What's to Be Done About High Frequency Trading?

High Frequency Trading (HFT) is essentially no different from a highwayman standing in the road with a gun demanding a tributary toll from all who would go about their business to the better without him. In his book, Flash Boys, Michael Lewis succeeded in arousing some moral outrage about this highway robbery mostly outside of the circle of financial professionals.

Most financial professionals seem to think that the amount it is costing investors is small enough to fall off their moral radar screens and that the high frequency traders deserve some reward for their ingenuity and investment. I find most of these professionals have not read Flash Boys and are not aware of the ways in which brokers breached their moral obligation by literally selling their clients' trades to HFTs, or how banks and brokers allowed HFTs to shine a bright light into their dark pools, completely betraying their fiduciary duties to their clients. Nor do they see as clearly as Michael Lewis how the SEC has been a willing collaborator with the HFT industry, obligingly letting it invent absurdly contorted and distorting order types which are of no use to anyone else; or of how the powers of government law enforcement have been used not to punish those who are stealing (however little each time) from their clients, but those who don't obey the rules of the Wall Street Mafia.

I take space and employ colorful rhetoric to emphasize the point that HFT is just one part of an economic and political system that is increasingly dominated by rent collecting, or rather the collection of the highwayman's toll, along with many bribes and other forms of protection money. Flash Boys makes very clear how much this is the culture and nature of most of the investment management and banking industry. To which we could easily add the similar foundation of extraordinary profits in the legal, health care, defense and oil and gas industries among others.

If we call it what it is: a system in which politicians are bought and paid for, and various gangs of bandits attempt to appropriate permanent streams of income that should have been someone else's, we have a pretty good explanation of our sclerotic economy and government. And we also have a pretty good notion that most of the simple, rational solutions to the problems of HFT have about as much chance of happening as all of the other regulatory reforms of the financial system that have been proposed, compromised, passed and stymied since the financial crisis.

Just to be clear, those simple, rational solutions include: defining a market maker as an entity that has knowledge of other entities' trades within less than a few milliseconds; enforcing the deployment of time delay technology like that employed by IEX at all exchanges; disapproving all of the deliberately deceptive order types used by HFTs; and a financial transactions tax (FTT). Even the conservative economists who wrote the Simon Report on the Crash of 1987 under an exceptionally conservative Secretary of the Treasury serving an exceptionally conservative president discovered the obvious fact that over the preceding hundred years of NYSE history, periods of very low transaction costs had also been periods of very high turnover and volatility. The whole point of a financial transaction tax is to impose a tax that mimics the social cost of excessive and volatile trading, just as a carbon tax mimics the social cost of greenhouse gas emissions.

Perhaps one more example will clarify my point. Many writers have pointed out that many people in the financial services industry went to jail for their violations of laws designed to protect investors and depositors after the Crash of 1929 and again after the Savings and Loan Crisis of the late 1980s and early 1990s. Since the 2008 Financial Crisis only a handful of people involved in the financial industry have gone to jail, and perhaps without exception their crime has been to disobey their superiors, often as "rogue traders". Those superiors are quite clearly guilty of massive frauds and deceptions; but none of them have gone to jail. Instead, federal and state prosecutors threaten them with jail sentences and they buy their freedom by agreeing to have their companies pay over $100 billion and more of fines, in effect stealing this amount of money from their shareholders in order to buy their own immunity.

Instead of a financial transaction tax or a change in SEC rules, perhaps the first thing we should be thinking about to solve the high frequency trading problem and a plethora of similar criminal incursions into our economy is a massive effort to achieve campaign finance reform, probably through a constitutional amendment.