"Project Omega" - Why HFTs Never Lose Money: The Criminal Fraud Explained

Two weeks ago, without knowing the details of the most recent market-rigging and frontrunning scandal involving "alternative" market veteran ITG's dark pool POSIT, which issued a vague 8-K it would settle with the SEC for "irregularities", we explained what we thought had happened:

ITG had an in house prop trading group, or "pilot", which operated for nearly two years, whose only signal was client order flow, which it would frontrun, and make millions in profits. In other words, once again precisely what we have claimed since 2009. But oh yes, not everyone is guilty of such manipulation. Only Liquidnet... and Pipeline... and ITG... and countless other ATS and HFT firms for whom clients are better known as either "easy money" or muppets.

And yes, we get the "trading experiment" narrative: calling it "criminal market manipulation and order frontrunning scheme" just does not sound like something the Modern Markets Initiative would spend millions of dollars to get Congressmen to agree on.

It turns out we were spot on, the only thing we missed was the name of this market manipulation exercise. Now, thanks to the SEC, we know: "Project Omega" (or as it was also correctly dubbed here the "criminal frontrunning scheme") is how ITG dubbed its secretive prop-trading desk whose only purpose was to frontrun clients.

Here are the details for all you suckers who still read the HFT apologists and believe the bullshit that all these algos do is provide liquidity, when in reality all the really do is frontrun your orders, assuring them of 6 years of trading without a single day's loss (or in the case of Virtu, one trading day loss). From the SEC:

Between approximately April 2010 and July 2011, ITG violated the federal securities laws and regulations in multiple ways as a result of its operation of an undisclosed proprietary trading desk known within ITG as “Project Omega” (“Project Omega” or “Omega”). During the period of April to December 2010, Project Omega accessed live feeds of ITG customer and POSIT subscriber order and execution information and traded algorithmically based on that information in POSIT and in other market centers. In connection with one of its trading strategies, Project Omega identified and traded with sell-side subscribers in POSIT and ensured that those subscribers’ orders were configured in POSIT to trade  “aggressively,” or in a manner that benefitted Omega by enabling it to earn the full “bid-ask spread” when taking the other side of their orders.

Project Omega, which operated as part of AlterNet, traded a total of approximately 1.3 billion shares, including approximately 262 million shares with subscribers in POSIT. ITG’s proprietary trading gross revenues resulting from Project Omega totaled approximately $2,081,304.

A quick point here: since ITG was quick to settle at a cost of $20 million, one can be absolutely certain that the true damages to clients, aka Project Omega revenues, were orders of magnitude higher, however since it wasn't the SEC's intention to disclose just how criminal HFTs are in general but just to put a black eye on ITG's dark pool (as Goldman flexes its muscles and prepares for world algo domination by taking down its competition one by one), and since it is difficult to capture all the "externalities" and dollar benefit from rigging, the SEC was happy to only point out the absolutely bare minimum of damages which were probably the explicit documented loss by those traders who brough this case to the SEC's attention in the first place. Everyone else will have to wait in line for the class action lawsuits to begin when laying out their damages.

But back to the SEC's big picture "explanation" of what we have said for years:

While Project Omega was engaging in proprietary trading, including with ITG’s own customers, ITG was simultaneously promoting itself, and POSIT, as an independent “agency only” broker that did not have conflicts of interest with its customers and that protected the confidentiality of its customers’ trade information.

Project Omega was managed and overseen by an ITG senior executive who at the time served as the firm’s Head of Liquidity Management (the “Liquidity Executive”). The Liquidity Executive designed and directed Omega’s trading strategies even though they violated written policies set by ITG’s compliance department restricting Omega’s access to customer information.

ITG Inc. and AlterNet violated Sections 17(a)(2) and 17(a)(3) of the Securities Act by engaging in a course of business that operated as a fraud and by failing to disclose to ITG customers and POSIT subscribers, among other things, that: (i) ITG was operating a proprietary trading desk while at the same time promoting its brokerage services and POSIT by describing ITG as an independent “agency-only” broker; (ii) the proprietary trading desk, until December 2010, accessed live feeds of highly confidential order and execution information and used this information to inform its own trading decisions; and (iii) one of the proprietary trading desk’s strategies involved identifying sell-side subscribers with which the desk wanted to trade in POSIT, and ensuring that those subscribers’ orders were configured to trade “aggressively” in POSIT.

ITG Inc. violated Rule 301(b)(2) of Regulation ATS by failing to file an amendment on Form ATS at least 20 days before it launched Project Omega disclosing the commencement of its proprietary trading activities and that one of its primary trading strategies would involve accessing confidential information regarding subscribers’ identities and orders and trading algorithmically based on a live feed of highly confidential information regarding open orders bound for the POSIT dark pool.

And here are the details of Project Omega, ör as we called it in July for what it really was "the criminal market manipulation and order frontrunning scheme":

During the period of late 2009 to early 2010, ITG explored initiatives to increase diversification and revenues for the firm, including launching a proprietary trading operation that would engage in algorithmic high frequency trading. Thereafter, on the recommendation of senior management, Group’s Board of Directors approved a proprietary trading desk that was limited in scope to inform whether ITG should launch a fully-scaled and disclosed proprietary trading operation. This initiative at ITG, which was managed by the Liquidity Executive, became known as Project Omega.

When he began managing Project Omega, the Liquidity Executive had overall product management responsibility for all of ITG’s electronic brokerage products, including its entire suite of trading algorithms, its smart order routers, and for the POSIT dark pool.  Prior to becoming Head of Liquidity Management in 2009, for several years the Liquidity Executive had been the Head of Product Management for ITG’s algorithmic trading group. In that role, he was responsible for designing and building ITG’s entire suite of trading algorithms and managing a team of software developers who wrote the computer code for the algorithms.

As a reminder, it was Zero Hedge who broke, and subsequently BBG and WSJ confirmed, that the "Liquidity Executive", aka criminal frontrunning mastermind, was none other than Hitesh Mittal, the same person who left ITG in 2011 and went on to become the head trader of the world's 4th largest hedge fund, Cliff Asness' (formerly of Goldman Sachs) mega quant fund, AQR Capital. It was this same "liquidity executive" who, after making hundreds of millions in HFT profits for AQR, was unceremoniously fired early this month. Per the WSJ:

Hitesh Mittal was terminated from his position as head of trading at AQR Capital Management LLC in a move related to an enforcement action the Securities and Exchange Commission brought against a former employer.

Mr. Mittal was head of trading at the $136 billion hedge fund since 2012. Brian Hurst, AQR’s former head of trading, resumed his role on July 31, AQR said in a statement. Mr. Mittal wasn’t formally named in the action, but his role in the project was reported by The Wall Street Journal and Bloomberg News in recent weeks.

“AQR has ended its employment relationship with Hitesh Mittal,” the company said in a statement. “Mr. Mittal has been referenced in reports about an SEC investigation of ITG. This investigation reportedly relates to misconduct that occurred in 2010 and 2011 while he was employed at ITG.”

Mr. Mittal didn't respond to attempts to reach him Wednesday.

His boss, Mr. Asness, did not respond to twitter inquiries if the reason he "loves High-Speed Trading", as he admitted in a 2014 Bloomberg Op-Ed, is because of the criminal frontrunning profit it may have afforded him courtesy of the hiring of the "liquidity executive."

And just so there is no confusion, ITG's "prop trading" group was all HFT and algo-based.

None of the Omega team members had experience with proprietary trading. Instead, the Omega team consisted almost entirely of ITG employees with significant experience in ITG’s algorithmic trading group designing, building and/or writing computer code for ITG’s trading algorithms. Based on that experience, the Omega team had detailed knowledge regarding how ITG’s algorithms operated.

Not surprisingly, the whole criminal scheme was shrouded in secrecy:

From the start, and during the entire time it was in operation, Project Omega’s existence and trading activities were kept confidential and were not disclosed to ITG customers or POSIT subscribers or to the Commission.

Proprietary trading represented a significant departure from ITG’s core “agency-only” business model and public profile, and ITG had concerns that Project Omega or proprietary trading at ITG could result in reputational risk for the firm. If ITG decided to increase the scale of Omega’s proprietary trading activities, ITG planned to disclose its existence publicly and to customers at that time. However, before reaching that point, ITG decided that Project Omega and its proprietary trading activities were to be kept confidential.

Even within ITG, Project Omega was only to be discussed on a “need-to-know” basis, and even the customer-facing side of ITG was not informed of Omega’s existence.

The company was smart: it would only rip off sell siders, not the buyside, because as everyone knows the biggest idiots on Wall Street are on the sellside; buysiders tend to be at least modestly smarter on average.

Project Omega was subject to the limitation that its total open positions could not exceed $500,000 at any time. In addition, it was designed to trade only against the orders of sellside subscribers in POSIT, and not against buy-side subscribers. Based on these limitations, and that ITG initiated Project Omega to determine whether it could profitably engage in proprietary trading and/or market making on a larger scale, ITG considered Project Omega to be an “experiment.”

In short, Project Omega was this:

That's right: dark pools, HFTs, and so on, are nothing more than the Office Space scam: steal a little, millions of times, just don't get caught.

However, just like in Office Space, they eventually got caught.

And here's why:

For the period of approximately April to December 2010, Omega’s Facilitation Strategy, which was designed by the Liquidity Executive, involved trading based on a live feed of information (the “Aleri Feed”) relating to open orders routed by sell-side subscribers to ITG’s trading algorithms for handling. 8 The Omega team accessed the feed by connecting to a software utility called “Aleri” that was used by ITG’s sales and support teams. The feed contained various categories of real-time information regarding “parent” orders routed through virtually all of ITG’s algorithms, including: (a) client identifier, (b) symbol, (c) side, (d) quantity of shares, (e) filled shares, (d) target price, (e) the ITG algorithm in which the order was located, and (f) time parameters.

The Facilitation Strategy was designed to detect open orders of sell-side subscribers being handled by ITG via the Aleri Feed and, based on that information, open positions in displayed markets on the same side as the detected orders, and close its positions in POSIT by taking the other side of the detected orders. The Facilitation Strategy was designed to earn the full “bid-ask spread” by opening and then closing positions.

* * *

For the entire time that ITG’s proprietary trading desk was in operation, the Omega team had access to the identities of POSIT subscribers and used this information to identify the full range of potential sell-side subscribers for Omega to trade with in POSIT. In addition, the Omega team used the information to which it had access to analyze the Facilitation Strategy’s profits and losses by contra party. Based on these ongoing profit and loss analyses, and without POSIT subscribers’ knowledge or consent, the Omega team made decisions about whether to stop trading with a small number of subscribers and to continue trading with others.

The Facilitation Strategy was designed to trade only with the sell-side subscribers identified by Omega. In order to effectuate this aspect of the strategy, the Omega team needed assistance from the POSIT development team – a group that also reported up to the Liquidity Executive. At the direction of the Omega team, ITG’s POSIT team implemented the required configurations in the dark pool to “enable” sell-side subscribers to trade, or interact, with Omega in POSIT.

* * *

Despite the strategy’s goal of earning the full “bid-ask spread,” there were times when Omega executed trades in POSIT at “midpoint” and did not obtain the “full spread.” In certain instances when this happened, the Liquidity Executive directed his team to investigate by coordinating with the POSIT development team to determine why the trades executed at midpoint, instead of at the bid or the offer, as the Liquidity Executive thought they should have.

No market participant other than Project Omega had access to the information provided in the Heatmap Feed.

From approximately April to December 2010, Omega’s Heatmap Feed included live trade execution information for all of ITG’s customers, including both sell-side and buy-side customers.

In December 2010, ITG’s Senior Management and Compliance Department Learned that Project Omega was Improperly Accessing Subscriber Order Information.

In the late fall of 2010, ITG’s CEO directed two other ITG executives to speak with the Liquidity Executive to gather information concerning the operation of Project Omega for the CEO’s information and to assist the CEO in making a presentation to Group’s Board of Directors in February 2011.

In early to mid-December 2010, ITG’s compliance department and senior management learned – based on the Liquidity Executive’s admissions – that Project Omega was trading based on a live feed of information regarding sell-side customers’ orders that had been sent to ITG’s algorithms. As a result, ITG immediately suspended Project Omega’s trading. Shortly thereafter, the compliance department and ITG’s senior management learned additional detail regarding the Facilitation Strategy and Omega’s use of the Aleri Feed, as well as certain information about Project Omega’s use of the customer execution feed in connection with its Heatmap Strategy.

The Liquidity Executive had not previously disclosed to ITG’s compliance department or senior management that Project Omega’s strategies involved accessing and trading based on the Aleri Feed and the Heatmap Feed. Instead, prior to December 2010, the Liquidity Executive had misrepresented to ITG’s compliance department the manner in which Project Omega’s trading strategies were operating.

On approximately December 20, 2010, a meeting among ITG’s senior management and compliance department was held to address Project Omega. During this meeting, the CEO reprimanded the Liquidity Executive for violating ITG policy and placing the firm at risk. Thereafter, Project Omega made certain changes to its trading strategies and was permitted to restart live trading.

As a reminder, this same liquidity executive went on shortly thereafter to become head of trading at Cliff Asness' AQR hedge fund.

But wait, despite being "reprimanded" Hitseh Mittal continued to defraud clients:

On or around December 21, 2010, Project Omega restarted a modified Facilitation Strategy that did not involve access to the Aleri Feed. In addition, Project Omega restarted a modified Heatmap Strategy on or around January 24, 2011, without direct access to the Heatmap Feed.

When Project Omega resumed trading, no changes were made to its organizational structure. As before the temporary suspension, the Liquidity Executive continued to manage Project Omega and direct its trading strategies while also continuing his overall product management responsibilities for ITG’s trading algorithms, smart order routers and POSIT, which included access to confidential customer order and trade information. The other members of the team also continued in the same roles they had before the temporary suspension.

Despite the removal of the improper direct feeds, in connection with the Facilitation Strategy, Project Omega continued to have improper access to information identifying POSIT subscribers. In addition, the Omega team continued to coordinate with ITG’s POSIT development team to identify the sell-side subscribers for Omega to trade with in POSIT and to ensure that such subscribers were configured to trade “aggressively” in POSIT.

After resuming trading in late 2010, Project Omega continued to engage in live trading until on or around July 11, 2011, when ITG terminated the Liquidity Executive as an employee and discontinued Project Omega’s operations.

During and after the temporary suspension of Project Omega’s trading activities in December 2010, ITG continued to keep Project Omega and its trading activities confidential and made no disclosure of it publicly, to subscribers, or to the Commission via an amendment to the POSIT Form ATS.

That's ironic: at the time Traders Magazine reported that Mittal had been fired in what was a "cost-cutting measure." That was incorrect. He was caught rigging markets. At this point he wasted no time to move to AQR where he was welcomed with open arms, and make his boss Cliff Asness millions in profits which in turn gave Cliff the green light to write pandering op-eds about why he loves HFT.

* * *

The fraud was so blatant not even the staunchest supporters of the HFT lobby could come up with anything even remotely relevant to justify this fraud:

... one thing to say about this is: Hahahaha, that's really bad! Like, paranoid-fantasy bad. The deep worry of modern equity market structure is that high-frequency traders, brokers, exchanges and dark pools are conspiring in some combination to front-run unsuspecting customers: The bad guys know, somehow, that the customers are trying to buy a particular stock, and can, somehow, race ahead of those customers to buy the stock and re-sell it to them at a higher price. And that's exactly what happened here! So, terrible. ITG will pay the SEC $20.3 million, a record dark-pool fine. "'The conduct here was egregious,' Andrew Ceresney, director of the SEC’s enforcement division, said during a conference call Wednesday," and it is hard to argue with that.

The "analysis" could have just ended there, and spared itself the footnoted embarrassment.

* * *

But none of the above is really shocking: after all the only business model of HFT is criminal order frontrunning, pure and simple, which is why it allows multi-millionaires to become billionaires even as they profess their love of said crime, under the guise of "high-speed trading."

What is shocking is the following, from the filing:

... on the recommendation of senior management, Group’s Board of Directors approved a proprietary trading desk that was limited in scope to inform whether ITG should launch a fully-scaled and disclosed proprietary trading operation. This initiative at ITG, which was managed by the Liquidity Executive, became known as Project Omega.

So the company's board was ultimately responsible for Project Omega, a board among whose members was the following :

Mr. O’Hara worked in the Division of Enforcement of the U.S. Securities and Exchange Commission and as Special Assistant United States Attorney at the U.S. Department of Justice
 

As we reported before, O'Hara promptly quit the day ITG announced the SEC settlement - after all it wouldn't look very good  to have a former SEC enforcer oversee a market rigginal, and criminal client defrauding prop trading group which was busted by, well, the SEC... but by then it was too little, too late.

And there you have it: open, outright, market rigging and criminal fraud, and best of all, with the explicit blessing of former SEC enforcers. As in, the fox is not only not guarding the hen house, but telling the hens to come right in: the water is warm.

And that's why the US equity market is a farce, broken beyond repair and will never be fixed until everything comes crashing down to be rebult from scratch.

Source: SEC Charges ITG With Operating Secret Trading Desk and Misusing Dark Pool Subscriber Trading Information

http://www.zerohedge.com/news/2015-08-13/project-omega-why-hfts-never-lose-money-criminal-fraud-explained

Dollar Tumbles As Fed Rate Hike Suddenly Looking Very Uncertain To Goldman, Bank Of America

After China's shocking currency devaluation, which some more conspiratorially-minded observers have concluded was China's retaliation to the west for the IMF's recent snub that pushed back China's evaluation for inclusion into the SDR to some indefinite point in 2016, the only question on everyone's mind is whether the Fed will delay or outright cancel any imminent "data-dependent" rate hikes as a result of the implicit tightening of monetary conditions thanks to China, and the dramatic appreciation of the USD which would not have taken place without China.

And while we await the first Fed speaker to hit the public circuit since Monday's night's dramatic event, which is Goldman's NY Fed's Bill Dudley speaking in a few minutes, here is what two of the most influential banks have to say on the topic.

First, here is Goldman:

We expect that Fed officials would evaluate the recent news in a similar way. All else equal, the unexpected appreciation of the yuan implies downside risks to inflation and an additional tightening of financial conditions that may affect growth--beyond the effects from the sizable appreciation in the dollar before this week. There could be some potential offsets, such as a healthier Chinese growth outlook and/or lower US interest rates. But on balance, the PBOC action marginally lowers the odds of Fed liftoff in September, in our view, and December liftoff remains our call. The FOMC’s post-meeting statement already indicates that the committee will take into account “readings on financial and international developments,” so we do not think any additional language would be needed at this stage. Fed Chair Yellen’s press conference would be a more natural venue for discussing the dollar’s impact on financial conditions, if this remained a concern at the time of the September 16-17 meeting.

And here is Bank of America:

The timing of Fed liftoff has always been a relatively close call in our view — and with the devaluation of the Chinese yuan this morning, it just got a little closer. A stronger US dollar is both disinflationary and a drag on US growth. While the depreciation of the yuan increases the uncertainty around the upcoming FOMC meetings, at this point it does not lead us to fundamentally shift our expectations for liftoff in September. However, the effects of a stronger USD may well slow the subsequent pace of rate hikes even if they do not delay liftoff. Of course, Fed policy remains data dependent. We thus recommend paying close attention to upcoming speakers to see how they assess the risks to the Fed’s objectives and expected policy path from this regime shift in China.

A stronger dollar is also disinflationary, but Fed officials have been largely unconcerned by weak commodity and import prices to date. The smaller estimated impact on core inflation in the staff’s model — about a 0.1-0.3pp drop following a 10% appreciation — may help explain the Fed’s reaction. We expect a larger and more persistent impact. In addition, Fed officials had cited stabilization of the dollar and energy prices as supporting their view that these disinflationary forces were “transitory.” Today’s market reaction may lead them to reconsider, as stocks, oil prices and inflation expectations all fell. The larger and more sustained these moves, the more likely the FOMC will react.

Today’s events won’t likely impact the incoming data before the September FOMC meeting. Instead, we think that the Fed will need to make a risk assessment: is the greater uncertainty after the Chinese yuan depreciation enough to warrant postponing liftoff? The FOMC also has the option to slow the pace of subsequent hikes, should downside risks be realized. Fed officials will need to weigh these risks against the realized cumulative improvement in the US labor market. The Fed call is now closer than before, but it may take a significant reaction by global markets for the FOMC to stay on hold in September.

Suddenly the case for a rate hike in 2015 looks very, very wobbly. Want proof? Look no further than the DXY which suddenly is not looking all that hot.

So did China get its revenge for the IMF snub? Check back in a few weeks when the CNY is down a further 10%.

And a thought experiment: if the PBOC will intervene to buy CNY after it devalues it just hours prior, will it now intervene to support a suddenly foundering USD?

http://www.zerohedge.com/news/2015-08-12/fed-rate-hike-suddenly-looking-very-uncertain-goldman-bank-america

Hedge Fund That Hired "Master Manipulator" From Deutsche Bank Implicated In LIBOR Suit

In many ways, Christian Bittar has come to personify the global effort to manipulate the world’s most important benchmark rates. Regular readers will remember Christian as the Deutsche Bank prop trader we first introduced in 2012 and who we later noted was dismissed from the German lender only to be hired at BlueCrest Capital Management. Here’s our six-point summary from 2013:

1. Deutsche tells an internal prop trader to "do everything legally and by the book or else."
2. Bittar colludes with virtually everyone else under the sun to generate billions in profits;
3. Bittar makes tens if not hundreds of millions of bonuses for himself;
4. Finally, DB no longer can hide the deception and claws back a portion of Bittar's bonuses, while washing its hands of the full affair;
5. He went to work for BlueCrest Capital Management LLP, Europe’s third- biggest hedge fund with $30 billion under management.

But that wouldn’t be the end of it.

Earlier this year, after Deutsche Bank agreed to pay $2.5 billion to settle rate rigging charges, we got a look at exactly what Bittar said on the way to fixing the fixes (so to speak). You can view some of the highlights here. 

Finally, when WSJ released the full text of a letter sent to Deutsche Bank by German financial watchdog BaFin, we got an in depth look at the relationship between Bittar and former CEO Anshu Jain. Unsurprisingly, Bittar’s lucrative trading activities at the bank made him a star in the eyes of upper management. 

Now, none other than Bittar’s post-Deutsche Bank employer BlueCrest is being sued along with the usual suspect banks for conspiring to rig the Swiss franc LIBOR rate. The allegations appear to stem from the documents which were made available when Deutsche Bank settled with US regulators earlier this year. BlueCrest is the only hedge fund named.

From the complaint:

On April 23, 2015, the NYSDFS revealed that BlueCrest conspired with Defendant Deutsche Bank to manipulate Swiss franc LIBOR for its financial benefit, requesting that Deutsche Bank make a false 1 month Swiss franc LIBOR submission on February 10, 2005. Upon information and belief, that request was sent via electronic communication to a Deutsche Bank Swiss franc LIBOR-based derivatives trader and/or Swiss franc LIBOR submitter located in New York.

Defendant BlueCrest has deep connections to the Contributor Bank Defendants, including several individual traders directly involved in the manipulation of LIBOR. In addition to being funded in part by Defendant JPMorgan, BlueCrest hired Deutsche Bank master manipulator Christian Bittar after he was publicly fired by Deutsche Bank for his involvement in various rate-rigging schemes.

So there you have it. Precisely what we said more than three years ago has been proven to be unequivocally (and usurprisingly) true.

To wit (ca. 7/18/2012): 

The bankers who were allegedly involved in Libor manipulation in some capacity in their previous lives working for banks, decided to quietly depart under mutually acceptable conditions and find new lives, still trading Libor and IR derivatives, in some of the best known, and even less regulated, hedge funds and private banks.

Our question then is the following: while much has been said about Lieborgate as being purely associated with the 16 BBA USD fixing member banks, just who else made money, and [are others in the financial community] about to be exposed for having profits far more from Lieborgate than any of the BBA member banks?

Because if the stigmatized traders were accepted with open arms at various hedge funds, one would think there may, just may have been, some quid pro quo in the past (for those who have worked in the financial industry this needs no further explanation).

Bluecrest Lawsuit

http://www.zerohedge.com/news/2015-08-10/hedge-fund-hired-master-manipulator-deutsche-bank-implicated-libor-suit

Yield Purchasing Power: $100M Today Matches $100K in 1979

by Keith Weiner

I wrote a story about poor Clarence who retired in 1979, and even poorer Larry who retired last year. I created these characters to challenge the notion of calculating a real interest rate by subtracting inflation. The idea is that the decline of a currency can be measured by the rate of price increases. This price-centric view leads to the concept of purchasing power—the amount of stuff that a dollar can buy. It’s the flip side of prices. When prices rise, purchasing power falls.

Recall in the story, Clarence retired in 1979. At the time, inflation was running at 14% but he could only get 11% interest. Real interest was -3%, and Clarence had a problem. He was losing his purchasing power.

Suppose Clarence bought gold. The purchasing power of gold held steady for the rest of his life (see this chart of oil priced in gold). Gold does solve this problem. However, gold has no yield. Clarence is only jumping out of the frying pan and into the fire. Sure, he escapes dollar debasement, but then he gets zero interest.

Let’s look at how zero interest impacts Larry. He makes $25/month on his million dollars. Obviously he can’t live on that. So he gives up his nest egg, for eggs. For a year, he feasts on omelets. Since inflation was
slightly negative, the same swap in 2015 nets him the same plus a few additional quiches.

Through the lens of purchasing power, we don’t focus on the liquidation of Larry’s wealth. We ignore—or take it for granted—that he’s trading his life savings for bread. We only ask how many loaves he got.

If you had a farm, would you consider trading it away, to feed your family for a year? I hope not. A farm should grow food forever. Its true worth is its crop yield, not the pile of bacon from a one-time deal.

How perverse is that? It’s nothing more than what zero interest is forcing Larry to do.

A dollar still buys about as much as it did last year. Larry’s purchasing power didn’t change much. However, debasement continues to wreak its destruction.  Steady purchasing power does not mean that the dollar is holding its value.

It means that prices are wholly inadequate for measuring monetary decay.

Our monetary disaster becomes clear when we look at the collapse in yield purchasing power. This new concept does not tell you how many groceries you can get by liquidating your capital. It tells how much you can buy with the return on it.

In 1979, Clarence’s $100,000 savings earned enough to support his middle class lifestyle. In 2014, Larry’s million dollars didn’t earn enough to pay his phone bill. To live in the middle class, Larry would need over a
hundred million bucks. That’s a pitiful income to make on such a massive pile of cash. It reveals a hyperinflation in the price of capital, which has gone up 1100X in 35 years.

It also shows that the productivity of capital is collapsing. Back in Clarence’s day, businesses earned a high return on capital. It was high enough for Clarence to get 11% interest in a short-term CD. Unfortunately, the dollar rot is in the advanced stage now. There is scant interest to be earned. Return on capital is low, and so borrowers can’t pay much.

Retirees suffer first, because they can’t earn wages. Normally they would depend on interest, but now they’re forced to live like the Prodigal Son. They consume their wealth, leave nothing for the next generation, and hope
they don’t live too long. Zero interest rates has reversed the tradition of centuries of capital accumulation.

Purchasing power may look fine, but yield purchasing power shows the true picture of monetary collapse.

This article is from Keith Weiner’s weekly column, called The Gold Standard, at the Swiss National Bank and Swiss Franc Blog SNBCHF.com.

http://www.zerohedge.com/news/2015-08-05/yield-purchasing-power-100m-today-matches-100k-1979

Greek Cyber Crime Unit To Investigate Varoufakis' Secret Drachma Plan

It’s been exactly one month since Yanis Varoufakis resigned his post as Greek Finance Minister, but his legend has only grown. 

The self-proclaimed "erratic Marxist" whose exploits in the Greek finance ministry include driving German FinMin Wolfgang Schaeuble to the edge of insanity and posing for a Paris Match photoshoot that was anything but austere, one-upped himself on July 16 when, in a recorded call with "international hedge funds," he detailed a James Bond-ish plot to set up a parallel payment system in Greece by creating secret accounts using tax filer numbers for individuals and corporations which he would obtain by hacking into the troika-controlled General Secretary of Public Revenues. The full audio recording of the call was eventually released. 

Varoufakis would later tell The Telegraph that "they" are out to get him for his "cloak and dagger" drachma plan. "The context of all this is that they want to present me as a rogue finance minister, and have me indicted for treason," he told Ambrose Evans-Pritchard.

Although it’s not entirely clear why having a Plan B constitutes a punishable offense (indeed, under the circumstances, it seems like the punishable offense would be not having a plan B), it looks like the chief prosecutor of the Athens First Instance Court is prepared to portray Varoufakis as a cyber crime mastermind and will now launch a full scale investigation into the General Secretariat for Public Revenues plot. Here’s Kathimerini with more:

Ilias Zagoraios, the chief prosecutor of the Athens First Instance Court, has asked Greece’s cyber crime unit to investigate whether the public revenues service was hacked as part of an effort to create a parallel payment system under ex-Finance Minister Yanis Varoufakis.

The former minister has claimed that he talked to a ministry employee about hacking into the General Secretariat for Public Revenues’ online system during alleged attempts to create a scheme that would help the government overcome liquidity problems.

Varoufakis did not clarify whether this breach took place. However, his claims prompted an internal investigation by the general secretary for public revenues, Katerina Savvaidou.

Now, a second probe will be carried out by the cyber crime unit, which should be able to provide its findings to Zagoraios before Savvaidou completes her investigation.

So we will now apparently learn whether Varoufakis and his elite "cyber crime" team actually succeeded in hacking into the public revenues service.

If they did, we imagine opposition lawmakers will push for the ex-FinMin to be drawn and quartered (politically speaking, of course) for attempting to ensure that in the event Berlin decided to shut the Greek banking system down entirely, the country wouldn't descend into outright chaos.

That, apparently, may be a crime.

http://www.zerohedge.com/news/2015-08-05/greek-cyber-crime-unit-investigate-varoufakis-secret-drachma-plan

The World's Biggest "Hedge Fund", $30 Billion Bigger Than Bridgewater, Remains Mysterious As Ever

Few things are as misunderstood as Apple's $203 billion cash hoard, first and foremost because of this amount $168 billion is not cash at all but actual securities: treasuries, investment grade bonds, perhaps stocks and junk, something Zero Hedge first made quite clear back in 2012 when we presented "The World's Biggest Hedge Fund You Have Never Heard Of" - Braeburn Capital, Apple's asset management corporation, tasked with preserving (and enhancing) the value of Apple's biggest asset: its "cash equivalents" which are anything but cash.

As the following chart shows, with $203 billion in investable dry powder which is probably the best way of calling AAPL's cash and investments...

... the Cupertino-based company is more than $30 billion larger than what is generally accepted to be the largest hedge fund in the world, Ray Dalio's Bridgewater, which however "only" managed some $171 billion as of May 2015.

Following our report, many tried to cover up the fact that nobody really knows what is on Braeburn's books, punting to the general explanation: "it is all invested in ultra-safe securities." Other said "It says it only invests in “highly rated securities”—think government bonds from rich, stable countries, and debt issued by companies with very solid finances. The overarching objective is “minimizing the potential risk of principal loss,” which means it’s safe to assume that Apple is not operating a secret investment casino in the Nevada desert."

Only that is not exactly true.

AAPL's gargantuan securities hoard, and the fact that the company is no longer a maker of gadgets as much as a massive hedge fund, was noticed two months ago by Bloomberg who wrote that "Apple Is the New Pimco, and Tim Cook Is the New King of Bonds." This is what BBG said:

Apple Inc., Oracle Corp. and the other tech giants hoarding half a trillion dollars in cash have joined the ranks of the biggest buyers of the debt, often snapping up as much as half of some bond issues, according to five people with knowledge of the transactions.

Apple, which had $193.5 billion of cash and marketable securities as of March 28, is now one of the biggest buyers of shorter-term debt sold by investment grade companies, often taking as much as $200 million of a $1 billion issue, according to four people with knowledge of the deals.

I am sure asset managers like Vanguard and Pimco would prefer Apple call them and have them manage the money rather than competing with them,” said Kevin McPartland, the head of research for market structure and technology at research firm Greenwich Associates in Stamford, Connecticut.

Of course they would: just think of the asset management fees that are not being paid.

But that is precisely why AAPL is now also the world's biggest hedge fund: with an "AUM" of over $200 billion, it would much rather do its asset-management decisions in house, and specifically in this house.

Or actually, that was the house located at 730 Sandhill Road in Reno, Nevada where Braeburn was housed as Zero Hedge first revealed, until shortly after our report when it decided to disappear. Cue Apple Insider from March 2013:

... the office at that address is now in use by another firm (Randstad finance and accounting). Asked about Braeburn, the receptionist told AppleInsider that she only knew that the firm is no longer operating at that location and that she didn't know where it had relocated. A search of Apple's record filings did not turn up a new address.

Apple doesn't appear keen on publicizing the address of its Reno operations ; neither Siri nor Maps offer any help in locating the Braeburn offices the way they do direct users to Apple's stores (including the one located in Reno) and its main headquarters facilities in Cupertino.

Actually that's not true. A 2 minute search reveals that Braeburn moved just down the road to a more impressive looking location at 6900 S. McCarran Blvd, Suite 3020, in Reno.

Far from the "boring, staid" buyer of ultra-safe treasuries, what is notable is that slowly but surely AAPL has become a dominant force in the corporate bond market, and has migrated into far riskier (and potentially illiquid) assets: as noted above, "[Breaburn] is now one of the biggest buyers of shorter-term debt sold by investment grade companies, often taking as much as $200 million of a $1 billion issue, according to four people with knowledge of the deals."

Which leads us to the second point about AAPL's "cash" - 90% of it is held offshore: in the latest quarter $181 billion of AAPL's cash, or about 90%, was held abroad.

It is here that Braeburn comes in, because it is funds held by Apple's offshore subs that provide the funding for Braeburn. As BBG reported a month ago, "Apple... had $171.3 billion of its cash and marketable securities in foreign subsidiaries and “generally based in U.S. dollar-denominated holdings” as of March 28, according to a regulatory filing." Make hat $182 billion as of June 30.

And just like every massive hedge fund, which prefers to operate in the shadows, Braeburn gets its share of shadow suitors seeking their share of its funds:

“We treat them as we treat Fidelity or Vanguard or any other investor,” said Curt Zuber, treasurer of Sydney-based Westpac Banking Corp., which has issued $6.1 billion of U.S. dollar-denominated bonds in the financial year started Oct. 1 and a total of $22 billion since October 2012.

All four of Australia’s biggest banks, heavily reliant on offshore debt markets, have sent representatives to Reno, Nevada, where Apple’s money-management unit, Braeburn Capital Inc., is based, according to people with knowledge of the trips. Oracle’s cash managers are also based in the city known for its casinos, where hotel rooms costing as little as $69 a night provide cheaper lodgings than banker stops in New York, Boston and Newport Beach, California, where Pimco is based.

The curious secrecy surrounding AAPL's asset manager once again raises the same flag we noted 3 years ago: just what does Braeburn hold, becuase while we would be happy to take Tim Cook's word, we would be happier if we could see some AAPL 13Fs.  Recall from September 2012:

Braeburn has no reporting obligations: there is no Investment Advisor Public Disclosure (IAPD) entry on Braeburn for the logical reason that it is not an investment advisor: it merely manages an ungodly amount of cash for AAPL's millions of shareholders. There is also no SEC filing 13-F filing on Braeburn's holdings. As such, not confied by the limitations of being a "long-only", it is in its full right to hold any assets it feels like, up to and including CDS on housing, puts on Samsung, or Constant Maturity Swaps that pay if the 10 Year collapses. It just doesn't have to report any of them.

Nobody knows: and that's the beauty of Braeburn. It is the world's largest hedge fund that is not really a hedge fund, nobody has heard of, and nobody knows just what assets it holds.

Another reason why some may want to know just what debt AAPL is buying: in a bond market as illiquid as the one right now, should AAPL be forced to dump any of its billions in TSYs, IG, Junk paper (say because rates are rising) just what will happen to the market price in what is generally quite a bidless market? 

Recall that the only reason why Bill Gross' departure and subsequent surge in redemptions from Pimco's Total Return Fund did not roil the market - as so many expected - is because as we learned laer, PIMCO sold from itself... to itself. 

Which leads us to another question: just what is the fair value of AAPL's "cash" if and when the company is actually converting it to real cash, and/or the bond market locks up due to the creeping wave of illiquidity, as so many increasingly fear.

And why is all this taking place in Reno, NV instead of Park Avenue or Wall Street? Because as we reported three years ago, Apple "uses Braeburn primarily in its capacity to find legal tax loophole all around the world and avoid paying taxes" and Nevada is perhaps the best state in the US where one can do just that.

Which also brings us to a tangential point: with only $22 billion cash held domestically, at a run rate of $10 billion in quarterly stock buybacks, AAPL will have no choice but to issue anywhere between $10 and $15 billion in bonds in the coming weeks since the company appears to enjoy a floor of about $20 billion in cash held domestically. All of this will continue at least until such time as the US allows corporations to repatriate the hundreds of billions held offshore without suffering a tax hit.

Perhaps the only question is whether AAPL's asset management unit will buy the bonds issued by AAPL's operating company used to repurchase the shares of AAPL's shareholders.

Until then: sorry Bridgewater, but you are still not hedge fund #1.

http://www.zerohedge.com/news/2015-07-23/worlds-biggest-hedge-fund-30-billion-bigger-bridgewater-remains-mysterious-ever

Japan Inc Rocked By Massive Accounting Fraud: Toshiba CEO Quits After Admitting 7 Years Of Cooked Books

While Abenomics has been an unmitigated disaster for Japan's ordinary population, where the soaring stock market has benefited the top decile of the population while everyone has been slammed by a record 25 consecutive months of declining real wages and soaring input costs, there had been one bright spot: corporate earnings, which unlike in Europe or even the US, have been growing at a steady double-digit clip. What was surprising is that Japan was perhaps the one place where currency debasement was leading to an immediate flow through to rising EPS.

Then on Friday, a report out of Reuters caught our attention when news hit that 140 year old electronics conglomerate, and "pillar of Japan Inc",Toshiba had inflated profits by a stunning $1.2 billion for a whopping 7 years, with fabricated figures amounting to 30% of the company's "profits" since 2008!

Suddenly we saw Japan's profitability "renaissance" in a very different light as Toshiba's scandal suggested that, if endemic,  Japan Inc's house of soaring profits was built on nothing more than fabricated foundations.

And while we await to see which other companies will admit they too had been cooking their books in the past few years, we will have to do it without Toshiba's CEO Hisao Tanaka, who together with five members of his senior staff, resigned earlier today.

According to the FT, "Tanaka said on Tuesday at a news conference, following a 15-second bow of contrition, that he “felt the need to carry out a major overhaul in our management team in order to build anew our company." “We have suffered what could be the biggest erosion of our brand image in our 140-year history."

Tanaka et al: "Sorry we got caught"

Of course, the only reason Mr. Tanaka apologized and resigned is not because he was actually cooking books the for an unprecedented 7 years, a period during which the CEO most certainly received tens if not hundreds of millions in equity and profit-linked compensation, but because he was caught.

We very much doubt he will have much if any of his generous bonuses clawed back even as "a panel of external lawyers and accountants said on Monday there was a “systematic” and “deliberate” attempt to inflate profit figures amid a corporate culture in which employees were afraid to speak out against bosses’ pushes for unrealistic earnings targets."

The panel said Mr Tanaka, who joined Toshiba four decades ago, and vice-chairman Norio Sasaki were aware that profits were being overstated and did not take any action to end the improper accounting.

The only action he did was bow down to suckers, aka investors, and offer a 15 second apology after which he was most likely on a one-way chartered flight out of Tokyo to some non-extradition island where his millions in ill-gotten comp will buy a lifetime supply of Mai-Tais.

As FT adds, the panel said Toshiba, which makes laptops, memory chips and nuclear reactors, "needed to revise its pre-tax profit figures by Y152bn ($1.2bn) over a seven-year period beginning in 2008, in addition to Y4.4bn in inflated profits estimated by Toshiba for three quarters of the 2014 financial year. The Y152bn accounts for nearly 30 per cent of the total pre-tax profit during the period."

Taro Aso, finance minister, said the scandal highlighted the need for corporate governance reform in corporate Japan. “We could lose trust in Japanese markets and the Tokyo Stock Exchange unless true corporate governance is in place,” he told reporters.

This is not the first massive accounting scandal involving a Japanese corporations: "the government has been seeking to improve investor confidence in Japanese corporate governance since 2011 when Michael Woodford, then Olympus chief executive, blew the whistle on Y117.7bn of covered up losses at the company dating back to the 1990s."

It won't be the last. In the meantime, investors are cautioned to take any numbers out of a country where cooking the books appears to be a daily occurrence with a huge grain of radioactive salt. Take the following example example of "dubious practices" as the company: during a meeting in December 2008 ahead of the third-quarter results for the financial year, the execs were told the operating profit forecast was a Y18.4bn loss, to which Mr Nishida said: “The figure is so embarrassing that we cannot announce it this coming January”. Accountants were forced to manipulate the figures to turn the forecast into a Y0.5bn profit.

The other executives who resigned are vice-presidents Hidejiro Shimomitsu, Masahiko Fukakushi, Kiyoshi Kobayashi and Toshio Masaki, and Keizo Maeda, representative executive officer. All were board members.

Yet despite the changes at the top nothing will change as the same culture of fraud and corruption that tainted the current executive team will persist in the future. The only question is who is next to admit that the only "working" aspect of Abenomics has also been a total fabrication.

http://www.zerohedge.com/news/2015-07-21/japan-inc-rocked-massive-accounting-scandal-toshiba-ceo-quits-after-admitting-7-year