Felix Salmon

Capco: WTF?

Felix Salmon
Jul 31, 2009 14:35 UTC

Zachery Kouwe has a great article today about Capco, a highly-secretive Vermont-based insurer which looks as though it’s massively insolvent:

By some industry estimates reviewed by the insurance department, Capco could face nearly $11 billion in claims but has only about $150 million with which to meet them. The state is examining whether the company sold policies without the means to cover them, according to a person with direct knowledge of the inquiry who had signed confidentiality agreements.

Capco was in much the same business as AIG Financial Products: selling insurance against the end of the world. Such businesses tend to be extremely profitable most of the time, and then blow up spectacularly. The question is who on earth would ever buy such insurance, given that the chances of ever getting paid out are slim indeed. The answer? The same people who own the insurer!

Capco was created in 2003 by Lehman and 13 other banks and brokerage companies as a kind of marketing tool. The pitch was that while Capco would not insure customers against investment losses, it would compensate them if the firms failed. Capco promises to provide virtually unlimited coverage above the $500,000 offered by the Securities Investors Protection Corporation and its equivalent in Britain…

Capco, which is private, is something of a financial mystery. Its members include Wall Street giants like Morgan Stanley and Goldman Sachs, banks like JPMorgan Chase and Wells Fargo, smaller brokerage firms like Robert W. Baird & Company and Edward Jones, and Fidelity, the mutual fund giant. Capco was initially registered in New York but later moved to Vermont, where state law enables it to operate without disclosing much about its finances…

It’s unclear who actually serves as the current president of Capco, and the company’s main phone number connects to a recording that tells callers they’ve reached a “nonworking number at Morgan Stanley.”

It seems that these banks’ clients essentially got their Capco insurance for free, which is lucky, because it wasn’t worth anything. But that doesn’t mean they won’t go after Capco’s owners if the insurer fails to pay them what they’re owed. One thing’s for sure: a lot of lawyers are going to get a lot of work out of this fiasco.


Konnie, your end-run comment says it all. Might add ‘ruse to circumvent the law’. Why bother with due process when this one shoud just be taken. No lawyers, just marshalls and vacuum cleaners.

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Solving the HFT problem: Abolish continuous trading

Felix Salmon
Jul 31, 2009 13:40 UTC

Michael Wellman has an intriguing idea for solving all the issues surrounding high-frequency trading at a stroke: switch from a market with continuous clearing to a market which clears once per second.

Orders accumulate over the interval, with no information about the order book available to any trading party. At the end of the period, the market clears at a uniform price, traders are notified, and the clearing price becomes public knowledge. Unmatched orders may expire or be retained at the discretion of the submitting traders.

Even with a period as short as one second, the call market totally eliminates any advantage of HFT systems. It does not eliminate the opportunities for algorithmic trading in general–just those that come from sub-second response time. No party has privileged information about order flow, and no party benefits by getting a shorter wire to the “trading floor”.

According to Wellman, there would be other advantages to discrete-time trading too, including lower volatility.

Would this plan essentially give everybody in the market the advantages of being in a dark pool which only exists for one second? On its face, I think it’s a good idea. What would the downside be?


The downside to a call market would be you would pay higher spreads. Instead of the spread going to competing HFT dudes who drive prices down, it’s going to go to someone else. If your goal here is to strangle companies like GETCO and Goldman, you will fail: they’ll probably make more money, as they’re best positioned to do so. Dark crossing ain’t all that dark if you know what you’re doing.

I don’t see what all this emphasis on “fair” is. It’s not fair the consumer has to pay more for market access than a dealer. It’s not fair the consumer doesn’t have a team of 20 Ph.D.’s to make his trades for him, or transparent access to dark crossing networks, or even what the difference between a limit and fill or kill is. If you want to understand this “controversy” you need to understand who started it. The people who started it are the buggy whip manufacturers of the digital trading age. They want to go back to staring at technical patterns and yelling into a squack box like liquidity providers did in the 80s.

Thursday links go back to where they started

Felix Salmon
Jul 31, 2009 02:48 UTC

I don’t think that “laughably simple” means what you think it means, Mr Hume

Goldmanites: Good to each other, bad to everybody else

I have a Kindle, and I like it, and I also really liked Nicholson Baker’s take-down of it.

We prefer advice from a confident source, even to the point that we are willing to forgive a poor track record.”

Always call a coin to land in the position it started in

Curse you, birch pollen!

Heidi Moore delivers 2000 words on the culture of Goldman Sachs, under the hed “Will Everyone Please Shut Up About Goldman Sachs?

I’m sure there’s no shortage of qualified people willing to do this for free, or very little money. Why not use them?

Behavioural Economics 101: What to do with the olive pits

Merciless WSJ takedown of… cheap Australian Chardonnay?

The “theory of local truth” as explained by a Chinese Internet censor


Regarding the Heidi Moore article, isn’t it strange that the ‘Goldman culture’ that is supposedly their huge advantage, sounds amazingly like a socialist styled company. Ideas and arguments being open and shared, not quashed and ignored; monies being spread around instead of hoarded; pride in ‘the system’ over individuality… if true, then crazed neo-cons beware – your great champions of capitalism are Commies! HAHAHAHAHA! Wonder how that will go over if anyone reads this…?

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Bringing my bike into my building

Felix Salmon
Jul 30, 2009 21:23 UTC

The good news is that the bikes-in-buildings law passed yesterday, by 46 votes to 1, and will come into effect in 120 days’ time: Ben Fried calls this “the biggest legislative victory ever achieved by bicycle advocates in New York City”.

But does this mean my battle is won? Not necessarily. Before the building needs to open up its freight elevator to my bike, my employer — Thomson Reuters — needs to file with the landlord a formal “request for bicycle access”:

The tenant or subtenant of a building to which this article is applicable may request in writing, on a form provided by the department of transportation, that the owner, lessee, manager or other person who controls such building complete a bicycle access plan in accordance with section 28-504.3. Such request shall be sent to the owner, lessee, manager or other person who controls such building by certified mail, return receipt requested, and a copy of the request shall be filed with the department of transportation.

You can guess what happens after that — suffice to say that it’s a very bureaucratic process. But in any case I now need to work out who at Thomson Reuters is even authorized to file such a request. And then I need to work out how to get them to file it. And then I need to whom to talk to about finding an out-of-the-way corner of the 18th floor which I could use to store my bike during the day. My guess is that a best-case scenario has me happily wheeling my bike in to my office at roughly the same time that New York temperatures drop well below freezing. Ah well.


Felix, be bold: Fill out, sign, and send the Bicycle Request for Access yourself.

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Annie Leibovitz, subprime borrower

Felix Salmon
Jul 30, 2009 21:06 UTC

Gawker’s John Cook has the 17-page complaint which Art Capital Group has lodged against Annie Leibovitz, and it makes for compelling reading, even though the really juicy stuff — the commissions that ACG has decided to pay itself on the sale of Leibovitz’s photographs and real estate — have been redacted.

In a nutshell, Leibovitz borrowed $24 million from ACG, at what on its face looked like a reasonably attractive interest rate. (It was 275bp lower than the $22 million line of credit which it replaced.) But in doing so, she allowed ACG to go ahead and sell the rights to every photograph she has ever taken — and every photograph she’s going to take through at least 2011 — as well as her homes in Manhattan and Rhinebeck. When ACG makes those sales, it first pays itself a commission on them, and then it repays itself the money it’s owed. Only then does Leibovitz get any money left over. As a result, ACG’s total profits on this deal are likely to be substantially larger than its headline interest rate might indicate.

Leibovitz, however, isn’t playing ball. She’s not allowing real-estate agents into her homes so they can be sold, and she’s even signed an agreement with Getty Images allowing them — and not ACG — to represent her for “a special multi-assignment collaboration”. Hence the lawsuit.

Here’s ACG, in its complaint:

Defendants have stated that they will not cooperate with Plaintiff in any sale of the Fine Art Collateral, which is nonsensical given that Plaintiff obtained an appraisal for certain of the Fine Art Collateral which exceeds the loan amount and, if sold at that amount, would not only allow Defendants to satisfy their loan and other obligations to Plaintiff and its affiliate, but also allow Leibovitz to earn a profit, and to obtain financial comfort and financial stability going forward.

The implication here is that ACG can sell the Leibovitz photography rights for a sum well in excess of $24 million, pay itself commission, pay off the loan, pay off the “other obligations”, and still have enough left over to keep Leibovitz in “financial comfort and financial stability”. Her homes wouldn’t even need to be sold at all.

And the alternative? Well, there really isn’t an alternative. Even if Leibovitz had the cashflow to service the loan, which is doubtful, it comes due in September, and she certainly doesn’t have the money to repay the loan. And she can’t borrow the money from anybody else, because ACG has a lien on all her real-estate and intellectual property.

Leibovitz clearly isn’t happy with this state of affairs, but she’s got herself into it, and now she has no choice but to go through with ACG’s scheme to sell off all her intellectual property. I’d advise her to start cooperating, since that’s her only chance of keeping her houses. On the other hand, Leibovitz does have some leverage over ACG:

“The agreement with her was that we’d they’d go out and sell it for more than $24 million,” says a source close to Art Capital. “And now, she’s not making herself available. Any likely buyer would say, ‘Gee, can I meet with Annie?’ I don’t think anyone would buy it if they don’t feel they have a cooperative seller.”

Which leaves ACG in a difficult position: they have something very valuable, but Leibovitz is making it impossible for them to monetize it. I’m not clear what purpose a very public lawsuit against Leibovitz serves in this context. And I’m definitely not clear why they’re talking to Gawker. But at this point it’s obvious that things are going to be very ugly between the two sides for the foreseeable future.

Update: So this is interesting. ACG’s flack, Montieth Illingworth, just pointed out to me that the quote I had from Gawker was incorrect: if you go to the page now, it clearly says “they’d go out and sell it” rather than “we’d go out and sell it”. But of course I just copy-and-pasted: originally, the word in the quote was “we’d”. It seems that Cook has changed his quote, without noting anywhere in the post that it has been changed. What’s going on?

I believe Illingworth when he tells me that neither of ACG’s principals, Ian Peck and Baird Ryan, spoke to Cook, so the quote can’t have come from either of them. Which leaves I think three possibilities:

  1. The quote came from Illingworth, which is how he was able to have it changed so easily: maybe Cook broke a verbal agreement about quotes being on background or attributable to ACG. Illingworth did talk to Cook before the piece came out, but is adamant that the quote didn’t come from him.
  2. The quote is genuine, and came from one of ACG’s advisers — a banker or lawyer, most likely — who reflexively used the word “we” but who was certainly not authorized to talk on ACG’s behalf. When Illingworth complained to Cook about the quote making it sound as though Peck or Ryan were talking to Gawker, Cook changed it.
  3. Cook made an honest mistake, and wrote “we’d” where his source had said “they’d”, and realized his mistake after Illingworth called, and quickly corrected it.

The main thing I don’t like here is the way in which Gawker changed their item after it was published, with no indication that they had done so. Blogs make errors all the time, and then correct them, publicly. They don’t go back and erase their steps, trying to make it seem that there never was an error in the first place. Or, at least, they shouldn’t.

Update 2: Annie Leibovitz has released a formal statement:

The claims in the lawsuit are false and untrue. This is part of Art Capital’s continued harassment and attention-getting efforts. There has been tension and dispute since the beginning. Annie is in the same shoes as many other people involved with Art Capital. For now, her attention remains on her photography and on continuing to organize her finances.


Felix, would love the answer to Gingeryellow’s questions, which none of the news reports have addressed: What does a private individual, busy at work and busy at home with three children, need $24 m. for? And why did she not hire a competent studio manager to organize her finances?

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Newspaper self-cannibalization datapoint of the day

Felix Salmon
Jul 30, 2009 19:29 UTC

Walter Hussman, the publisher of the Arkansas Democrat-Gazette, adds an interesting datapoint to the question of self-cannibalization in the newspaper industry:

Hussman, an early pioneer in newspaper paid online content and frequent speaker on the topic, said his newspaper now has about 3,400 online subscribers who pay $5.95 per month for access to everything on the Web site. Non-subscribers still get a significant portion of online news – including some blogs, multimedia, AP and others – but not everything.

Hussman said the paid content online generates just one-tenth of 1 percent (0.1 percent) of the newspaper’s total revenue. But the newspaper has been very successful in keeping print circulation up in part because the newspaper is not giving all its content away for free. The Democrat-Gazette’s daily circulation is up 3,000 to more than 176,000 over the past 10 years, while other newspapers in the Southeast are down (some significantly). Sunday circulation for the Democrat-Gazette is down just 1 percent in 10 years.

A USC-Annenberg study this spring (the Annual Internet Survey by the Center for the Digital Future) reported 22 percent of survey respondents said they stopped their subscription to a printed newspaper or magazine because they could access the same content while online.

My general opinion on the subject of self-cannibalization is that you first need to get past the natural hubris of newspaper publishers. Yes, there is a degree to which print and online versions of a newspaper compete with each other. But there’s an even greater degree to which a print newspaper competes for its readers’ attention with the entire rest of the internet. If you put your website behind a subscription firewall, there’s no shortage of other content which your readers will happily consume for free.

That said, Hussman has a point: in terms of reader psychology, newspaper subscribers lose a free excuse for not renewing if you create an online firewall. If the paper is available online for free, they can say “I’ll just read it online” — even if they don’t. But if they have to pay for it online, they realize that in order to read the content they’re going to have to pay for it somehow, and if they’re paying a subscription fee anyway, they might as well get the paper delivered to their door, like they’re used to.

I’m interested in Hussman’s online subcription level, too, or $5.95 per month: it’s higher than I would have guessed. The obvious model to use is the magazine subscription model: sell subscriptions at $10 or $12 per year — the minimum possible level at which advertisers really value your readership, on the grounds that you make much more from advertising than you do from subscriptions. Advertisers will pay a premium to reach paying subscribers, but they don’t much care how much those subscribers are paying. So you make the subscription price as low as you can, in order to maximize the number of subscribers and therefore the amount of money you can get from advertisers.

What’s more, the effect of a subscription firewall on print circulation is effectively binary: it’s the existence of the firewall which matters, not the price level at which it’s set.

So what’s the reason for charging $71 a year rather than $10, if online subscriptions account for only 0.1% of your total revenue? I suspect that there’s an anchoring effect at work: a print subscription is $17 a month, or $204 a year, and the online subscription has been set at 35% of that figure.

In any case, if a newspaper is both increasingly reliant on paper subscription revenues and is seeing its paper subscriber numbers decline, there might indeed be a colorable case for implementing a subscription firewall in front of the online content. That doesn’t apply to big papers like the WSJ, FT, and NYT which are not seeing their print subscription numbers fall, and which aspire to being global news sources. But it does apply to smaller, regional papers, where the economics of newspaper publishing are particularly gruesome.


in all the debate about newspaper subscriptions, I never seen anyone mention The Economist and its amazing ability to still generate subscriptions even though absolutely everything is offered free online-except their audio edition. The audio edition (awesome British voices reading all the articles) is fantastic but it costs $9 if you don’t have a subscription or its free with magazine subscription.
I was working internationally where I couldn’t receive mail, but I kept my Economist subscription (and sent it to my brother) just so I could enjoy the audio edition. Perhaps more newspapers need to change the forms they deliver news.

Conditional probabilities and evil insurers

Felix Salmon
Jul 30, 2009 17:18 UTC

Mike Konczal picks up on a great Taunter post about conditional probabilities, which comes with a nasty sting in the tail. When you buy health insurance, the main thing you’re concerned about is tail risk: you want to be sure that in the unfortunate event you have stratospheric medical bills, the insurance company will be there to pay them.

The problem here is that you can’t be sure of that. Indeed, by Taunter’s math, if you have stratospheric medical bills (this is where the conditional probability comes in), the chances of the insurance company paying them are quite possibly no higher than 50-50. The term of art for an insurer not paying an insured’s medical bills is “rescission”: the insurer rescinds the policy rather than pay the bills.

Here’s James Kwak:

The legal basis for rescission is that when you sign an insurance application, you are warranting that the information on the application is true; if it turns out not to be true, the insurer can get out of your insurance contract. It’s particularly nasty in practice because the insurer does not immediately investigate your application to determine if it is accurate before selling you the policy (that would be impractically expensive); instead, the insurer waits – years, in many cases – until you actually need expensive health care, and then does the investigation, which at that point is worth it because of the payments the insurer could potentially avoid. Also, you can lose your coverage for innocent mistakes, which are easy to make since the application form asks you if you have ever seen a doctor for any one of a long list of medical conditions that you are certain not to recognize or understand. (In a Congressional hearing, the CEO of a health insurer admitted that he did not know what several of the conditions listed on his company’s application were.)

Kwak’s parenthetical about how insurers can’t examine applications before they’re approved on the grounds that that would be “impractically expensive” misses the true evil here: the insurer wants to cash the insurance-premium checks of people who made fraudulent applications. Those are the most valuable insureds of all, because the minute they make claims which cost more than their premiums, their policies can be immediately rescinded. As Taunter puts it, you are free to play, you just aren’t free to win. And that’s why you get people being denied breast-cancer surgery on the basis of having had acne in the past.

This is a huge problem with any private-sector health insurance: it’s essentially impossible to gauge the quality of that insurance until it’s too late.

More generally, as Konczal says, this applies to other insurance policies too: CDS, for instance, or even hurricane insurance. In general, if you’re making a series of small payments now on the grounds that you will be paid a large sum of money if something bad happens, you’re running some large and unhedgeable counterparty risk. Which just goes to confirm what everybody deep down suspects: that a significant part of the money we spend on insurance policies is wasted.


The problem with the analysis is that it pretends almost 100% of the policy rescissions occur because applicants do not know they are not telling the truth.

Simply put, the individual insurance market is difficult because of adverse selection. Typically, people seeking coverage realize they have risk and are seeking to pass it off to the insurer. Furthermore, they understand rates will go up (or coverage will not be available) if they disclose medical conditions on their applications. Unfortunately, many outright lie and most will bend (forget) the truth to minimize their premiums.

If we put the burden on the carriers to spend the time and money to track down the applicants medical records before they accept a policy, I would expect doing so would easily cost hundreds of dollars for each application. Since rejected applicants would not pay any premiums, the millions of dollars in investigative costs would need to be passed on to actual customers.

While there certainly have been cases of abuse of rescission, the current system relies on information provided by the lowest cost source of information on the health of the applicant – the applicant.

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Mortage servicers’ perverse incentives

Felix Salmon
Jul 30, 2009 14:13 UTC

Last month, I wondered whether banks’ seeming inability to effectively modify mortgages was a function of “greed on the part of the banks — that while they pay lip service to the idea of modifying mortgages, they actually make more money by being recalcitrant and obstructive and unhelpful.”

It turns out that the answer is yes, it is — and the NYT’s Peter Goodman has chapter and verse:

Many mortgage companies are reluctant to give strapped homeowners a break because the companies collect lucrative fees on delinquent loans.

Even when borrowers stop paying, mortgage companies that service the loans collect fees out of the proceeds when homes are ultimately sold in foreclosure. So the longer borrowers remain delinquent, the greater the opportunities for these mortgage companies to extract revenue — fees for insurance, appraisals, title searches and legal services.

In a sidebar, Goodman examines the case of a mortgage servicer, Countrywide, which refused to let Alfred Crawford sell his house for $620,000 in settlement of mortgage debts exceeding $800,000. The latest offer on the house is now just $465,000, and still no short-sale is being allowed.

In the meantime, Countrywide is paying itself lots of fees — fees which will ultimately come out of the pockets of the investors who bought the mortgage-backed bonds which Crawford’s loan was bundled into. The minute that Countrywide allows the house to be sold, that fee income dries up.

Countrywide’s official response is hilarious:

David Sunlin, Bank of America’s senior vice president in foreclosures and real estate management, acknowledged that Mr. Crawford’s applications for short sales had suffered from “a number of communication issues,” but he said that the bank had acted in good faith.

“We have to protect our investors’ interests,” he said. “We have reputational risks involved.”

A bank spokesman, Dan Frahm, said Bank of America owned a second mortgage on the property with a balance of $85,000 and stood to “take the full losses on it,” so it is at risk of loss along with the investors who own the first mortgage.

Countrywide clearly isn’t protecting its investors here: in fact, it’s gouging them for fees. And the second lien is a sideshow: that’s going to zero whether the house sells for $620,000, for $465,000, or for even less.

It’s not going to be easy to solve this problem. And I particularly feel for Mr Crawford, who moved out of his house two years ago, but who, it turns out, could simply have lived there rent-free for the past two years instead, while the process dragged on. Why should the servicers be the only people benefitting from all this inefficiency?


I love how people like Griff act like this is a normal situation where it should be obvious that people who take out loans should pay them. Under normal circumstances, people who find themselves in financial trouble could SELL their homes. Not so today. My partner and I had to move so that he could keep his job and we\’ve have been unable to sell our condo, so we\’ve been paying for a condo and an apartment for nearly a year. We paid $145k for the condo and put 20% down, so we hardly got into a situation where we were in way over our heads, yet it is not reasonable for anyone to pay for 2 homes indefinitely. The house has been listed for $124 and still no one even interested. So, please, spare me the personal responsibility BS.

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How big is high-frequency trading?

Felix Salmon
Jul 30, 2009 13:40 UTC

I have a bit more clarity on the $20 billion figure for total profits from high-frequency trading: it comes from the TABB Group. In a recent publication, TABB’s Robert Iati writes:

TABB Group estimates that annual aggregate profits of low latency arbitrage strategies exceed $21 billion, spread out among the few hundred firms that deploy them. While we know all the large investment banks such as Goldman Sachs are committed to prop trading profitability, the hundreds of smaller, private high frequency prop shops extend much greater influence in the marketplace by providing liquidity that keeps activity flowing.   

The Bloomberg article, meanwhile, explains the figure thusly:

The firms compete for a slice of $21.8 billion in annual profits from equities and derivatives market making and arbitrage, according to Tabb. Among the largest are hedge funds Citadel Investment Group LLC, D.E. Shaw & Co. and Renaissance Technologies Corp., as well as the automated brokerages Getco LLC, Hudson River Trading LLC and Wolverine Trading LLC.

When John Hempton, then, says that “quantifications of this as a $20 billion issue are insane”, I think there are two questions: firstly, what is “this”, and secondly, how profitable is it, in aggregate.

It would be most convenient if the HFT algorithms were split nicely into a “trading” bucket and a “quant arbitrage” bucket, so that Hempton could complain mildly about the “trading” algos while saying at the same time that they’re not all that big of a problem, while ignoring the stat-arb shops and other high-frequency, low-latency traders. But in reality there’s very little difference: the traders all have strategies, and the stat-arb strategies are all implemented so as to maximize trading profits.

To put it another way, I don’t think people are making billions of dollars in profit just by being fast. But there are definitely people making billions of dollars in profits through strategies for which being fast is a necessary precondition.

Which leads us to the second question: if you tot up all the profits from high-frequency, low-latency traders, including big shops like Citadel, Renaissance, and Goldman, can you get to $20 billion? My gut feeling is that you can, and that the TABB estimate is not obviously unreasonable.

I also got a note from Jon Stokes yesterday which is worth disseminating more widely:

It’s quite remarkable to me that many of the econ and finance folks who insist that “HFT is the same thing we always did, just way faster” don’t seem to realize that frequency and amplitude matter a whole lot, and that for any given phenomenon when you suddenly increase those two factors by an order of magnitude you typically end up with something very different than what you started with. This is true for isolated phenomena, and it’s doubly true for complex systems, where you have to deal with systemic effects like feedback loops and synchronization/resonance.

What I’ve noticed anecdotally is that engineers and IT pros are more concerned about HFT than people who just handle money for a living. These guys have a keen sense for just how fragile and unpredictable these systems-of-systems are even under the best of conditions, and how when things go wrong they do so spectacularly and at very inconvenient moments (they get paid a lot of money to rush into the office to put out fires at 4am).

There’s an analogy here with e-voting, which I did quite a bit of work on. In the e-voting fiasco, you had people who were specialists in elections but who had little IT experience greenlighting what they thought was an elections systems rollout, but in actuality they had signed on for a large IT deployment and they had no idea what they were getting into. To them, it was just voting, but with computers, y’know? They found out the hard way that networked computer systems are a force multiplier not just for human capabilities, but for human limitations, as well.

This is why I’m sympathetic to Paul Wilmott’s view of all this: there’s simply too much complexity here for comfort, and too many things which can go wrong. When the stat-arb shops imploded in the summer of 2007, the systemic consequences were mild-to-nonexistent, and that does provide a certain amount of reassurance. But we can’t be sure that if and when such a thing happens again, the consequences won’t be much worse.


Do the so called circuit breakers apply to this type of trading?

And is anyone looking out for positive feedback loops in these systems? As many an engineer knows, they tend to be unstable and then blow-up.

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