There was a time when Arthur Levitt was the Chairman of the
Securities and Exchange Commission (SEC) which is a public sector job, and
something happened. He is now employed in the private sector, and something is
happening which, to some degree, mirrors what happened when he was in
government.
What happened then was that the financial markets were
heating up, and money was made by virtually everyone, except that some were
having much better luck than others. It turned out that the internet and the
proliferation of personal computers were greatly aiding the rise of the markets
and the luck of some individuals. Of those who made serious money was a
computer savvy kid in his late teens or early twenties. He was a good kid in
that he did well in school, and he spent a great deal of the money he made on
his parents; showering them with such gifts as a brand new Mercedes and other
valuables.
But the kid got into trouble with the law because he was
caught doing something worse than unethical; he was doing something that was
downright illegal. At least this was the opinion of Arthur Levitt, Chairman of
the SEC who spoke about the subject publicly, expressing – in the strongest
possible terms – his total and absolute indignation at the crimes committed by
that awfully bad kid. And he recommended that the book of law be thrown at him
with no mercy shown or a hint of it.
Well, that's not what most people thought needed to be done
because the kid did nothing that wasn't being done by everyone else at the
time, and continued to be done even after him. What the kid was doing, in fact,
was buy a stock cheaply when it was down. He then got on the internet and
promoted the stock, saying glowing things about it using the jargon of the
trade – a ruse perhaps – that made him sound like the expert who knows what he
is talking about – which he may well have been, at least when compared to those
who got paid for giving advice worse than his. When the stock went up as a
result of his promotion of it, the kid sold and made a big profit. After that,
he picked other stocks, and repeated the performance again and again.
That was then. What is happening at this time is that the
markets are heating up again, and people who are called high frequency traders
are making big profits using methods which are, to say the least, not kosher.
And Arthur Levitt – who is now in the private sector – has written about the
subject in an article that came under the title: “We're All High-Frequency
Traders Now” and the subtitle: “Faster buying and selling is being blamed
unfairly for some problems caused by the fragmentation of markets.” In fact,
Levitt teamed up with someone else, Burton G. Malkiel, to co-author the article
that was published in the Wall Street Journal on April 11, 2014.
To a reader that did not live through the earlier episode in
the life of Arthur Levitt, and having missed his reaction to the success of
that kid, the article sounds like a run-of-the-mill piece. But to those of us
who remember how the Chairman of the SEC reacted then, the article sounds like
something written by an apologist for the modern criminals whose serial armed
robberies make the kid of yesteryear look no worse than a baby caught with the
hand in the cookie jar. Yes, the angry tiger of an earlier era has transformed
into the purring pussycat of today. What happened?
Let's look at the article. The first thing you encounter is
a title which conveys the notion that if high frequency trading (HFT) is
cheating, we're all doing it. With this, the two authors neutralize the whole
issue and take the sting out of the debate. The second thing you encounter is a
subtitle that discusses a fictitious problem to hide the existence of a real
problem. Thus, the authors speak of “fragmentation of the markets” as being the
cause of problems which they say are unfairly blamed on the speed of buying and
selling. This is all hogwash because that's not the core of the problem, and
this is not the complaint.
Still, Malkiel and Levitt set out to frame the debate in
those fictitious terms while cautioning: “There are calls to regulate the
practice … Before taking such a step, let's consider what high-frequency
trading is.” They go on to tell the history of trading, and how the speed by
which a trade is executed has continued to increase from the days in 1792 when
the orders were shouted from office buildings to traders on Wall Street – to
the current method by which trading is automatically executed by high speed
computers.
But here is the catch. They manage to bury in that short
passage, a contradiction that is as big as the galaxy we inhabit. It begins
with this: “High-frequency trading involves the placement of high speed
computers in close proximity to stock-market servers to give some participants
the ability to buy and sell stocks faster than the blink of an eye.” Did you
catch it? Most likely not, because it did indeed happen faster than the blink
of an eye. Read that passage again and concentrate on those two words: “some
participants.” And that is the problem. It is that all animals are equal but
some – that is, SOME ... not all but SOME – are more equal than others. Where
are you George Orwell?
How does that make a contradiction? It makes a contradiction
because it clashes logically with this: “And whether you're buying 100 shares
of a stock or 100,000 shares, you directly or indirectly participate. We're all
high-frequency traders now.” No, we're not. This, my friend, is an intellectual
fraud of monumental dimensions. The truth is that we all trade faster than the
blink of an eye, but we're not all high-frequency traders. Those referred to as
SOME are the ones who buy and sell, buy and sell, buy and sell frequently thus
become high-frequency traders. High speed makes high frequency possible but the
two are different things. The first is inevitable and benign; the second has
one purpose only – to cheat.
What differentiates the high-frequency traders from the rest
of us is not the speed of their trades – which is the same as ours – but the fact
that they are given other advantages which are denied to the rest of us. And
the authors of the article explain what these advantages are. Unable to
contradict the critics who have been speaking out, they now admit: “as critics
note, optimally positioned traders can see trade orders from other investors
before they are executed … this is a form of insider trading called
'front-running' that should be illegal. In the same way, 'phantom orders' are
those posted by high-frequency traders to tease out counter orders, but
disappear.” Here is the crime: “optimally positioned traders.” It is a
conspiracy worked up between those who are positioned and those who position
them i.e. the stock brokers and the exchanges. All these people must go to
jail, and they must make restitution.
If Arthur Levitt had shown the same indignation as when he
spoke about that kid long ago, he would not be pleading for the maintenance of
HFT today. He would have explained the situation as it exists, knowing that the
speed of computers will not be diminished. He would have called for the
outlawing of optimally positioning some traders, and would have left it at that
because this act alone will solve the problem. In fact, without the ability to
see trades coming from other investors and without placing phantom orders,
those traders will not see the need to trade frequently. We will all be trading
at high speed, doing it faster than the blink of an eye but none will trade
more frequently than is needed to conduct normal business. Problem solved; case
closed.