extraordinary income faster than they could count it. From that point forward, Levin aspired to acquire the luxuries and lavish lifestyle that a trading career could bestow. His financial pursuits sparked a decision to drop out of Chicago’s Columbia College.

Levin’s hard work running contracts eventually hoisted him up to the next link in the chain, phone clerk to the S&P desk manager. Though trivial, both positions taught Larry the logistics and intricacies of both the futures pit and the commodities market. He began trading on his own account in 1993, and became a full-time floor trader a year later.

Between the years 2002 and 2005, Larry accumulated a sum of $1.9 million trading commodities, according to his aptly titled 2007 book, “How I Made $1,900,336.82 Trading Commodities.” However, it was not a smooth ride. Levin lost every penny in his brokerage account not once, but four times. While most traders in such a predicament would hang up their trading jackets and try their hand at a career involving less crippling consequences, Levin, understanding the roller coaster behavior of the market and willing to trudge forward, picked himself up from rock bottom and rebuilt his account back up to profitability each time.

Throughout his bumpy trading career, Larry picked up on the widespread public fascination with floor traders and their techniques. Knowing this, Levin formed Trading Advantage, an educational service designed to help aspiring traders master the commodities markets. Now known for his strong views, Levin appears regularly on many of the mainstream business media networks, such Fox Business News, CNBC and Bloomberg Television, providing insight and advice to the world’s traders.

Trader Daily caught up with Larry to discuss his past and to get his take on the current market.

TraderDaily: In your career, you have successfully climbed the ranks from the bottom to the top of the ladder. Do you think this type of advancement is possible in today’s market, particularly without formal education? What advice would you give to the guys at the bottom trying to follow your lead?

Levin: No, the trading floor was a place where you could start at the bottom and work your way up, or even find an opportunity with a different trading company in the same place (the trading floor).  Back then, it was pretty easy to get an entry-level job on the trading floor, and if you were sharp, you had a chance to get noticed.  Now, you must try to get in with each individual company, and that’s much more difficult.  And without a finance degree, most won’t even talk to you.

TraderDaily: In the mid-1980s, Richard Dennis began his Turtles experiment, where he gave relatively inexperienced personnel a clearly defined trading system and some capital, with impressive results. In today’s markets, are traders born or can they be made?

Levin: Traders are made, not born.  Every trader has to go through the same learning process.  They all must learn from their mistakes, just like you’d learn any skill.  The problem is most people don’t have a Richard Dennis to show them how to avoid the mistakes quickly.  Therefore, people will run out of money long before they figure out how to trade.

TraderDaily: You first started marketing your training program, “The Secrets of Floor Traders,” in 1998. How much has commodity trading — and its secrets — moved off the floor in the years since then?
 

Levin: The edge used to be gained on the trading floor by seeing institutional orders and learning from other experienced traders.  Today, the edge is to understand technical analysis and how to trade electronically.  There is no edge on the floor anymore.

TraderDaily: Some trading firms like to start with people who have not traded before and, therefore, carry no bias or pre-conceived ideas to the table. Does this kind of approach work today, or are trading firms hiring people with as much experience as possible?

Levin: If the trading strategies are extremely defined, then hiring inexperienced people can work.  But when you ask a trader to think and trade in a discretionary method, then experienced traders are necessary.

TraderDaily: In addition to the S&P 500 index trading that’s been going on for years, many institutional players use index ETFs to take long and short positions. Does heavy trading of ETFs distort the markets they are supposed to track?

Levin: I don’t really think so. Even if they do, it doesn’t really matter, as the market will move the way all traders make it move. Unless large positions are not allowed in the ETFs, it’s just something else that traders have to deal with.  I don’t think about it much.

TraderDaily: A majority of your trading career took place prior to the widespread electronic trading that moves markets today. What’s your take on this evolution? Has it affected you personally?

Levin: I don’t fight it. I took on electronic trading as close to its onset as possible.  It made me a lot of money!  Unfortunately, many traders haven’t made the evolution to electronic trading, and they are struggling.

TraderDaily: Do you think that automated and low-latency trading played a role in the May 6 flash crash, or is that just an attempt to find a convenient explanation for something that is difficult to explain?

Levin: I do think HFT trading is a big part of it.  But this is the world we live in, and you must have stop losses in place on all positions at all times.  Naked positions are the kiss of death.  In all honesty, I don’t know exactly what caused the Flash Crash, but it wouldn’t surprise me one bit to see one happen again.

TraderDaily: A lot of prop traders blow out — you did it four times and managed to get back in the business. Was there a common thread behind your four wipe-outs? What did you learn from them?

Levin: The common theme was that I figured out how to get more money each time I blew out.  I’m a big fan of learning from your mistakes and evolving into a better trader.  The reason most people blow out is that they trade with real money before they know what they are doing.  The key is trading with a simulator until you have the proper skills.

TraderDaily: How did you avoid giving away your edge when you came out with “The Secrets of Floor Traders”?

Levin: The edge is different with each person.  Each trader needs to find what works personally for them (and it can be different for each person).  So you can’t really give it away, you can only help someone find his or her own “personal edge.”

TraderDaily: How helpful are E-mini S&P 500 contracts for traders who are not starting out with a substantial amount of capital?

Levin: They are extremely helpful as they were devised for the small trader in mind.  They allow you to trade a contract that is 1/5 the size of the big S&P 500.  It was the smartest move the CME group ever made.

TraderDaily: What is the biggest single mistake you see new traders make?

Levin: Not using stop loss orders.  It’s how to end your trading career very fast!

The inspiration behind an autobiographical bestseller and the 2006 major motion picture, “The Pursuit of Happyness,” Gardner went from one extreme of the sociological spectrum to the other. While working his way up the ladder in a competitive internship at Dean Witter’s San Francisco office in the early 1980s, Gardner and his infant son spent nights in a local homeless shelter. Eventually, hard work and persistence resulted in success, wealth, hobnobbing with the likes of Nelson Mandela and Oprah, and gracing the cover of Trader Monthly’s December 2007 issue.

That issue’s feature story captured the tale of the man who has seen all sides of life: poverty and wealth, sorrow and joy, love and despair, and most everything in between. As an illustration of the American dream, it doesn’t get much more vivid than Chris Gardner.

After watching Bear Stearns, the investment house that cemented his career, “burn” to the ground, Gardner recently gave Trader Daily his thoughts on the current market, restoring client trust, and building a brokerage career today.
.

“A slow walk to Wall Street is how others describe my life.”
.

Gardner was born on the north side of Milwaukee in 1954 into a life of poverty and domestic violence. After graduating from high school, Gardner enlisted in the Navy and served four years at Camp Lejeune in North Carolina. He eventually supported a wife and new son, Christopher Jarrett Medina Gardner Jr., by selling medical equipment throughout San Francisco. However, Gardner’s path took an immediate 180-degree turn at the sight of Robert Bridges, of then-boutique investment house Donaldson, Lufkin & Jenrette, climbing out of a red Ferrari.

Gardner immediately asked Bridges two questions; what did he do, and how did he do it? Bridges admired Gardner’ desire. He explained the world of investment management for wealthy individuals and how, in spite of Gardner’s lack of financial experience, he could qualify for a brokerage training program. As he would later comment to Trader Monthly, “For reasons I can’t begin to explain, I knew with every fiber of my being that this was it!”

His first big break, acceptance into E.F. Hutton’s trainee program, fizzled after his hiring manager was fired before the course began. Gardner had already quit his sales job to pursue the now-terminated offer, and to make matters worse, he and his wife had separated. Now faced with supporting a 19-month-old son, Gardner persisted, scouring trainee programs and knocking on doors. And not without a price – $1,200 in parking tickets amassed as a result of interviews around the city was settled via a 10-day stint in jail. Upon his release, he found himself reunited with his son, but homeless and with no prospects.

While spending nights wherever he could find shelter, Gardner was eventually offered a $1,000-per-month position as a broker trainee at Dean Witter. Arriving early and leaving late each day, Gardner tirelessly worked the phones, contacting prospective clients with a personal goal of 200 calls per day. He showed a knack for the business and passed his licensing exam, making him a full-time employee of the firm. All the while, though, Gardner continued to struggle clandestinely with homelessness. With shelters at full capacity, Gardner would often lock himself and his son in one of the public bathrooms of the Bay Area Rapid Transit (BART) train station for the night. The two ate in soup kitchens, bathed in public restrooms, and lugged their few positions via shopping cart.

It wasn’t long before Gardner’s militant work ethic caught the attention of Gary Shemano, a manager at Bear Stearns. Gardner joined Bear, and it was there that he evolved into a true institutional player. As he gained experience, Gardner’s increased compensation allowed him to move off the streets and afford day care for then 2-year-old Chris Jr. Gardner was finally getting by, but he would not settle for mediocrity. His 100% work ethic eventually brought him east to Bear’s New York headquarters with a position analyzing total return strategies for institutional portfolio managers.

Start Where You Are by Chris Gardner

By 1987, Gardner had launched his own firm, Gardner, Rich & Co., servicing public pension funds with equity and fixed-income brokerage. Ironically, in the early 1990s, his company oversaw bond offerings associated with the financing of BART, the very train line that once provided the only shelter Gardner could afford.

Fast forward years later, and Gardner remains CEO of his multi-million-dollar firm, is a sought-after motivational speaker, and has helped fund numerous philanthropic projects including a $50 million, low-income housing initiative for San Francisco’s unemployed. As a follow-up to the 2007 article, we caught up with Chris to get his current take on the markets and the financial industry in general:

TraderDaily: You said in the original Trader Monthly interview “money is the least significant aspect of wealth.” As someone who was once living out of doors for a time, do you value security differently than money and the ability to buy nice but unessential things?

Gardner: Security is entirely different from, far more important than, and not necessarily tied to, money.  Money and the stuff you buy with it will come and go.  You can never be secure about money – and at the end of the day, that’s OK.  What you need is to be secure in your ability to create the life that you want.  That’s invaluable.  That means everything.  Even at my lowest point, when I didn’t have any money, I was secure in the knowledge that I could create my own successful future.  Money would be a part of it – but only a part.

TraderDaily: In that same interview, you mention that wealth is not derived only from money. Yet you pursued wealth with an extraordinary tenacity – do you think it is easier to make such observations AFTER being successful?

Gardner: I have to correct you…I was not pursuing wealth – I was pursuing my passion, and wealth was a byproduct because I was so tenacious in my pursuit of my passion.  It was never solely about the money.  You know the only other profession I think I could have been as passionate about?  Being a school teacher.  Now those salaries are low, but seeing the lights come on in a kid, knowing you’re helping to increase the promise in the lives of children, that would have made me the richest guy in town.  And if I was truly passionate about teaching, I bet you I could’ve come up with a way to make additional money doing something related to the field.  That’s the only way you do make money – by being so jazzed about what you’re doing that you can get creative and work at it with a passion that makes others take note and support your vision.

TraderDaily: In our age of slashed commissions, internet brokers, and non-commission products like exchange-traded funds and no-load mutual funds, how would you adjust if you had to plot another ascent from nothing to everything?

Gardner: The first thing I’d be doing is trying to understand how and where I could add value to my clients.  One of the biggest problems we have in our business today is a lack of confidence in the government, the banks, and financial institutions in general.  And that can’t be regulated or legislated.  So, more than ever, you need the eyeball-to-eyeball contact, you need to create the situation where confidence is instilled.  Your client needs to be able to look you in the eyes and ask himself, “Do I trust this guy?”  And you have to get a sense of what he needs, and not be afraid to say “my company can’t help you with that.”  But if you can work together, then you must DELIVER the goods.  This has always been true, but now it is truer than ever.  People have just been so rattled.

TraderDaily: Have you ever come across other “diamonds in the rough” that could impact the financial community as you have but did not have the resources? Anyone who has reminded you of yourself?

Gardner: I see those people every day, and not only in my business.  Everywhere I go, people stop me on the street, in airports, in elevators.  They tell me their stories, they show me how passionate they are, how hard they are willing to work.  There’s no shortage of diamonds.  There’s a shortage of opportunities.  And not just on Wall St., but all across America in almost every field you can think of.  Those “diamonds” who make it are the people who are the most resourceful and tenacious – they are borderline fanatical about pursuing their dreams.

TraderDaily: Would cold calling get the job done in today’s socially-networked world, where people obsessively screen calls and use other forms of communication?

Gardner: No.  It wouldn’t work.  In some places it’s illegal to cold call!  You can’t call between this hour and that hour.  I’ll tell you something: I’ve had people cold call me.  No kidding.  Cold calling me – the guy who spent a few long years making hundreds of calls a day, digging himself out of a hole with every number dialed.  “Chris I just wanted to give you a follow-up call…”  What?!  That ain’t gonna work.  Do you know who you’re talking to?  Hell, no!

TraderDaily: Do you think what you accomplished could take place on today’s Wall Street, or have ETFs, index trading and self-directed discount brokerage customers diminished the role of the stockbroker?

Gardner: I could do it.  I’m not being flippant or braggadocios.  But if the situation was the same – I was homeless and hungry and had a 14 month-old baby son to support – nothing would stop me.

TraderDaily: Did you encounter racism on Wall Street? How did you overcome it?

Gardner: I did and I still do.  Racism is not new, and it’s not personal, and it’s not going away.  But I put my energy into the people who are giving me an opportunity and ignore those who have been conditioned to try to block me.  Know that.  Accept that.  And have your passion be bigger than their small-minded racism.

TraderDaily: Do you feel the lack of a college degree was a hindrance?  Or were you frankly better off without it? What advice about education would you give today to a young person considering a brokerage career?

Gardner: Personally, I was better off without a degree.  A very linear thought process often comes from a classic education and to be an entrepreneur you can’t have a linear brain.  Nothing is 123, ABC.  I have two words for you: David Geffen.  Two more: Bill Gates.  Some of the most talented people in this country don’t have a degree in the field in which they work, or don’t have a degree, period.  But I do have to say that my seeing my daughter graduate from college – the first Gardner ever to do so – was one of the proudest moments of my life.

For those young people thinking of a brokerage career?  Consider the world your classroom.  Learn from all of the talented people you meet.  Create and nurture relationships.  You don’t need an alumni network – hell, everyone in your class will be fishing in the same hole.

TraderDaily: Do you think clients are more or less distrustful of financial professionals than when you were coming up?

Gardner: Clients are much more distrustful today, and understandably so.  They’ve been so badly hurt.  As a financial professional nowadays, you have to have a touch of the therapist in you.  You need to evaluate and treat the whole patient.  When I sit down with a client now, I need to understand all of their hurts, their hopes, their plans for the future.  It’s not just about how to make them money.

TraderDaily: Moving to Bear Stearns looks like it was the beginning of your transition to an institutional player. What are your feelings about the demise of Bear?

Gardner: It’s like watching the house you grew up in burn and there’s nothing you can do about it.  You know something?  When I sold my stock in Bear 22 years ago to start my own business, people told me I was nuts.  Turns out I got more money then than I would have when they got sold to JP Morgan.  And I’m still in business!

TraderDaily: What’s your take on the rise of high-frequency trading in the market? Does this rise take a positive or negative effect on the overall market?

Gardner: Technology has taken trading into a whole new space.  Financial firms are putting hundreds of millions of dollars into creating “The Terminator” – a machine that will take advantage of any arbitrage opportunities anywhere in the world in any asset, and in the blink of an eye.  And you can’t out-trade the Terminator, so don’t waste your time.  And let me tell you - right now someone is building an even bigger Terminator and soon we’re gonna be talking about ultra high-frequency trading.  But let’s recognize that there’s a difference between trading and investing.  Investing is taking a long term view – you’re in it for the long haul.  You’ve done your homework and decided these are companies you want to own.  You are comfortable with them. It’s a whole different space.

TraderDaily: You told Trader Monthly a few years ago that you were starting a private equity initiative in Africa. What is the status of that project now?

Gardner: Very, very close.  Can’t comment further right now.

TraderDaily: You have suggested that former commodities trader Marc Rich, who was pardoned by President Clinton, is a great inspiration to the financial community, and even named part of your firm in his honor. What is it that you admire about Marc?

Gardner: He was a poor, smart guy from the wrong side of the tracks who created his own opportunities.  No one gave him anything.  He had a vision and he realized it.

TraderDaily: What do you think will be the next huge debacle in finance?

Gardner: I believe it will be one of two things: commercial real estate or a total catastrophe in the student loan market.  Debt from student loans have become more than all the credit card debt in the country for the first time in history.  That’s staggering.  And guess what?  How are you gonna pay back that student loan if you don’t have a job?  It could sink a whole generation.

TraderDaily: What’s next? There’s already a movie and a book about you — is a reality TV show next?

Gardner: Stay tuned.  We’ll be right back after these messages…

Back in 2004, Trader Monthly ran a feature story about a gathering of fixed-income experts at a seminar hosted by UK analytics firm GannCorner. In addition to the chatter about new strategies and optimizing portfolio returns was gossip and speculation about a mysterious Eurex trader known around Europe only as “the Flipper.” At the time, attempts by other market participants to uncover the identity of “the Flipper,” who by then was the biggest trader on the Eurex, were frustratingly unsuccessful, due mainly to the anonymity that cyber-based trading allows.

The trader was thought to reside in Ireland at the time, and was notoriously known for aggressively working both sides of Eurex trades. It was the “steering of German government-bond futures markets in a tactical manner — posting substantial lot blocks, not all of which [were] traded upon, and doing so on both sides of the order book in numerous but nonetheless interconnected markets — that birthed the Flipper moniker,” according to Trader Monthly’s 2004 article.

At one point during the GannCorner event, one attendee stood up and asked the leader of the session if she had any information on the notorious Paul Rotter. “Yes, I know Paul Rotter,” she said bluntly. “He’s one of my clients. And he’s sitting right behind you.”

Since Paul Rotter’s unmasking as “The Flipper,” he has been as controversial as he is well-known in the world of electronic-trading. Rotter’s success coincided with the rise of the Eurex in 1996. The German/Swiss electronic futures exchange has been an undeniable powerhouse for international derivatives trading since its inception, and Rotter became very adept at utilizing the herd mentality prevalent there to his advantage.

Click for the original 2004 article

At age 9, Rotter moved to Germany from the Czech Republic (then Czechoslovakia) and later made his financial start as a trainee on the bond desk of a Frankfurt-based bank. Rotter climbed the ladder, and was soon trading the Deutsche Bund (German 10-year notes) in large lots. By the time he left the bank in 1996, Rotter was the biggest single trader in German debt futures on the Deutsche Termin-Börse, Germany’s derivatives exchange and precursor to the Eurex.

During “the Flipper’s” reign, fellow Bund and Bobl (short for German 5-year notes) traders began noticing giant orders placed on one side of the market that soon flipped and went the opposite way. Unbeknownst to them, Rotter was buying and holding massive buy orders until the inside market began moving close to his indicated price, then flip the position by going the other way instead — causing mass bewilderment for his fellow traders and whipsawing more than a few of them. Eventually, as Rotter was unmasked as “the Flipper,” he went to Switzerland to form his own shop, Rotter Invest, in 2001. He has kept a relatively low profile since; but, after reading the 2004 feature article in Trader Monthly, we were curious what Paul was doing these days.

We recently caught up with him to get additional details on his history, his take on the current market, and thoughts for the future:

.
TraderDaily: You have a reputation for trading the Bund, along with Bobl and Schatz interest rate futures. What are you trading now? Is your emphasis still in Europe?

Rotter: I am still trading mainly the Bund and Bobl, but also heavily in the Eurostoxx because it is very liquid most of the time. Generally, I like markets with high liquidity. At moment, I am also relocating to Singapore and want to explore new trading opportunities in Asia. I am becoming a member on SGX, as they offer a variety of interesting products and their officials are very customer friendly.

TraderDaily: According to one report, you and Oliver Kinski first started trading on your own with $1.3 million in capital. Does one need more or less to start a successful trading operation today?

Rotter: At that time, we had some minimum margin requirements from our clearer. We were a DTB member and were thus connected directly into the exchange. There was no possibility for a pre-trade position limit; therefore, the clearer had to trust us to not overtrade. Today, the brokers offer you all kinds of trading software where they can set your limits based on your buying power or position size. Therefore, I think as a high frequency intraday trader, you could start with e.g. 300,000 EUR and aim for a profit of a few thousand Euros every day. If you plan to hire many traders quickly, and want to trade on many different exchanges, you would need more capital, especially if you need a membership on some exchanges. It is also important to choose the best location with the best technical infrastructure, low taxes, and a trader/investor-friendly environment.  I think the best place for traders right now is Singapore – it is growing rapidly and has a great lifestyle, very safe, with the best schools and world-class infrastructure.
.

“In the old days, there were quiet periods with no data flow but, one machine starts creating…
.

TraderDaily: Two statements from your website caught our eye. First, you state that “total control is an illusion”, and then you say “machines cannot yet replace highly skilled people.”How do you balance the use of technical and algorithmic trading with the input of human judgment? Likewise, when it comes to risk management: how much do you rely on computerized risk assessment as opposed to human expertise?

Rotter: Addressing the second point first, I do all my short term trading manually. For our longer-term positions, we use computer-based models that generate automatic entry signals.  My traders can exit two thirds of their positions at their discretion and the rest is liquidated when the exit signal is generated. These are mainly trend-following strategies and there could be good fundamental reasons to exit a part of the position before the trend reverses. On the other hand, risk management must be computerized, as there is no place for emotions. “Total control is an illusion” means that, for example, an exchange’s margins are based on recent volatilities and when some sudden unexpected event occurs, it could blow out a lot of traders even though their risk models were working just fine for a long period.

TraderDaily: Where do you draw the line between trading a market and manipulating it?

Rotter: This is the best question for all the regulators!  The answer is very easy: there is no line!  If you buy just one contract you already affect the market, especially with all the automated systems.  If you enter a small buy-order below the market and cancel it couple minutes later you always can see an immediate reaction in the order book.  Today, the algorithmic systems permanently enter orders and delete them very quickly to enter them again a second later…so what is manipulation?  In my opinion, there should be very clear and specific rules for this topic.

TraderDaily: You were once known as “The Flipper,” a term that arose from distrust of short-term traders. High frequency trading has been suspect in market distortions and events like the May 6 “Flash Crash”.  Do you think people are more or less skeptical of short-term trading than they were ten years ago?

Rotter: Basically, ten years ago, fully automated trading was not allowed and only locals were doing short term trading and providing liquidity. The typical locals were some unshaved guys sitting at arcades or smaller prop firms, dressed in just surf shorts and having their breakfast, lunch and dinner at their desks. Today, it is very fashionable to get involved in high frequency trading. My guess is that 70% of the volume is generated by algorithmic trading systems, so you can be sure that there will be more ”Flash Crashes” or ”Flash Squeezes” in the future. This could be great fun for some locals. And there we come back to the manipulation topic, as the Flash Crash was obviously caused or supported by the machines. In my opinion, people (especially regulators) will get more skeptical about this type of short-term trading.
.

…a trend and the others follow, so today’s ‘sheep’ are also machines.”
.

TraderDaily: Back in the 1990s, so-called “SOES Bandits” were criticized for gaming Nasdaq’s Small Order Execution System. Is there an equivalent of the SOES bandit in today’s world of electronic trading — for traders with relatively small amounts of capital, that is?

Rotter: I think it will be more and more a battle between machines, where the better ones try to destroy the smaller ones by learning from their behavior and trading against them.  In the old days, there were quiet periods with no data flow but, today  one machine can create a trend and the others will follow. Today´s ”sheep’ are also machines. I am pretty sure there are all kinds of similar ”bandits” in the different electronic markets.

TraderDaily: How helpful are $250 forex mini-accounts and products like the CFD (Certificates For Difference) to individuals who hope to parlay a small amount of capital into a fortune? Are these valuable tools or just the malt liquor of the financial world?

Rotter: In my opinion, this is just a kind of gambling similar to online poker. I know some smart guys who consistently make money in online poker, just taking it from all the gamblers. If you are not just a gambler, you need some professional equipment like news feeds, etc., and then, with the right strategy, you might turn even a small amount into a fortune. The biggest problem with these products is that you do not trade on an exchange and it is not regulated.  That means your counterparty is the broker who probably doesn’t even hedge your position. So, if you are too successful, the broker won’t like you, and kick you out or just not give you good fills. I’ve heard many stories like that. The broker is your counterparty; you must accept his prices and his fills. So, basically it is “malt liquor” for these brokers and not for the financial world. You definitely have much better chances playing online poker, as this is level playing field

TraderDaily: Long Term Capital Management’s Andrew Meriwether said in an interview with Michael Lewis that the downfall of LTCM was partly the result of copycat activity by executing brokers the firm had to use after the traders left Slomon Brothers. How do you avoid losing your “secret sauce” to institutions that clear or execute your trades?

Rotter: Unfortunately, I have always had worries about other participants watching my activity. It could be the clearer, the broker, the software provider, or even some technical staff at these companies. The main protection is to have accounts at different brokers so nobody knows your exact position.  Generally, I try to get in and out of large trades pretty quickly to avoid that anybody [attempting] to trade against me, but I am never sure.

TraderDaily: Your website says your “core competence is in trading financial derivatives, especially options and futures. On peak days, we trade contracts on the bond markets with a total value of up to €50 billion, more than many major banks.” Are you concerned that Basel II and other ongoing regulation efforts will make it harder to trade on such a large scale?

Rotter: This number doesn’t necessarily mean big position sizes.  When I get heavily involved in the markets, I executed hundreds of trades quickly, in a few hours – this is the real high-frequency trading.  I have been doing this now for more than 16 years and I’ve never really had a problem with any regulators. I am basically a “human” liquidity provider, which is important for any electronic market today.

TraderDaily: What happened to Greenhouse Capital Management, the firm you formed in 1998? Did you learn anything from that experience that you would want to pass on to others attempting to start a trading business involving a small number of traders?

Rotter: Greenhouse was a tremendous success for a short period of time.  Originally started by my good friends Oliver Kinski and Michael Mareneck in Dublin, it brought together some of the most active, creative and successful proprietary traders of the day into one company. It was a victim of its own success in a way. We wanted to raise capital to bring in even more traders and increase our market presence and we were positioning ourselves for an IPO when the Tech Bubble burst in March 2000.  The banks – not unlike their reaction to the economic turmoil of the last 2 years –  pulled in their horns and the situation changed overnight. We went from 8-10 banks courting us to no one even returning our phone calls.  From that point, everyone in the company was thinking different things about the future so we decided to wind down the company and go our separate ways.  The advice I would give others in a collaborative effort is to clearly define your objectives, make sure you will be fairly compensated for your best efforts, stick to what you do best, keep the structure lean, and don’t depend on others to make it happen.

TraderDaily: Is the overall mindset of the market and the “sheeple” trading in it different than it was five or ten years ago?

Rotter: Today the herd is the computers, and I think they are doing very well being the herd. The trends created by them are more dynamic then before.  They can reverse their mind very quickly and follow the opposite trend immediately, so I would call them the “dynamic herd”.

TraderDaily: How would you invest in BP if you had to do so today?

Rotter: I had an investment in BP for many years and sold it a bit too late.  I won´t invest in BP anymore, but it is great for trading.

TraderDaily: Thanks Paul!