The logical answer is “stocks go up and down.” Let’s get more specific. Among the 20 largest asset managers at the end of 2009, ten were bank-owned, says consulting firm Towers Watson. The five largest – Blackrock, State Street, Allianz, Fidelity and Vanguard – are independents that pass the preponderance of their buying and selling through the biggest sellside firms on passive equity and ETF trading programs.

The banks behind ten of the twenty largest asset managers include BNP Paribas, Deutsche Bank, JP Morgan, BNY Mellon, Credit Agricole, UBS, Goldman Sachs, HSBC and Bank of America.

The top ten futures brokers for 2009 were Newedge (Societe General/Credit Agricole joint venture), Goldman Sachs, JP Morgan, Deutsche Bank, Citigroup, UBS, BofA, MF Global, Morgan Stanley and Barclays.

The five largest banks behind derivatives contracts, according to the US Treasury are JP Morgan, BofA, Citigroup, Goldman Sachs and HSBC and the top 30 banks control nearly 100% of this business.

The top prime brokers offering value-added trade-execution services to investment managers in 2010, according to Global Custodian, were Credit Suisse, Deutsche Bank, Morgan Stanley, Goldman Sachs, JP Morgan, BofA Merrill, Newedge, UBS, Citi and Barclays.

The twenty-odd primary dealers for the Federal Reserve’s security auctions include most of the banks mentioned here, from BNP Paribas, to MF Global (formerly hedge fund giant Man Financial), to UBS.

Tracking trading, we have observed big gains in equity program volumes for BNP Paribas, Newedge and Credit Agricole. Barclays, Goldman Sachs, Morgan Stanley and Credit Suisse dominate still.

Do you see the pattern? The same banks that manage risk also drive trade executions. The ones that underwrite futures and options also help money shift from equities to futures and options. The ones managing the movement of government money are behind program trading in equities.

And the rules, from how trades match, to order-types, to best execution, to order-routing practices, are uniformly decreed by the SEC. Risk-management requirements are so steep that just big banks qualify to handle massive globally sloshing cash.

Thus, the answer to our opening question is this: When investors buy and sell, their liquidity becomes a tool for trading tactics that may be the exact opposite of what the investors actually think about your shares. Liquidity flows to prime brokers in fragments that congregate into tributaries forming a mighty stream that meets execution requirements and fuels index arbitrage or relieves counterparty risk.

But it’s not fundamental. It’s a device controlled by the few who transfer risk from asset class to asset class.

As you head out this autumn fulfilling the IR tradition of traipsing to sellside conferences, don’t forget the small brokers, the boutiques. Maybe they will buck this monochromatic crowd.

Yet often, boutiques can’t execute trades for investors who buy and sell stock on merits. They may be unable to meet SEC best-execution requirements. So they route to Morgan Stanley, which rolls orders into programs to earn rebates from exchanges, while simultaneously fostering index-arbitrage schemes with algorithms for top clients.

If this bugs you, IR pros, read everything you can about how trading works now. Then tell your management. It’s a place where IR can shine. The rub inescapably rests with the well-intentioned but unfortunate rules that cause all the money to work the same and look the same and flow to the gigantic few.

To borrow the title of a Bob Saget HBO comedy special, “That ain’t right.” And it can change.

Debt chaos, sour economic data, sure. We’re not market prognosticators, we track behavioral data. Under the skin of the news at market level, institutions shifted to managing portfolio risk about July 21. These events were observable. Algorithmic execution changed, and we saw what started it and what followed.

Large diversified asset managers swapped out of equities. That means they assigned the risk in portfolios to others through agreements that traded risk for safety at a cost. Why not just say “investors sold to manage risk”? It’s not accurate and it won’t be reflected in settlement data.

Of course, hedging produces a range of consequences too. Those underwriting hedges themselves hedge the risk they assume. That prompts speculating in whatever instruments are being used to hedge the hedges. The idea is to offset every point of exposure – like double-entry accounting, a credit for every debit.

Consider the Treasurys market – the one in peril till today. Primary dealers ranging from Banc of America to Goldman Sachs make markets in Treasurys. Average daily trading volume in Treasurys is more than $500 billion. Bond trading in total in the US averages more than $950 billion daily and nearly 80% is government securities.

There is searing growth in Treasury futures and options trading, which increased by 48% in the March quarter at the Chicago Mercantile Exchange. The daily currency trading market averages nearly $4 trillion in notional value. The same firms that dominate equity program trading and the Treasury market – the biggest bulge-bracket firms – are kingpins in currency trading.

GETCO, which stands for Global Electronic Trading CO., says it focuses on “helping investors efficiently transfer risk.” GETCO is both a designated market maker on the NYSE floor and a global proprietary trader in multiple asset classes. GETCO is an example of the role intermediaries play now, whether liquidity providers or market makers. They move money fluidly from place to place so debits and credits offset in large institutional accounts, and risk diminishes.

This is what institutions were doing starting July 21. The effects of hedges to manage risk, and hedges to manage hedges, and speculation between, is now afflicting US equities. Daily dollar volume in US equities is about $100 billion, a fraction of some other asset classes. Reweighting portfolios to reduce risk by moving from assets to derivatives has a big effect on market value.

Which brings us to large traders like GETCO. The SEC issued Rule 13-h1 requiring large traders – those trading more than $20 million daily or $200 million monthly in NMS equities – to register. There is a fear that these large traders are culpable for market risk.

Yet large traders exist principally because SEC rules fragmented markets and turned them into automated, high-speed risk-transfer devices rather than places where capital is formed. The construct hinges on liquidity from large traders. And the SEC is now penalizing those participants, whose presence they encouraged.

And what about trading in currencies? Bonds? Treasurys? How about grey-market securities where NMS rules don’t apply? Imposing restrictions in one class without doing so in another will produce migration and regulatory arbitrage. And what’s to stop large traders from fragmenting operations into units that trade less than $19 million daily?

The rule is 179 pages long. There are exemptions. The SEC admits it lacks jurisdiction over certain foreign large traders whose countries’ laws prohibit disclosures the SEC seeks. They can apply for an exemption. In effect, the SEC will demand more disclosure from traders in the land of the free where privacy is sacrosanct than what many foreign jurisdictions allow. Take Brazil’s Latour – now #6 among program traders.

While not the intent, the effect may be that US firms are disadvantaged in their own markets by rules that don’t apply to international traders. What’s more, only firms that exercise discretion over funds can qualify as large traders. Large traders might contract with agency brokers and lease their algorithms to skirt the rule.

Rule of thumb: If your rule does not apply to everyone, scrap the rule.

And we will have accomplished exactly jack-zero in preventing nefarious behavior. We’ll have driven more competition from markets, created greater cross-asset-class risk, and stultified and constipated markets where rules are supposed to avoid impeding free function. And worst, we will have exacerbated the confusion, complexity and inconsistency crippling our capital markets.

We don’t embrace high-frequency trading. But another 179-page rule is no solution, and no help to public companies. The path to freedom and health is simple: junk the rule-structure that favors high-speed arbitrage. Reg NMS. We don’t need a national market system. Money could not arbitrage prices in multiple markets if the SEC didn’t demand that all the markets display their prices. I’ll be blunt: it’s crazy.

Imagine how markets would thrive if we blitzed this convoluted mess and started over with basic rules that everybody regardless of size or speed could follow.

Speaking of sharing personal details, Facebook is the biggest entrepreneurial deal of the current day. It’s also a focal point for the widening divide between public markets and growth enterprises. Facebook may or may not go public. If it does, much of its prodigious progress will already have been funded, and the public markets will serve more as a wealth-transfer device than a capital-raising tool.

It’s a microcosm for investor relations. Speaking of speaking, I’m at the NIRI Tri-State Chapter tomorrow for what I have assured my hosts will be a riveting exploration of how to be cool in an IR seat heated to silliness by transient trading. Hope to see you locals there, by sled, snowmobile or telemark!

Anyway, according to the stock-market newsletter Crosscurrents, the average holding time for institutional positions is now 2.8 months. “The theory that buy-and-hold was the superior way to ensure gains over the long term, has been ditched completely in favor of technology,” writes Alan Newman, its author.

If buy-and-hold is out, whither the IPO? Not gone, but gone gargantuan. Small companies can’t count on sustained sellside support. There’s no money in it for bankers. Instead, bankers grow private companies, then cash out by IPO and leave behind not what Peter Lynch called a “ten bagger” but a massive trading vehicle with limited real growth. To wit, GM. Do you really think that’s going to produce…growth?

Translate that to the IR job and attracting institutional holders to established stocks. Institutions want cyclical value opportunities now. That’s basically what it means when big money looks for stocks yin when others yang. But now it’s about things out of step with the market, not with fundamentals. Well, how much time are you spending on tactical investor-relations with money that passes in and out? You should rotate how you target value, GARP and growth money according to short-term cycles. Grouse if you like. That’s the tape and you can’t fight it.

Back to the wealth-transfer idea, Goldman Sachs has taken heat for giving prized clients chances to participate in Facebook equity ahead of a possible flotation that will transfer wealth from the folks who buy the IPO to The Chosen who were in before.

Something similar happens daily in equity markets. Many broker-dealers, especially trading intermediaries, facilitate “risk transfer.” GETCO, an electronic trader, says it “helps transfer risk in the most efficient way possible.” GETCO uses its own capital in trading systems to be in the right place to profit by helping institutions move from premium-priced assets to discounted ones (for fleeting periods). Say, from a basket of equities to a conclave of currency futures.

Behind the scenes, brokers in the wholesale counterparty market are swapping interest in all kinds of things, including the rights to returns in equities. Remember, the currency and derivative markets are magnitudes larger than equities, which are but a means to an end. Your holders are doing this, probably the very ones that seem never to budge off core positions.

Do you see the theme? Facebook forms capital privately, then bankers transfer risk from limited upside for the privileged to somebody else, such as small investors who still think equity markets work as they always did.

Same with underwriters – the sellside. They’re brokering risk and wealth transfers and profiting in ways they never imagined when information, patience and relationships formed the foundation for capital instead of divergence and risk-transfer.

What do you do to make your fundamentals stand out in this environment? Part of me thinks banks would fall all over themselves to help public companies create, say, Exchange Traded Notes representing only interest in your profit outperformance versus a select set of peer companies. Or maybe you create a tracking stock with exactly the same features as your primary shares, so that you offer traders both arbitrage and risk-transfer yourself. Then every year, you retire them or dividend out the tracking units to shareholders. It’s sort of beating transient institutional money at its own game.

On the other hand, that’s absurd. But that’s what reality is for now – absurd. The only real way to solve this problem is to remove the incentive behind $4 trillion daily in currency arbitrage. Stop letting currencies float – at least the dollar – and fix values, so company shares have lasting, buy-and-hold substance. If we’re just transferring stuff, something is out of whack.

The SEC thinks so. Continuing a raft of rules in response to the Flash Crash, the commissioners voted last week to restrict “naked access,” or trading at somebody else’s terminal.

Executives and IR professionals, you’ll get questions. Your shares are affected by these rules. What do you know about naked access, and is stopping it good?

SEC Chairman Schapiro likened naked access to “giving your car keys to a friend who doesn’t have a license and letting him drive unaccompanied.” But the term is hyperbolic. “Sponsored Access” is better. Traders pay owners of market gateways like seats on exchanges for access. The renters do it for a speed advantage, anonymity, to save money, and to reach liquidity. These were also reasons the same parties once used a specialist on the floor.

The SEC is targeting access perceived to lack risk controls. The fear is that today’s complex algorithms – which the SEC has proposed now to certify – might unhinge the markets by entering from an unguarded spot. It’s a gambit, because there are no documented incidents of problems from these sources. The Flash Crash occurred within regulated walls. Mini flash crashes among individual stocks have happened through risk-managed channels. Experience would suggest then that you not breathe easier.

Where is this access and who’s using it? The kind targeted here would appear to us to be occurring mostly at small floor brokers. There are few left of what used to be called “two-dollar brokers.” After regulations desiccated floor commissions some few remaining floor brokers adapted to the Reg NMS world of fast, anonymous volumes by sponsoring access through their seats. Trading data indicate that the biggest users are institutions beta trading around holdings and large risk managers adjusting asset allocations.

It’s too bad that institutions trade around positions. That’s a symptom of a bad structure, not a cause, however. Now, these participants will be forced back to big broker-dealers. The SEC doesn’t hinder sponsored-access big guns like bulge brackets UBS and Goldman Sachs. Likewise, dominating high-speed sponsors such as the Wedbushes and Pensons have in-house risk systems or outsourced architecture from firms like FTEN. In essence, the SEC has picked winners and losers by rule.

We suspect that big banks, whose proprietary trading has been outlawed by Dodd-Frank, might have lobbied for this concession. Drive business back to us, they could reason, and you regulators can couch it as a response to risk. Along with proprietary trading firms, big banks are crucial to transactional and data revenues at the exchanges, which have invested heavily in both technology and a regulatory structure reliant on high-speed trading.

As to risk, we’ve increased it. Weren’t these big banks our bane two years back? Now we want them preventing financial calamity on the fruited plain, with help from the folks who never saw Bernie Madoff. Fills you with warm fuzzies. We’ve expanded rules, compliance requirements and costs, while concentrating compliant behavior through fewer channels and infusing it with a false sense of security by shifting oversight to brokers from customers. We can’t pronounce caveat emptor anymore.

And instead of diffusing risk through a diverse and free market, we’ve knotted it up in a kind of regulatory nylon twine that will keep things together long enough to make the next inevitable rupture that much more spectacular and disastrous.

And we haven’t touched the end of stub quotes and how an 8% guaranteed range is a lot easier for transient automated systems to game than prices set by participants free to trade as they please. No time today either, for the Continuous Audit Trail, the full scope of the Market Access Rule related to naked access, or the Large Trader Reporting System.

Are we daft? Were we to parent by prohibiting any behavior with consequence, our children would be psychopaths. The society they’d form would exist in a bubble waiting for the oxygen to run out.

If you think Orwellian notions belong only on pages of fiction, then by all means say so. It’s easy to write to Chairman Schapiro (we’ll tell you how) and express your reservations that a market run by five commissioners, big TARP recipients and some proprietary traders is the kind to guarantee vibrant future capital formation.

A last note: Veteran readers know we’ve long inveighed about monetary policy commoditizing equities. There is a big QE inflation quotient. You can’t grow an economy by 2% and a stock market by 100% and lay the spread on future earnings anticipation. It’s inflation. So it’s good to see the grand chorus now calling it crazy. Trouble is it’s Brazilians and Germans, not our government.

A word on trading: We expected money to move after options expirations, but changes to program-trading plans came early, on July 14, we observed in the data. So with expirations July 15-16, markets were shellacked when money shifted to other assets. The past two days have given us massive arbitrage around this shift and ahead of tomorrow’s volatility expirations. Thus, the week could end on a rough note, we fear.

Switching gears, you’ve heard of Direct Edge? It came out of Knight Capital Group and has for many years operated Electronic Communications Networks, or ECNs, called EDGA and EDGX. One was for active algorithms, the other for passive black-box trading systems, in essence.

In 2008, Direct Edge traded Eurex, the operator of the International Securities Exchange, a 31.5% stake for the ISE Exchange. Started ten years ago, it was the first all-electronic options exchange, and it’s one of the globe’s biggest such, offering electronic trading in options for more than 2,000 equities, ETFs, indices and foreign-exchange products. Eurex is itself owned by the German and Swiss exchanges, the Deutsche Borse and the SIX. Direct Edge is partly owned also by Citadel Derivatives, Goldman Sachs and Knight.

With the advent of two new Direct Edge full exchanges tomorrow, EDGA and EDGX, the ISE Exchange will be blended in and discontinued.

Why does this matter to IR? You need to know what’s happening out there. Direct Edge routinely handles nearly a billion traded shares daily. Its platform best serves highly automated volumes in multiple asset classes. It commands about 12% of total equity volume. Its growth mirrors the explosion of global high-frequency trading in equities and other asset classes.

Like other trading innovators, Direct Edge sees growth opportunity in the evolving nature of trading. Both NYSE Euronext and the Nasdaq operate two options exchange each, and midcontinent rival Bats Exchange got approval in February this year for an options exchanges. Direct Edge hopes to offer simultaneous trading in many things – currencies, commodities, stock loans, futures, options, equities.

Why operate exchanges rather than alternative trading systems? It lowers clearing costs, expands data revenues from the consolidated trading tapes (exchanges get a better share than ATS’s), and opens doors to more products for traders.

For IROs, it’s a window into what’s behind price and volume. These are things you have to know now. Markets are fragmented and trading is spread across asset classes. It’s akin to the digital book market. Amazon is now selling more hardback books via the Kindle than in print. That’s how customers are consuming books.

How are customers consuming your shares? One big key to longevity in the IR chair is becoming the source of data and information about trading. We can’t control how traders use liquidity – but we sure can become expert at understanding how it works.

And from that knowledge comes the power to change markets. Or least understand them — and that’s both cool and valuable these days.

Meanwhile in Europe, Morgan Stanley launched a lending book for European Exchange Traded Funds (ETFs) today. Here is the key to understanding financial reform currently mucking up Congress. It encapsulates everything that’s wrong with today’s capital markets.

You may think we’re overstating it. Nope. This is the Grand Unified Theory tying all manner and form of derivatives together, and illustrating how high-frequency trading fits in this puzzle.

It’s not Morgan Stanley’s fault. The bank didn’t create the rules. The story today at UK financial publisher IFA Online about the ETF launch concludes: “Morgan Stanley says by providing a constant supply of manufactured inventory, ETF borrowers can benefit from lower borrow fees than current market rates, and greater availability of ETF supply.”

Broker-dealers under existing rules use a create-to-lend process with ETFs. They borrow shares of the underlying components of an ETF, then use that inventory to create new shares of ETFs for trading. Then those new ETF shares may be lent out for shorting, because the broker-dealer can pass through liquidity from the borrow market for the underlying securities – stocks comprising the ETF – to those shorting the ETFs. Voila, instant arbitrage opportunity.

This process increases liquidity, which is good, except that a market thirsting for liquidity has a value problem, not a supply problem. Supply-growth also spawns derivatives that have no underlying assets. That’s like a single batch of residential mortgage-backed securities carved into multiple tranches of collateralized debt obligations that don’t represent the full underlying value.

It’s also what happens with our money. Member banks of the Federal Reserve may use Tier 1 and Tier 2 capital to create money on their books in what is called fractional lending. That’s derivative capital – something for nothing. Similarly, dollars issued by the Federal Reserve in support of US-government backed obligations are derivatives disconnected from either the assets of the country or its productive capability to meet and service those obligations. Just like the CDO market that collapsed in 2008.

Now add in high-frequency trading. As TheStreet.com writer Don Dion observed in August last year, “Both bona fide market makers and proprietary traders are seeking out the fastest way to hedge trades, create units and maximize ETF trading capabilities.”

ETFs are assigned a lead market maker like Morgan Stanley, which fashions the first units and delivers the underlying mix of stocks to the sponsor in exchange for them. After that, it can sell shares of the ETF to buyers and hedge with equivalent mixes of underlying shares. By balancing out these two and fashioning more ETF units, then doing these same things at high speed, trading trumps investing and arbitrage becomes the goal, rather than capital formation.

Making money on the spreads between residential mortgages and their collateralized derivatives is a form of arbitrage. Do it a bunch and make a ton of money.

When the Federal Reserve issues debt obligations for the government and then increases the supply of cash, it is arbitraging the value spread between the earlier debt-denominated dollar and the later, cheaper version. When ETF creators and investors buy and sell the ETFs and the underlying securities, it’s arbitrage.

And when all these things are happening simultaneously, nobody knows the real value of anything anymore. No ratings agency can accurately assess risk because no single instrument represents the full picture.

The Federal Reserve, according to statistics at its web site, was counterparty to primary dealers for transactions totaling $12 trillion of US Treasuries and mortgage-backed securities in 2009 alone. It also says that trading in government obligations averaged $570 billion DAILY in 2007. The Fed provides no current statistics, but by comparison, daily dollar volume in NYSE and Nasdaq stocks combined is less than $100 billion.

If we want this something-for-nothing, derivative problem to stop in the private sector, the government needs to get out of the derivatives business itself, first. The very body wanting to regulate this activity is the one fathering it all.

That’s the Grand Unified Theory of derivatives. It’s the notion of creating something from nothing. Something for nothing subsumes our society, our markets, our financial instruments, and our currency. The chief propagator of this policy is the government itself.

This should get our attention across the spectrum of interests, from Left to Right. We can’t treat symptoms like Goldman Sachs and expect the disease to disappear. We need to rip out the root, which is, frankly, the Federal Reserve Bank, the limitless source of manufactured ETF-like paper from government. That’s the cancer killing our markets and pointlessly enriching banks.

The SEC last week sued Goldman Sachs for misleading investors about certain collateralized debt obligations during the subprime mortgage meltdown. We’re not a news rag so we won’t regurgitate the facts and accusations. We’d observe, as did a fine Wall Street Journal blog at Deal Journal yesterday, that the investors supposedly mislead were the world’s most sophisticated CDO investors, that Goldman lost money, and that the disclosures about these swaps that always require two parties with opposing expectations of outcomes were of monolithic proportion. Up to and including acts of God, everybody party to them knew the outcome could be good, bad or ugly.

Which leads to trading last week. Options expired April 15-16 when markets gyrated. Markets were up a hundred points the day before, April 14, then down a hundred points. Today, April 20, volatility futures expired, and short-term trades between stock and index options last week and volatility moves today could pay with little time decay or risk for the savvy trader. There was actually more fundamental buying on April 14, the up day, than fundamental selling on April 16, the down day, data indicated. It’s not always about the news. There is no better proof than what happens under the skin of the market with monthly expirations.

So what’s it mean? Market structure tells us that money thinks the Goldman accusation is hooey.  And speculators were taking advantage of disruption in the markets around expirations. It’s been a fantastic run in the markets since expirations in March when we told you that risk hedges were perhaps the largest we’ve seen. Traders bet big on equity gains from March 19 to April 16, and the move paid off. And the dip on April 16 had little to do with Goldman Sachs.

We promised examples about using market-structure analytics, so we’ll leave you with one. Before its analyst day recently, a large public company wanted to set expectations. We could see reticence on the part of active money to pay up for shares. Speculators were working hard to foster intraday trading ranges, which meant that investors had uncertain views (speculators often know). Thus, meeting expectations alone would be positive, despite high expectations this spring for outperformance.

The stock rose a dollar the following day. Real or Memorex? Often, traders create momentum around analyst days – not difficult in this age of anonymity and electronic trading. But data showed that real money indeed paid $0.75 cents more. Price held up even during the recent market pullback.

It’s darned cool in the IR chair not having to guess if your trading activity is real or noise. As is using that information to make management wonder how in the world you know the stuff you know.

Speaking of derivatives, the dollar retreated today, and US equities rebounded. We all want it to be about investing. Commentary everywhere today polished bullishness to an economic sheen. But that won’t make it reflect reality. Money keeps buying short-term love because the direction of the dollar is like a blacksmith’s bellows on equities.

Tomorrow starts three days of expirations. We saw speculative trading spike last week, while European money returned on Feb 10. Traders had already discounted Greece’s woes and had gone searching for alpha. There are too many reasons for traders to pursue global statistical arbitrage (and regulators keep giving them more). Translating, that means it’s fun trading similar instruments in opposing fashion in different places to profit on spreads and timing, and not much fun investing in stuff.

What changes that? Funny you ask. We want to hate banks. We’d like it all to be Goldman Sachs’s fault that our economy is bloated on derivatives. Those blasted Wall Streeters and their nefarious schemes, like borrowing money at 15 basis points from the Fed, then using it to buy Treasuries paying 350 points of interest. Taking TARP cash and trading with it. Manufacturing reserves and using them to float atmospheric notional value swaps for obscene fees.

All that may be true. But banks don’t set interest rates on Fed money. Banks don’t decide, “Hey, let’s go con the Fed out of some cash.” Banks don’t determine the size of the money supply. Banks don’t write reserve rules. No, while we’re all tarring and feathering sellside CEOs, the folks spraying gasoline on everything and playing toss-the-match can be found at the Federal Reserve.

If we don’t want our stock markets to behave like roulette wheels, we must stop playing with Federal Reserve house money, which is cheap and artificial – or shall we say, derivative. Primary dealers from Barclays to BofA march as the Fed orders. Don’t think those folks who OK’d 100-cents-on-the-dollar payouts to AIG counterparties are aw-shucks hayseeds who got jobbed. They knew what they were doing. We should be asking why, rather than railing at the foot soldiers. We may not like the answer, but it’ll be true.

Speaking of money, I personally put cursor to Excel workbook and tallied 2009 earnings before non-cash items and taxes for seven of the primary dealers – the eighteen big US, European and Japanese banks commissioned by the Federal Reserve to make orderly markets in dollar-denominated US obligations – and came up with $185 billion. With a ‘b.”

From whence came these profits? Who deployed cash in the capital markets? It wasn’t institutions and individuals. The US government deployed about $3 trillion. Lord only knows how much came from other global central banks.

Lesson of the day: Governments create money. Goldman Sachs is not responsible for it. Banks work with what they’re given. If they get a gigantic mountain of cash, you can bet they’ll work with it.

If we want more investing and less trading, we might dump all that snow on the east coast atop the Federal Reserve and put the fire out. Unless Whistler offers a better deal.

Everybody’s got an opinion on why the market is yinning and yanging. We, I believe uniquely in IR, look at market structure first. That is, we see the trading data and behavior, and then from it we ask, “Why did that happen?”

Most everybody looks at what happens and infers that these are the causes for market activity. But, here’s the thing: money moves for three reasons today – investment behavior, speculation, and risk-management. It’s easy to get it wrong from the outside looking in. Thus, we think there’s greater accuracy in drawing conclusions from the evidence than in applying the evidence to your conclusion.

We saw a large rift form in the equity markets on February 2. Trading and investing activities were subordinated to risk-management flows. These are orders managed by software systems that respond to instructions and data about market risk. It may have been prompted by Greece’s problems. Perhaps American jobs data, or central bank woes in Argentina, where inflation was 17% in 2009. Maybe something else.

But that would be looking in from the outside. Inside looking out, here’s what happened: Systems executing orders for defensive reasons rose up in mass. It’s like a crack in the continental crust that squeezes out the stuff that forms mountains. Except here, it was risk-management volume – both buying and selling – that extruded from the rupture. When it ripples through nearly every issue like a fault line, you may be fairly certain it’s macroeconomic, not about your stock or story.

In fact, from the completion of monthly expirations on Jan 20, to February 4, we saw strong indications of risk management trading. It was similar to what we observed on October 1-2 last year, when the markets nearly fractured, and akin to the “healing” volumes in March and April 2009.

There are certain entry points where these volumes can be found. Among them is Goldman Sachs. When GS appears with large volume increases in 80% of issues (but you won’t see it in trading volumes), it’s a curious thing, and it affects all other behaviors. If you try to isolate whether it’s buying or selling, it’s impossible. All programs do both. So it requires seeing the activity in relation to other activities in order to understand what form of behavior has changed conditions in the markets.

Goldman isn’t alone. In fact, most times these volumes hit the markets through “sponsored access,” one of the activities that the SEC considers a gateway for exploitation. We don’t know if that’s true or not. We do know that in three different significant instances in the past twelve months, sponsored access has helped the markets heal.

We call these events “synthetic weaves” in the markets, stitching up a gash in the market structure. It leaves big question marks. Who’s behind it? Where is the money coming from? Why does it buy and sell seemingly unrelated issues en masse? Is it helpful or hiding a chasm ahead?

We can posit ideas in response, but who’s to say? We surmise, however, that economic data are secondary to the supply and pricing of currencies. And we can think of only one force with that sort capital capability.

Why does it matter? It’s a great way to clear the crowd out from around the water cooler. People quickly go quiet and start glancing at their watches when you let drop “synthetic weave in the equity markets.” Also, it helps explain why your business isn’t properly valued by trading markets.

TRAVEL UPDATE: I’m in Kansas City today joining Joe Ratterman, CEO of BATS, and Jeff Albright, head of equity trading at Waddell & Reed, for a NIRI panel on how stocks trade. Thursday Jan 21, I’ll be at the NYC NIRI meeting with Professor Bob Schwartz of Baruch College, Jim Ross from NYSE Euronext, and Donald Bollerman of Nasdaq OMX to “demystify the markets.” See Events & Articles at modernir.com for more, and join us.

Last Friday, money moved from equities to derivatives as options expired. News perhaps influenced the shift, but on the whole, trading was a sum of reactions. These shifting sands haven’t changed much since June last year. Despite the reasons why not, we hoped for more rational enthusiasm in the New Year. Instead it’s more of the same. Money isn’t acting, it’s reacting. Market behavior is determined by other market behavior. There’s no goal to outcomes, except to adapt.

That part isn’t surprising. Capitalism is the profitable adaptation to change. Now, around the globe, the mortgage markets, the banking industry, a large portion of the automotive business, the insurance markets in substantial part, a growing portion of the health care sector, the breadth and scope of risk management, and the chief medium of exchange, the dollar, are defined by something other than profitable adaptation. What’s left is tick-by-tick trading. No wonder that’s what we’ve got.

Speaking of trading, Mary Shapiro said last week that the SEC may soon prohibit “naked access,” a somewhat voyeuristic term for renting out your courtside box seat at the equity market. It’s better termed sponsored access, because you’re using somebody else’s seat.

Shares today move at bionic speed. That renders ponderous trading moot at most times. It consigns small floor brokers and old-fashioned one-customer-at-a-time orders to the backwaters and eddies. So imagine you were on Main Street and all the big-box retailers in the suburbs emptied the town of customers. Then somebody came and said, “I’m going to run eighteen-wheelers down Main Street. I just need your store as a loading dock.” That’s sponsored access.

Sure, some sneaky forces use it. But the SEC is yet again regulating to capillaries to the harm of arteries. An example: KeyBanc Capital Markets, a full-service broker-dealer and money manager offering research and underwriting but no algorithmic trading, in October began using SunGard Assent for sponsored access, algorithmic trading and access to dark pools. Keybanc can’t compete on the trading floor. Assent gives them the access, speed, risk-management and trade-optimization tools they lack.

Assent itself is a product of market evolution. Assent was formerly Andover Brokerage, a provider of trading systems under the HammerTrade brand. We used to consider their volume proprietary day trading.

The SEC and others, including Goldman Sachs, think sponsored access might increase risks. If we have lots of it and the markets have behaved well, where’s the evidence? We have seen data that suggest to the contrary how sponsored access may have crucially forestalled a global equity retreat October 1-2 of last year. Risk-management, we observe, is often a primary purpose for sponsored access – not its biggest shortcoming. Sponsored access provides a means to move large liquidity fast and within market rules. This is essential to offsetting slippage in other asset classes when you’re managing risk.

Perhaps an exception will be granted for the Keybanc form of sponsored access. Yet, that’s the root problem at all levels – at least in the USA. We are about uniformity. That’s what “created equal” means. Our form of government is supposed to reflect uniform justice. Instead, it’s a gigantic collection of exceptions.

I’m moved to reference Section 15A-6 of the SEC Act. It’s for broker associations like FINRA, but the principle applies:

“The rules…are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information…to REMOVE IMPEDIMENTS TO AND PERFECT THE MECHANISM OF A FREE AND OPEN MARKET…to protect investors and the public interest; and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers…or to regulate by virtue of any authority conferred by this title matters not related to the purposes of this title…”

Perhaps the SEC should return to basics. The best way is not to do, but to undo.  IR professionals and the business of forming capital and fostering creative, productive enterprises would benefit. Investors would again find equity markets a place to leave money for the long term with an expectation of a return.