Let’s stop talking about HFT for a little while
It’s unusual that I find myself in the position of defending Wall Street activities, but here goes.
I just don’t think HFT is that big of a deal relative to other Wall Street evils. I have written a couple of times about HFT and I’m not a huge fan, and I don’t buy the “liquidity is good and more liquidity is better” argument: at some point enough is enough. I do think that day-to-day investors have largely benefitted from it but that people whose money is in massive funds which are regularly traded have seen their money get skimmed every month. Overall it’s a smallish negative tax on the average person, I’d expect.
Here’s why HFT deserves some of our hatred: there’s way too much human resources going into this stuff and it’s embarrassing, what with the laying of cables and blasting through mountains and such. And it’s a great sociological look into the absolutely greed-led mindset of the Wall Street trader, but honestly I think we already had that. It’s really business as usual at a microscopic scale, and nobody should really be surprised to learn that people will do anything to make money that’s technically possible and technically legal, and that they will brag about how they’re making the world a better place while they do it. Same old same old.
So I’m not saying HFT is awesome and we should encourage more of it. I’m all for thinking about how to slow down trading to once a second and make it “more fair” for more players (although that’s hard to do even as a thought experiment), or taxing transaction to make things slow down by themselves, which would be easy.
But here’s the thing, it’s not some huge awful thing we should focus on, even though Michael Lewis is a really good and engaging writer.
You wanna focus on something? Let’s talk about money laundering in HSBC and now Citi that is not under control. Let’s talk about ongoing mortgage fraud and robo-signing and the ongoing bailout/ taxpayer subsidy and people still losing their homes, and the poor still being the targets of illegal and predatory loans, and Too-Big-To-Fail getting worse, and the direct line between the bailout and the broken pension promises for civil servants and the overall price list for fraud that has been built.
Let’s talk about the people who created the underlying fraud still at work in places like Bank of America, and how few masterminds have gone to jail and how the SEC and the Obama administration has made that happen through inaction and passivity and how Congress is sitting on its hands because of the money coming in from lobbyists. Let’s talk about the increasing distance between the justice system for the poor and the justice system for the rich in this country.
Tell me what I missed.
The HFT noise is misplaced and a distraction from the ongoing real story.
mathbabe 
Is it possible that the only reason that Lewis is talking about HFT now is that he has discussed many of the other items on your list in either Liar’s Poker or the Big Short, and he has to think of something new to talk about, irrespective of the new thing’s relative importance? From Lewis’ perspective, half the battle of being engaging is cherry-picking the story, after all.
Mick Jagger is obviously biased, but sometimes it is the singer, not the song.
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I think it’s a pretty good starting list. But I think the real horror is that our culture now exalts greed, and treats it not like a deadly sin but the ultimate good. That our culture says that if the poor weren’t such wretched subhumans, they’d have money like the shining demi-gods of wealth. That we now treat as a virtue skinning the vulnerable alive. And piously go to church with our peers on Sunday and drop coins in the plate to assuage any remaining guilt. The whole idea that there are “abundance ministries,” that claim to be based on the teachings of a propertyless radical reformer, puts the lie to the depravity of what we’ve become. And the relentless mining of not only the earth, but anything communal that had value worth stealing — which is lovingly called “privatization,” but is really just the tragedy of the commons on a global, all-encompassing scale.
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Yes, this sounds like Savonarola. And what is the solution?
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HFT Front-running is pure Pump’nDump, exacerbated by knowing ahead of time how to massively prime the pump, and when to do the dump. The perpetrators are criminals and should join dozens of deregulating bribers and scheming back-stabber Banksters in long-term prison.
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Lou Puis, you’re confused. HFT is all dump, but no pump. The end result of it is to steal a penny off your price but ensures the price you see is tightly correlated with other similar instruments.
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@mathbabe: I think you’ve got the general emphasis exactly right.
Though, I do think there are some big potential problems with market structure that could contribute to a systemic crisis (market fragmentation and the absence of genuine liquidity. They are not what Lewis focuses on.
@travelingact I loved Liar’s Poker and it did skewer to the culture (more on that below).but the Big Short was also kind of a side show to the crisis. Michael Lewis is obviously great at writing entertaining books and has been extraordinary at promoting this one (60 minutes and the NYT magazine cover) but since Liar’s Poker hasn’t really gotten to the core of the problems.
@Savonarola: Yes, the culture of greed is a big part of the problem. Anohter part of that is that we assume people who have amassed great wealth are also wise. So, we are looking to the billionaires to solve our problems (and run out cities and country). The two reinforce each other because the billionaires certainly believe they themselves are wise.
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Hi Josh,
I agree with pretty much all of what you’ve said, and certainly enjoyed your take on billionaire wisdom.
The idea I tried not so successfully to express was that we aren’t really seeing any genuine interest in HFT, we are just experiencing a ‘Lewis effect’ where people are talking about what an engaging talk show guest and interview subject promoting his book has to say, even though last week they hadn’t heard of it, and would normally find it dull. Better they talk about this minor form of Wall Street greed than not talk about Wall Street greed at all, as Oscar Wilde might have said far more elegantly.
No doubt Lewis is motivated to remain a bestselling non-fiction author, and chooses topics to maintain that status above all else. In particular I concur that as Lewis is primarily focused on the people within the story, he is unlikely to provide in-depth treatments of market structures or other systemic issues if there is any risk of losing narrative drive.
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Exactly! If companies want to compete in the exploitation of tiny and extremely short lived arbitrage opportunities, it may not be the most efficient thing for the economy but the market distortion is tiny compared to other objectionable behaviours in the financial world. And the fact that this is all supported by advances in computer and network technologies means that even though some new inefficiencies have become visible, they may be replacing worst inefficiencies and opportunities for unfair exploitation. Arbitrage opportunities must have been greater when prices had more than a few millisecond to drift away from fair prices.
Plus there are greater benefits to some of these investment in networking. I know a guy who designs internet backbone type of routers, and he says a lot of the R&D investments into better speeds and lower latency on the internet comes from financial clients.
If these guys weren’t pushing and investing in these routers, it’s quite possible that your online gaming and skyping would be slow and laggy.
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You are way more evangelistic than I am comfortable with.
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I agree that HFT is not the issue. HFT is all about tech arbitrage which only those with deep pockets can afford — by definition confirming that the system is inherently asymmetric, biased and unfair.
But I’m not convinced that reducing transactions to the second is a solution either. If some governance rule like that is introduced, instead of first come, first served, there will be a queue where, again, those with deep pockets will be able to buy their way to the front of the line, again foiling tattered notions of “free markets.”
To Josh’s point re the absence of liquidity, this does concern me, esp wrt HFT. Every extreme market move since Black Monday in 1987 has had issues with liquidity — liquidity “black holes” to be precise where prices dropped and demand, instead of rising as dictated by classic asset price theory, dropped as well — with both prices and demand going into a black hole of free fall.
Algorithmic HFT can be blamed for this recent and novel behavior. To the best of my knowledge, and other than circuit breakers, I’m unaware of any solutions for this major defect in our “free market” system. That is unless you’re shorting capitalism or subscribe to the views of those “free market” fanatics who consider such catastrophic events “cathartic” and systemically healthy as in “no one’s too big to fail.”
That said, is greed any worse today than it was 50 or 100 years ago? For those who would roll back the regulatory curtain to around 1900, the generally unregulated developing world provides broad cautionary tales re what that might look like…”wild, wild west” only begins to capture the despicable and virtually guaranteed outcomes. I submit that while there undeniably remains much that is wrong, corrupt and f**ked up today, the historic record and emerging market horror stories all suggest that things could be much, much worse…especially if the “free market” fanatics were running the show.
If anything, there aren’t enough regulations in this country. It would take a whole separate, book length essay to make the highly politically charged case that the lightly regulated economy that we have in this country has failed on so many fronts and in so many ways.
Pick any issue — health care costs, drug prices, transportation costs, the cost of internet access, book publishing pricing — and in all comparisons with international markets in the developed world, the US is paying multiples times more for the same or worse products and services — particularly in comparison with the much more heavily regulated, social democratic European countries.
This is not just criminal, it’s a complete betrayal of what American capitalism is supposed to be doing for us.
Enforcement at the federal level is something that comes and goes with the pendulum’s swing and the administration in office. So, well meaning laws enacted in response to political pressure or flush times are subsequently gutted during the anti-regulatory Reaganite eras of draconian and largely unnecessary budget cuts.
In the case of regulatory statutes such as AML, they seem to exist only for hand waving, window dressing and toothless non-enforcement possessing no real purpose other than to allow Congress to check off a political debt to the DEA and anti-illicit drug lobby.
The case can be made that all banks stand to make so much money from burying a drug cartel’s paper trail, that their AML units are charged with doing nothing beyond filing paperwork or, at best, the absolute minimum required for regulatory compliance up to but not including exposing any collusion with criminals.
This puts the burden of proof on hapless federal regulators and prosecutors to make a case…witness the years the Feds were required to spend in building an unassailable insider trading case against Galleon.
Then consider that the earliest signs of trouble concerning the most recent Downturn were not Shiller’s analysis of the real estate bubble or the FBI’s warnings in 2004 of a looming “epidemic” in mortgage fraud. It was the 1998 testimony of Brooksley Born, then head of the CFTC, who was quite vocal of the risks inherent in unregulated OTC derivatives and other off-balance sheet assets, particularly after the collapse of LTCM which, in large part, was a vindication of her position. Greenspan, among others, counseled her to remit arguing for stronger regulations, that sophisticated hedge funds were more than capable of regulating themselves. We all know how that turned out.
Is this Nash equilibrium? A case can also be made for this as well.
Sorry for the long post :)….
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I like the idea of taxing each transaction. We already live with sales taxes on all our other everyday transactions. We are seeing more states push for sales taxes on internet transactions. Wall Street is simply another trading arena which might as well be taxed.
But my background is Industrial Engineering and Quality Control. In Quality, we strive to understand and control variation as best we can. One major realization in Quality Philosophy is that every process has its variability, its random noise. The statistical controls are used to distinguish non-random variation (signals) from the process-characteristic random variation (noise). Reacting to random variation as if it is non-random variation, that is, mistaking noise for signal, is known as tampering and drives the system into greater variation. Every Quality Engineering bone in my body says that Wall Street trading on every bit of random variation must be driving the system into more variation.
Higher highs and lower lows may be good for traders, but it makes predicting future economic conditions very difficult for everyone from Mom&Pop to WalMart.
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I fail to see the benefit from having the same asset quote 2 different prices. With the degree of precision future economic condition are based on, nobody cares about a lag in 5 minutes. Most countries actually fail to know their past or present economic, let alone ‘predict’ it…..
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Thank you Cathy. I also find Lewis’ current discussion misplaced and spreading misunderstanding. It sells books, but it’s mostly incorrect, it’s not true. People don’t understand the subtleties of how HFT affects the markets – because they don’t understand what HFT really is and does, normal because HFT traders are notoriously secretive and the practice involves a lot of technology, besides most people have no idea how automated markets really work – but the money that’s being made there was otherwise before going into the pockets of brokers and there was more of it being taken from investors back then! There’s a genuine argument that can be made that gran-ma is actually benefiting from it because her mutual fund manager is able to rely on prices being in line and highly arbitraged products like ETFs and futures, and tighter spreads ultimately mean that the transfer of assets is cheaper, even if HFT shops are front-running fat orders. Technically, it *could* be seen as a just another cost of business: the price to pay for a market that is geographically aligned precisely is that of having parasites on the line taking a small increment of the price away from you: those same parasites are also the ones making sure the prices of fungible markets are in line with each other, that’s their function.
That’s not to say there aren’t a few real problems with HFT: 1) the cost of implementing the very most efficient entry/exit strategies is high because of it, because you’re competing with people whose bread and butter is just that – and they’re far better than your fund manager, and that fund management firm is likely to pass on those costs to you down the line – and 2) the liquidity that you see on the book is basically not really there, i.e., it will disappear or move away as soon (or before) any significant event occurs, and none of those firms are willing to put on any real risk. So unless you’re looking at a steady statement environment, the book is basically bogus. The aggressive orders are not reliable, and the big traders are not showing theirs on it either.
I like the idea of creating randomized and “slowed down” solutions, but I’m not convinced that the result will be more efficient for the utilitarian traders, and thus that the public would ultimately benefit from it. I think in the end we will see a large consolidation of all the small HFT shops into a few large ones who will eat everyone else – probably GetCo, Virtu, Tower, GS – but in the end, someone will end up fulfilling that function on the markets permanently.
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Actually Cathy, what your view on the old broker Direct Market Access (DMA) terminals connected to the Ex via leased T1/E1 or ATM say and this HFT situation? Somewhat different in access and function, but a broker with DMA will usually beat a punter using ETrade e.g. ? Like HFT you pay more for this terminal, but it could save the day under certain market conditions. I’m not defending HFT as personally I think it’s over the line, but the average punter has always been up against it since DMA has been available. Maybe I’m wrong, but would be interested in views on it.
Cheers
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“I just don’t think HFT is that big of a deal relative to other Wall Street evils.”
It is an obvious red herring. The dominant narrative is that if HFT is well regulated (by whom and how?) than the stock markets will once again become safe for the Suckers and Turkeys.
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Making the existing financial systems virtuous is an impossible task. HFT is but one manifestation of the lunacy which has evolved from the structural flaws in the economic system and it sits on top of a system which is inherently abusive and exploitative.
A Tobin Tax is not the answer either – a bandaid applied to a gangrenous limb.
One needs to get to the root causes of disease to find a permanent cure to the economic crises and remove the systemic incentives which drive inequality, wars and environmental destruction – the economic system.
http://freecriticalthinking.org/daily-pickings/913-critical-thinking-on-radtv
It’s the system not people which is causing problems and instability – people respond to incentives.
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