Tag: crash

High Frequency Trading and Deeper Questions about Capitalism

A recent PBS Newshour report by Paul Solman on Thursday 3/15/12 in his series “Making Sense of Financial News” gave pause concerning the role of high frequency traders (HFT) on Wall St. (and doubtless on other markets around the world). First, you might ask what are HFTs? These are traders who use computer-based algorithms to select, buy, and sell shares on the markets. The speed of these transactions and the “thinking” that is performed is driving the HFTs to locate in lower Manhattan as close as possible to the main Internet port in the city. The few microseconds saved by not being a half mile away on Wall St. turns out to have great significance to HFTs.

The existence of HFTs first came to public notice when the great “flash crash” took place. On May 6, 2010 at 2:42 pm the Dow Jones industrial average, already down by 300 points that day, suddently lost more than 600 poijts in 5 minutes. 20 minutes later the market had regained the 600 point loss. Investigations pointed to the role of HFTs in these events. Since then there has been a lot of discussion of the stability of financial markets and the potential role of HFTs.


The Solman report noted that HFTs represent 2% of all the firms trading on Wall St., but conduct over 75% of the transactions. So, when you here that volume of the Big Board today was 3.56 billion shares (3/26/12) 2.67 billion were traded by HFTS. Solman also noted that the average time a share is held is 22 seconds.

What seems strange is that the question of the function and utility of HFTs is never examined beyond economists trotting out the well worn explanation that they are providing liquidiity to the market. By liquidity they mean the presence of buyers and sellers in the marketplace when someone wants to make a transaction. But is this a serious claim in favor of HFTs? Does this incredible display of computing power really mean anything more than people gambling on a fractional move within a few seconds?

"Capitalism works for me! true/false" by Steve Lambert 2011

Now an aside. In a video presentation1 by Steve Lambert about his work, “Capitalism Works For Me! True/False” he notes that people seem perfectly at ease thinking about global warming and the need to undertake massive changes in the fundamental underpinnings of our world, but when it comes to our economy we engage in endless euphemisms and obfuscations. From his website he says:

“For 50 years it has been unacceptable, politically, in the United States to ask what is basically a straightforward question. We have a particular economic system, it’s called capitalism. We have every right as a society to ask of that system, is it working? Is it working for us? Do the benefits and the costs balance themselves out in a way that says, do we want to keep this system? Or that says, we want to change this system? Or that says, we ought to look at an alternative system. We’ve been afraid to ask that question. We’ve been afraid to have public debates—that’s the legacy of the cold war. We can’t afford anymore to not do that. We have to raise the question.”

To turn back to HFTs, why do we need this kind of transaction? How do they contribute to economic growth? These activities are by definition a zero sum game. They are like every other form of gambling a zero sum game. There are winners and losers, but no incremental gain for the economy. Other than enriching the HFTs at cost to others with smaller computers and fewer PhDs on staff what do we get for allowing these activities? Potentially catastrophic destabilization of financial markets? Where is the upside for society as a whole? Isn’t  a primary purpose of any economy to increase the size of the pie, not just to redistribute existing wealth?


  1. I saw this at the the de Cordova Sculpture Garden and Museum in Lincoln MA []

Free Markets – free? markets? – lessons not learned

“Free market” has always struck me as a rather strange phrase. Never more so than in this period of financial market disasters. The phrase ‘free market’ continues to be used reflexively. Just as commentators go right on speaking of Wall St. as a source of capital and innovation, few want to ask out loud why we need most of  Wall St.’s “services”; few people are openly using the most obvious words to describe these services as gambling; and, we go right on using this phrase, “free market” to describe an economy that is not free and in many sectors not a market. A recent exception to this are the comments of Ben Friedman, a professor of economics at Harvard, who said, speaking on the PBS Newshour1  of the continuing high percentage of our “best and brightest” going to employment on Wall St., “…it’s all the more troubling when I think that, after they leave us, so many of them go into activities that are not economically productive for the country, for society, even, just narrowly, for the economy.”

  1. http://www.pbs.org/newshour/bb/business/jan-june10/makingsense_06-04.html []

Book Review: Manias, Panics, and Crashes: a history of financial crises by Kindleberger

Manias, Panics, and Crashes: a history of financial crises, fourth edition by Charles P. Kindleberger (New York: Wiley 2000)

Manias,Panics,and Crashes by KindlebergerA recent Wall St Journal article described this book as a “must read” classic for anyone involved in financial markets. I have been involved directly in financial markets in two ways recently. First, I spent a year chasing around chasing angel investors and venture capitalists during the DotCom boom to fund Valuedge (the software company I co-founded in 1999 and left in 2004, though I still hold a large ownership interest).  Second, I receive quarterly statements for my 401K retirement investments. Primarily driven by my experiences with Valuedge and the phenomenal boom time of the DotCom era, I read through Kindleberger’s durable book (originally published in 1978 and never out of print since).

Although I have come to refer to the year 2000 as the Tulip Phase of Valuedge after the well-known Dutch tulipmania in the 1630s. Little did I know that financial bubbles, booms, and the inevitable crashes and depressions are a very common feature of capitalism. The first couple of chapters describe or mention dozens of bubbles and booms located around an amazing array of geopolitical centers. These have been focused on anything and everything: the well-known tulips in the 1630s; railroads; copper; English country houses; agricultural land; private companies going public (Britain 1888, US 1928 and IPOs 1998-2000); and many others.

The first lesson, then, is that booms and speculative bubbles are a commonplace feature of the capitalist world.

So, why do these bubbles and speculative manias occur? The answers are complex, involving human psychology, malfeasance, regulation (or lack), banks, and government. Read Kindleberger .

An important explicit message from Kindleberger is that economists’ models of “homo economicus” and “the market” are far from a useful mirror of what actually goes on. People are not even vaguely rational in their economic behavior and markets never constructively approach the model of a market found in Econ 101 or for that matter anywhere else that I have ever heard of.

This is not just an academic concern. In recent years our politics has displayed a dominant rhetoric that calls for the application of “market solutions” to almost every area of our lives, particularly those where traditionally we expect government to provide services, regulations, etc. Instead, we now reflexively think that “market solutions” are inherently more efficient and effective than government services. Liberals, trapped in their abandonment of even the moderate criticism of capitalism that the Catholic Church, for instance, engages, have provided no useful critique of “market solutions” as a universal policy approach.

At a practical level, this public policy fixation on “market solutions” combined with a generalized attack on all government spending, is driving a generalized impoverishment of the public infrastructure of our civil society and not coincidentally an enrichment of the wealthy and particularly the super-rich.

I recommend this book to anyone with an interest in the day-to-day political and economic life of the world.