New York, NY – On the heels of the introduction of the “Wall Street Speculator Tax” in Congress, national policy center Demos released a new report showing how the rise of high frequency trading (HFT) comes at a massive cost to the real economy, despite Wall Street’s claims to the contrary. “Cracks in the Pipeline 2: High Frequency Trading” demonstrates the ways HFT siphons value from the pipeline of capital intermediation, impeding the long-term investments the economy needs for sustained job growth. This is the second paper in Demos’ series offering a new framework for the proper function of markets in our economy.
According to Demos Senior Fellow and former Goldman Sachs investment banker Wallace Turbeville, author of the report, market efficiency and reliability have declined since HFT has become the norm, now making up as much as 73 percent of volume in many markets.
"This report is an important contribution to the debate over the impact of high frequency trading on the financial system,” said Senator Tom Harkin (D-IA), sponsor of legislation recently introduced in the U.S. Senate creating a 0.03 percent tax on financial transactions.
"This report is an important contribution to the debate over the impact of high frequency trading on the financial system,” said Senator Tom Harkin (D-IA), sponsor of legislation recently introduced in the U.S. Senate creating a 0.03 percent tax on financial transactions.* “It calls into question many of the strategies employed by high frequency traders and raises legitimate concerns that these actors are having a significant negative impact on the fairness and safety of the financial system. I commend Demos for their work to shed light on these complicated and important issues."
New studies show that HFT traders earn consistent and high profits with little risk by taking advantage of information acquired using behavior pattern recognition software and then extracting value from investors at speeds measured in milliseconds. Traders, as Turbeville details, are completely unconcerned with the inherent value of stocks, bonds, and derivatives and have no interest in investment.
During the Flash Crash of 2010, the danger of this speed was famously illuminated when “trader-bots” misread a market transaction and precipitated a $1 trillion stock market sell-off and a recovery all within a 40-minute period. Less known is that smaller events occur daily, disrupting prices and introducing costly volatility that has nothing to do with the fundamental value of securities and commodities.
“Cracks in the Pipeline 2” finds that this volatility actually inhibits the translation of information that is relevant to fundamental value into market prices. If Americans cannot distinguish irrational price moves from those based on facts relevant to value, market prices become less responsive to legitimate information.
“Put yourself in the shoes of an investor holding shares of stock. That investor is constantly considering the value of positions, deciding to hold or to sell and replace with an alternative investment. If you can’t know the real prices, the entire investment enterprise becomes uncertain. Rather than reflecting the market’s increased value, the rise of high frequency trading instead reflects the rise of gamesmanship by Wall Street at the expense of everyone else,” said Turbeville. “The cost of HFT is ultimately borne by the real economy.”
The report endorses a financial speculation tax to minimize the diversion of capital that HFT represents. According to Turbeville, “Circuit breakers, the only regulatory requirement adopted to date, do nothing to stop the daily flow of money out of the real economy and into the pockets of HFT traders. The costs of HFT dwarf the benefits, and safeguards against catastrophe are not enough.”
This paper is the second in Demos’ “Financial Pipeline Series,” which examines how Wall Street’s share of GDP has jumped dramatically since deregulation commenced in the 1980s and, at the same time, it has become less and less efficient at its true utility – serving as a pipeline funneling capital from investors to businesses in the Real Economy. The “Financial Pipeline Series” is part of Demos’ ongoing work to promote a vision of Wall Street as a conduit for productive investment and expanded opportunity in the broader economy.
*Congressman Peter DeFazio (D-OR) has introduced an identical measure in the House.