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Wall Street's Drug Problems

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WALL STREET
AP

Italy is considering requiring stock traders to take mandatory drug tests due to concern about a link between substance abuse and fluctuations on the Borsa Italiana.

Italian savings may be invested by people "not capable of making decisions" due to drug use, said undersecretary Carlo Giovanardi to Bloomberg this week in justifying his initiative. He's responsible for the country's drug prevention policies and last year promoted voluntary testing for Italy's members of parliament too.

The story rhymes elsewhere. Substance abuse has been cited as pandemic in London's financial district where bars routinely offer cocaine to clients by credit card, but describe the purchases as "wine." Several recent drug busts have resulted in multiple arrests and shutdowns of some of these drug fronts in London.

Of course, cocaine has been the drug of choice for well-heeled financial types around the world for decades, and a 1987 Wall Street scandal first revealed its popularity on trading floors.

But what is even more worrisome is the fact that stock markets themselves are behaving like addicts. They are unbelievably volatile, erratic and fluctuate between highs and moodiness in a matter of seconds and minutes almost daily.

For instance, who knows whether substance abuse played a role in the rogue trading scandals, frauds, insider trading convictions and poor judgment that has come to dominate market headlines and events? Some stories have come forth, such as the one this year when one drunken "buy" side trader gained access to his oil trading firm's computers and single-handedly manipulated oil prices globally a couple of years ago.

And who knows whether coke heads created the synthetic side "bets" on side "bets" on side "bets" that turned stock markets into casinos, destroyed the financial sector in 2008 and may yet result in bringing about another Great Depression. Do cocaine-addled persons occupy some of Wall Street's corner offices or do they just behave that way? And have the drug-crazed invented robo-trading (high frequency trading) that is destroying markets and driving out individuals investors?

Reforms sought
Concern about this threat was the reason behind a high-level meeting yesterday between American and British securities officials. Estimates are that between 80 and 85 per cent of financial trades are machine trades and are placed on a one-day basis and never held overnight. Positions are cleared out by the end of the day at the whim of algorithms. Traders use these to devise models that move them in and out of stocks within milliseconds.

This has proliferated because the exchanges, or casinos, love them because the robots can do 500 orders a second. But individual or smaller investors are being obliterated and blindsided by these trades which often bear no resemblance to underlying economic or business events.

In July, the U.K. government, Bank of England and International Monetary Fund met to talk about the effect of such financial frenzy on markets. Now the U.S. and Britain are secretly talking reforms about machine trades, derivatives and short selling, all of which are out of control.

"High frequency trades have a speed edge and weapons that are like machine guns in World War I and individual investors are foot soldiers, mowed down by a new technology they can't understand. The individual investor is fodder in the face of these fields of fire," said CNBC's stock guru Jim Cramer.

But there is another factor ruining capital markets. The concentration of economic power into the hands of gigantic, secretive sovereign wealth funds, hedge funds and pools of speculative capital amplify volatility because fewer execute bigger, irrational trades based on unknown equations.

This is a return to the 19th-century Gilded Age, as a Wall Street Journal article pointed out this week. Back then, markets were roller coaster rides manipulated by robber barons and speculators who spread good news if long in a stock and bad news if short selling. The result was volatility and churn: In 1901, U.S. stocks turned over at the rate of 392 per cent of their total value. Reforms calmed markets and in the 1960s, the turnover was 20 per cent of value. But in 2009, turnover leaped to 244 per cent and has stayed at that rate since.

The result of this is that markets may become invalid pricing mechanisms. There have been few IPOs for months and more than $60 billion worth of investments had fled this summer from markets.

Even worse, politicians, who also need drug tests, appear frozen in the headlights and the Occupy Wall Streeters have turned into a disparate group of protesters and troublemakers. Ironically, some are indulging in lewd and drug-related behavior.

So Italy may not be the world's foremost governance role model, but their drug crackdown may be on the right track. Traders and the world's big investors must be brought to heel, their robots should be taken away and stock markets that operate like crack houses should be shut down.

This blog was previously published by Financial Post.

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