Dark pools’ lifeguard

Jul 7, 2014 22:45 UTC

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“Insider Trading 2.0,” New York attorney general Eric Schneiderman’s war on high-frequency trading abuses, wages on. At the end of June, Schneiderman filed a complaint against Barclays over the activity of the firm’s dark pool, Barclays LX, which is the second-most active alternative trading system in the United States. Schneiderman is accusing Barclays of fraud, suggesting that instead of protecting investors in the dark pool from high-frequency traders (as advertised), the firm did the opposite, and actually “operated its dark pool to favor high frequency traders.”

A dark pool is a non-public place to trade, which is advantageous for big institutional clients because they can buy and sell in large blocks without the transparency of public exchanges. Big investors see this as a good thing, because they can trade without the interference of high-speed trading firms that have the ability to affect the price of the trade between the time a trade order is announced and when it is executed. (Here’s a longer explanation). According to Schneiderman, Barclays sold this narrative to institutional investors to get them to trade on Barclays LX. It then also invited HFT firms into the dark pool, and, to add insult to injury, charged the HFT firms lower fees than their other clients.

“Barclays was lying to customers. They weren’t protecting them — they were setting them up,” Columbia securities law professor John Coffee tells the New York Times. The larger worry, writes Matthew Phillips, is that if this sort of behavior is normal in other dark pools, this makes them “pretty much the exact opposite of what they claim to be.” In a story that includes the words “market structure nightmare” in the headline, Bloomberg’s Sam Mamudi and Doni Bloomfield write that “the action provided ammunition to those who say the stock market’s opaque structure mainly serves insiders.” After the complaint was filed, add Mamudi and Bloomfield, a number of institutional investors left the platform.

On the other hand, Matt Levine says that without HFT, there simply wouldn’t be a lot of trading in dark pools. “You can run a pristine dark pool without ‘predatory’ high frequency traders, and without much trading, or you can run a useful dark pool with high-frequency traders,” he writes. Regardless of the reason, Dominic Elliott says it is important to remember that “the growth of commoditised, electronic platforms has made [equity trading] less profitable,” and “dark pools may be one of the few lucrative areas left,” which is likely why Barclays moved so aggressively to grow its own.

Finally, this is perhaps neither here nor there (but still a wonderful twist): back in February, Barclays LX was awarded the title of “Best Dark Pool” at the Markets Choice Awards. Barclays’ head of equities electronic trading, Bill White, said at the time: “For us, the biggest theme of the year was transparency. It was an important topic throughout the year, and it remains a core element of our strategy.” — Shane Ferro

On to today’s links:

Dollar Bills
Post-BNP settlement, the French would like a little bit less global reliance on the dollar - FT

A crackdown on international money laundering also threatens legal remittances - NYT

“Monetary policy can’t halt the violence in Iraq or make it rain in California” - Bill McBride

Sovereign Debt Problems
Argentina’s “little vultures” - WSJ

“Economic entropy (money) is directly linked to thermodynamic entropy which is equivalent to information entropy” - David Galbraith
The case for more apprenticeships - Timothy Taylor

Truck drivers at the ports of LA and Long Beach are on strike indefinitely - Ned Resnikoff

Easing Ain’t Easy
There have been lots of failures in the repo market lately, possibly connected to QE - Liz Capo McCormick

The cell phone battery revolution we’ve all been waiting for… is still a few years off - Kevin Roose

Stuff We’re Not Linking To
The college dropout behind NYC’s most exclusive credit card

High-frequency news

Jun 6, 2014 20:55 UTC

Yesterday, Securities and Exchange Commission chair Mary Jo White gave a speech about the current structure of US markets. Her comments directly addressed the controversy over high-frequency trading (HFT) and dark pools (trading outside of exchanges) brought up by Michael Lewis’s book “Flash Boys” and New York Attorney General Eric Schneiderman’s recent series of moves to try to ban HFT. Lewis’s one-sentence summary of his book on a post-release interview: “The US stock market… is rigged”.

White, however, disagrees. The structure “is not fundamentally broken, let alone rigged”, she said. However, she did announce a plan to reform market structure. The two most concrete new rules require high-frequency traders to register with the SEC and operators of dark pools to let the SEC know how they match buyers and sellers. Sam Mamudi and Nick Baker at Bloomberg Businessweek note that “praise for White and the SEC was almost effusive yesterday from exchanges and high-frequency firms”.

Yves Smith is unimpressed, suggesting White is dragging her feet. What regulators have done all too often lately, Smith says, is “make sufficient noise about a problem so as to appear to be doing something, but take a generally Panglossian view of the current system and focus only on a few undeniable warts to as to appease critics”.

Of course that’s what she’s doing, says Matt Levine. This is just a reflection of the SEC’s worldview, which is essentially that HFT makes markets more efficient at the end of the day:

If you think that the current HFT business model is basically good for the world, then you will be hesitant to make fundamental changes to it. And if you’re the SEC, and you’re under a lot of Michael-Lewis-driven pressure to make fundamental changes to market structure, what do you do? Disclosure. You do disclosure. To be fair, disclosure is the SEC’s answer to most questions, but it’s especially the answer to questions that the SEC doesn’t especially want to talk about.

Whether or not you think this was the right move by the SEC, there is some question as to whether it even has the ability pull off enforcement of big changes in market structure. Georgetown finance professor James Angel told Bloomberg, “The SEC has so many irons in the fire and they are so under-resourced. The real question is can they actually do it?” — Shane Ferro

On to today’s links:

After six years, the US economy got its jobs back! (Sort of.) - Shane Ferro

Primary Sources
The economy added 217,000 jobs in May. Unemployment unchanged at 6.3%. - BLS

Some people think Uber is worth $17 billion, and maybe that’s not so crazy - Emily Badger

The week in charts - Matt Phillips

Crisis Retro
Larry Summers responds to Atif Mian and Amir Sufi - FT

If you are in your 20s and not rich it’s best to just assume you will never get to retire - Danny Vinik

Possibly Useless Data
The opportunity cost of Gangnam Style - The Economist

General Whimsy
“The gratifying moral is that getting rich in business qualifies you as a judge of literature” - Matt Levine

Big Questions
Why does a pack of peanut butter M&Ms weigh more than a regular pack? - NPR

MORNING BID – The Cleveland Administration in the market

Apr 2, 2014 13:43 UTC

It took the market a little while to get the full measure of the day’s biggest economic news. (And no, it wasn’t the shout-fest on CNBC that seemed to have resulted in the delaying of an IPO and one of the first real reckonings among many people about the ramifications of high-frequency trading.)

But it seems to have truly settled in now: Car sales were up big in March, to a seasonally adjusted annual rate of 16.3 million units. That’s better than expected, and it’s one of the first big data points that lends credence to the idea that there was a real constraint linked to winter weather that was the worst in about 13-14 years.

With all things market related, it’s the future that matters, and that’s what allowed the S&P to push past its most recent level for its first close in the ‘Grover Cleveland administration,’ as blogger Eddy Elfenbein pointed out, pushing past Chester A. Arthur for the first time (that’s 1885 – this is a bit too ridiculous to further, so I’ll stop here).
The gainers were once again, technology, with an odd mix of leadership between a few big momentum favorites turning it back around again (Priceline, TripAdvisor), and some older tech names getting a bit of a boost like Cisco Systems, helped by it being its ex-dividend day, and Hewlett-Packard, which is just sort of old.

And that kind of puts us at a crossroads. Michael O’Rourke of JonesTrading suggests we could see a breakout after a month of churning in this market, though it’s possible the day’s gains came from some beginning-of-month flows into equities as investors allocate funds in that direction. ETF flows per Credit Suisse show lots of money headed in the direction of large-cap stocks – $6.4 billion out of the $7.5 billion on the week – with the biggest outflows out of healthcare ETFs, not exactly a surprise given the selling in biotech last week.

Now then, on the high-frequency trading (HFT) issue. Felix Salmon points out that the fervor over Michael Lewis’s book comes at a time when HFT action has diminished somewhat and the money being made isn’t what it was a few years ago.  But critical mass takes a while on these things, and a Lewis book seems to have turned out to be a catalyst for discussions of both the fairness question and how it relates to the underlying technology: Is this skimming or the way these firms provide liquidity (though one would argue who has asked them to act as an intermediary in some of these cases).

It seems to have thrown a monkey in the wrench of Virtu Financial’s IPO as well, at least for the time being. The times have changed – when smaller shops were doing the bulk of this activity and hitting other banks in their prop trading operations, it seemed like it was in a weird area and the nebulous definitions of what HFT did in the market didn’t move anyone to act, despite books from the likes of WSJ’s Scott Patterson or others. Things seem to be moving another direction now — and the old defense, that the HFT world provides liquidity and is totally benign (or worse, the knee-jerk “free markets gotta be free” assertion), isn’t enough. Institutions may be the ones most affected, and the concerns people have are there even if, as Salmon notes, the idea that Greenlight’s David Einhorn qualifies as the “little guy” doesn’t quite pass muster.

US stock ownership: Fact-checking Michael Lewis

Ben Walsh
Apr 1, 2014 20:13 UTC

Before the flash crash, 67 percent of U.S. households owned stocks; by the end of 2013, only 52 percent did: the fantastic post-crisis bull market was noteworthy for how many Americans elected not to participate in it.

–Michael Lewis, Flash Boys, pp 200-201

Is this true?

There are four issues: (1) applying the percentages to “households”; (2) the percentages themselves; (3) the implication that the May 2010 flash crash caused a massive drop on stock ownership (rather than, say, the financial crisis of 2008-9); (4) the implication that the drop in stock ownership was elective.

(1)  is relatively minor.

The 52% Lewis references comes from a Gallup poll result that refers to “stock ownership among US adults”. That is, individuals, not households, although Gallup does include holding stocks “jointly with a spouse” as a “yes”.

Gallup doesn’t appear to track a household number, but the Economic Policy Institute cites a study that does (Wolff 2012). The share of households that own stocks is lower and less volatile than the share of individuals who do: it peaked at 51.9% in 2001 and was at 46.9% in 2010. Here’s the chart going back to 1989. The decade between 2000-2010 is marginally down, but in practical terms, essentially flat.households_stocks_1989-2010.png.536

(2) Looking at the Gallup poll itself, Lewis gets the results a bit tangled up.

He is right that 52% of US adults owned stocks in 2013.

But, per Gallup, 56% of US adults owned stocks in 2010, not 67%.

In fact, this poll hasn’t ever produced a “67% of US adults own stock” result. This data series peaked at 65% in May 2007. Here’s the Gallup chart:ydinxq9ege2qvofblcdlaa.gif

(3) The Gallup chart above doesn’t indicate any trend emerging or accelerating in 2010.

 What you see is that US stock ownership plugs along in the low 60s in the first half of the aughts, spikes in 2007, drops very rapidly in 2008-9, and then continues to decline at a slower but steady rate.

The main driver, therefore, would seem to be the financial crisis and the subsequent recession, not HFT.

(4) Here’s Catherine Rampell:

 Lydia Saad of Gallup suggests that Americans’ withdrawal from the stock market may be “more a function of their ability to buy it, than of whether its value is soaring,” and notes that high unemployment seems to correlate with low stock ownership rates.

It’s true that many Americans mistrust the stock market — but it’s also true that most of America hadn’t even heard of HFT before Lewis’s book came out. If they mistrust the stock market, it’s because of the 2008-9 crash, not because of HFT. And if they’re not investing in the stock market, that’s probably just because they don’t have any money to invest in the stock market, because their savings were wiped out in the crash. And not because they’ve elected to stay on the sidelines. After all, standard investment advice is to build up a cushion of roughly 6 months’ worth of expenses, in cash, before you invest any money in stocks. And the percentage of US households with 6 months of expenses in cash is much lower than 52%.


Mmm, my own personal experience was gradually withdrawing from the stock market due prior to the crash largely due to reading blogs like mlimplode and Barry Ritholtz’s Big Picture. Watching the housing bubble expand made me nervous. Hearing Greenspan testify that homebuyers should take greater advantage of ARM’s convinced me that those at the top had taken leave of their senses. Then the bubble hit and although I didn’t lose my job 2009 was hard, with weeks on furlough and a reduction in my hours. So, what little I had left I sold as I needed it.

So, yeah, I got out of the stock market mostly for economic reasons.

But after things stabilized, I stayed out of the stock market, and one of the main reasons for that was the notorious “Flash Crash”. When that happened I just lost whatever confidence I had left in the stock market. As P.J. O’Rourke quipped, when something is too complicated for you to understand whether or not you are being ripped off, you are being ripped off.

Financial “Innovation” will be the destruction of our economy.

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