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It’s Time for a Tax to Kill High Frequency Trading

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It’s frustrating to know that there’s a simple solution to a serious problem but no one seems willing to do the obvious.

Tax maven Lee Sheppard in an article at Forbes describes how transaction taxes could very quickly put a brake on numerous undesirable activities: high frequency trading, the explosion in derivatives, and overuse of repo financing. You might collectively think of these things as “junk liquidity” or “junk trading”.

HFT has proven to be singularly destructive. Despite the claims of it defenders, it does not increase market liquidity; it merely increases trading volumes without improving ease of execution. 60% of US stock market trading volume comes from HFT. HFT has undermined how markets operate. Institutional investors have diverted some of their trades to “dark pools” to escape the pred Retail traders have become increasingly distrustful of equity markets, thanks to HFT-related debacles like the flash crash and Kraft’s first trading day at NASDAQ, when its initial trades had to be cancelled. CFTC commissioner Bart Chilton pointed out some other casualties of “cheetah trading” in a speech on Tuesday (hat tip Michael Crimmins):

A few weeks ago, the Tokyo Stock Exchange closed due to technology problems. We’ve seen a few contracts shut down for different periods in Chicago and New York last month. We’ve seen market volatility increase wildly: natural gas plummeting eight percent in 15 seconds last year. One day silver plunged 12 percent in about as many minutes. One energy trader lost $1 million in one second—in a second! We saw crude tumble $3 in a minute last month. We continually see sharp rises and falls in precious metals. Knight Capital Group, in August, lost $440 million based on software trading mistakes—throwing it to the threshold of bankruptcy. There are numerous other instances and it’s a safe bet that there will be still others.

Sheppard points out that HFT is front running and the SEC should have barred it; a transaction tax is thus a way to compensate for SEC enforcement failures:

HFT is computer-generated front running. It ought to be illegal, but the SEC is too timid to kill it. Yes, front running is already illegal, and yes, the SEC has slapped a few wrists about preferential access to order data. But the tiny fines show that the SEC cannot be trusted to put the interests of investors ahead of those of traders and exchanges..

HFT computers, parked right next to the exchanges’ order-matching computers, pay the exchanges to receive order feed ahead of it being transmitted to network computers for the consolidated national best bid and offer. Called co-location, this placement permits HFT algorithms to reconstruct the national best bid and offer before it is publicly disseminated…Moreover, the exchanges have created special types of orders at the behest of HFT traders, such as “hide not slide” orders that are not displayed to other market participants.

And please, get over the idea that these trades make the markets work better:

All U.S. exchanges pay for order flow.

The exchanges pay rebates for posted quotes and charge a smaller amount for orders filled—the maker-taker rebate system. The exchange usually keeps the spread—unless both sides of the trade are the same trader. So HFT algorithms hunt for rebates when prices are stable, buying and selling the shares at the same price and pocketing the spread on the rebate.

Gee, isn’t that a guaranteed profit from the rebate when a share is holding its price? Yes, absolutely. The maker-taker rebate guarantees riskless profits for HFT. The exchanges’ euphemism for this practice is “guaranteed economics,” according to Scott Patterson of The Wall Street Journal, author of Dark Pools: High Speed Traders, A.I. Bandits, and the Threat to the Global Financial System. European policymakers are considering eliminating the maker-taker rebate.

HFT is notorious for disappearing orders—toxic quotes. Bombarding the system with toxic quotes is how the algorithms drive up prices. “They add volume, not liquidity,” said Arnuk, who originally became interested in HFT when he noticed quotes vanishing.

The primary objective of a transaction tax is like a vice tax: its primary objective is to discourage activity, not make money, although a transaction tax would generate a decent level of revenues at low cost. It’s no where near as radical as the banksters would have you believe: the United Kingdom, Hong Kong, Singapore, and (gasp) the US have forms of transaction taxes.

A new transaction tax of one basis point on securities transactions would pretty much end the HFT business, since the average trade generates less profit than that, while having a trivial impact on retail investors (a $2000 trade would face a $0.20 charge). A bill before Congress (Harkin-DeFazio, S. 1787) is revenue rather than behavior oriented, and calls for a three basis point charge, and claims it would raise $350 billion in 10 years. That seems high, since it also appears to assume that the junk trading would remain in place. But even if this number is overestimated, it’s a nice chunk of change, particularly given that transaction taxes are easy to collect.

Harkin-DeFazio would also tax derivatives transactions, not on their notional amount but the net payment. Anyone who has had any contact with the derivatives business knows that they are used overwhelmingly for speculation, accounting gaming, or regulatory arbitrage. The real tell is the insanity that is uncritically taken up on some of the more OTC markets oriented financial outlets, that of the “scarcity of good collateral”. The demand for collateral is due to the need to secure derivatives positions. When the value of side bets is so large you can’t find enough good assets to secure your positions systemically, there is something seriously wrong with this picture. Sheppard recognizes the connection between derivatives and repo financing, which is something that Harkin-DeFazio missed, and she argues the tax should include repo as well:

Repos should be taxed under a FTT [financial transactions tax] to discourage the use of this fragile form of finance. Repos are collateralized loans that are formally documented as purchase and resale contracts (hence the name).

The big banks turned themselves into publicly traded hedge funds, heavily reliant on short-term finance and leveraged to 30:1 or higher (they are at roughly 14:1 now). A lot of that leverage came through repo finance. A New York Fed research paper described repo finance as a linchpin of the frightening codependency of the regulated banking sector and the equally large unregulated, shadow banking sector, composed mainly of hedge funds and money market funds.

But borrowing against securities holdings is a longstanding market practice! Rehypothecation contributed to the meltdown. The big banks ran their repos through London, which has no limits on rehypothecation. (SEC Regulation T limits rehypothecation to 140 percent of broker/dealer loan balances.) The IMF found a lot of churning, concluding that $1 trillion of hedge fund collateral was used for $4 trillion of borrowing by big banks.

Sheppard seems unduly worried that imposing the tax might lower securities prices. First, the level of taxes is trivial for that dying breed, investors; it’s quick trigger traders that will feel the pinch. This will have a marginal impact on transaction costs for most investors. I grew up in a world where transaction costs across the board were vastly higher and despite enthusiast claims to the contrary, lowering transaction costs does not seem to have been a price booster (I’ve seen pretty dramatic examples to the contrary, where bidders on NYC apartments are insensitive to flip fees, 2% to 3% charges imposed by the co-op when they sell). Second, if she believes her own argument about the detrimental effects of HFT, getting rid of junk trading would reduce market volatility, making investments more attractive. That would likely more than offset any negative impact of miniscule increases in transaction costs.

Of course, there are more draconian remedies being bandied about. Consider Bart Chilton’s suggestion:

I’m calling for significantly increased penalties for cheetah trading that results in harm to our markets. And here’s how I propose doing it: we need to re-think what the term “per violation” means. Let me explain.

Under our statute, we can fine a miscreant $140,000 per violation—and that used to be sufficient. That dollar figure made sense in yesterday’s world of human-to-human trading. But it doesn’t work in these markets, in this incredibly fast-pace, instantaneous-almost-incomprehensible world of cheetah trading. So, my idea is that we revolutionize how we determine what “per violation” means. In the past we’ve looked at, say, each day that someone breaks the law, and for each single day, make that one violation. That’s not good enough anymore.

Today I’m suggesting that we look, not at each day of trading as being one violation, but instead look at each second. That’s right: each second. So, for every second that a cheetah trader is engaged in conduct that violates our law, we could fine them the statutory maximum of $140,000—and that could add up to sufficiently high penalties so that they actually mean something. Hey, this type of unfathomably fast trading can reap millions for the guys betting with their algorithms, and at the same time it can wreak havoc on our market players and legitimate trading of investors and consumers—we need to have a fitting consequence for rule violators, a whack that actually has some teeth.

I’m calling today for this new type of calculation, because if we don’t do something like this, our fines can be essentially meaningless—just a slap on the wrist, cost-of-doing-business. It’s this simple: if you’re making millions in seconds, then you should be liable for fines for bad conduct, counted in seconds. I know this is a revolutionary way of thinking about money penalties, but I believe it’s a necessary step to take in order to both deter illegal conduct and assess sufficient penalties to bad actors in our markets.

There are many ways to skin this cat, um, cheetah, and it’s high time we set about to do it.

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62 comments

  1. Hugo Stiglitz

    “It’s frustrating to know that there’s a simple solution to a serious problem but no one seems willing to do the obvious.”

    Now that’s a sentence that applies to a lot more than HFT. Too bad the public interest is no longer an operating principle of governance.

    1. fajensen

      There is always a simple, obvious, solution – that is also Wrong!

      In this case it does not help ANY to tax the public markets, which actually sort-of works even most of the time, while permitting Central Banks to back the 700 Trillion USD in OTC derivatives in the Unregulated Markets!

      Kill OTC first, with neutrons preferably, force all trades onto the regulated and public exchanges – THEN worry about regulating technical trifles such as HFT.

      The gravity waves from the black hole of OTC cause a lot more “instability” than HFT.

      PS: I am not sure “stability” is great either – it favours leverage and stupid bets.

      1. scraping_by

        First off, sort of works for whom? A small cadre of well-connected grifters and their bought government protectors. For those of us in the real economy, the financial markets long ago ceased to have any utility for capital investment or long term insurance.

        Next, while OTC is a well-known cesspool of scam-feed, the exchanges are only a bit better, and that by accident. Enron, among others, lose their seal of approval only after the money is suckered in.

        It’s true derivatives are attractive only to pure traders.

        Not only acting as a brake, the Tobin tax would raise money from the only place money’s to be found. After shelling out the American real economy in favor of financialization, it’s only fair the financials pay back their social support. Let Peterson and Bowles double talk that.

    2. Lil'D

      “Obvious” to whom?

      For almost all “problems” like this, there is some entrenched interest collecting rents from the status quo. If that interest has sufficient power to at least block reforms, status quo remains, and they win.

      Game theoretic analysis of many issues ends up making me sad and pessimistic about the likelihood for results which are “globally optimal”…

      1. Hugo Stiglitz

        I would say obvious to most people who follow these and many other issues. Looking at survey data it is obvious that many public policies are not what the public would prefer, and in most of those cases, I would argue, the public is correct.
        As far as introducing a financial transactions tax, I think most people would support it. Certainly most small investors like myself, who know how they are affected by this, would favor such a policy.
        As far as the OTC market and the negligent or outright corrupt practices by the regulators, well, no one has to trade there. Buyer beware, though this is not an excuse for criminal fraud and corruption. For small players in the major exchanges however, we have no choice if we want to own certain investments.
        HFT serves absolutely no social good, it does not improve market efficiency or capital allocation or any other reason it’s apologists throw out there. Tax it or ban it (I’d prefer a tax) and target the receipts toward improving enforcement and oversight.
        Of course, none of this is going to happen, which was my larger point. The US government does not operate in the interests of the general public. THe US is not a democracy in any sense.
        I am somewhat fortunate in that I no longer live there. However, I do invest there.

  2. polistra

    Excellent ideas. Won’t happen until an actual party with actual candidates pushes the ideas. Politicians aren’t moved by popular pressure or moral suasion; they’re only moved by the prospect of losing an election. Until we have a real second party that can take votes from the “two” Goldman brands, nothing at all will change.

    Look at what’s happening in Britain for a good example. They have THREE identical brands collaborating to ruin the country. Things are finally starting to change now that UKIP and BNP are pulling serious numbers of votes away from the three brands.

    http://www.telegraph.co.uk/comment/9615124/Why-the-Tories-are-ready-to-risk-detonating-the-Brussels-bomb.html

    1. link

      In the “good ole days,” the old-line industrialists would be the establishment counterweight to Wall Street. Those days are gone.

      And as the current administration didn’t care for its once-in-a-generation chance at pushing back against Wall Street, the status quo will continue until (as usually happens in American politics) something catastrophic happens and the public demands that heads roll.

      So basically if you want to save the village, you have to let it be destroyed first.

      1. OpenThePodBayDoorHAL

        I loved Ron Paul’s quote that it was time to “let a second party into the debates”. How true that is.
        Obomba’s failure to lift a finger for real reform or law enforcement on Wall St. is the real stunner. Or not. Before the inauguration when he appointed Geithner and Summers I suspected we were cooked.
        I wonder if anyone even remembers LIBOR, it was only the largest criminal fraud in the history of mankind. What more obvious signal that we live in a world of men, not laws. In this case the men want to have their little fraudlent fun with their computers, at the expense and risk to the entire capital structure of the world. Best place to find the blame is in a mirror, and when you pull the lever in the ballot booth for one of two criminally fraudulent parties.

    2. Aquifer

      “Won’t happen until an actual party with actual candidates pushes the ideas. Politicians aren’t moved by popular pressure or moral suasion; they’re only moved by the prospect of losing an election.”

      Bingo! And thank you – i have been saying that for some time now …

      Luckily we do have a “3rd” (or 2nd, as you point out) party that proposes exactly such a FTT = The Green Party, on ballots available to 85% of the population. Unfortunately, that party’s candidates for Pres and VP were hand cuffed to chairs by “America’s finest”, preventing them from presenting these ideas in a TV debate with DnR candidates ….

        1. Nathanael

          Well, this has not been a democracy, nationally, for some time (since the 2000 election), and the rule of law seems to have been eliminated entirely.

          The real questions are 1) how will the system of government be overthrown? (Someone will do it, sooner or later), and (2) what will replace it? (We’d like a democracy with the rule of law; we could get some warlord).

      1. fajensen

        Losing elections is not a problem for modern politicians, they just join the opposition while The Policy of Austerity carries on unchanged!

        Personal risk to life, limb and property of politicians is the natural consequences of “politics without change”. This is why “society” needs laws against “causing offence”, the police state to enforce the laws, anti terror laws, torture of suspects, and their indefinite detention in secret jails.

    3. Jonathan

      The motivation to win elections is considerably depressed by the brighter, steadier prospects on the other side of the revolving door. You can’t really project the blue-collar motivation to not get fired onto the political class, where performance is measured (and dictated) predominantly by social factors.

    1. Bert_S

      The most elegant would be the SEC saying “Oh yes, we just realized this is frontrunning, and frontrunning has been illegal forever! We now have a way to justify our taxpayer paid lawyer salaries!”

      2nd is I’ll toss in the first 20 cents, whether I make a trade or not.

  3. JB McMunn

    Why not just require that all orders are open for at least a couple of seconds or until executed? You don’t need a tax or a fine. You can do it in software on the exchanges and there’s no risk of regulatory capture, mild slaps on the wrist, etc.

    1. Cynthia

      Agree. A fast easy solution would be to introduce a 1-second rule for all orders entered into the electronic marketplace. All orders must remain in the system as open for at least 1 second. An order cannot be entered and cancelled/changed inside of 1 second. This will/may eliminate 99% of these issues and will go a long way to leveling the playing field.

      1. paul

        Maybe I’m wrong, but it seems to me that creating orders that you don’t intend to fulfill, with the intention of moving the price, is pretty much one definition of securities fraud. Creating shills is certainly fraud in human-to-human transactions.

        The other thing, of course, is that markets could stop doing the rebate thing, which only really makes sense as an unlawful inducement…

        1. Susan the other

          Thinking about Max Keiser’s regular rants on HFT wash trades. Not done for profit but just to move a moribund and pointless market so someone else, yes colluding, can slip in and make a profit. I guess my question is why is the market moribund and pointless? Could it be debt levels? Or perhaps risk insurance? Or bizarre shorts and still shorters done in the unregulated derivatives trade? Whatever shorts even are. (panic attacks?) If risk is so thoroughly hedged, why don’t we just go with price controls? Leave the market to the carnival.

        2. Mark P.

          Paul: ‘it seems to me that creating orders that you don’t intend to fulfill, with the intention of moving the price, is pretty much one definition of securities fraud.’

          Yup. HFT is centrally about the quote stuffing and the front-running. It’s notionally legal simply because the technology has outrun the law, and the HFT algo servers can fire off bids, analyze the patterns, and respond quicker than the competition.

          But it’s killed the stock market as a means of credible price discovery and capital allocation. See for example this from last week: -

          One Algorithm Made Up 4% Of All Trading Last Week, And No One Knows Where It Came From

          http://www.businessinsider.com/mystery-algorithm-4-of-trading-last-week-2012-10#ixzz29gKjdD90

          Even if you’re a big institutional investor with little choice you want to be out of stocks as much as possible

    2. chad

      I’ve always felt this is the best way to go. Once the rule is on the books it’s a simple change to the software systems and any one still violating the rule is easily detected.

      The logistics of setting up a tax and all the overhead that goes along with that is unnecessary. Just make a rule that can be obeyed with a code change.

  4. ldm

    http://www.automatedtrader.net/headlines/141650/price_based-circuit-breakers-not-enough-to-prevent-flash-crash–repeat–study-says

    US reforms will fail to avert another market meltdown such as the “Flash Crash” of 2010 unless they are coupled with new “liquidity-based circuit breakers”, a new study said.
    “Price based circuit breakers do not necessarily offer a good protection against such illiquidity spirals because the latter may happen without trades and therefore without changes in prices.”
    To counter the risk of illiquidity spirals, the authors argue new “illiquidity-based circuit breakers” should be introduced in tandem with price-based circuit breakers. They say trading could be stopped when market-wide depth falls below a specified threshold.
    “It could be an effective way to block an illiquidity spiral at its inception and thereby help traders to re-coordinate on a regime with higher liquidity,” Dr Cespa said.

  5. Jim A

    Actually with computers trading with computers in a dueling algorithms “robo-war” on Wall Street, the surprising think to me is that events like the “flash crash” aren’t really common.

    1. JCC

      They are far more common than most realize:

      “The analysis involved five years of stock market trading data gathered between 2006 and 2011 and sorted in fine-grained, millisecond-by-millisecond detail. Below the 950-millisecond level, where computerized trading occurs so quickly that human traders can’t even react, no fewer than 18,520 crashes and spikes occurred. The study’s authors call those events “financial black swans,” though they’re so common that the black swan label probably doesn’t fit anymore.”

      http://www.ufppc.org/us-a-world-news-mainmenu-35/10878-background-hard-to-think-these-things-through-because-nobody-understands-them.html

  6. Nicole

    HFT is a mere symptom filling a void of a far deeper and obvious crisis – confidence.

    There is a cataclysm of non-participation in equities. When buyers and sellers cannot be found they are manufactured via HFT. 100% manipulation and fraud.

    Why anyone is an “investor” in any of these rackets posing as markets is beyond insanity.

    1. Nathanael

      Well, people are involved because it’s the only way to *get* shares of companies. There are still companies whose shares are worth buying and holding long term (Berkshire Hathaway, perhaps) — but you have to go to the fraud merchants at the brokerage in order to buy shares.

      Which is nasty, but where else are you gonna go? When the mafia has a monopoly….

      1. Smokey

        I think you misunderstood the argument.

        Regardless of who one has to go through, outright revulsion will impact even the Berhshire Hathaways negatively.

        This may very well be coming sooner than later. A lot of quacks are making all sorts of racket about a manufactured pre-election “crisis.”

        In this fraud-valhalla marked to hope and change fantasy I tend to agree.

        1. Nathanael

          Oh, but serious investors don’t actually plan to resell. They wait for dividends. And even Berkshire Hathaway will issue dividends sooner or later.

          The dividends are not affected by the machinations of the stock market; only general economic collapse and currency collapse affects them.

          You may have noticed the popularity of dividend stocks going up. It’s not a coincidence.

  7. John R

    If the goal is to end HFT, then why should the tax have even a trivial impact on retail investors. The retail public, whether an investor or an active trader, should be exempt from such a tax as they are not engaged in HFT.

  8. EVmarc

    Any government that will not prosecute crimes will not allow the crimes to be taxed.
    But action is being taken by citizens
    Join the nurses they have a wall street tax in congress
    Tell Your House Rep. to vote for HR6411, a Robin Hood Tax on Wall Street transactions!
    http://www.nationalnursesunited.org/page/speakout/tell-u-s-leaders-to-vote-for-a-robin-hood-tax-on-wall-street-transactions-hr6411-
    Untied Front against Austerity Public Assembly
    October 27, 2012
    1% wall street sales (Tobin) tax all transactions
    http://againstausterity.org/
    5 point program to stop the depression
    http://tarpley.net/five-point-program.pdf

    1. Aquifer

      Unfortunately, the NNU has just come out endorsing Obama for reasons that escape me – talk about shooting yourself in the foot … Their signature political issues are the Robin Hood tax and Single Payer – both of which Obama opposes – and both of which are championed by the Green Party …

      Wouldn’t you think that the nurses would team up with the Doc (Stein) to treat our sick politics? Maybe they forgot the first rule – always wash your hands to get the germs off before you take care of the patient ….

  9. Ray Duray

    The Real News Network has just posted an item with Michael Greenberger discussing taxing HFT.

    http://therealnews.com/t2/index.php?option=com_content&task=view&id=31&Itemid=74&jumival=8917

    Select quote:

    (Paul)JAY: And do you buy that this would also slow down high-frequency traders? That’s one of the arguments, that you would somehow mitigate high-frequency traders if you tax it so it’s not as—the small margins [crosstalk]

    GREENBERGER: Now, there are ways to limit high-frequency traders, but the margin on this is so small that it would not block people from doing high-frequency trading.

    JAY: Well, unless you had a bigger margin, ’cause—.

    GREENBERGER: Well, but then the—the margin does not have to be that big. I think to the extent you argue for a bigger margin, you’re setting barriers in getting the financial transaction tax off the ground.

    For high-frequency trading, it’s as simple as making sure that there’s a human behind the engine that’s doing the trading. You know, when you go to send an email letter off a website, you have to type in letters that are put out there so they know there’s a human being doing the transaction. The trader should be required to do the same thing.

    JAY: ‘Cause right now—I was told by someone at the commission that does research at the commission that Goldman—I think he told me 600 to 700 people doing nothing but writing computer algorithms for high-frequency trading.

    GREENBERGER: Well, it’s not [incompr.] the problem that 600 or 700 people are writing the algorithms. The problem is the algorithms are in place where decisions are being made with no human intervention, they go askew, and we have calamities. And we really—we had the market drop, in May 2010, 1,000 points in half an hour. That’s going to be a walk in the woods compared to the damage that can be done by this.

    1. Yves Smith Post author

      This is embarrassing.

      The profit on the average HFT trade is UNDER ONE BASIS POINT.

      The proposed tax is THREE BASIS POINTS.

      And he says a tax won’t impact HFT? He’s actually saying they’ll blithely do trades at a big loss? Help me.

  10. Zach

    How about a tax on cancelled orders? Like $.0001 per cancel? HFTs aren’t even completing orders. That level of tax wouldn’t affect real people in any way.

  11. EnergyTrader

    You should realize this has been tried before. The problem with a tax is that it will just push volumes offshore. Take a look at Sweden’s experience with the Tobin tax or the UK’s Stamp Duty. Its great for politicians to say it will raise X dollars, but lets face it that political projections are a joke. Sweden projected 1.5B in tax income…actual income < 80M. People wont pay it unless they can still make profit. Therefore all you'll see is wider markets. To solve the issue at hand the regulating bodies have to have a better understanding of the markets they regulate. The CFTC isn't too bad with the futures markets, but the SEC is clueless as they've shown time and time again with just about every report they release.

  12. Paul Niemi

    I used to favor a transaction tax, but I’m rethinking. I think what this kind of tax could do is tend to institutionalize or cement in place the status quo. In the stock markets we have the buyers, the sellers, and the middlemen. It is possible that in the future, buyers and sellers could negotiate directly with each other, cutting out the middlemen. Technology has changed, permitting me, for example, to search for and buy the exact part for my project from virtually anywhere in the world. I no longer need to drive to a local store and hope what they have will work. The same can be true for stocks and other financial products. I think I would put a financial transaction tax on the back burner and wait and see how companies and investors start getting around the extraction of rents by brokerages using the HFT algorithms.

  13. Nathanael

    Each second is wrong.

    Each *trade order* issued — even if cancelled — constitutes market manipulation. The $140,000 penalty should be per trade. That would add up to a suitable amount of money.

    HFT caused the ‘flash crash’, among other things. It needs to be stopped. A transaction tax should have been in place long ago. And it doesn’t need to be large — a very small one would be quite sufficient.

    Paul: the only way copmanies can get around the abuses by brokerages (without help from the LAW) is to make their shares non-tradeable. Expect this to happen. If you want shares to consinute being traded, you have to apply a transaction tax.

    Why are sales of shares exempt from sales tax anyway? …. very little is else is.

  14. Tom

    In spite of the ingenious methods devised by statesmen and financiers to get more revenue from large fortunes, and regardless of whether the maximum sur tax remains at 25% or is raised or lowered, it is still true that it would be better to stop the speculative incomes at the source, rather than attempt to recover them after they have passed into the hands of profiteers.
    If a man earns his income by producing wealth (money is not wealth), nothing should be done to hamper him. For has he not given employment to labor, and has he not produced goods for our consumption? To cripple or burden such a man means that he is necessarily forced to employ fewer men, and to make less goods, which tends to decrease wages, unemployment, and increased cost of living.
    If, however, a man’s income is not made in producing wealth and employing labor, but is due to speculation, the case is altogether different. The speculator as a speculator, whether his holdings be mineral lands, forests, power sites, agricultural lands,( HFT, credit Derivatives, currency and commodity speculation, making takeover loans and other predatory financial practices, computer-driven interest rate and currency arbitrage, CDOs, casino capitalism) or city lots, employs no labor and produces no wealth. He adds nothing to the riches of the country, but merely takes toll from those who do employ labor and produce wealth.
    If part of the speculator’s income – no matter how large a part – be taken in taxation, it will not decrease employment or lessen the production of wealth. Whereas, if the producer’s income be taxed it will tend to limit employment and stop the production of wealth.
    Our lawmakers will do well, therefore, to pay less attention to the rate on incomes, and more to the source from whence they are drawn.

    Written around 1925 unknown author – items in Parentheses are my addition

    1. Smellslikechapter11

      As F. Scott Fitzgerald famously said “the rich are very different than you and I”.
      To which Earnest Hemmingway equally famously replied “they have more money”.
      Your wonderful quote so vividly shows that, no matter which side you take in the debate between these two great authors (I prefer Hemmingway), one can be truly said that the rich are not alike. The money of a Andrew Carnegie tainted in many ways is certainly nothing like the money of a hedge fund manager that speculates on the movement of commodity prices.

      1. Mark P.

        If you prefer Hemingway, perhaps you could spell his name correctly, with one ‘m’ in the surname and ‘Ernest
        without the ‘a.’

        1. Smellslikechapter11

          Sorry, not much of speller and I have the hardest time fixing the auto correct on my phone.

          Love them both as writers
          Just like Ernest’s take better

    2. Finnucane

      Meaning: make rent extraction impossible. One way is through criminalization. Another, in the case of land, is public ownership. Robert Fitch advocates as much in the programmatic section of The Assassination of New York, a book I just finished reading in part because it was cited on this site. Thanks, Yves.

  15. Hugh

    I like Nathanael’s question about why isn’t there a sales tax associated with these transactions. Talk about putting the fear of God into traders…

    HFT is just another form of looting. It represents a private tax on investors, a skim on the markets. Of course, precisely because it is looting nothing will be done about it.

    I think a transaction tax of 25 to 50 basis points would cut out most of the action of traders and refocus markets, i.e. investors on holding stocks with good long term potential for growth. I mean that is supposed to be the point, isn’t it?

    I would hold open any orders for at least a minute before they could be acted on so that human operators could assess them in real time.

    As for dark pools, I would ban them for any corp that was also listed on or traded in the markets. And I would apply a sales tax and immediate reporting to the markets for all others.

    As for volume going elsewhere, I would require US firms only to trade on exchanges where these HFT rules were in place, give foreign companies a choice between being listed on US exchanges and other exchanges with the same rules or being barred from them.

    I would apply a sales tax to OTC transactions.

  16. pathman

    This all presumes that the government that would institute this so called tax isn’t owned by Wall St. Never fucking happen.

  17. Siggy

    Don’t tax HFT. Force the offer to buy or sell to be good for a full 5 seconds.

    HFT depends on speed of entering and canceling. In HFT the cancel order immediately follows the enter.

  18. jayackroyd

    THANK YOU. I’ve been saying for at least a couple of years that I didn’t see how HFT was not just front running.

  19. Marcel

    WTF do we need another tax? Clean house at the SEC and overhaul Regulation NMS so that it absolutely prohibits the provision of customized market data feeds to “certain” customers. Stop the front running; end of problem. Yves, now I know why I rarely read your blog. You sound like a Communist.

    1. RalphR

      And you sound like an idiot. Like pretty much everyone on this site who uses the “Communist” word, you clearly need to acquaint yourself with a dictionary. If you knew squat about anything, you’d know that economists advocate taxation as a wasy to deal with externalities.

      Introduce me to the alternative reality you live in. Clean house at the SEC?

      Sheppard is clear that this was a way to deal with the abject failure that is the SEC, and the reason this might get done is that it also is a revenue generator.

  20. Joe Earls

    I think government — both pre-election but also post-election- is the only place where a real discussion of the Common Good is ever going to happen — if and when it happens again. I don’t predict it will happen, but it’s where my faith and certainly my hope have to lie. That discussion won’t even happen in classrooms, if the motiviation to be in classrooms is to compete economically with the person sitting next to you. (Who is probably a bit late to class because she is working two part-time jobs.) I think we’re at a Hegelian moment in history, or maybe coming towards it, where the central thesis of the culture gives way to an alternative synthesis. The American thesis that Capitalism that is energized by self-interet will produce commonly shared wealth will finally be seen as a canard, a flawed idea that has been dishonestly perpetuated as the truth. Capitalism of the Adam Smith variety, still endorsed by most Americans in some vague or specific way, has led only to profound income inequality and absolute social stagnation. The percentage of wealth in the top 1% is literally unfathomable. The percent of people who move out of the social class they were born into is miniscule. In Capitalism, the money simply moves UP. It never, ever, comes back down. To quote John Lennon in “Working Class Hero..”We’re still f—ing peasants, as far as I can see.” A more aggressive graduated income tax is a tiny step in the right direction. A greater step — and here’s wishing that Occupy has better spokesmen — would be the articulation and the widespread acceptance of the idea that the current income inequality is, in and of itself , unjust. “The arc of the moral universe is long, but it bends towards justice.” ML King. Let’s hope he’s right, in the end.

  21. s jay

    I’m 61 years old, and have had the following experience several times in my life: an eloquent individual who knows a lot about a complex subject which I wish to understand, becomes someone I admire and trust. They are a source of knowledge for me. Then, randomly, they wander into one of my areas of expertise, something I truly understand as a practitioner (I’m a physicist by degree). And I’m stunned at their total lack of understanding of the subject matter, though they sound just as convincing as they do when describing things for which I had been using them as a teacher. You have managed to give me that familiar experience with this post, and it saddens me. You’re not as smart as you think you are, you don’t understand what you think you do, and you’ve descended to being a repeater of lowest common denominator false internet memes. Based on the quality of many of your previous posts, I know you are capable of thinking for yourself and puzzling through complex subject matter. In this case, you’ve been lazy, and I’m quite certain, if you are honest with yourself, you will be able to admit that you really haven’t confirmed most of the concepts that you are putting into this post. Regulation by mob fantasy is not the way to repair our wounded markets, nor to establish a truthful understanding of how the world works, a prerequisite to improving our life circumstances.

    1. skippy

      Complete non factual rebuttal.

      I’m old, have experience, “(I’m a physicist by degree}” [like physics and agency are correlated]… duh, rhetorical I trust and admire shtick pandering, complex matter (its my bread and butter), Gnostic claptrap.

      skippy… wheres your evidence?

    2. RalphR

      I’ve searched past comments and see you are an awfully vociferous defender of HFT, so it looks like you are an industry troll, and not a very articulate one at that.

      The Forbes article is by a top international tax expert. Did you bother reading it? Looks like not.

      And you also don’t even understand the difference betweeen taxation and regulation, and also ignore the basic issue that HFT is ALREADY illegal as front running, but the SEC can’t be bothered to enforce the rules.

    3. Nathanael

      The tax on trading *is already in place in NY*, has been since before the 20s, and is for no-good-reason reimbursed to the brokers. There’s a “stamp tax” on pretty nearly every European exchange, which amounts to the same thing.

      So, uh, the Tobin tax exists and works. Fact.

  22. Achilles

    Interesting discussion. I believe HFT in it’s current form adds no value, and harms the integrity of the market. I also disagree with the tax- I think a time requirement of 1 or 5 seconds for all quotes would work better. I do think the goal of the public markets is to give investors confidence that they are investing on a level playing field. It’s a goal, I’m not saying it’s possible in a pure sense.

    First, since some people don’t understand how HFT does harm, here is a short list:

    1) It is bad for transparency. Can anyone argue that for an institution or individual investor, a quote that changes every .00001 seconds is a reasonable or valuable quote to the market?

    2) False, fake or stuffed orders. Under current market rules, only the quote on the inside market is even required to be liable to be executed. The rule changed around 2003 that traders could not trade “through” the current inside quote. The SEC reasoned that “why would an investor want to trade at a price that is worse than the current inside market?” I’ll tell you the reason. The inside quote in most securities is the minimum 100 share quote. Most HFT quotes seem to be based on that. If you want to execute the 10,000 share quote $.01 higher? Guess what? It’s an algorithm that cancels as soon as the 100 shares is executed. Can I preference/ go directly to the 10,000 shares? Not since the rule change. So the market is stuffed with quotes that have no intention of being filled. To me, this is a clear problem. This is already illegal- but I see it all the time.

    3) Strain on the markets- harming all market participants One HFT algorithm I know of canceled 1 million orders every minute from 9:30 to 10:00. This was in the early days of HFT- maybe 2003. Considering there is no financial penalty for it doing this, it doesn’t matter if it is 1 million or 1 trillion orders that are canceled. I’m sure others on here would have the exact stats on the state of cancelled orders flooding the system, but it is absurd. I’d like to hear the argument that this doesn’t put unnecessary strain on market servers.

    4) Liquidity is only added when it’s not needed. I’m not going to get too far into this. It should be clear to anyone who has any market experience. HFT has made Stop Loss and market orders basically useless except in stocks with the highest volumes. For any mortal trader, a market order in a second tier volume stock means executing 100 shares, seeing the rest of the quotes fall away, and getting filled at a much worse price than it would appear when the order is entered. This is because the chances of a quote below the inside market being there when the inside market changes is next to nothing. Can somebody tell me why this is good for the market? Sure traders use smart routing orders, marketable limit orders to try to counter this- but why this BS game? I just want to buy a stock, why is it so hard to figure out at what price I will get executed? When did it become OK to trick the market into paying a different price than it wanted to?

    I don’t like the tax, but I like the sentiment. I believe a simpler solution, as suggested above is to simply make quotes be active for a minimum of 1 or 5 seconds. Alternatively, I like the $.00001 fee for canceled orders over say 100 in the same account. I think the time rule would be better. It would all but eliminate the harms of HFT. Maybe somebody could explain what harm it would do to the integrity of the market to have quotes required to actually be executable. I don’t understand why institutions would deal with the current HFT driven market. I would only trade on dark pools if possible.

    I do understand that HFT are the biggest customers, have the best lobbyists and influence money can buy, and pay the highest SEC fees, so I don’t see this changing any time soon.

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