One of the areas that Sen. Ted Kaufman and his chief of staff Jeff Connaughton tried to focus on during his accidental two-year term in the Senate was high-frequency trading. The 2010 “flash crash” showed the potential dangers of this fast-growing industry. Consider that our financial system places a large emphasis on where super-computers are sited relative to the trading machines. As Felix Salmon points out, one of the consequences of the melting polar ice sheet is not just that companies want to drill for oil in the Arctic. They want to lay cable through the shorter Arctic route, to increase the speed of information between the US and Asia by a matter of 20-60 milliseconds. And that infinitesimal shaving off the time of a trade matters. It’s the difference between placing a trade too early and placing it too late. It means billions upon billions of dollars. And that’s a huge problem.
This makes the normal function of the market as an efficient allocator of capital into a video game relying on split-second dexterity. And because no game of this sort comes without glitches, the inevitable breakdown of this system has the potential to cause a huge crisis.
The problem is that the government has fallen woefully behind in trying to regulate these high-speed algorithmic trading systems. They have to hire the same firms just to understand what is happening in the market. And this reliance on the same tools pretty well assured that the tools will never get abolished or even downsized.
Tradeworx, a 45-person firm based in New Jersey, will dispatch its experts to Washington this month to tutor regulators on a sophisticated computer program that will give the S.E.C. its first real-time window into the stock market — something firms like Tradeworx have had for years. The S.E.C. program, designed by Tradeworx, is set to go into operation at the end of this year.
The program, called “Midas” by the S.E.C., is part of a broader effort at the agency to monitor the proliferation of new technologies and to crack down on practices that have given sophisticated traders an advantage over ordinary investors [...]
Some industry experts have said that the Tradeworx program is the quickest and, at a cost of $2.5 million this year, the cheapest way for the agency to catch up with the high-speed trading industry, which has gone from being a niche player a decade ago to being responsible for more than half of all trading in American stocks today. But the initiative raises a new set of questions about whether the industry is the best source for unbiased information about the markets.
David Lauer, a former employee of other high-speed trading firms, wrote in recent testimony to a Senate subcommittee that the Tradeworx program was “reminiscent of the fox guarding the hen house.”
“You don’t rely on the subject of your study to build the device you are going to be studying them with,” Mr. Lauer said in an interview after the hearing.
Precisely. Tradeworx isn’t an unbiased actor here. They have every reason to perpetuate this system and won’t willingly participate in anything that would lead to its destruction. Nobody can articulate what benefits high frequency trading to the marketplace. But they deliver lots and lots of benefits to Tradeworx.
So many of the high frequency “trades” aren’t even trades at all. They are test trades that algorithms float to check the price of a particular security. Hundreds of thousands of these could happen in a matter of minutes without any actual trading going on. You get the sense that this can all just fold over onto itself, where the robots battle to a draw and the financial system grinds to a halt. The machines have become so sophisticated that the human traders don’t want any part of the game anymore. So we have a system that has massively reduced trading, and massively increased the possibilities of an unforeseen and destructive circumstance. Why are we subjecting our markets to this?
The answer is that there’s money to be made. And now the SEC has gotten into that act.