big finance

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Have Financial Markets Gone Post-Human?

So, Thomson-Reuters pays the University of Michigan a million dollars a year to provide selected clients with the results of the latest survey of consumer sentiment 5 minutes before the rest of the world sees them — and to provide higher-paying clients with this information in a machine-readable format ready for algorithmic trading 2 seconds before the rest.

This was not first revealed by the issuers of the consumer confidence survey, or by Thomson-Reuters, but rather by Nanex:

On May 28, 2013, about 1/4 second before the expected release of the Consumer Confidence number, trading exploded in SPY, the e Mini and hundreds of other stocks. Even more interesting, activity exploded just 1 millisecond earlier in the futures (traded in Chicago) than stocks (traded in NYC). The speed of light separates information between Chicago and NYC by at least 4 or 5 milliseconds. Which means this was more likely the result of a timed trading in both futures and stocks, rather than a arbitrage reaction between the two.

We found no other instances of early trading in the 11 previous monthly releases of the same Consumer Confidence data.

Nanex’s data:

screen shot 2013-05-28 at 1.55.25 pm

So, is having a two second jump on the market “insider trading”? Well, yes — but it’s legal insider trading with consent, out in the open. And it likely provides a valuable income stream for the University of Michigan. With or without an early information premium, the algorithmic traders would still have the jump on the wider market. A two second delay in the high-frequency world is an eternity. This kind of early information premium is more like a financial tax on high-frequency traders. If we’re going to have high-frequency trading at all, it may be better for publicly-funded information providers to be able to recoup some or all of their costs by charging the high-frequency traders. In fact, while high-frequency trading continues states might want to look at rolling this out across other datasets, and putting the proceeds toward infrastructure spending or some other public good. After all, while banning high-frequency trading makes for attractive rhetoric, it would probably send an even greater amount of financial activity offshore into a jurisdiction that allowed it. That implies that it would probably be about as effective as prohibiting marijuana and alcohol.

And is this financial markets going post-human? These kinds of barriers to entry cannot be healthy for inclusive, open, transparent markets. If there was anything that might drive retail investors out of the markets — retail investors remain significantly under-invested on where they were before the advent of high-frequency trading, for example — it is massive information asymmetries that render the little guy entirely uncompetitive. Of course, retail investors can still be fundamental value investors, buying and holding. But trying to daytrade against the algorithms seems analogous to a human runner competing against a Ferrari. In fact, given the timeframes (microseconds, in some cases) this analogy is many orders of magnitude too small; it’s closer to a human runner competing against an Alcubierre warp drive. Not so much picking up nickels in front of a steamroller as picking up nickels in front of a Borg cube. If this continues, trading is going post-human.

But in the long run — given how badly traders tend to do against the market — perhaps driving daytraders out of daytrading where they tend to lose money against the market, and into holding diversified index funds is a cloud with a silver lining. Let the robots read the tape (i.e. use regression analyses) and do financial battle. Robots are fast, they don’t get bored or discouraged. Just as in other areas where human endeavour is threatened by robots, it is important to note that while robots can do many things, there are many spheres where humans still have a great advantage. Let humans act in the roles in which they have a natural advantage, and in which robots do not have any skill at all — abstract thought, creativity, social interaction. Robots are still largely confined to drudgery; the word itself is rooted in the Czech word for drudgery, after all. In finance, while robots may some day soon do the overwhelming majority of the trading, humans can still devise the trading strategy, still devise the marketing and sales strategies, and still devise the broader macro strategy.

So perhaps the beginning of the end for human traders is just the end of the beginning for global financial markets. Perhaps that is less of a death sentence, and more of a liberation, allowing talented human labour that in recent years has been channelled into unproductive and obscure projects in big finance to move into more productive domains.

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Save Our Bonuses!

With the British economy in a worse depression than the 1930s , bank lending to businesses severely depressed, and unemployment still high, a sane finance minister’s main concern might be resuscitating growth.

Prime Minister David Cameron And Chancellor George Osborne Ahead Of A Critical Week At The Leveson Inquiry

George Osborne’s main concern, however, are the poor suffering bankers:

Chancellor George Osborne flies to Brussels later determined to water down the European Parliament’s proposals to curb bankers’ bonuses.

But EU finance minsters in the Economic and Financial Affairs Council (Ecofin) are expected to approve last week’s proposals.

They include limiting bonuses to 100% of a banker’s annual salary, or to 200% if shareholders approve.

The City of London fears the rules will drive away talent and restrict growth.

Mayor of London Boris Johnson has dismissed the idea as “self-defeating”. London is the EU’s largest financial centre.

On Monday, a spokesman for Prime Minister David Cameron said: “We continue to have real concerns on the proposals. We are in discussions with other member states.”

But Mr Osborne’s bargaining power may be weakened further by Switzerland’s recent decision to cap bonuses paid to bankers and give shareholders binding powers over executive pay.

Now, I couldn’t care less about bonuses or pay in a free industry where success and failure are determined meritocratically. It is none of my business. If a successful business wants to pay its employees bonuses, then that is that business’s prerogative. If it wants to pay such huge bonuses that it puts itself out of business, then that is that business’s prerogative.

But the British financial sector is the diametrical opposite of a successful industry. It is a forlorn bowlegged blithering misshapen mess. The banks were bailed out by the taxpayer. They do not exist on the merits of their own behaviour. Two of the biggest are still owned by the taxpayer.  So I — as a taxpayer and as a British citizen — have an inherent personal interest in the behaviour of these banks and their employees.

In an ideal world, I would have let the banks go to the wall. The fact that the financial system is still on life support almost five years after the crisis began tells a great story. It’s not just that I don’t believe in bailing out failed and fragile corporations (although I do believe that this is immoral cronyism). The excessive interconnectivity built up over years prior to the crisis means that the pre-existing financial structure is extremely fragile. Sooner or later, without dismantling the fragilities (something that patently has not happened, as the global financial system today is as big and corrupt and interconnective as ever), the system will break again. (Obviously in a no-bank-bailout world, other action would have been required. Once the financial system had been allowed to fail, depositors would have to be bailed out, and a new financial system would have to be seeded and capitalised.)

But we do not live in an ideal world. We have inherited a broken system where the bankers (and not solely the ones whose banks are owned by the taxpayer — all banks benefit from the implicit liquidity guarantees of central banks) are living on taxpayer largesse. That gives the taxpayer the right to dictate terms to the banking sector.

Unfortunately, this measure (like many such measures dreamed up arbitrarily by bureaucrats) is rather pointless as it can be so very easily gamed by inflating salaries. And it will do nothing to address financial sustainability, as it does not address the problem that led to the 2008 liquidity panic — excessive balance sheet interconnectivity (much less the broader problems of moral hazard, ponzification, and the current weakened lending conditions).

But, if it is a step toward a Glass-Steagall-style separation of retail and investment banking — a solution which would actually address a real problem, and one advocated in the Vickers report — then perhaps that is a good thing. Certainly, it is not worth picking a fight over. The only priority Osborne should have right now is creating conditions in which the private sector can grow sustainably. Unlimiting the bonuses of the High Priests of High Finance has nothing whatever to do with that.