Flash Boys Doesn’t Ask the Important Question

Flash Boys cover by Michael Lewis

photo by Patricia Wall/ NYTs

The new book, Flash Boys, by Michael Lewis has reignited the discussion of how our financial markets are rigged by high frequency trading.1 From my 2012 note: 

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?

We should demand that our financial markets serve their fundamental purposes – connect investors with those who can deploy those resources to create new products and services and enable the flow of these goods and services. To call holding financial instruments whether stocks, bonds, or other assets for mere seconds investments is to beggar the mind. Government needs to step in to penalize economic activity that looks like gambling and certainly does not “grow the pie”. A sliding scale of transaction costs (aka a tax) could bring this to a screeching halt.2 There are sure to be complexities in how to implement such a strategy. But, if at every step we ask how a financial transaction contributes to economic growth at a systemic level, solutions will appear. Right now we have financial markets that are not only rigged but so complex and non-transparent that we are certainly setting ourselves up for future calamities like that which struck us in 2008.

  1. I have written about these issues earlier:  “High Frequency Trading and Deeper Questions about Capitalism” and “Wall St – not about investing but fixing the game” earlier []
  2. We would have to face the international crisis of how to employ all those PhDs currently engaged in the HFT wars []

Wall St – not about investing but fixing the game

playing cards courtesy of Chance Agrella, photographer

photo courtesy of Chance Agrella, photographer

An article in the NY TImes today reports1 that NY Attorney General Schneiderman is pursuing various information providers, Thomson Reuters in the immediate case, for their practices of selling market sensitive information preferntially. Those paying a premium get information several minutes before its release to the general public. This is more evidence that Wall St (standing in here for the financial sector as a whole) is largely a fixed gambling racket. Not much different than a casino. Continue reading

  1. Regulators Examining Early Sales of Financial Data http://nyti.ms/12hDF3t []

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.” Continue reading

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