Home > #OWS, finance > High Frequency Trading and Transaction Taxes

High Frequency Trading and Transaction Taxes

January 14, 2012

If you look at this list of the 20 biggest donors of the 2012 election, and you scroll down to number 20, you’ll find out stuff about Robert Mercer:

Robert Mercer is co-CEO of the $15 billion hedge fund company Renaissance Technologies. In 2009, according to the New York Daily News, he accused a builder of overcharging him $2 million for a construction project in his mansion—a “museum-quality” model train display “about half the size of a basketball court.” During the 2010 midterms, Mercer was outed as the funder behind $300,000 worth of attack ads targeting Rep. Peter DeFazio (D-Ore.). In the 2012 election cycle, he and his wife Diana have given $150,000 to the Republican National Lawyers Association and $100,000 to the free-market super-PAC Club for Growth Action.
Total giving for 2012 race: $384,100
• Giving to outside-spending groups: $260,000
• Giving to candidates and parties: $124,100

First, if I’m the model train set guy from above, I overcharge Mercer $2M and hope that he’s too embarrassed to sue me. And I am wrong.

Second, let’s look a bit more into the attack ads against DeFazio. Why is he spending so much time to work against this guy? Oh maybe this explains it. DeFazio was trying to impose a small transaction tax to curb high frequency trading, and Renaissance Technology, where Mercer works, makes their money through high frequency trading on the futures exchanges:

Capitol Hill Democrats introduced legislation today that would impose a tax on financial transactions in order to curb high-frequency trading and force Wall Street to contribute a bigger share to the federal budget.

A measure written by Sen. Tom Harkin, D-Iowa, and Rep. Peter DeFazio, D-Ore., would place a 0.03% levy on financial trading in stocks and bonds at their market value. It also would cover derivative contracts, options, puts, forward contracts and swaps at their purchase price.

So this is how politics works. As Sarkozy mentioned in this Bloomberg article where he was discussing imposing a similar transaction tax in France:

“If France waits for others to tax finance, then finance will never be taxed,” Sarkozy said today in a speech in the eastern French city of Mulhouse.

It seems like the Harkin/DeFazio transaction tax bill is still alive, for now. What’s so worrisome about it? To find out I registered to read this article from Investment News (registration is free), which starts out quite nicely:

Hark: Beware of Harkin tax plan

Investors, beware of the financial transactions tax proposed by Sen. Tom Harkin, D-Iowa, and Rep. Peter DeFazio, D-Ore. The tax may appear to have no chance of adoption at present, with the Republicans in control of the House and in position to block many proposals in the Senate, but the situation could change after the 2012 elections.

If Barack Obama retains the presidency and the Democrats regain control of both houses of Congress, we could see a tax on securities trades, especially if the passions evidenced by the Occupy Wall Street demonstrations remain high.

Woohoo! I love it when people are afraid of Occupy Wall Street, especially when they think they are only talking to their insider friends. After explaining the scope of the tax (again, 3 cents on 100 dollars), the article goes on:

In a breathtaking display of economic ignorance, Mr. Harkin declared: “This measure is not likely to impact the decision to engage in productive economic activity. There’s no question that Wall Street can easily bear this modest tax.”

Does Mr. Harkin not realize that customers, not Wall Street, would pay the tax? As opponents of the proposal argue, the proposed levy — effectively, a sales tax — would increase the cost of investing and be passed on to the ultimate customer, not absorbed by the brokerage firms, hedge funds and other professional traders at whom it is nominally aimed.

In effect, it also is a tax on liquidity. As anyone who has studied economics knows, when you tax something, you get less of it, so the result would be less liquid markets and more-costly transactions.

The article then goes on to warn that such a tax would move business offshore:

Finally, a transactions tax might drive trading and investing offshore to financial centers, such as Singapore or Dubai, that don’t impose such taxes. Academic research suggests that after the imposition of a transactions tax, market volatility would rise, while trading volume —and with it, liquidity — declined.

Just in case you’re not sufficiently worried yet, the article makes some further scary suggestions, which bizarrely allows for the fact that the current plan is benign:

Other dangers regarding the transactions tax proposal are that the low initial tax rate, 0.03%, might be absorbed by investors without too much pain, leading it to be raised quickly to a more burdensome and damaging rate.

That is what happened with the income tax in the U.S., and, more recently, with the value-added tax throughout Europe.

Another danger is that a transactions tax could be extended quickly to other financial transactions, including credit and debit card transactions, checks and bill payments. These likely would be even more damaging to economic activity.

The financial services industry should continue to resist the financial transactions tax, even at the proposed low rate. Once the camel’s nose is in the tent, the whole camel soon follows.

I asked a quant friend of mine what he thought of this article, and he said the following:

I’m personally not a huge fan of transaction taxes because I guess I feel trades should be encouraged (people should, for example, be able to have an S&P500 account instead of a checking account, where you sell units of S&P each time you buy some milk) and in general tight spreads means more actionable information (in the sense of knowing whether a bank is solvent for example, or allocating resources to build a new power plant). In addition, they are often avoided at some additional cost to investors. In the UK, they have a stamp tax on equities, and as a result only a few people trade equities, and almost all funds trade “swaps” with some additional arb/copmlexity added to the system as a result.

That said, the doomsaying in the article is definitely overboard. It would certainly wipe out a lot of HF trading, which is of limited value to society (I think HF does make for better pricing, but the resources put into it might not match the societal benefit of the slightly more accurate prices).

This would cause some trading to go offshore. In the UK for example, various regulations were (a small) part of the reason ManU decided to list in Singapore. The loss in capital gain taxes are from a bunch of sources, but one of the major ones is sure to be deferred sales, meaning the taxes would just be paid later.

It does make some sort of intuitive sense to match the costs associated with overseeing transactions paid for by the transactions though. If you feel that financial transactions are burdensome and need more regulation, the people who are causing that burden should pay. Whether that should be via a transaction tax or by a profit tax or by an exchange/regulatory fee, I don’t know.

(You know my bias, that it’s really the hidden transactions that are the main issue, and so I think if anything you should be taking financial intermediaries for having illiquid/non-tradable assets on their books rather than encouraging them to have more of it).

I’m left kind of rooting for the transaction tax, personally, and it’s not just because I want to see Mercer miserable; it can be seen as a tax that most people will not notice but people who make enormous number of bets will be affected by. On the one hand, this means it’s a truly progressive tax, and on the other hand, it means you will actually need to think a trade is worthwhile before making it.

Categories: #OWS, finance
  1. Emanuel Derman
    January 14, 2012 at 8:34 am

    I kind of like the idea of a small transaction tax too. You can have too much liquidity when you don’t need it and not enough when you do. (Admittedly though, there is a tendency for tax imposers to raise rates once people get used to it.) http://blogs.reuters.com/emanuelderman/2011/08/18/tobin-or-not-tobin/


  2. GB
    January 14, 2012 at 12:35 pm

    When I got my MS in Mechanical Engineering with a minor in Controls, one of my advisors, professor emeritus, would joke about using control theory to make money in the stock market. We all knew it was morally wrong, but exciting. So this is it. High frequency algorithmic trading, algo. 70%+ of trading is done by cyborgs. They have no remorse. The exchanges are complicit as they charge very high rent to lease access. Do you know how many trades happen each day? So if there are winners, which there obviously are, who are the losers? The losers are the traders who do not have this inside access, and rely on real market changes and their own canny. The cyborgs recognize and cut in front of them for fill orders all day, every day. On aggregate, it suppresses the economy and concentrates wealth.


  3. January 14, 2012 at 7:20 pm

    David Crisanti – a 25 year NYC Hedgie says – A Financial Transaction Tax Could Weed Out All The Pointless Trading ==>> http://www.businessinsider.com/a-financial-transaction-tax-would-get-rid-of-pointless-trading-2012-1

    His main point is that flash trading wastes human capital, for no apparent benefit. In my words that’s – physicists should be spending there time looking for where gravity’s hiding out,and rocket scientists should be getting us to another planet to loot and plunder 😉


  4. plm
    January 15, 2012 at 10:39 am

    Thanks for the post. I am totally new to thinking about financial regulation.

    Is there some sort of repository of such tax/regulation ideas for finance, accompanied by comments, pros and cons, and ideally (open) models justifying those comments? What are the best links?

    I find the whole topic quite beautiful because it looks a little like cell biology, financial regulation may be our “animal model” for more cumbersome regulations, because of how computerized and flexible it is. I have in mind experiments like quick enaction of short-selling bans. We have problems which we can attack with a variety of tools, which try to complement/compete with experimental checks.

    And in general, thanks for all the efforts of mathematicians (Cathy, other quants, economists, and hopefully some politicians too) to foster quantitative thinking about real politics. I think it’s the major challenge of current generations, to control ourselves, our interaction with nature, to write good laws. And I really think this is the mathematicians’ job. I hope that emotional reflexes toward justice will be replaced with the more humble attitude we have toward other complex topics. It’s a bit of a sacrifice perhaps. Now we don’t have as many wars in developed countries… and no need for much muscles!


  5. jeg3
  6. RTG
    January 16, 2012 at 5:10 pm

    Thanks for this post. I have actually had a few arguments with my husband about transaction taxes. He has long favored them, and I’ve been somewhat ambivalent. I’ve come around, though, to thinking that they are probably a good thing. Leaving aside for the moment the question about whether taxes should only be levied against actions we find undesirable or societally burdensome, in this case I think that there is an argument that high frequency trading (HFT) does have a net negative impact. In general, HFT is “justified” on the premise that there is a true price at any given moment for a particular stock, and the closer we can get to infinitely variable pricing (i.e. the time it takes for making a transaction going to zero) the closer we can get to “truth”. In reality, though, tails are fat (I admit to not being familiar enough with the underlying math to know whether this is a function of transaction times being finite or the inherent variability in stock prices…though I suspect it may be both). The idea of “true” pricing doesn’t have a lot of meaning compared to the types of distributions with which we may be more intuitively familiar. In fact, the reason there is money to be made off of HFT is that tails are fat…even if we call the most likely value the “true” price, it is statistically likely that it will often be overpriced and often be underpriced and the trick is to buy low and sell high. None of this requires making informed decisions about the underlying value of the stock, it only requires playing a numbers game. What HFT seems to miss, though, is that the pricing distribution shifts when many people are making these types of trades. This can cause shifts in the most likely price and have disastrous consequences for an individual company. While much of HFT may be harmless, in general it tends to divorce stock price from a company’s value which generally seems undesirable. On the other hand, it’s not actually the frequency of trading but rather this type of quantitative trading that’s the real problem…leading to my ambivalence about these laws. That said, a transaction tax to reduce this type of trading and its ability to skew markets may be the best solution to a difficult problem.

    Returning to the question of when taxes should be levied, it’s interesting that when new taxes are proposed the debate often centers around how a tax impacts behavior. Most people think that earning income and buying things are good for the economy, but we generally accept taxes on both of those activities. I’m not sure where I stand on whether tax policy should be used for behavior modification, but I do think it’s interesting how people approach the question…particularly in a society where the wealthiest portions of the population tend to earn the bulk of their income from financial transactions rather than from more traditional “work”.


  7. HFTer
    January 16, 2012 at 10:19 pm

    The SEC is already collecting a fee on equity and futures transactions — see http://www.sec.gov/answers/sec31.htm
    It does exactly what the quant friend proposes — have the people who do the trading bear the cost of regulating them. For equities, the fee of $19.20 per million dollars sold (let’s call it $10/1M traded for each party, or 0.001% per transaction) is deemed sufficient to cover that cost.
    One can certainly argue that the SEC needs to do more regulating and needs to collect more in fees, although I find it hard to believe that their equities-regulating budget needs to increase by a factor of 30. I can be easily convinced of the benefits of such an increase with an empirical study — define target metrics, split all listed stocks in two groups, flip a coin, increase taxes on one group, anyone? (I am not crazy, the SEC routinely runs pilot programs with subsets of stocks.)
    Sadly, the transaction tax discussions seem more bullish on “let’s stick it to the model-train-collecting financiers” than on models and data.


  8. April 23, 2012 at 3:10 am

    HFT is just a convenient scapegoat that allows the higher up Wall St figures to throw the geeks under the bus. This is what they always try to do since it allows them to deflect attention from the more obvious problem that is Wall St executive compensation. The asymmetric compensation structures (heads, I win, tails I break even) of investment banking cause systemic risk to the entire financial system and remain un-addressed. Even the staunchest of free-market proponents would find it suspect that traders and executives are compensated with a bonus if they succeed and no charge to their own income if they lose money (the difference of course being funded by government bailouts).

    The worst HFT can do is similar to what it already did — the Flash crash, which was arguably better than the problems of human psychology in October 1987 or 2008. Computers can behave irrationally if intentionally programmed to but the entire market of computer traders is less likely to develop irrational fears that will destabilize the underlying businesses or economy. Also HFT cannot ever need a bailout since it simply supplies liquidity, so again unlike humans it won’t be destroying Main St with “too big to fail” bailouts. In many ways the advancements of technology have improved the more corrupt natural psychology of humans, viz. the Internet, open source, Wikipedia, etc, and I view HFT as fitting into this benign order.

    Labeling it as a scapegoat is really a red herring to distract from the more evil human nature that gave us backroom deals, insider trading, inconvenient calls to brokers who had conflicts of interest and high commissions, etc, that everyone forgets were present a decade or two ago, and in the continued corruption ongoing today in Wall St executives.


  1. August 8, 2012 at 7:22 am
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