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â€śThe US stock market… is rigged.â€ť That wasÂ Michael Lewisâ€™ one sentence summation of his new bookÂ Flash BoysÂ on last nightâ€™sÂ 60 Minutes.
In an excerpt of the book inÂ the NYT, Lewis writes that around 2007, one of the Royal Bank of Canadaâ€™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 wasnâ€™t fair, and speed was the reason why.]
â€śHigh-frequency trading is a tax on investorsâ€ť, saysÂ Barry Ritholtz. Institutional investors pay a â€śskimâ€ť to HFT shops on every trade. Just how big the skim is is unclear â€“ Lewis puts the daily gains from US HFT trading atÂ $160 million, or about 0.07% of average daily volume of $225 billion â€“ but its very existence is, to Ritholtz, â€śprima facieÂ proof that something is amissâ€ť.
Matthew Oâ€™BrienÂ calls HFT â€śWall 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 nowâ€ť.
Josh BrownÂ isnâ€™t too worked up. Summoning his innerÂ Carl Schmitt, he points out that the intention of the founding of the US stock market in 1792Â was to create an exclusionary clique that benefited membersÂ and disadvantaged outsiders: â€śonce theyâ€™d seized control of all securities trading… they ran that shit like a powdered-wig mafiaâ€ť.
Matt LevineÂ thinks thereâ€™s a strong alternative to Lewisâ€™ narrative: â€śthe smart young whippersnappers build high-frequency trading firms that undercut big banks’ gut-instinct-driven market making with tighter spreads and cheaper trading costs.â€ť
One fascinating part about the debate over HFT is how unsatisfying the search for the victim is. AnÂ ex-Galleon traderÂ says â€śwe knew someone was stealing from usâ€ť. But the small investor, he says, is unharmed.Â Kid DynamiteÂ goes a step further: the little guyÂ actually wins because â€śHFT competition to capture spreads has resulted in extremely tight marketsâ€ť, and that means low trading costs for small order. The losers, are â€śbig boys â€“ traders executing big orders who leave big footprintsâ€ť.
Felix pointed out inÂ 2012Â 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 aÂ mild increase in trading costs. â€śThe real costs of HFTâ€ť, in Felixâ€™s view, â€śare found in fat tails and systemic risks and the problems that are endemic to ultra-complex systemsâ€ť. And Lewis misses those issues when heÂ focuses insteadÂ on “a false narrative that itâ€™s bad for the little guy”.
On to todayâ€™s links:
The IPCC report on climate change: things are bad and getting worse -Â IPCC
Euro area inflation falls to just 0.5% -Â Eurostat
“The recovery still feels like a recession to many Americans, and it also looks that way in some economic statistics” -Â Janet Yellen