Press-Republican

April 6, 2014

Tax could limit high-frequency trading

Colin Read, Everybody's Business
Press-Republican

---- — High-frequency trading is finally receiving the regulatory scrutiny it richly deserves. I harken back to a simple solution I proposed to a problem that is now much bigger.

Let’s first describe the phenomenon. While our minds begin to whirl when we speak of milliseconds, high-frequency traders are simply reinventing a wheel of corruption that goes back generations.

Almost since the invention of markets, it has occurred to speculators that they can make easy money in the worst possible way — by doing nothing.

When the railroads sought land to connect our nation, speculators would arrive in town just before the railroad land surveyors. The speculators, often tipped off by their political cronies hoping to cash in on inside information, knew in advance the routes for which the railroads sought approval. These unscrupulous speculators would buy land from unsuspecting farmers and sell it days, weeks or months later to the unfortunate railroads for handsome profits.

Many millionaires were made by such parasitic traders. But, these millions were not earned. No new products were made, the world was not made better off, and no efficiencies were gained. Instead, the immoral became rich on the backs of farmers and the users of the railroads who would have to pay higher rates to cover higher-than-expected construction costs.

We can outlaw such behavior, and some tried, but it is very difficult to prove that someone speculated on inside information. It is possible that some of these land flips were simply the advantage of betting well, if not good. Insiders don’t talk or tell on each other, else they will all go to jail.

There is a special place in hell for those who work so hard to rip off others when the sweat of their brow could have been better employed to truly make the world a better place.

Fast forward a century or two, and we have reincarnated these robber barons. Now, though, days, weeks and months are instead measured in milliseconds and microseconds.

The robber baron speculators 21st century style do the same thing, but this time by making deals with stock trading floors to see where stock orders will be routed next, and getting there to buy up the particular stocks and resell them a blink of an eye later to the unsuspecting purchaser.

They may make only a penny or so each time, but add these trades up, millions and even billions in a day, and we are starting to talk about some real money. The trade still occurs, so they argue they are not inhibiting commerce, but they are nonetheless siphoning off millions each day that would have otherwise gone to you, to me, to our pension funds, and to those who take a long view on investment.

There are no efficiencies gained from this speculation. They are not making the market more efficient by allowing prices to converge to their proper values more rapidly. In fact, by siphoning off millions of profits for us, they give us all the impression there is no level playing field. Stock market participation is discouraged, and we all suffer.

This problem is easy to fix, though. If they can profit only by earning a penny a trade on billions of shares trading hands each day, let’s just impose a penny tax on each purchase or sale. This simple act would take much of the profit out of their surefire speculation, and yet would not at all affect those who are purchasing shares as a long-term investment vehicle. The tiny spread could even go to pay down the national debt rather than into the pockets of the greedy.

This strategy would also cool the heels of the related action of algorithmic trading that tries to capitalize on the worst psychology of the marketplace. Such computer-to-computer trading makes up the majority of trades in certain securities on some days. While it may be a battle of microchip wits, it also does not do anything to encourage thoughtful investment in innovative enterprises. In fact, these computers don’t really care what the stock is. They are in the business of generating and then capitalizing on volatility. In the end, we all lose.

Colin Read chairs the finance and economics faculty at SUNY Plattsburgh and has published a dozen books on local and global finance and economics.