As it did before the financial crisis, Wall Street is bankrolling academics to bolster its case against regulation. Then, the research gave warm tongue-baths to the virtues of derivatives. This time, the beneficiary is high-speed trading.
A highly publicized research paper from Columbia University claiming that high-frequency trading benefits society and shouldn't be regulated too much was paid for by -- surprise -- a high-speed trading firm.
Unlike most academic papers, this one, by Columbia Business School economics professor Charles Jones, was announced to the world last week and turned into an op-ed at Politico headlined "The Reality Of High Frequency Trading."
In his paper and his Politico piece, Jones declares that high-speed trading bolsters that magical market stuff known as "liquidity," pushing stock prices higher and making companies richer and more willing to spend money, making us all wealthier. None of that has actually happened yet, of course, with markets and the economy flat since the advent of high-speed trading a decade or so ago. Never mind all that, though: Regulate high-speed trading too much, Jones warns, and the liquidity could go away. And bad things happen when the liquidity goes away.
"Overall, there is no evidence of any adverse effect due to high frequency trading in the average results," Jones writes in his paper, warning, "those formulating policy should be especially careful not to reverse the liquidity improvements that we have experienced in the U.S. over the past few decades."
Not as well-publicized, and not mentioned at all in the Politico piece, was that Jones's research was supported by a grant from the hedge fund Citadel LLC, one of the country's top high-speed trading firms. Its Citadel Securities division offers high-speed trading for institutional clients, and it has a high-speed trading fund that last year returned nearly 26 percent.
"Citadel’s largesse does not mean that Professor Jones's work was biased," Wallace Turbeville wrote on the Policy Shop blog of the think tank Demos. "But the very fact that he published an opinion piece in Politico, overtly entering into the political discourse over HFT, is concerning, to say the least."
As the Wall Street Journal reported in a story about lobbying by high-speed trading firms, Citadel last year hired Jones expressly to write this paper, after he had already expressed public support of high-speed trading.
"This has been an area where there's been a lot of emotion and too few facts," Jones explained to the Journal. (Columbia Business School did not respond to a request for comment.)
If this sounds familiar, you may be thinking of the researchers who were bankrolled by the financial industry before the financial crisis and wrote influential papers about how derivatives and other financial innovations couldn't possibly cause any harm, and that regulating them too much was the real worry.
One of those researchers was another Columbia professor, Glenn Hubbard, most recently a top economic advisor to Republican presidential candidate Mitt Romney. In an infamous moment in "Inside Job," the documentary about the financial crisis, Hubbard, who wrote an influential 2004 paper about the wonders of derivatives, reacted with fury when questioned about how much of his personal wealth came from serving on the boards of financial institutions.
Yet another Columbia professor, and a former Fed governor, Frederic Mishkin, also was cornered in "Inside Job," over a paper he wrote about the rock-solid financial system of Iceland, not long before Iceland's financial system collapsed -- a paper for which Mishkin was paid $124,000 by Iceland's Chamber of Commerce.
The trouble with this kind of research is that, with the bouquet of academic credibility, it can have a huge influence on policymakers in Washington who are currently trying to figure out just what to do about high-speed trading. Even better when the research is turned into an easily digestible Politico op-ed.
And Jones's take is far from balanced. It ignores many counter-arguments, including research suggesting the damage done by high-speed trading and allegations that financial market operators often give high-speed traders unfair advantages over slower, human traders.
"Overall, we are very disappointed in Professor Jones and Columbia Business School for leaving out a key part of the story," Themis Trading, a firm vocal in its opposition to high-speed trading, wrote on its blog last week. "The paper strikes us as an attempt to possibly influence some key people that may be appointed to some new positions soon in Washington D.C."
Full disclosure: Themis has its own gamecock in this fight, as a purveyor of human-based trading services. But then, it's up front about that.
Update: The authors of that WSJ story, Jenny Strasburg and Scott Patterson, had another one last December with a long list of researchers paid by Wall Street to write papers touting the virtues of high-speed trading. The first anecdote in that story is about Knight Capital, which in 2010 paid for a study favoring high-speed trading. Knight's CEO cited the study in congressional testimony two years later -- just before a trading glitch cost the firm $460 million in a matter of seconds, ending the company's independent existence.