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Daniel Dicker

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Knight Capital Debacle Screams for Transaction Tax Now

Posted: 08/09/2012 10:52 am

Our stock markets have been hijacked and are coming apart, unsafe at any speed for any investor. That's the message that the $440 million scandal at Knight Capital Group is telling us.

But Knight's problems with their latest software are certainly not the first sign of an electronic market gone amok. We've seen it over and over again, first with the "flash crash" in 2010, high speed "mistakes" like the Facebook and other highly anticipated IPOs and countless small electronic missteps over the past three years -- all of which have sapped investor confidence in the fairness of our stock and commodity markets.

They're not sure why or how, but investors suspect that the game is rigged and are refusing to be a part of it -- the monthly outflows from stock mutual funds and indexes shows how deep their distrust has become.

It's not just the regular retail investor that's been marginalized in this rise of the machines -- a generation of traders, mostly of my generation, have been slowly and literally nickeled and dimed out of a career that used to allow their wits and courage to generate a living - now all of their historic advantages are instead delivered inexorably to those diabolical black boxes, leaving nothing -- not a crumb -- for a smart kid looking to work hard and be his own boss as a trader, a job I was lucky enough to have for more than two decades.

The big boys are feeling it too -- it's no coincidence that monster hedge funds run by the likes of George Soros, Stanley Druckenmiller, John Arnold and Louis Bacon have decided to return money to investors, becoming smaller, entirely private or totally retired and gone: Sure, the markets aren't delivering the "easy" returns of the '90s, but mostly they're a lot less reliable, courtesy of machines that generate thousands of trades an hour for reasons no human can possibly understand or process.

I'm no Luddite -- I hear the inexorable march of technology. But I also think its time to try and put at least a part of that genie back into the bottle from whence it came. A transaction tax is a great first step to doing that.

The idea is simple: Charge a miniscule extra fee on every trade executed at every registered exchange. Such a simple charge would make much algorithmic 'churning' of volume uneconomic, while bringing institutional and retail trade back to the major exchanges and away from the ECN "dark pools." You'd begin to re-level the playing field for retail and private investors, generate confidence by returning fairness to the stock markets, greatly reinvigorate employment in the financial markets and gain a nice source of unexpected revenue too.

Besides the black box owners, only the exchanges wouldn't like it: They've spent the last 5 years encouraging the machines -- even spending money to buy algorithmic volume generation and giving access preference to the biggest "market makers" like Citadel, Goldman Sachs and Knight. The exchanges don't care about fairness -- they only care about volume growth.

But trying to reverse the tide on algorithmic trade will help the exchanges in the long run, like a bartender cutting off the chronic drunkard before he goes over the edge. As more and more machines remove more and more humans, these glitches, wild prices, failed offerings, flash crashes will doom the proper operation of the stock markets for everyone -- and ultimately bankrupt the exchanges too.

It's time to put people first and reverse the trend on the machines -- reinvigorating what once was an industry that showcased the best of American capitalism and individual grit.

 

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