The Players at the Table
In 1909 Mafia families all over America got some news: the Morello gang was selling counterfeit two- and five-dollar bills at fifty cents on the dollar. Eight years earlier fakes had gone at a sixty per cent discount, that is, at forty cents. Why the price rise? The quality had gone up. The new engraver did careful work, and the paper was chosen with care. Orders came in from all over the country. One Brooklyn banker, Dash writes, wanted to buy fifty thousand dollars’ worth of the product.
And then Dash adds a detail that anyone who has ever sold anything at a market will understand. The men who distributed the fakes didn’t often get the fixed fifty cents. As a rule, thirty-five at most. And quite often twenty or twenty-five. Though even that, Dash adds, was twice what other counterfeiters usually made.
The advertised price and the price a deal actually goes through at are two different things. That’s the first thing to know about any market.
Who’s at the Table
On a market, the seller and the buyer almost never meet face to face. Between them sits a whole crowd.
The broker takes your order and carries it to the market. The dealer, or market maker, keeps a stock of the goods and is always ready to buy from you a bit cheaper and sell to you a bit dearer. The difference between the two prices is the spread. That’s his bread and butter. The portfolio manager handles other people’s money and decides what to buy. The speculator bets on the price going up or down. Each one takes his cut. And each one, if you think about it, is needed: without the market maker you’d wait weeks for a buyer, and without the speculator prices would respond more slowly to news.
Orders come in different kinds too. You can tell your broker: buy at whatever price there is. You’ll buy fast, but maybe dear. Or you can say: buy at no more than such-and-such a price. Then you’ll buy only if a seller agrees. Or maybe you won’t buy at all. Morello’s couriers faced the same problem every time. Hold out for the advertised price and wait for a buyer? Or let it go cheaper, but today? More often they let it go cheaper. When your pocket is full of goods you can be arrested for, you don’t feel like haggling.
The Bookie as Market Maker
Who in our world comes closest to a market maker? The bookie. He takes bets on both sides and makes his money not on who wins, but on taking bets on both sides. If as much has been bet on one team as on the other, the bookie comes out ahead whatever happens: he takes his percentage. If the bets fall lopsided, he’s taking a risk, like a dealer with too much of one item in his warehouse.
Pistone writes that Lefty, a lifelong gambler, preferred to bet with private bookies rather than at the betting shops. The shops took a percentage of the winnings. The private ones took nothing on top and gave better odds. Without knowing it, Lefty was reasoning like a seasoned trader. He was looking for where the spread was narrower.
And the economist Peter Reuter, whom Critchley cites, explained why the Mafia’s illegal bookmaking operations almost always stayed small: thin margins, expensive credit, debts hard to collect, pressure from the police, and owners who are bad at making decisions. Sounds like any small dealer. Just without the police.
The Man Betting on a Fall
There’s a special seat at the table for the man who makes money when the price falls. He borrows shares, sells them now, and hopes to buy them back cheaper later, return them and keep the difference. It’s called short selling, or going short.
The first known short seller was Isaac Le Maire, one of the founders of that same Dutch East India Company. He quarrelled with the board and in 1609 put together a group that sold the company’s shares without owning them. And spread nasty rumours about the company while he was at it. The company complained to the authorities. Short selling was banned, the short sellers were given a year to close their positions, and many of them were ruined. Le Maire died a man of modest means.
Short selling is useful to the market: it makes the price take bad news into account, not just good news. But it carries a dangerous temptation that our world knows all too well. Whoever wins from a fall may want to arrange one. Morello’s people insured other people’s shops against fire and then set them alight. A pure short on someone else’s property. That’s why short sales are watched more closely than ordinary purchases.
And the short seller has a risk the buyer doesn’t. The man who bought can lose only what he paid. The man who sold short can lose any amount: the price can rise without limit. In October 2008 Porsche announced that it had effectively gathered up almost all of Volkswagen’s available shares. The short sellers had to give back the shares they’d borrowed. And there was nowhere left to buy them. In two days the share jumped from a little over two hundred euros to more than a thousand, and for a few hours Volkswagen was the most valuable company in the world. The short sellers lost, by some estimates, tens of billions of euros.
When the Market Makers Leave
And what happens when the table suddenly empties?
On 6 May 2010, in the afternoon, the American market fell almost a thousand points on the Dow Jones index in a few minutes, about nine per cent, and then won almost all of it back in about half an hour. Partly because a lot of market makers got scared. They pulled their real quotes and left only deliberately absurd ones—a cent, or hundreds of thousands of dollars—just to stay on the market on paper. Computer programs that traded at any price executed orders at exactly those quotes. The share of one big consulting company was worth one cent for a moment. One cent.
The good thing about a market maker is that he’s always ready to trade. Right up to the minute he gets scared. And that’s the minute you need him most.
The Don Keeps a Warehouse
Don Vincenzo was, in essence, a market maker in olive oil. He bought from the olive mill, kept a stock, sold to the restaurants. His bread and butter was the difference in prices. His risk was the warehouse.
He had an iron rule: three weeks’ stock, no more. Once the mill offered a good discount on a double consignment. I talked the Don into taking it. A month later the new harvest came in, prices fell, the restaurants were waiting for fresh oil, and we had old oil standing in the warehouse. We’d bought cheap, and we could only sell cheaper still. We sold at a loss. The Don didn’t shout. He said: “The spread is what you earn. The warehouse is what ruins you. Don’t mix the two up.”