The new book, Flash Boys, by Michael Lewis has reignited the discussion of how our financial markets are rigged by high frequency trading. ((I have written about these issues earlier: “High Frequency Trading and Deeper Questions about Capitalism” and “Wall St – not about investing but fixing the game” earlier)) From my 2012 note:
To turn back to HFTs, why do we need this kind of transaction? How do they contribute to economic growth? These activities are by definition a zero sum game. They are like every other form of gambling a zero sum game. There are winners and losers, but no incremental gain for the economy. Other than enriching the HFTs at cost to others with smaller computers and fewer PhDs on staff what do we get for allowing these activities? Potentially catastrophic destabilization of financial markets? Where is the upside for society as a whole? Isn’t a primary purpose of any economy to increase the size of the pie, not just to redistribute existing wealth?
We should demand that our financial markets serve their fundamental purposes – connect investors with those who can deploy those resources to create new products and services and enable the flow of these goods and services. To call holding financial instruments whether stocks, bonds, or other assets for mere seconds investments is to beggar the mind. Government needs to step in to penalize economic activity that looks like gambling and certainly does not “grow the pie”. A sliding scale of transaction costs (aka a tax) could bring this to a screeching halt. ((We would have to face the international crisis of how to employ all those PhDs currently engaged in the HFT wars)) There are sure to be complexities in how to implement such a strategy. But, if at every step we ask how a financial transaction contributes to economic growth at a systemic level, solutions will appear. Right now we have financial markets that are not only rigged but so complex and non-transparent that we are certainly setting ourselves up for future calamities like that which struck us in 2008.
