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Finance

Dick Bove: We must stop this out-of-control trading or the US capitalist system will break down

Dick Bove: We must stop this out-of-control trading or the US capitalist system will break down

Real harm is being done by out-of control trading.

Market volatility is an outrage for Americans who have trillions of their dollars in 401(k) and other retirement and savings plans.

Market volatility is an outrage for companies that hope someday to fund themselves with new equity.

Market volatility is an outrage for the economy that expects to use free-market capitalism to spur growth.

The fact that trading in the United States equity markets has been captured by out-of-control technological investment systems is a reneging on a key implicit promise. That promise is that the free market trading systems will fairly represent the economic values in the United States. This market volatility is a clear indication that the study and analysis of the economy, the financial system, and companies is an ancient system no longer relevant in today’s technologically advanced markets. It is a complete denial of the “Prudent Man Rule.”

In 1830, Massachusetts Justice Samuel Putnam wrote that trustees must “observe how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.”

It was Putnam’s intent that fiduciaries (people who invest other people’s money) must use diligence in protecting those investments by investigating and understanding the reasons for the investments.

High-frequency trading may not be based on a thorough study of the actions being taken when funds are deployed. Passive trading may be a call to ignore the Prudent Man Rule altogether in favor of simply going with the flow. The direction of customer funds into poorly understood ETFs and ETNs would seem to be another example of the willingness to walk away from Prudent Man dictums.

In Europe, a new rule with the acronym MiFID II was put in place with full knowledge that many actively managed investment funds do not have the ability to buy research. Many United States asset managers are now adhering to the MiFID II doctrines by gathering research on the internet and not buying well-researched data.

This is always the key question. The answer is if this market truly cracks and drops 20 percent to 25 percent, the decline will not be attributed to a failing economy or a financial crisis. It will have been assumed to be the result of a market failure. That failure will be that too many dollars were invested without the investor having very much knowledge of why they made the investment in the first place and the fiduciary not able to justify the investments being made since no thorough study was made to justify the investment.

Thus, a market crack of any significance will destroy confidence in the investing process itself (the core reason that the Congress established the Securities and Exchange Commission was to prevent this from happening). Should this occur households will withhold funds from the equity markets. New companies and established corporations will not find the liquidity in the markets they need to fund their growth. The economy will lack the money necessary to grow at faster rates.

Unless this volatility is brought under control by fiduciaries having to justify their actions, confidence in the most core capitalist system in the United States will be broken. Investing in equities will be equated to a “crap shoot.” This will not be good for anyone. It is simply unacceptable for values to swing 1,000 points in a day or hundreds of points in less than five minutes.

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