At the Business of a Better World Conference last week, former U.S. Vice President Al Gore said that one of the biggest obstacles to investments in sustainable business is the "impatient, short-term" mindset of investors coupled with a "debilitating" reliance on automated financial transactions. He called the short term business view functionally insane and that this mindset is a "deep threat to a sustainable economy."
Gore said that the situation has degraded as more trades have become automated. He noted that close to 70 percent of the trades on the New York Stock Exchange, for example, fall into the high-frequency category, which means they are managed by algorithms and supercomputers rather than humans. In that kind of environment, the short-term view can be compressed from 90 days to a matter of one second.
With all due respect to Mr. Gore, I don't think he understands what algorithms really do. Algorithms are programmed by people, and it is people that are taking the short term view. While I understand the frustration that high volatility can cause investors, to blame the automation of transactions for short-term HFT strategies is naive. Automation is the single most important thing that has happened to markets, making them cheaper, more transparent and more liquid.
Short-termism relates to human greed; the ability to take huge profits and bonuses out of the market in a short period of time is too tempting for many. MF Global is a case in point; the firm wanted larger profits than were possible given its broker-dealer business model. So it rolled the dice and lost.
The consultants at Woodbine Associates nailed it: "Our economic system is broken -- it has been transformed and adulterated. Our corporate culture has changed to the point where individuals -- across many levels -- are able to put the entire enterprise at risk. The play is for the big pay-day at almost any expense."
The system may be broken but it can also be fixed. I've talked a lot about the ability of real-time monitoring and surveillance technology to detect and prevent human error, market abuse and fraud. It is time that financial firms, exchanges and regulators take this seriously and institute processes and systems to monitor the activities of algorithms and human beings.
High-speed algorithmic markets that lack adequate real-time monitoring and surveillance risk even scarier things than a flash crash, which happened on May 6, 2010. An algorithm can go into an infinite loop, take on an irreversible and un-hedged position that is difficult to detect and shut down quickly enough. All of this can end up costing a firm billions along with its reputation.
The human equation shows us that traders can hide losing positions until the losses have grown to billions of dollars, such as the recent case of Kweku Adoboli at UBS. Adoboli was a trade support analyst, in charge of looking after the bank's electronic trading and post-trade platforms, prior to his becoming a trader. The same was true in 2008 when rogue trader Jerome Kerviel at Société Générale hid $6 billion in losses, all because Kerviel had knowledge of and abused risk management systems at the bank to hide losses.
There is little excuse for financial firms allowing errors, fraud and market abuse to happen. The problem is not the trading algorithms, but the corporate culture instead. If the CEO or head of trading wants to grab a big bonus in a short period of time he or she may well take chances or even break the law.
As Woodbine Associates said: "Corporate culture needs to change. The change must come from within organizations themselves. You can bet that if they don't do it, regulators will try."
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