Should High-Frequency Trading Be Banned? One Nobel Winner Thinks So

The IMF recently held a conference entitled Macro and Growth Policies in the Wake of the Crisis. Here’s a video summary from Michael Spence, former Stanford School of Business dean and winner of the 2001 Nobel Memorial Prize in Economic Sciences. It includes Spence’s thoughts about inflation and the coming divergence between growth and employment in the developed world:

Of the four post-conference points that Spence lays out, perhaps the most controversial is his opinion that high-frequency trading should be banned. Not curbed. Not reined in. But banned.Photo: iStockphoto
This caps a busy month for HFT news. The algorithmic method of computer trading makes up as much as 70 percent of all equity volume in the U.S. Last spring’s Flash Crash, sparked debate over the role the practice played in the event, when the Dow Jones dropped more than 600 points in five minutes, only to gain it back within the next 20 minutes. On March 1, a Commodity Futures Trading Commission panel recommended that trading firms implement a mandatory set of internal controls, including “limits on quantity, price collars and a ‘kill button.’” This after the same panel admitted that any externally enforced rules would be “virtually impossible” to enforce.

The next day, March 2, incoming chairman of the EU’s securities watchdog, the European Securities and Markets Authority (ESMA), promised a deep review of the practice. And as evidence of the degree to which banks value their high-frequency source codes, and their vigor to protect them, two cases of attempted code theft have resulted in recent prison sentences: on March 18, Sergey Aleynikov was sentenced to 8 years in prison. The former Goldman Sachs computer programmer came to attention in July, 2009, when he was arrested and accused of stealing Goldman’s secret algorithmic trading code. From the get-go, Goldman went after Aleynikov as hard as possible: FBI stakeouts, a public arrest as he deboarded a plane in Newark. Deemed a flight risk due to his dual Russian/U.S citizenship, he’s been in jail since last month.

And in France, a former Société Générale SA trader was sentenced to 3 years in prison for stealing the French bank’s code. As Spence might see it, one way to better protect high-frequency trading codes is just to ban them. But with $7 billion in profits coursing through fiber-optic cables at something approaching the speed of light, is that even possible?

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  1. MW says:

    Does HFT give any societal benefit, such as reducing inefficiencies or directing capital to where it should go? I confess I am largely ignorant of how financial markets work. (I do own some shares – every year or so, I look to see what they’re worth.)
    If there is no such benefit (or such benefit is very small) and if a simple intervention could remove the opportunity without adversely impacting useful investment, then I think it should be prevented. If it is making money for people and doing nothing useful, then that money must be being taken from those who are doing something useful.
    How about changing the trading so that they are performed to the ‘tick’ of some clock? Say every 30 seconds, all orders for trades in ACME are collected and resolved, then nothing happens (except storing the incoming orders) for another 30 seconds. (In my ignorance, I have no idea what the appropriate ‘tick’ time for the clock would be, but I’m guessing some time between 5 seconds and 5 minutes, with different times for different types of investment.) Different shares would have different schedules, to even out data flows and computer processing demands – e.g. ACME processes at 12 and 42 seconds past the minute, whereas TOON trades at 3 and 33 seconds past the minute.

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    • JC says:

      HFT provides broad, instant liquidity to every market it’s in. No matter your price point, there’s a trade to be had right now thanks to HFT.

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      • Highbrows says:

        Yeah, and MBS and CDO’s made the mortgage and housing markets almost rsk free places to invest. The liquidity argument is crap. There was liquidity before HFT and if they went away there would be liquidity again.

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    • R says:

      I think your idea solves the problem in a wonderful way. Regarding the tick, I think it is essential that it IS the same (or they have a simple relationship like 2:1) for every share. That way arbitrage (which increases efficiency) would be easier.

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  2. Art says:

    I think HFT should be banned outright but I’d go even further and make every trade should that the purchaser needs to hold the financial product for a non-trivial period before it could be sold. Maybe a month or longer. This would shape the stock market such that it will smooth out the wild shifts in stock value. It would prevent good companies from being ruined in an instant due to some unflattering article in the WSJ. It would force investors to look to the long range benefits of the companies themselves keep those investors (parasites) who are trading just for the sake of a quick buck.

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  3. Roland says:

    How would you enforce such a thing? Just put a small tax on all transactions that don’t involve physical property (i.e. all financial instruments, stocks, bonds, futures, derivatives, etc.). It wouldn’t affect ordinary investors like me in any significant way. It would slow down day traders. But HST people make so many transactions they would be killed. And the govt. needs the revenue.

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  4. JC says:

    For the record, the Societe Generale guy was using Excel VBA macros . . . not exactly high-end hacker stuff. And frankly, it makes him not even close to the same species as the guys with the high-end data centers.

    Most computer people would not even consider him to be a computer person. He’d be viewed as an office stooge using a highly customized component of MS Office. Which, in hacker circles, is like walking into an outlaw biker bar without a weapon.

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  5. mfw13 says:

    Instead of banning it, why not simply tax it to death….90% capital gains rate on any trade held less than one trading day…70% capital gains rate on any trade held less than five trading days (i.e. one calendar week)…and 50% capital gains rate on any trade held less than twenty trading days (usually about one calendar month).

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    • Bruce says:

      The majority of HFT transactions are never carried through to completion. So there is no capital gain.

      I would say tax the transaction itself. A penny per trade — or whatever amount is just a cent or a fraction of a cent greater than the income that the trading houses derive from cancelled trades. So if the exchange is paying brokerages 1 1/2 cents for a transaction, even if it’s cancelled, put a 2 cent tax on the transactions. That will disincentivize (?) the “probe trades” that pin down the market price without actually completing the trade. If the algorithms can’t obtain data from the probe trades their information about the available trades and their price points will be cut drastically. If don’t have the masses of data on the supply/demand curve of the market that are generated by the probes, they lose most of their advantage over the average trader.

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  6. Kate MacMahon says:

    I agree that electronic high-speed trading should not be allowed. The amount of value damage that can be done in a very short time to portfolios managed by those of us who do not have access to this technology is frightening.

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  7. Joshua Northey says:

    People cite the main benefit of this as “increased market liquidity”. But the whole point is that the market is TOO liquid, and it starts sloshing around like crazy. No reason the market cannot take a few hours to adjust to news instead of a few milliseconds.

    Sure we don’t want the market to flow like honey, but flowing like water is fine, it doesn’t need to be a super-fluid, and in fact that is undesirable.

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  8. A says:

    Indeed, some posters got it right: A small tax on all financial transactions would significantly increase the stability of the markets. (For currency trades, it is called a ‘Tobin tax,’ see Wikipedia). No legitimate investment would be hindered by it. And it would even bring in some money better spent on the crumbling US infrastructure. But unfortunately, with Wall Street owning 1 1/2 of the two political parties in Congress, a proposal for a Tobin-like tax can never be passed, and not even mentioned prominently on any TV program, or the NYT.

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