Sunday, February 10, 2013

Al Gore, Sociologists, Address HFT

Al Gore's latest tome The Future warns us that: 
There are already several reckless practices that should be immediately stopped: the sale of deadly weapons to groups throughout the world; the use of antibiotics as a livestock growth stimulant; drilling for oil in the vulnerable Arctic Ocean; the dominance of stock market trading by supercomputers with algorithms optimized for high-speed, high-frequency trades that create volatility and risk of market disruptions..
As to how the stock market volume hurts the economy, he isn't clear, but his intuition is that 'trading' doesn't add value, and gives the example of the project to trim 3 milliseconds off the internet trip from New York to Chicago, which he says could have been spent on something productive.  Just stop trading, and boom, one could transfer say 50% of the 8% of GDP we currently spend on finance to our inner cities.

Yet, a lot of innovation is an off-shoot of something pretty banal, like porn and VCRs, and I would hate to have all projects need a sign off from some centralized Star Chamber because that would lead to all sorts of corruption. One could say that Al adds dubious value on his various boards and venture investments, as his main value consists of knowing the right regulators and big government contractors, crony capitalism, which is much more destructive than those dreaded limit orders that are often cancelled.  The thought that this guy is a Nobel Peace Price winner, Oscar Nominee and centimillionaire should remind everyone that Life Isn't Fair because he hasn't had an original or courageous thought in his life, as his book presents a caricature of free markets that is obviously indefensible. Only the simplest minds can think that in any great controversy such as that between those believing in more government the other in less, one side is mere folly or cupidity.

It's strange that a lot of people with no real interest or knowledge have very strong opinions on how much assets should trade, even though it doesn't affect them. They hate the idea that someone's getting rich doing something they don't think adds value, though it occurs in a competitive environment. If the average daily volume for a stock was 100% of the shares outstanding, should it optimally be 200%? 50%? I don't think anyone knows, anymore than one knows whether interest rates should be 2% or 5%. The great thing about markets is that while they are often wrong, they correct themselves a lot faster than collectives do, and further, they decentralize decision making. Asset markets don't just produce prices, but they allocate investments to their highest perceived value; when wrong, the owners pay the price, so incentives are aligned.

If you are a dictator the last thing you want to see is your work being second-guessed in real time, you would rather see it evaluated at completion, and never compared to anything. Further, like the Post Office or Medicare, you would like to have no shareholders so you could say you are doing a great job regardless, just point out the services provided to customers without a choice. A stock market on such entities would highlight how inefficient such programs are being run relative to those who would like to run them, and they would have motive, means, and opportunity to follow through.

Unfortunately, such idle rambling is not merely a spectator sport of closet socialists, but PhD students. There's a Howard Zinn-type exegesis of trading in Destructive Destruction? An Ecological Study of High Frequency Trading by some students of Heterodox Economics and Sociology of Financial Markets:
According to heterodox economics the development of thermodynamics brought an end to the dominance of classical physics in economic theory, in particular the dogma of efficient markets hypothesis, and reversal to equilibrium.
Given that the theory of efficient markets wasn't really developed until the 1960's, and Hayek's The Use of Knowledge in Society was written in 1945 I'd say the relation between physics, especially thermodynamics, and this economic theory was pretty independent, though I would agree that every broad economic theory has a vague relation to some physics (optimizing individuals are kind of like the principle of least action).

Anyway, these poor saps figure that it's all based on the 'fourth law of thermodynamics.'
The true novelty of Georgescu-Roegen's formulation lies in his proposal for a fourth law of thermodynamics, where it is not only energy that is subject to decreasing returns, but also matter; friction robs us of available matter
Trading is like friction that simply robs the economy of value.
In as much as it diminishes the risk of trading through higher matching speeds, HFT allows buyers and sellers to reduce their transaction costs considerably.
Like most discussions of risk and return, they suggest there's a risk-return nexus and these firms are merely accessing it, but that metaphor is as misguided as their entropy-flow thesis (not discussed here, but its a vague metaphor these authors think is the key to everything). How does HFT reduce risks, and for whom? I actually think of HFT as simply trying to efficiently parcel orders out of a big trade, and reacting quickly to movements in related securities when providing liquidity. This reduces the risk to retail traders because it gives them greater liquidity because placing a bunch of limit orders at the best bid/ask is like being an electronic market maker.  This allows regular Joe's to trade without moving prices so much, and at more efficient prices. It does not reduce risk for the high frequency trader himself, as this activity generally takes risks because you can't make profits without taking risks in this highly competitive domain. Further, taking intraday positions does not generate a positive return per se, so there's no risk-return relationship merely for taking the position.

As someone against the status quo, I have to say my fellow anti-current-paradigm intellectuals are mostly moon-bat crazy like those above. Clowns to the left of me, but I find myself more broadly sympathetic with the 90% of the jokers to the right such as Cam Harvey, John Campbell, or John Cochrane.  Not that I think they are correct, just that they are much more fruitful to read than those who think there's a fourth law of thermodynamics that's essential to understanding the economy.


Anonymous said...

just because gore doesnt know what he's talking about doesnt mean we aren't in dire need of a transaction tax to eliminate some of this nonsense. you and gore both suffer from dunning-kruger. amazingly, he actually might be more humble about his knowledge than you.

zby said...

I wonder what you think about Soros - here is his lecture from 2009: (look for the transcripts, the videos are now deleted). This reflexitivity theory sounds very vague, but in my view he is spot on in nearly all of his points in the conclusions. He is against efficient market hypothesis, but your batesian mimicry theory is not very far from his arguments. He is for some regulations, but he admits that regulations mostly fail.

zby said...

After finishing the fight lecture I have to add that his calls for a global (financial) government are quite scary.

Mercury said...

“As to how the stock market volume hurts the economy, he isn't clear,…”

Well, LOW stock market volume probably doesn’t help the economy. US equity market volume peaked in 2009 and has been on a sharp decline since. You can argue about how much of this is due to a lame, post-crisis economy, Sarbox or other regulatory headaches but I think HFT spooks away more potential trading activity than it attracts.

Only a government wonk like Gore would conclude that more private transactions and opportunities for price discovery are detrimental to capital markets but the fact is some HFT algos have demonstrated an ability to achieve desired ends by overwhelming the mechanics and plumbing of the market with results that are less than confidence inspiring to outsiders. This isn’t to say that various iterations of the old market structure were perfect or that the technologies that make HFT possible haven’t been hugely beneficial in other ways but at some point it is best for the larger economy if a free, fair, stable and transparent marketplace is something that can be taken more or less for granted. That some market participants can gain an advantage by digging a tunnel (or building microwave relay stations) to the exchange probably doesn’t help that desired perception even if in other ways this current HFT dominated market structure is more “fair” than older versions dominated by “upstairs” power players.

Also, by definition a market is a central venue where people with different needs and preferences can have the most opportunities to exchange capital with others and observe similar transactions. Ultimately it is probably best for all market participants if our current, very fragmented equity marketplace (still evidence of robust competition to many) re-concentrates in some way.

Jeffrey said...

Like Mr. Gore the Anonymous (1) responder doesn't share a shred of evidence to support his/her pronouncement.

Are we really in "dire" need for a transaction tax to stem so-called nonsense?

What exactly "dire" here? Explain what is nonsense, please. And in doing so kindly leave your partisan talking points at the door.

And speaking of nonsense, is Mr. Gore's drive to riches truly ethical? Mr. Gore is a hypocrite with his hand in the taxpayer's pocket both directly and indirectly. There is nothing to be proud of there.

Evidence is readily available in the public domain, but one need pull their head from the sand in which it is planted.

As for Dunning-Kruger; pot meet kettle.

Good grief.

Tel said...

I think that HFT is a legitimate problem, but I don't see Gore's crony capitalism as a solution, nor do I believe that a transaction tax is the right approach.

It should be in the interests of the stock exchanges to attract investment. If the small-time investors who just trade once every week or so think they are being shafted by a robot trader with the ability to react in milliseconds, then the investors will keep their money in their pockets and the robots can go play with each other. That's a bad situation for the exchange once it becomes entrenched.

Thus, innovation in the design of an exchange should lead to way that discourage robot traders and it is easy enough to do. Just queue up all bids until a random "tick" comes around and then freeze all trades instantaneously, resolve the backed-up queue as far as it can be, and then unfreeze and start accepting new bids. Try to make the random "tick" happen only about 10 times a day, because quite frankly the real value of a corporation does not change any faster than that.

Quartz said...

@jeffrey: as much as I despise Gore (probably more than you all, and feel he's one of the most relevant threats to a serious discussion of certain significant problems), I do also get upset when hearing yet another time the old hypocrisy rant, possibly thanks to a step back abstracting from the specific case.
Let me put it this way: do you really think it would be a worse world if the mafia was a bit more hypocrite, and instead of a "honorable" walking the talk they atleast preached for something better instead? Half of their strength arises from blind faith and perverted but consistent "honour", draining resources for free, not from some superior and efficient social model.
Still this doesnt apply here, it has nothing to do with the fact that yeah, Gore's silly rants on finance as such dont make any sense, "hypocrisy" or not. But you're probably not his target audience anyway :D
The first anonymous was imho technically correct, he dindt say that we *actually* are in such a situation. But is that possibility really out of question, just because of what he or Gore said? I would have expected a more serious discussion...

Actually the reason those morons insist with such dumb gut appeals is that they're invariably rewarded by media attention, even by otherwise serious blogs such as this one. :)

Unfiltered said...

"Try to make the random 'tick' happen only about 10 times a day, because quite frankly the real value of a corporation does not change any faster than that."

I love it when people bookend their uninformed musings with a statement so ridiculous as to give their entire entry the air of a comedic performance.

Imagine a scheme like this having been in place for the stocks of major financial firms in October 2008.

If a non-HFT dominated exchange (and its attendant wider spreads) is something that would attract retail investor confidence and volume, as you seem to be arguing, then why doesn't someone start such an exchange and lure all that latent business away from all the others? The SEC is not exactly putting up roadblocks to new equity exchanges these days.

In actual fact the subdued trading activity we're witnessing now is not limited to unsophisticated retail investors. It's also taking place in the institutional world. And it's exactly what *always* occurs in a post-crisis period following the bursting of an asset bubble. Why was there a similar low volume period following the 1929 stock market crash? There was no computerized trading in existence then.

Mercury said...


These days the spread at any given split second is less indicative than ever of what price you can actually buy or sell X amount of shares – although this should be more or less a non-issue for most retail traders.

Even without any HFT a separate exchange with very different rules like that would probably just get arbed to death and beyond a certain point I think the downside of more market fragmentation outweighs the upside anyway.

Obviously there are more ingredients to a robust public equity market than just HFT issues but I’m hardly encouraged by the “It’s just like the Great Depression!” analogy.

Tel said...

Imagine a scheme like this having been in place for the stocks of major financial firms in October 2008.

What is your point?

You are trying to claim that the problems leading to the crash of 2008 just happened to turn up all in one day? Or perhaps you are claiming that it is perfectly reasonable for some slightly better connected market participants to have that critical opportunity to bail out early and let the suckers take the fall for them?

What exactly are you claiming here?

Tel said...

Even without any HFT a separate exchange with very different rules like that would probably just get arbed to death and beyond a certain point I think the downside of more market fragmentation outweighs the upside anyway.

The point is to encourage stocks to list on THAT exchange rather than other exchanges. Remember, only IPO's actually raise money for investment. The rest is horse trading.

Unfiltered said...

"I’m hardly encouraged by the “It’s just like the Great Depression!” analogy."

The point of the analogy is not to offer you encouragement but to point out that periods of low trading activity are often observed in post-crisis periods (and this is true of any such periods, not just the 1930s). The "HFT has scared away retail investors!" panic utterly fails to contend with (or even consider) such confounding variables.

"You are trying to claim that the problems leading to the crash of 2008 just happened to turn up all in one day?"

No, I'm saying that the available information about these problems, and the trading public's interpretation of it, was changing so rapidly from minute to minute that the ability to "get liquid" at a moment's notice was critical to not exacerbating the declines and sending the level of panic higher than it already was. (There are a lot of stocks out there, and this kind of uncertainty shows up on a regular basis in individual issues from time to time.) In general, stopping two people from making a trade they would otherwise like to make seems like a particularly unwise regulatory arrangement to me.