High frequency trading: does it hurt the little guy?
I’ve already written about high frequency trading here, and I came out in favor of a transaction tax to slow that shit down a little bit. After all, the argument that liquidity is good so more liquidity is better only holds to a point – we don’t need infinite liquidity. It makes sense to actually have a small barrier to trade – you actually have to think it’s a good idea one way or another, otherwise you have no incentive not to do something dumb.
And as we’ve seen recently with Knight Capital, dumb things definitely are likely to happen.
It’s been interesting to see the media reaction. On the one hand, the Room for Debate over at the New York Times has a bunch of people discussing high frequency trading (HFT), and the most pro-HFT guy essentially says that the SEC should keep up technology-wise with these guys, and everything will be ok. That’s called living in a fantasy world.
More interesting to me was Felix Salmon’s post yesterday, where he rightly complained that, all too often, journalists dumb down and simplify reporting on these things, and then he proceeds to dumb down and simplify reporting on this thing.
Specifically, he complains that no “little guys” were hurt in Knight’s crash, even though the press is always looking for the little guy that gets hurt. [Side note: he also complains about the LIBOR manipulation not hurting municipalities, which is false, it did hurt them. He needs to understand that better before he dismisses it.]
But, if I’m not dreaming, Fidelity was one of the large customers of Knight that’s pulled out, and if I’m not unconscious, Fidelity manages quite a few of my many 401K accounts, as well as a huge proportion of the 401K accounts in this country. So it’s quite possible that my retirement money was part of that massive screw-up which is now owned by Goldman Sachs, not that I’ve been notified by Fidelity of any harm (but that’s another post).
As for small investors vs. little guys, there’s a difference. If you have enough money that you’re investing it through brokers, I personally don’t count you as small, even if you appear small to Goldman Sachs. So I’m not interested in whether the small investor was all that harmed by Knight’s meltdown, but I’m pretty sure the small investor was scared away by it.
But looking at the larger picture, I’d definitely say this is an indication of the outrageous complexity of the financial system, which most definitely is hurting the little guy, i.e. the taxpayer. This complexity is why we have the government guarantee in place, the Too-Big-and-Too-Complex-To-Fail banks and markets, and the little guy on the hook when things melt down. Moreover, there’s a direct line from that whole mess to the destruction of unions and pension programs, even if people don’t want to draw it.
So if you want to be myopic you can say that this was one firm, making one major blunder, and it’s self-contained and that firm is failing just like it should. But if you take a step back you see they were doing this as part of a larger culture of competition for speed and technology that they are so focused on, they threw risk to the wind in order to achieve a tiny edge over NYSE.
That laser focus on having a tiny edge really is the underlying story, and will continue to be, at the expense of risk, at the expense of our retirement funds trading for us, without regard to unnecessary complexity or, yes, the little guy, until our politicians and regulators grow some balls and put an end to it.