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“The US stock market… is rigged.” That was Michael Lewis’ one sentence summation of his new book Flash Boys on last night’s 60 Minutes.
In an excerpt of the book in the NYT, Lewis writes that around 2007, one of the Royal Bank of Canada’s stock trading teams began seeing odd market behavior: quotes vanished as soon as orders were entered. Other big banks and hedge funds were having the same problem. In trader-talk, the market kept moving away from them, no matter what they bid or offered. High-frequency traders were milliseconds ahead, buying, selling, and, perhaps most importantly, canceling quotes faster than RBC. The market wasn’t fair, and speed was the reason why.]
“High-frequency trading is a tax on investors”, says Barry Ritholtz. Institutional investors pay a “skim” to HFT shops on every trade. Just how big the skim is is unclear – Lewis puts the daily gains from US HFT trading at $160 million, or about 0.07% of average daily volume of $225 billion – but its very existence is, to Ritholtz, “prima facie proof that something is amiss”.
Matthew O’Brien calls HFT “Wall Street at its most socially useless. HFT funds aren’t allocating capital to where they think it’ll be most productive. HFT funds are allocating capital to where they think other people will put it 50 milliseconds from now”.
Josh Brown isn’t too worked up. Summoning his inner Carl Schmitt, he points out that the intention of the founding of the US stock market in 1792 was to create an exclusionary clique that benefited members and disadvantaged outsiders: “once they’d seized control of all securities trading… they ran that shit like a powdered-wig mafia”.
Matt Levine thinks there’s a strong alternative to Lewis’ narrative: “the smart young whippersnappers build high-frequency trading firms that undercut big banks’ gut-instinct-driven market making with tighter spreads and cheaper trading costs.”
One fascinating part about the debate over HFT is how unsatisfying the search for the victim is. An ex-Galleon trader says “we knew someone was stealing from us”. But the small investor, he says, is unharmed. Kid Dynamite goes a step further: the little guy actually wins because “HFT competition to capture spreads has resulted in extremely tight markets”, and that means low trading costs for small order. The losers, are “big boys – traders executing big orders who leave big footprints”.
Felix pointed out in 2012 that while individual investors can now trade for historically low fees, the drop in execution costs actually pre-dates the rise of the algobots. And costs are so low right now, he says, that we can tolerate a mild increase in trading costs. “The real costs of HFT”, in Felix’s view, “are found in fat tails and systemic risks and the problems that are endemic to ultra-complex systems”. And Lewis misses those issues when he focuses instead on “a false narrative that it’s bad for the little guy”.
On to today’s links:
The IPCC report on climate change: things are bad and getting worse – IPCC
Euro area inflation falls to just 0.5% – Eurostat
“The recovery still feels like a recession to many Americans, and it also looks that way in some economic statistics” – Janet Yellen