This is a terrible idea that for some reason keeps cropping up again and again. The major problem facing the Global Financial System(tm) is not high-frequency trading, it is large, illiquid, unhedged assets held by systemically important financial institutions. The nature of an illiquid asset is that it is traded infrequently, which makes it especially un-affected by a transaction tax.
OTOH, a tax like this may discourage high-frequency trading [despite it not being at all a systemic risk], but it also discourages certain legitimate and extremely useful forms of hedging, such as large notional currency swaps [http://en.wikipedia.org/wiki/Currency_swap]. And in the likely event that some esoteric forms of derivatives are exempt from the tax [they may be executed overseas, or just be exempted from the statute due to lobbying pressure] then it will encourage banks to shift trading activity from actual assets to much-more-fragile derivatives.
Bottom line: it's very likely that the net result of any Tobin Tax type implementation will be to actually make the Global Financial System(tm) more dangerous. And that's assuming you can actually discourage HFT, which is not at all clear. It will probably just migrate to some island that sets up a tax-shelter exchange.
I have no great love for HFT, but this proposal is the epitome of dangerous, populist feel-goodery. It makes no regulatory sense, and the fact that the Europeans keep threatening to hold hands and jump over this cliff together should not make you think that it is in any way good public policy.
It is exactly what happened in France when they introduced a similar tax. All traders moved into CFD (contract for difference) instead of trading the underlying stock.
What exactly are these large, illiquid, unhedged assets? Bad mortgages?
Who would shift trading from assets to derivatives? It's my impression that HFT traders make money from HFT; that is there is no "core" business that would continue without HFT. I'm also not clear how they're supposed to HFT the derivatives from another country when apparently every foot of cable counts.
Bad mortgages are one type of large, illiquid unhedged asset, yes. But my general point is that the main danger to large institutions is a huge asset that loses value very quickly and can't be easily sold. If you accumulate too many of those, other banks can lose faith in your ability to meet short-term obligations, and then you're essentially up the creek. That is exactly what happened during the 08 panic.
As for #2, the main way trading shifts from assets to derivatives is this template: the government says I have to pay a tax if you sell me one share of AAPL. Instead, you sell me a contract that says, "if the price of AAPL changes by $X, I will give you $X. This is financially equivalent to a sale of AAPL stock for both parties, but does not require you to transfer ownership of a share of AAPL stock, and so you can avoid the transaction tax. Even if the US tries to impose the transaction tax on the derivative, it can be moved offshore, and thus avoid the tax.
What I just described is a simplified version of a Contract For Difference (CFD), as mentioned by another commenter. But there are innumerable other sorts of derivatives that could accomplish the same basic purpose.
The problem is that any transaction fee is going to be strongly lobbied against and if it passes will likely have loopholes. I'd prefer a simpler structural change that isn't tied to a specific wording or implementation (like modifying the tick size/sub penny rule[0]).
Thank you, came here to mention the penny-spread regulation. It's a little known fact about HFT that the reason speed is the primary advantage, is because the exchanges don't allow orders at prices which are fractions of a cent, and its first-come first-serve at each price point. The minimum spread permitted on the NYSE was 1/16 of a dollar (6.25 cents) until 2001, when the SEC forced all exchanges to the "decimal system". So now the minimum permitted spread is one penny.
If the exchange allowed orders at prices which are fractions of a penny, then algorithmic trading systems would have to compete on price as well speed. But it would also narrow the spreads, which would mean less profit for the "market makers".
Where is the evidence that HFT is affecting anything? History had plenty of bad market crashes long before computers were a twinkle in anyone's eyes. (South Sea bubble, anyone?) And HFT didn't corrupt Enron and Worldcom's leadership, or robo-sign a bunch of bad mortgages.
Also worth noting is that equity markets are a tip of the iceberg: there are also foreign exchange and bond markets. If anything, charging transaction fees will suck up liquidity in the secondary markets, causing bond issuers to have to raise rates to compensate for the illiquid secondary market. (And in the case of treasuries, guess who pays the extra interest? Not Wall Street: you.)
HFT is not just a risk of synthetic crashes, it's essentially a tax collected by private companies. I say I want to buy XYZ, you run in front of me and buy the last XYZ at that price and kindly offer to sell it to me for just a trifle more. Why thank you for providing me such a fantastic service.
I've never seen anyone else in the markets proclaiming how great it is that we have HFT providing liquidity, not like the bad old days 5 years ago or so, when it was so very difficult to push a market order through. It's always the HFT companies themselves insisting how vital they are.
Do you have any evidence that the business model of any particular HFT firm involves front-running? If so, you should probably do something about it beyond leaving comments on the internet. Front-running is, of course, against the law.
5 or so years ago a large number of your counterparties were probably algorithmic market-making strategies.
HFT serves the same purpose that human Market Makers and Specialists do, only better. Kill it, and you will end up paying more.
Did you complain when human travel agents were replaced by expedia and like? Would you complain if car salesman as a profession is gone? Do you see your profit when amazon is competing with all brick and mortar shops? What makes HFT so special in that list?
So strange to see that sentiment from a science fiction author. Afraid to lose to reality evolving faster than you can imagine?
There have been studies proving that the majority of HFT traders are net liquidity 'takers'. The notion that HFT provide liquidity is false but the industry still propagates the myth to main street.
This paper is a joke. It only looks at the S&P futures. If I added liquidity in SPY or any of the other S&P ETF, hedged my exposure by removing liquidity in the futures, they would consider me an 'aggressive' trader.
You're citing a very old paper that makes no mention of HFT? Not sure I follow the reasoning for the citation.
No one is saying that speculative traders don't serve a function in the market place. However you said "HFT serves the same purpose that human Market Makers and Specialists" when it has been proven they don't. HFT want you to believe that they serve some altruistic purpose to the marketplace to legitimize their existence. The truth is that HFT serves as a quasi-tax on each and every share traded because to execute a trade in today's marketplace non-HFT volume almost invariably passes through the hands of HFT volume thereby shaving pennies of profit off each trade.
Do you have some citation for that statement? Is there something that makes trading every millisecond much more efficient than trading, say, every tenth of a second?
For example traders in equities can participate in "on close" auctions if they prefer to do so. No millisecond guessing, no bid/ask at all, pure double side auction. Yet only ~10% of the volume goes there.
You can open up your own ECN and offer fixed auctions every minute if you think this will attract people who feel cheated by HFT.
While algorithmic trading may provide liquidity, it tends to exit markets during crashes and abnormal events. Moreover, I suspect that high-frequency trading's real advantage is not in providing lower spreads, but in much faster reaction time. I would eagerly agree to slightly higher spreads and slower times for trades if it meant less volatility and fewer crashes.
Those traders who didn't exit during the flash crash profited the most, what makes you think they will pull out the next time? On the flip side: those Market Makers that were forced to trade Facebook on the day of the IPO lost the most, when the system was totally broken, what makes you think they will handle the next problem better?
Anybody who's making a profit is almost by definition making the markets more efficient and less volatile. They buy when the price is low (pushing it up) and sell when it is high (pushing down).
No, they don't serve the same purpose that market markers and specialists do. MM and Specialists serve to stabilize the markets and are obligated to create and maintain orderly markets.
HFT have no such obligation, so they can create liquidity and remove it whenever they want. They caused the Flash Crash in 2010 by removing a large amount of liquidity when the markets needed it the most.
If HFT were forced to maintain liquidity like real market makers and specialists, then I would have no qualms with them. But they want to have their cake and eat it too, they say they provide liquidity but only when it's convenient for them, and that is the part that is total BS.
It's interesting to note that the effect of this transaction tax would be to 'reduce volatility' in the market. I say this because recently I watched the Authors@Google video of Nassim Nicholas Taleb (https://www.youtube.com/watch?v=S3REdLZ8Xis) where he stated that volatility in the market place is a good thing, creative destruction and all that.
More precisely the point he made was it was good for the market to appear and be volatile because otherwise it would only appear stable but with high and disasterous volatility brewing underneath the surface, ready to explode (the great moderation and subsequent GFC in the video).
I think it's important to distinguish between volatility within a market (e.g. hog futures) and volatility in The Market, meaning the whole economy. The first is perfectly normal and its absence across the economy would be very strange if not dangerous.
The second one is the problem -- when it happens it's because you're on the losing side of a systemic risk. It isn't that hog futures go up or down but everything is still fine for normal people because the DJIA only moves by a tenth of a percent, it's that some jackass causes a panic and a trillion dollars disappears out of the economy for no good reason. The latter is something everyone should want to prevent, which is why all the talk at the individual level about diversification and hedging. But the same goes at the macro level: We need to "diversify" the banks and major industries so that no individual company is too big to fail anymore, so that we can have volatility within specific industries without it breaking the whole world economy.
And the sort of volatility HFT creates is the second kind. When something bad happens, it happens across the board, regardless of the "fundamentals" of the underlying industries. Even when it's "working" the result is only to transfer wealth from ordinary stockholders to high frequency traders, which is a net loss for anyone who isn't a high frequency trader.
My understanding of the point in the video is that the volatility resulting from the systematic risk is a symptom of the market not having enough normal/baseline volatility to clear out the dead wood, so to speak. Quite analogous to forest management, where more smaller fires clear out the fuel on a regular basis so that a large scale fire cannot occur.
Now it is probably the case that the HFT traders make The Market far more intertwined than is sensible, and hence far too combustible as a whole. In the video Taleb points out that he favours many smaller organisations over fewer larger ones for the simple fact that within an ecosystem a few small systems can fail with little negative effects on the whole. Where as if a large system fails it is far more catastrophic.
So perhaps the solution here is to make some sort of upper limit in financial (HFT, Banks, etc) firms so that there would be more smaller ones, where failure would be more common and the destruction of smaller companies should not disasterously affect the system as a whole.
That said, the recent wiping of trillions of dollars in value, seemed to be an effect of the many years of apparent calm. With a lot of companies creating new derivatives with the appearance of safety but were anything but safe.
To bring it back to the parent article, I do agree that everyone on the exchange should be paying some sort of transaction fee, I have to pay one when trading shares, and so should other traders.
One reason that HFT is disliked is that it gives disproportionate advantage to the big players who put in the high speed infrastructure and equipment. This means that a few companies are able to extract profits from the market by simply spending the most money up-front.
Now obviously markets are not zero-sum games, but there is theoretically only a certain amount of growth returns available and some of this is being siphoned off. Couple this with the idea that the purpose of the markets are to most efficiently distribute capital to where it can be best used in the real world, HFT does not seem to be improving much.
Traders don't "game markets" for profit. They're part of the infrastructure that makes markets work. It's like saying E-Bay "games markets for profit" because they take a piece of every transaction. Being an intermediary != gaming the market.
The European Parliament has called for changes to EU law to stop food price speculation that has been linked to the famine that has claimed tens of thousands of lives in East Africa.
A hard-hitting resolution adopted by Euro-MPs on Thursday 15 September calls for changes to EU directives on market abuse and financial trading to stop "abusive speculation" which has been identified as a contributing factor to the current famine in the Horn of Africa.
While it is widely accepted that the humanitarian emergency in the region was triggered by drought, a recent World Bank report identified high food prices as a key contributing factor.
Academics and international development charities working in the sector believe that food price volatility caused by speculation in agricultural derivatives on the financial markets are exacerbating the situation.
How does what happen? A drought led to reduced supply and higher food prices. That's exactly what you'd expect in an efficient market. People blame the traders because they're the mechanism through which the market incorporates the fact of the drought.
You see the same crap-throwing with traders in oil. People blame the traders for "bidding up" oil prices. The traders are just helping the markets reach a price--it's the market that's bidding up oil prices. And that's exactly what you'd expect when India and China are guzzling up the stuff but production has been flat since 2005 (and we hit peak discovery in 1965...)
I know nobody wants to pause their high-speed HN binge for the seeming eternity it takes to listen to a podcast, but I promise you will not regret this one.
The same reason McDonald's would benefit with a tax of 10 million dollars for all restaurants. It would eliminate a large swath of weaker competition and they would make more profit with reduced competition.
That's a terrible idea. Destroying liquidity and masking market volatility. You don't destroy your clock when upon looking on it you figure you don't have enough time. The clock is the only thing telling you time is running out.
What you have to do instead is legislate and enforce transparency in all global organisations and put in jail high level executives who (may have) turned a blind eye to deliberate borrower misrepresentation (may be fraud) in investment banks and which on-sold those loans on to investors, knowing the risk of those loans were understated.
If anyone can find a link to the Joint Committee on Taxation's report for the Financial Transaction Tax (AKA: Securities Transaction Tax / Tobin Tax) it would be much appreciated. The ProPublica article[1] and Defazio's press release[2] mention the JCT report but I have not been able to locate the actual report. It is even referred to in a CRS report[3] but it seems that everyone is taking Defazio's word and nobody is bothering to look for the report. I scoured the jct.gov website but could not find the publication listed anywhere.
OTOH, a tax like this may discourage high-frequency trading [despite it not being at all a systemic risk], but it also discourages certain legitimate and extremely useful forms of hedging, such as large notional currency swaps [http://en.wikipedia.org/wiki/Currency_swap]. And in the likely event that some esoteric forms of derivatives are exempt from the tax [they may be executed overseas, or just be exempted from the statute due to lobbying pressure] then it will encourage banks to shift trading activity from actual assets to much-more-fragile derivatives.
Bottom line: it's very likely that the net result of any Tobin Tax type implementation will be to actually make the Global Financial System(tm) more dangerous. And that's assuming you can actually discourage HFT, which is not at all clear. It will probably just migrate to some island that sets up a tax-shelter exchange.
I have no great love for HFT, but this proposal is the epitome of dangerous, populist feel-goodery. It makes no regulatory sense, and the fact that the Europeans keep threatening to hold hands and jump over this cliff together should not make you think that it is in any way good public policy.