Interview with Shah Gilani

The following is an interview I had with former hedge fund manager Shah Gilani. He is also a contributing editor to bothMoney Morning and The Money Map Report.

Q. Would you say that Wall Street is transparent right now?

Gilani: No, it’s not. It’s confusing to investors. The average investor is not privy to how it really works. If you don’t know what is woven into that cloth, then it’s hard to tell what kind of quality it’s going to be. You can’t tell. Investors know there is a problem but they can’t put their finger on it. The problem would be self evident if they had an understanding of values.

Q. What do you see in the market right now?

Gilani: I see more volatility, particularly in the global markets. Debt is the problem in the global picture. The market is incredibly dangerous right now. Although investors want to make back their money, they also don’t want to get duped. They don’t want to be used as a backstop. Sadly, though, many don’t have a choice.

Q. What should investors do?

Gilani: Right now you have to cherry pick stocks. You also have to be an investor-trader. You have to be proactive, and look at your portfolio every day or two. You can’t wait a month anymore. The days of buying and falling asleep are over. You also have to put in stops, and have profit targets. And as your stock goes higher, raise your stops higher. That way, if the market falls, you can get out. The market moves so fast you could lose all of your profits in a matter of days.

Q. What is the problem with the market right now?

Gilani: The market is unfair but it doesn’t have to be that way. In my opinion, volatility has been engineered into the financial markets for the sake of Wall Street and traders, and to the enormous detriment of the public, investors, and the economy.

Q: Could you expand on that?

Gilani: Capital markets are set up to serve to raise cash, equity and debt, to facilitate business development, and to provide liquidity to investors providing financing so businesses can grow and share the wealth. Wall Street was set up to be the capital market’s intermediary, but they realized it’s better if they could be principal risk takers as well as market makers. Then they can trade their own book against the market, which includes their clients. Wall Street doesn’t like a calm market. There isn’t a lot of money to be made when volatility is low and spreads are super tight. In the old days, the market was calmer, which was bad for the traders on Wall Street.

Q. How did they change the system?

Gilani: The first thing they did was eliminate fractions. At the time, it seemed to make sense. After all, fractions came from the days when the Spanish, for example, cut up silver and gold into “pieces of eight.” Unfortunately, by moving to a decimal system, it destroyed liquidity by greatly reducing the “depth” of bids and offers investors were once willing to line up to execute. That changed the market. And now Wall Street specialists and market makers, instead of risking an eighth or a quarter, only risk a penny if they step in front of any client or book orders to try and profit themselves as a principal. Everyone seems to think that decimalization was good for the markets.

Q. Was there anything good about decimalization?

Gilani: The only positive was that transaction costs came down. Another problem it created was that no one knows where the liquidity is anymore. When specialists and market makers can step in front of client orders to take their positions essentially from them, it caused traders and institutional players to look for different venues. Now many high volume traders are going into hidden venues like dark pools. This is not good for investors or traders who don’t have the same access to multiple venues, or the market, but it is good for the Wall Street players. Instead of making the market more efficient for everybody, it decreased liquidity for the general public and increased volatility.

Q. Any other rules that caused problems?

Gilani: Eliminating the uptick rule was another mistake. The uptick rule was working just fine until they took it away. When you think back to all of the rules that Wall Street changed since the eighties: deregulation, decimalization, the uptick rule, allowance for multiple venues, no central order handling book, and the blind pools, it all adds up to a trader’s game. Wall Street is no longer facilitating A and B in the capital markets, but is all about making money for themselves now. That is why the Occupy Wall Street people are protesting. They know that something is wrong, but they don’t know what. They don’t know why they are protesting. Instead of a level playing field, all of the investors have been leveled. The tail is wagging the dog now.

Q. What’s the solution?

Gilani: We have to start looking at what is good for the economy and investors, not just Wall Street. But banks and lobbyists are pushing back. They don’t want the rules to favor investors. Let’s see what happens to the Volcker Rule, which will keep banks out of the securities business. We’ll see if that ever gets implemented as it was originally contemplated.

Q. Are there any other ways to stop the shenanigans?

Gilani: Wrongdoers should be punished. If fraud was done on purpose, and you made a lot of money and caused pain, you should not be able to walk away and hurt the economy and investors. The first place to hit them is in the wallet and claw back that money. If you do it legally, go for it. But if it was illegal, and you manipulated the system, then it’s fraud. If guilty of the crime, you should do the time. Make certain things are punishable by prison time. If guilty, they might even have to sell that second house in the Hamptons.

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