Sunday, May 8, 2011

Repost--"CLASSIC!: 'Bear Raid' Stock Manipulation: How and When It Works, and Who Benefits" (Jesse Livermore makes an appearance)

The rout in commodities last week reminded me of this May 10, 2010 post.
The Knowledge@Wharton link is worth the read but the 1925 stories about the bear raid in the wheat pit reminds us that there really is nothing new under the sun:

CLASSIC!: 'Bear Raid' Stock Manipulation: How and When It Works, and Who Benefits"

...From Knowledge@Wharton:

...No one openly admits to conducting a "bear raid," since deliberately manipulating stock prices is illegal. But Wall Street has long believed bear raids can and do take place. There has, however, been little academic research to explain the forces at work. Now two finance experts have shed some light on the process. "We basically describe a theory of how bear raid manipulation works," says Wharton finance professor Itay Goldstein. He and Alexander Guembel of the Saïd Business School and Lincoln College at the University of Oxford describe the procedure in their paper titled, "Manipulation and the Allocational Role of Prices."
Their key finding illuminates the interplay between a firm's real economic value and its stock price, showing how traders who deliberately drive the share price down can undermine the firm's health, causing the share price to fall further in a vicious cycle.
"What we show here is that by selling [the stock], you have a real effect on the firm," Goldstein notes. "The connection with real value is the new thing.... That is the crucial element."
Goldstein and Guembel find that the process only works when the intent is to damage the firm; traders do not have the same power to create a feedback loop that drives the share price up....

Here's an example from the grain pits, via Time Magazine May 25,1925:
Last Black Friday that is, March 13 when the Messrs. Jesse L. Livermore (Manhattan) and Thomas Howell (Chicago) loosed an avalanche of wheat and rye that proceeded right through the bottom of the grain market, Mr. Arthur Cutten (Chicago) was notably annoyed and the U. S. Department of Agriculture was somewhat alarmed (TIME, Mar. 23, 30, BUSINESS). Mr. Cutten was annoyed because he, the big holder of wheat and rye, was feeling bullish, and his enormous paper profits were being swept rudely into oblivion . Also , Mr. Cutten felt that the catastrophe had been timed purposely to do him injury, since it happened while he was on an automobile excursion, out of touch with his agents. U. S. Secretary Jardine was alarmed because the simultaneous action of the Messrs. Livermore and Howell suggested possible collusion to manipulate grain prices-a practice painstakingly prohibited by the Capper-Tincher Grain Futures Act.
Mr. Cutten could do nothing about it save abuse the Messrs. Howell and Livermore beneath his breath and hope with a great hope that Secretary Jardine would order an investigation, discover collusion, punish his oppressors.
Investigate, Secretary Jardine did. Last week he was still investigating. It was known that the Departments of Jus tice and Commerce were also sniffing about the Midwestern brokerages. But not one of the investigators had yet run upon any proof of correspondence between the Messrs. Livermore and Howell nor any records of sales in those gentlemen's names executed in other than legitimate "contract" markets. As far as the evidence went, it was mere business acumen that had moved them separately to sell their grain at the same time and keep on selling until it was time to buy again and start the price-swing going upwards. The Messrs. Livermore and Howell are alleged to have made between them some 22 millions on the operations. Some Europeans lost much money, others saved much by buying necessary wheat shipments when the price was down. From the U.S. standpoint, this latter feature was not creditable to the Messrs. Livermore and Howell as an "economic service," for the U.S. farmer lost a fat slice from prices he had hoped to command this month and next.
Last week, it seemed that the most important result of last Black Friday would be recommendations from Secretary Jardine that the Boards of Trade institute rules limiting the fluctuation of grain futures prices in a single day-rules similar to those found beneficial on the Cotton Exchange.