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The Flash Crash Spoofer of Hounslow

Now we get to marvel at the story of Navinder Singh Sarao, the most recent financial market miscreant who almost got away with millions. He was operating a pop up high frequency trading operation out of a semi-detached house in the London Borough of Hounslow, far from the City and Docklands. The British press, always attentive to trappings of class and always the protectors of the big banks on which their home economy is totally dependent featured those tidbits in their coverage.

The Brits lionize traders as the ultimate expression of the new England, hailing them as modern versions of Thatcherite entrepreneurial shopkeepers. Yet the financial trader, whether backed by small capital like Sarao or by a mega universal bank like Goldman Sachs, is an odd profession on which to found national pride. In terms of social value, these traders make Don Draper look like Mother Theresa. Of course they make money and the occupation is open to non-elites in an elitist society, but so is drug dealing.

They say he made $40 million over a four-year span, apparently trading mostly other people’s money, a tiny operation compared with the size of the market and with other traders. He was hauled before the bar because he was engaging in market tactics called “spoofing” and “layering” just prior to the “Flash Crash.” That was on May 6, 2010 when US equity markets plummeted by about $1 trillion and then rebounded like a super ball, all in less than half of the time it takes to do a proper gym workout. (I know because I was watching CNBC on the treadmill during the episode.) The implication in many press reports was that Sarao’s sketchy trading schemes contributed meaningfully to the Flash Crash.

It seems absurd to suggest that Sarao’s tiny operation caused the Flash Crash, though if it truly did the fragility of the trading markets is even more frightening than thought. Nonetheless, what he was doing is a marvelous exemplar of how technology and quantitative analytics have magnified the excessive financialization of the economy. Sarao flooded the markets with offers to sell stocks and derivatives tied to stock prices. He did this in “layers,” meaning he made offers at several levels of declining prices, indicating interest to sell at ever decreasing prices.

He had no capacity to fulfill these offers, and never intended to. He was able to make them because his computers allowed him to cancel the orders before they could be taken up. However, traders in the market took his original offers as an indication that the market was tanking, as he intended them to since he was “spoofing.” Sarao had made a bet using derivatives that the market was going to dip, and dip it did as panic selling took hold.

There were undoubtedly other spoofers like Sarao in the market and some may well have been at big institutions. The market conditions on that day were very good for running a spoof, but there is proof that this goes on every trading day. There is no reason to think that regulators could have detected this spoofing. They discovered Sarao when someone turned him in. But it is clear that Sarao and others managed to spoof the spoofers as traders using HFT technology were at the front of the panicked crowd fleeing the market during the Flash Crash.

People will pay to read about high-frequency trading (or HFT). Just ask Michael Lewis, whose best selling “Flash Boys” landed him another turn on the talking head circuit to hawk his book. Unfortunately, HFT is merely a slice of a system of finance that injures our economy, crushing wages of workers and ratcheting up inequality of incomes and wealth. HFT is nothing more than good old fashion market manipulation, supercharged with computers that execute algorithms at high speed and move mega data.

Here is the real story: Financiers now dominate the entire economy, using a new form of market power to create inefficiencies and then profit from them by extraction of rent. Finance in the US and in other developed economies has become parasitic, sucking the well-being out of the vast majority of households, and in particular households of color, and transferring it to the wealthiest among us (This was a subject of a recent Demos report.)

Finance has become a vehicle of a growing form of income and wealth inequality that has been shown to damage the US economy more than the financial crisis and the ensuing Great Recession. Our economy is drifting in the direction of a zero sum game in which the increased wealth of the wealthiest comes at the expense of the majority of households. That is unsustainable, as Thomas Piketty observed in his blockbuster tome Capital in the 21st Century,” but it is not our inevitable fate as he asserted. Government can change finance if politicians have the political will to do so and the courage to investigate the real economic effect of an industry that is reported to spend $1.4 billion per election cycle on campaigns and lobbying.

Let’s not be distracted by either this small time operator or the seductive technology story from the main point: the financial system is far too complex, made so to allow the financial sector to better extract value, and no longer serves the interests of the vast majority that make up the real economy. The efficiency of our system of allocating and trading capital needs a complete retooling—not just Dodd-Frank Act style financial regulation—if we are to avoid unsustainable inequality and wage compression.