As radical Conservatives continue chanting that fairness has no place in the free market it's worth remembering that ONLY an expectation of fair dealing allows the free market to work. If the expectation is to be cheated, if it's believed the market is rigged in favor of a tiny minority of elites the free market collapses. A vast swath of hard working Americans refuse to participate in the stock markets because they believe them to be rigged. Financial advisers bemoan that fact...except of course that those hard working Americans are right.
Listening to the furor engendered by author Michael Lewis’ excellent new book about Wall Street, I was reminded of the famous quote from Harry Truman: “I don’t give them hell. I just tell the truth about them and they think it’s hell.”
In Flash Boys: A Wall Street Revolt, Lewis simply tells the truth about the financial meth labs that pass for banks, brokerage houses and so-called high-frequency trading firms on Wall Street. He chronicles in painstaking detail how traders use high-speed computers to front-run stock trades and basically skim a little juice off a lot of trades.
I will explain front-running in a moment, but know that this book offers one of the best inside looks at Wall Street since, well, Lewis penned Liar’s Poker in 1989. Lewis is an accomplished author, not a bomb thrower, but proponents of high-frequency trading have been vicious in their attacks of him.
For example, a verbal food fight broke out on CNBC when Lewis and a high-frequency trading supporter debated this issue. Traders on the floor of the New York Stock Exchange actually stopped and watched as Lewis and Bill O’Brien, president of the BATS Global Markets Inc., which runs four U.S. stock exchanges, went at it. BATS was founded by a high-frequency trader.
O’Brien was especially miffed at Lewis’ characterizations of the stock market as rigged and high-frequency traders as digital predators. In one passage, Lewis writes: “The stock market at bottom was rigged. The icon of global capitalism was a fraud.”
People who read here regularly will know I've regularly called for a small per-transaction tax on stock trades in order to kill this activity. It's parasitic, destabilizing, and even big players in the market have already borne significant expense trying to keep from being rolled. This is a sterling example of how deregulation and Laissez-Faire Economics are a failed ideology.
“Each of these services offers clients a timing advantage – often in milliseconds – that allows high-frequency traders to make rapid and often risk-free trades before the rest of the market can react,” Schneiderman said last fall. “As a result, these traders guarantee themselves enormous revenue and force large investors to develop complicated and expensive defensive strategies to conceal their orders from parasitic traders.”
These defensive strategies in turn have led to the proliferation of “dark pools” – alternative trading venues in which financial institutions can conduct business outside the public exchanges. These defensive and behind-the-scenes trading pools, which attempt to hide from front-running algobots, are far less regulated and have far less transparency. They involve only a few traders agreeing to prices outside the broader market.
“Today I think we need to revisit some issues relating to this much-litigated and scrutinized territory because we’re seeing something far more insidious than traditional insider trading,” Schneiderman also said last fall. “Small but powerful groups within the market are able to use soon-to-be public information combined with high-frequency trading in a way that distorts our markets far more than ... Ivan Boesky or even Gordon Gekko could ever have imagined.”