High Frequency Trading, or Not a Double Rainbow

Meet the new trading floor.

While we have been focusing a lot on the Presidential race around here recently - we too get caught up in the sheer volume of reportage of the campaign and equate that with importance - this is a story that is actually relevant to all of us on a daily basis.  All of us that interact with the financial system, that is.  So, unless you are living off-the-grind in a barter based commune in the woods, you might want to pay attention to something called high-frequency trading (hft), or algorithmic trading.


The animated gif below is a daily history of algorithmic trading activity from the past five years provided the analysis firm Nanex.  Take note of how crazy this plot gets starting in about 2010.  We first noticed that something was amiss when we saw articles in the NYT and Reuters back in August [The chart below originally came from this article, but it was taken down.  This article in Technology Review about high frequency trading (HFT) has it archived. -ed.] reporting that Knight Capital Group experienced nearly fatal losses when their high-frequency algorithms went wonky for 30 minutes.



We were reminded of the issues with high-frequency trading this morning when we heard this story on NPR's Morning Edition.  There is apparently some hand-wringing in the halls of Congress over the Knight Capital incident and the glitches that caused a delay in the Facebook IPO.  Like it's a double rainbow we have to ask ourselves about the data and the above chart, "what can it mean?"  If algorithmic trading is an innovation that gives the inventor an creative advantage, then that's what the whole capitalism game is all about.  That's true even if incompetent or unprepared firms make a hash of their algorithms and suffer self-harm, as in the case of Knight, or as presciently imagined by Kurt Vonnegut in his novel Hocus Pocus.  But, if this is little more than a way to game the system and sidestep the letter or intent of SEC regulations, then Congress should absolutely be doing its job to find out and prevent it.

We all know painfully well how the fallout from cavalier regard for risk and volatility on a systematic scale always comes around to bite "normal people".

The Quadrennial World $port Activity, or A Two Week Party for Shoe Companies?

[This post is inspired by years of reading the excellent, trenchant The Sports Economist blog.  We can't recommend this blog more highly if you are at all interested in the business of sports.  Go there now and search for Olympics related posts to find some of the best thinking about the financial and economic impact of major events on the host.  And by the way, we aren't economists and we don't play one on TV, so don't get fussy if our reasoning is askew on this topic.  Just leave a comment and explain where our logic is off.   We enjoy watching the Olympic Games, because we love sport.  There is no fiction that matches the dramatic reality of most any athletic competition.  We wonder, however, if we would enjoy the games any less if they weren't as extravagant, and less of a drain on the host's economy.  We suspect not. -ed.]

If you are at all paying attention, you will inevitably hear about the vast sums host countries spend preparing for the Olympic Games - building new sport venues, beefing up public transit, etc.  This is almost always at taxpayer expense.  In fact, the decision to award a particular country an edition of the Games is often swayed heavily by the extent to which that country will dip into the public coffers.  If you might recall the coverage surrounding the final vote of the International Olympic Committee in 2005 to award the 2012  games to London over the putative favorite Paris.  There was wide speculation that Paris' plan to minimize their investment in new venues by erecting mostly temporary facilities was a factor that ultimately pushed the decision in favor of the British and their promises to spend on a massive scale.  Something about ensuring the "legacy" left by the games on London.  A more perfect example of the principle in economics known as "the winners curse" we have never seen, not to mention the big disruption to the normal enterprise that occurs on a daily basis in London.

No trunk or big ears, but this is what a white elephant looks like

Let's show them what they've won.  Here is what London, and the British taxpayer, is going to "own" on August 13, 2012: lots of big white elephants dotting the  London skyline.  Yes, London, that's even after having the honor of being the most over budget and expensive games in history.  [Even the broadcast rights fees go back to the IOC, meaning that the state-supported BBC is paying to cover the events commercial-free.  Not that we're complaining.  We've been watching web streams of BBC's coverage, and been loving it.  No #NBCFail for us. -ed.]  Not convinced?  Just ask Montreal, Athens, and even Beijing how awesome it to have massively expensive, empty stadiums that take decades to pay off.  Maybe Greece would rather not have the extra billions tacked onto their national debt from the 2004 Games right about now?

It should be noted that Beijing is the exception that proves the rule.  Only a country with that much trade-surplus cash on hand could afford to throw a pile of money down the Olympics hole.

It should read, "Good luck paying for it."

There is something else that occurs to us about the Olympics, though.  This is a unique time for most of the athletes.  For a few days every four years, their largely ignored sport gets a ton of media and public attention focused on it.  That attention can lead to vast riches for those players who are particularly successful (Mr. Phelps, Mr. Bolt, et. al.), particularly photogenic (Ms. Solo, and nearly any beach volleyball player), or extremely media savvy (Tyler Clary).  It also occurs to us that the companies that make all the shoes, apparel, and various other bits of the athletes' kits seem to always report windfall profits in an Olympic year. Go check out some of the financials on participating companies.  Not mentioning any names but there have to be many smiling faces around Beaverton, OR and Herzogenaurach, Germany these days.

All of this leads us to wonder aloud whether all of the money sunk into Olympic preparation, and the hype that it engenders, acts as some kind of Keynesian stimulus for endorsed athletes and shoe companies.  It's likely the worst, least efficient stimulus imaginable, but it looks like at least somebody is being enriched by the Games.  It's just not the taxpayers of the UK footing the bill, nor the fans paying to watch in person, nor the hapless schmucks in the USA forced to watch nightly coverage on NBC.

Paying Attention to a Nobel Laureate in Economics, or A Krugman By Any Other Name is Just as Smart

In case you are not a regular viewer¹ or you just happened to miss the June 18th edition of The Colbert Report, Paul Krugman was the guest.

The Colbert Report
Get More: Colbert Report Full Episodes,Political Humor & Satire Blog,Video Archive

Colbert outing Krugman as a member of The 1%, now can openly drive his Bentley to the yacht club²

[We think you really need to know who Paul Krugman is if you are at all interested in public affairs, but in case you don't, here's his Wikipedia page.  He won the Nobel Prize for economics in 2008.  It's kind of a big deal. -ed.]


While Krugman's appearance on Colbert was nominally to pimp his new book, End This Depression Now!, the by-proxy focus of the interview was on the Presidential race and how it pertains to the world economy.  Colbert takes his usual satiric, arch-conservative stance to draw an analogy between Obama and the European Union, but Krugman astutely points out how the ruined nations in the Euro Zone are more akin to the Romney economic platform.  And, he also notes that one of the most socially generous nation in Europe, Sweden, is doing just fine, thankyouverymuch.  The punchline here happens at the 5:45 mark where he explains how Republican pet policies line up best with one of the biggest disasters in Europe: Ireland. 

As should surprise no one, the Democrats are failing to fully utilize someone like Paul Krugman to hammer the Modern Republican Economic Message.  You see, Paul is highly educated with a Ph.D. from MIT, and a professor at a prestigious Ivy League University, and a columnist with The New York Times, and the author of a book and blog entitled The Conscience of a Liberal.  Heaven forfend.  So, naturally he is pushed to the periphery of election-year discourse.

The shame of it is Paul Krugman is just the type of person that best disarms the Republican's misinformation machine piloted by Karl Rove and his band of neck-less-old-white-men.  The failure of the Democrats to effectively counteract the Fiction-Based Truth from the far right has been their biggest weakness of late.  The Dems have to be the most frustrating, self-destructive political parties in history, but that is a different blog post entirely...


¹We can assure you, dear reader, that your intrepid blogger is a regular viewer


²We can assure you, dear reader, that Paul Krugman doesn't drive a Bentley and probably doesn't belong to a yacht club

Wealth Destruction, or If You Don't Fix the Door the Burglars Will Be Back to Steal Everything Else

As you, dear reader, may have already heard reported elsewhere the Federal Reserve recently released its Survey of Consumer Finances for 2007 - 2010.  No doubt you were camped out in front of your closest Fed regional office for weeks in anticipation for the release of the report, but in case you weren't here's the shocking conclusion: US median net worth is down 38.8% since 2007. The median net worth for US households in 2010 fell back to the same level as it was in 1992.  That was when this was #1 on the Billboard singles chart.*


18 years of financial gains evaporated as fast as Right Said Fred's popularity.


Not surprisingly, most of that wealth destruction was concentrated in the decline of real estate valuation, which is what most middle-class household wealth is dependent upon.  Some more wealth evaporated when the stock market decline in 2008-2009 eviscerated most people's retirement saving, which are now most likely to be in at-risk 401(k) accounts rather than defined-benefit pension plans.  And still more wealth was surely wiped away by stagnant wages and high unemployment.


Naturally, there is plenty of blame to spread around, and we can quibble about the how legitimate the wealth gains through real estate appreciation were in the middle part of the last decade.  But, I defy anyone to deny that reckless Wall Street speculation - speculation that was bound to go bust - was not a large part of the wealth destruction we have all experienced.  So, we should learn from this catastrophic reduction in national prosperity and repair the systems that ran amok, right?  We need to reign in the excesses that caused the mess, right?


I think only a madman would differ.


That is why I can't countenance people like Edward Conrad.  "Who?" you might ask.  He used to be a big shot at a little company called Bain Capital, and he has a new book out arguing that risk taking by investors isn't being rewarded enough.


(I'll let that little gem sink in as you consider what your bonus was last year in relation to the size of bonuses paid out at firms like Goldman Sachs and JP Morgan.)


(Angry yet?  No?  Ok, Gov. Romney you can put on your jodhpurs and click here now.  The rest of my enraged bretheren can continue reading.  Don't worry we're almost done.)


Now, I admit I haven't read Mr. Conrad's book, nor do I intend to.  I only have so much free time and I'd rather spend quality time with my son than read some overwrought fairy tale of the benefits of speculation.  (We've been over my views of finance before, so go read that before you fire up the angry email writing machine.)  Besides, we have this interview of Conrad by Jon Stewart on The Daily Show from 6/7/12 where Jon skewered Conrad's less than cogent arguments from the book.

The Daily Show with Jon Stewart
Get More: Daily Show Full Episodes,Political Humor & Satire Blog,The Daily Show on Facebook

One does not have to do too much sleuthing to connect the dots from Conrad to Romney's economic platform.  I for one am hoping that the remaining 60% of my net worth is spared a Romney administration.

[Next time we will discuss Paul Krugman and Ireland...probably. - ed.]


*Number 1 by measuring revulsion to bare midriffs, we're guessing.

Earnest, But Ultimately Misguided

I too was taken up in the Occupy Wall Street phenomenon when it was a nascent movement. Yes, they had - and still do have - a solid point that needed making and they largely made it well. The financial sector had become a cancer on our society with a bunch of empty suits pushing zeroes around on a balance sheet and extracting fees. There is no value to the economy being created by CDO's, CDS's, and synthetic versions of same. The public should be outraged at what transpired in the financial collapse. It's the old axiom, "If you are not outraged, you are not paying attention."

(Moreover, the criticism of Occupiers not having a coherent message was off base. OWS was a true mass popular movement organized around a single guiding principle, so there was bound to be a lot of different voices speaking up for the group.)

Despite my general agreement...

...I think the OWS movement is largely misguided. While we need to reign in the reckless gambling and exclusionary tactics on Wall Street, but there is a growing mistrust and vilification of finance and capitalism (with a small "c") that is troubling. Historically, a big reason the United States has been such a successful nation by many measures, has been the ease by which we can raise capital to start new ventures, enhance our national welfare, and grow our wealth.

(An aside: If you think it's just a coincidence that the US has dropped from first to tenth in per capita wealth since Wall Street drove our economy off the cliff, then I have some land in Florida I can sell you.) 

Finance, especially as "regular people" are more entrenched in the system through credit purchasing and retirement saving, needs strong, fair, sensible regulation to ensure a level playing field for all comers. But, in demonizing all financial institutions with a broad brush the general public is creating an atmosphere that is more distrusting of the very economic engine that makes us great.

I look at my own life's status, and I can clearly see where the (smart) use of finance has greatly raised my and my family's standard of living. There is no conceivable way that I would posses the education, assets, and piece-of-mind without the application of financial leverage at key times.

We can see this dangerous game playing out in the Presidential campaign, as well as in other less obvious, but ultimately more harmful ways. Exhibit A would be the median age of the typical OWS member.