The New York Times recently reported that the latest scheme--or scam--on Wall Street is something called High Frequency Trading. Very sophisticated financial firms, such as Goldman Sachs, are tipped off by the New York Stock Exchange's own computers to pending buy and sell orders. Armed with ultra sophisticated computer algorithms, the insiders anticipate the direction of the market based on what they learn about supply and demand for a given security. They can make an extra penny here and an extra penny there at the expense of us suckers, adding up to billions.
"Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed," wrote the Times' Charles Duhigg in a front page piece that was the talk of New York and Washington. "High-frequency trading is one answer."
As debates in the blogosphere in the last couple of days have made clear, there are a couple of possibilities of what is at work here. One is that Goldman and others are literally using privileged information to make trades ahead of markets, in which case they are committing a felony. Specifically, the abuse is known as "front-running," or trading ahead of customers, and it is an explicitly illegal form of market manipulation. Front running is epidemic on Wall Street--the whole point of an investment bank trading for its own account is to take advantage of its specialized knowledge of markets--and the SEC or the Justice Department shuts down front-running when it becomes too blatant to ignore.
The other possibility is that the Goldmans of the world have found themselves a nice loophole. Tapping into the Stock Exchange's own computers and other sources of trading activity is something that anyone in theory could do, but only a few privileged insiders have the sophistication to exploit what they find. Often orders are placed, only to be cancelled. Their purpose is to figure out what the market is willing to pay, and then get in ahead of it.
But suppose that High Frequency Trading doesn't violate any law. It still is the essence of what's wrong with the recent metastasis of money markets into private game preserves for insider-traders.
Consider for a moment some first principles. The legitimate and efficient function of financial markets is to connect investors to entrepreneurs, and depositors to borrowers. There is no legitimate reason whatever for this to be done by the millisecond. At bottom, the process is pretty simple. The intermediary--the bank, savings institution, or investment bank makes its fees for making a judgment about risk and reward. How likely is the loan to be paid back? How high an interest rate should it charge? How should a new issue of securities be priced? The investor decides whether to indulge a taste for risk or for prudence.
But the hyperactive trading markets and creations of recent decades such as credit default swaps and high speed trading algorithms add nothing to the efficiency of financial markets. They add only two things--risk to the system, and the opportunity for insiders to reap windfall profits.
Therefore, whether or not Goldman's lawyers have figured out how it can engage in High Frequency Trading and stay within the law, there is a strong case that this entire brand of financial engineering should be prohibited. The whole game should be slowed down. Bona fide investors should get in line under the rule of first come, first served. Anything else should be considered illegal market manipulation. No dummy transactions. There is absolutely no gain to economic efficiency from having prices of securities change in milliseconds, and much gain to the opportunities for manipulation.
The need to restrain traders from exploiting their privileged knowledge is an old fight. During the New Deal, for example, many reformers proposed that floor specialists for investment bankers and brokerage houses simply be prohibited from trading for their own accounts. They should be there simply to execute buy and sell orders for customers. Otherwise, the conflict of interest would be overwhelming--and this was before computers. These reformers were overruled, but insider trading was explicitly prohibited (and good luck catching it.)
Now, as then, it is a mark of Wall Street's stranglehold on politics that the most sensible of remedies seem impossibly radical. One very good way to damp down the dictatorship of the traders, and raise some needed revenue along the way, would be through a punitively high transactions tax on very short term trades. Genuine investors should get favored fax treatment. Pure traders should be taxed, and very short term manipulation taxed into oblivion.
If the financial crisis has proven anything, it is that capital markets have become an insiders' game in which trading profits crowd out the legitimate business of investment. The whole business-models of the most lucrative firms on Wall Street are a menace to the rest of the economy. Until the Obama administration recognizes this most basic abuse and shuts it down, it will be more enabler than reformer.
Robert Kuttner is co-editor of The American Prospect, and a senior fellow at Demos. His recent book is Obama's Challenge.
It is disheartening because at stake for me personally are my childrens two college funds and various accounts for my retirement. Like everyone else, these accounts have taken a savage beating lately and I believe that things are not going to get any better for the 'little guy', especially after reading this article regarding HFT on Wall Street.
It has become pretty obvious over the years that Wall Street is only interested in maximizing profits at any expense and our Government has only been too happy to oblige them by destroying what little regulations there were on the banking and finance indusrty to begin with. To add insult to injury our government has been wasting (handing over) billions of tax dollars to prop up an unsustainable financial system that is built on a foundation of greed and unethical business practices.
The point is that Wall Street will win no matter how the cards fall. Investing is gambling, and like Vegas, the house ALWAYS wins. As soon as the general public starts realizing this, the better off it will be.
- maybe due to Jon Stewart - a bit less a present.
A look back at some bad habits, pundits forecasting and advising incredibly wrong, like in the video
posted below, in 06/07 (and still posing some danger, again; - and hopeful overcome one day):
http://www.youtube.com/watch?v=2I0QN-FYkpw
Private banks are intimately linked with the US Treasury, Federal Reserve and supposed regulators such as the CFTC and SEC in said rackets, and it is all anything but a "free market".
Welcome to Stalingrad, Comrades......
Why?
Because they are the reason for the bailout money and our new found national debt that will bankrupt this once great nation.
Risk rewarded should carry a high price and pay for its own damage.
Fat cats get rich by risking you and my future.
The tax on these CDO's and other derivitives should be economically neutral to the nation and the government. (That would be your new payed and unpayed taxes of 200,000 each of us owes).
These bailouts should be insured by the industries and people that are getting rich by them.
if a punitive tax were imposed this would tend to push money into more conservitive, less risky, and longer lived benefits for or nations economy than the lavish vacations to Barbados and other foriegn destinations that these investors spend their money on when they leverage the insider information there positions allow them to manipulate.
Past Presidents with a desire to bring in some form of Universal Healthcare have been thwarted by your big Phara and Congress.
Obama is determined not to let this happen again, a task that is monumental.
You can only manage so many big changes.
He has put in place, or more aptly put, allowed to run their course, the economic recovery measures implemented by his predecessor.
Until a healthcare bill has been put in place (or not if your rightwing crazies have their way), he is "keeping his enemies closer" (the Wall Street smoothies).
He is also likely watching closely the interplay between ardent reformists and the obstructionists in his administration.
He is no fool, so knows that to wade in on making big changes without getting a firm understanding of the lay of the land is the a characteristic of a poor manager.
What the people of this country need to be SCREAMING for is capital ganes taxes based on how much real capital and social responsibility it creates. If a company has jobs with a living wage, benefits, and is ecologically responsible then it gets a very low tax rate. But if the company makes money the old fassion way like these crooked credit default swaps then it pays a very high rate. Then there is less pressure on regulators. People will pay more attention to their investments and our country will get more tax revenue or REAL CAPITALISM!!!!
As well as commissions and risk, we pay a little tax to favored corporations at every trade. Frequent trading is not the ideal way to cope in the market. Ideally, you put your money in the most likely stock according to your hope of capital gains and dividends.
The capital gains are best psychological since, if your money is in the best stock, you must be a fool to take it out to reinvest. Perhaps, you may figure a stock will max out and you get a clue to an undervalued stock that will do better for a time. This is the stock market as a casino. If you want to play it this way, winning is always a possibility and I wish you well. There are big boys with research departments competing with you.
Equity investors use leverage to take a firm over, seize its assets and exhaust its credit: then, cash out. This is a serious threat to the continued existence of a firm. The ordinary investor should put a hand over his wallet and run away as fast as possible. Getting out as soon as possible is the best prospect for overall gain since the equity investor means to get the most to himself.
The soundest strategy for the ordinary investor is to simply park the money (keeping your eyes open with consideration for the foregoing) and let the dividends accumulate. This also circumvents the strategy Robert Kuttner describes.
Mr. Todd Harper works for Congressman Paul Kanjorski, the chairman of the House subcommittee that oversees banking, the SEC, CFTC and other federal agencies. I spoke to Todd Harper yesterday and he said that they are working on these problems.
Hopefully, you will send this article to Congressman Kanjorski's office at pa11ima@mail.house.gov.
Also, call 202 225 6511 and tell Todd how you feel.
Finally, contact your members of Congress. Let them know you want these companies punished.
The same with the housing market. Is it really right that a home originally built for a family sold for $35,000, the family lived in the house for say 20 years and sold the house for $350,000? then a "investor" purchased the same 30 or 40 year old "Rental Property" for 400,000 and sold it a year later for $500,000? by this time the plumbing is about shot, the structure has probably been infested and weakened by termites, The roof needs to be replaced... and the neighborhood has most likely been run down... Is the shack really honestly worth more than when it was brand new?
Try the same logic with your new Chevrolet Impala, you buy it new for say, $20,000, as soon as you register the sale, it is then only worth maybe 15,000, drive it for 10 years, put 100,000 miles on it, when you sell it, (or trade it in) you will be lucky to get $5000 for it. It is easy to look at the greedy CEO's making millions for sending the nations wealth of manufacturing base jobs to cheaper third world nations, but are they really much different than the rest of us?