Today I’m going to make a blanket indictment, and I’m going to back it up. No doubt some of you will see it my way, and some of you will tell me I’m just plain wrong. Either way, bring on the comments!
I ended Thursday’s WSII post – “Why High-Frequency Trading is a Scam” with this comment and threat: “There’s nothing redeeming about high-frequency trading. Nothing. Maybe I should write a real article on why it’s a bunch of crap and who’s really behind it? Oh, I’ve done that. I did it two-and-a-half years ago, at Money Morning. Guess it’s time to do it again. Maybe I’ll call it my new high-frequency muckraking series on HFT B.S. (Think my publisher will go for that?)”
Well, my editor over at MoneyMorning.com agreed that it’s important to tell the world the truth about this scam, how it actually works, and what should be done about it.
So, tomorrow (Monday) and Tuesday, in a two-part series, you can read exactly how HFT players play their game, what B.S. they lay on us to justify their moneymaking schemes, how it can blow us all up, and what steps we should be taking to defuse the bomb.
But first, here and now, I’m going to tell you how high-frequency trading was allowed to happen in the first place – and, by extension, how what looks like the unintended consequences of past rules and regulations changes, which manifested multiple Wall Street scams, were never “unintended” at all.
In the old days, Wall Street brokers made their (very nice, thank you) living mostly buying and sometimes selling stocks for customers under a fixed-commission umbrella.
That umbrella, not surprisingly, was held up by the industry, which (wink, wink) took the term “fixed” to a level that looked like price fixing (because it was).
In the 1970s, new-on-the-scene wannabe discounters (namely Charles Schwab) who weren’t part of the old guard made the case for a free-for-all, let commissions fall from competition, federal case… and won. On May 1, 1975 – known in the industry as May Day – negotiated commissions came into being.
All the old “customers’ men” were aghast. What was going to happen to their lofty salaries? And worse, if commoners were going to have cheap transaction costs, would they start buying and even selling stocks on their own, without the sage advice of brokers?
Of course they would.
So, Wall Street being Wall Street, they huddled, looked into the future, and decided right then and there to create it themselves – the future that is – in the craven image of the world as one giant exchange; an exchange without borders, where everybody traded everything.
But the beauty of the monster wasn’t about little transaction costs they could pocket. It was to be a magnificent future, you see, where trillions of trades were possible. And not just on stocks and bonds in the here and now, but on futures, on derivatives of synthetic squared portfolios of loans on American homes, and on what the Fed will do with interest rates, and pollution credits, and who will get elected – and even more stuff in the works that will blow your mind.
They knew they could make billions of dollars on everything that would be traded. They would make some of their money, a piddling little of it, on those annoying little negotiated commissions. But more to the point, they would make money on doing their own trading with their insider advantages, their speed, their duplicity in telling the public one thing and doing the opposite. They would all become masters of the new tradable universe, plying their trade as market-makers and market destroyers. All battling one another, one and all and all for one against the stupid public, who might look upon the billionaire hedgies and aspire to their ranks by trading their oneseies and twosies… but trade them they would.
And so it came to pass.
In order to make things more tradable and to give themselves more of an advantage, the increasing pool of Wall Street game theorists and game-trading practitioners had to clear runways so their plans and planes could takeoff.
Starting in 1980, it was all about deregulation. That would expand the airfield by creating innumerable new runways, where plans could take off in any direction, at any speed, and go anywhere, without the bother of a flight plan or the ignorant oversight of traffic controllers.
Then in the 1990s, they targeted the binding effect of having to funnel trades through only a few exchange pipes. They hacked away at the old pipes, took them over, and rechanneled them with PVC and copper and fiber optics. And more and more electronic trading venues in cyberspace came into being. That spread out trades across multiple highways where dumb investors could get run over because of far too much “fragmentation.” But the insiders, the players, the traders, and game theorists knew how to negotiate the back alleys of all these electronic communications networks.
But still, when it came to stock trading, quotes and trading increments were still based on the old Spanish system of “eighths,” which wasn’t just quaint but actually had a huge impact of how risk was measured and managed by the specialists and market-makers responsible for “keeping fair and orderly markets.”
Then again, the game wasn’t about fair and orderly markets, it was about trading, and more and more trading.
So, under the guise of narrowing spreads, which was supposed to reduce transaction costs (it didn’t, read my upcoming articles) the push towards decimalization was completed in 2001. Now stocks move in increments of a penny as opposed to a minimum of twelve and a half cents in the past. It’s a long explanation, as to what effect decimalization has had. But trust me: It hasn’t helped the public one bit.
It did make for more trading, however; a lot more. That was the intention, after all.
I could go on and on and cite a lot more changes that look like they had unintended consequences. But here is my point.
All those changes were intended to create more trading.
Trading – that’s where the money is on Wall Street. It’s not about capital formation. It’s about trading, stupid.
And the latest example of those unintended consequences? Guess.
Yep, that would be the billions of dollars made annually in high frequency trading.
Get it? HFT does nothing for the markets, adds nothing to liquidity, has no reason, there’s nothing redeeming about it. That is, unless you’re the one doing it.
The system is corrupt. Wall Street is the tail wagging the economy and America, and the world too. The business of trading has hijacked American business. It has to stop.
Okay… bring on those comments.