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 []

Economics Explained for 6th Graders

I ran across this somewhat longish article at NakedCapitalism.com. Even if you are not a 6th grader you will find this interesting. In part, Andrew Dittmer, who in fact has taught 6th graders, our author,  points out that modern economics is based on certain assumptions that render  much of the application of advanced mathematics in economics false, misleading, yet amazingly resistant to criticism by non-economists exactly because of the use of obscurantist fog of mathematics.

One of these assumptions is that players in a market have “perfect information” – this is summed up in action by Wikipedia as “Perfect information would practically mean that all consumers know all things, about all products, at all times (including knowing the probabilistic outcome of all future events) , and therefore always make the best decision regarding purchases.”  There has been plenty of criticism of this concept even by economists, yet this concept is still embedded. Another assumption is that people will be rational and strive to achieve well-being. Again borrowing from Wikipedia, “well-being as defined by the utility function is optimized given perceived opportunities. That is, the individual seeks to attain very specific and predetermined goals to the greatest extent with the least possible cost. Note that this kind of “rationality” does not say that the individual’s actual goals are “rational” in some larger ethical, social, or human sense, only that he tries to attain them at minimal cost.”

Dittmer devotes most of his attention to Samuelson’s assumption “ergodicity”. As near as I can make it out this asserts that no matter what happens in the world, everything will reach a point at which things stop changing. This is the equilibrium point.  Kind of amazing. I will let you delve into Dittmer’s discussion. He is aiming at 6th graders so I only had to read through his article three times to get the gist. Maybe you will be quicker about it. Just keep in mind that these underlying assumptions are contributing to our current malaise. They have become the armamentarium of Wall St. and government bureaucrats.

Economics Debunked: Chapter Two for Sixth Graders

Religious Doubt Spreads – Free Flows of Capital Seen as Dangerous to Some

Money floating aroundThere is more evidence that the current run of religious mania about “free markets” is finally giving way to a more fact-based approach to this important human invention, many countries are now applying capital controls on the flow of monies into  their economies. The world flood of money seeking higher rent districts is terrorizing smaller economies like a tsunami. Fears of speculative bubbles burgeoning and then bursting with disastrous consequences for local economies are driving many to control inflows. Recently the NY Times posted an article about this phenomenon, “Countries See Hazards in Free Flow of Capital1.

“The world has learned about the perils of free market finance — global financial liberalization just does not work as advertised,” said Dani Rodrik, a political economy professor at the John F. Kennedy School of Government at Harvard. “Just as John Maynard Keynes said in 1945 — capital controls are now orthodox.”

Despite the obvious lessons of the last 4 years, “free market” advocates, just like religious zealots throughout history, remain undeterred by the facts on the ground. Financial firms ride along with this zealotry because its suits their business strategies to a T. Nevertheless, some governments, in the face of what must be enormous pressures from the world financial industry that profits coming and going in these financial boondoggles, are facing up to the facts and doing their best to take actions to control the impacts of markets on their local economies. Unfortunately for us in the US, we have no such governments. Ours are owned more than ever completely by big money, overwhelmingly by big corporate money and the super plutocracy of the super rich. They have always known that “free markets” is a wonderful religious cover their control over the real wheels of commerce and politics.

  1. By LANDON THOMAS Jr. Published: November 10, 2010 http://www.nytimes.com/2010/11/11/business/global/11capital.html?_r=1&emc=eta1# []

The Mortgage Debacle – Redux

The current tsunami of revelations of misbehavior, if not outright criminality, by the banking industry in their pursuit of mortgages gone bad, is further evidence of how fundamentally corrupt and cynical this industry continues to be. On the front end of this global economic disaster the financial system engaged in misleading sales tactics using financial products that were baroque in their complexities. Aided by governments seduced by the siren songs of free market religion and  floods of money to grease the ways, the industry expanded spreading its load of debt everywhere. Finally the whole Ponzi scheme collapsed under the weight of its own lust.

Now, in a further display that the people running these institutions have learned nothing, nor been disciplined by either market forces or governments, we are suffering through another round of their arrogance.

Time to call again for these institutions to be broken up. They are not serving the basic purpose of a banking system to supply credit. And, even after being bailed out at enormous expense, directly and indirectly to the general populace, they are again displaying utter disdain for the very laws and procedures that make it possible for the system of capitalism to function at all. Time to put some of these bank managers in jail for organizing and directing this massive fraud against the legal system and homeowners. Time to break them up to form a banking system that will both serve the needs of the economy for credit while not allowing any of them to be so large as to threaten the system as a whole.

But, who will do this? Obama’s administration seems strangely silent. But, given the continuing prevalence of Wall St. executives and their supporters in the Federal Reserve and academics in the administration this is not surprising. Similarly, the Congress, both houses, are still amazingly in thrall of the gods of the “free market” religion and money.

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 []

Do We Need Wall St. and all the other gamblers in the financial services world?

What Is the Function of Wall St.?

The global financial meltdown of 2008 – 2009 with its ongoing sequelae seems not to have definitively demonstrated the dangers of our continuing belief in the religion of “free markets” nor shaken, especially it seems in the Obama administration, our thrall with Wall St. and all things financial. We are seeing the combined effects of Wall St.’s funding of the Democrats and Republicans, the primacy of Wall St-ers in positions in government,1 and the tendency of the rest of us to want to beat the table and make wonderfully large profits (winnings). A deeper question here is what is the function and usefulness of gambling in the financial markets for our overall economy and society? Continue reading

  1. Obama did not invent this situation; Wall St-ers have held most of the important economic positions in the government for generations of presidencies. []

Controlling Gambling by Wall St. and the Big Banks – Bad for Business?

Anti-Wall St Does Not Mean Anti-Business

President Obama’s proposals to break up the “too large to fail” mega banks and otherwise reapply the Glass Steagall Act to the financial sector has predictably brought loud complaints that this is populist and anti-business. Even the rhetoric of the reporters and expert talking heads reflects a general bias that anything that we might do to prevent a re-occurrence of last year’s global financial meltdown is anti-business.

How Is It Anti-Business To…. or

Is the New Rule of Banking, “Privatize profits, but socialize losses (risk)”?

As a business person and a citizen I have to point out that having a sector of our economy that caused so much damage to the rest of the economy and citizens continue to conduct themselves in a fashion that is likely to cause a repeat breakdown is not a good state of affairs. How is it anti-business to want to control the gambling addictions of the financial services sector? How is it anti-business to prevent banks and other financial firms to become so large that they can place another call on the the nation’s treasury to bail them out because they indulge another round of gambling with other people’s money through dangerous leveraging? How is it anti-business to want the banking system to perform their primary function that is necessary to make the economy run, that is to take in deposits and make loans? Or, to capture this in a current diddy, we have an economy where for the financial services sector they follow this unique rule of crony capitalism, “Privatize profits, but socialize losses (risk)”.

How Is Gambling With Other People’s Money Good For Us? Continue reading