Innovations in Trading and Technology (The following commentary is an excerpt of a response written by TABB Group founder and CEO Larry Tabb to a recent New York Times editorial. The complete commentary originally appeared in the New York Times' DealBook online.
A recent editorial in The New York Times looked at the proposed acquisition of the New York Stock Exchange by the IntercontinentalExchange and that of Knight Capital by Getco. The editorial argued the following: that these acquisitions and the promotion of high-speed trading put smaller investors at risk; that the regulatory infrastructure is not sufficient to oversee the combined futures and securities exchanges; that acquisitions of this type created larger derivatives players that escalated systemic risk and posed a risk to taxpayers, and that the two acquisitions were tied to the little progress in developing comprehensive rules to stave off another financial crisis.
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11 Comments to "It May Be ‘Bye-Bye to the Big Board,’ But the NY Times Should Get Its Story Right":
aeron
29 December 2012
Try telling investors that have suffered large losses during any of the many flash crashes that have been caused by hft liquidity shortage...when hfts act as market makers and account for a large proportion of this service without the regulatory rules of traditional market makers. Saving a few pips on the spread for the democratic majority is much less of a concern than market stability...also you have failed to backup your claims of a more democratic and transparent market with any examples or evidence. nanex povides numerous examples for your reference.
Comments (1)
Anonymous
29 December 2012
You could tell that to those "investors who have suffered large losses during the many of the "Flash crashes" but they do NOT exist. Where are YOUR examples? Anyone who suffered as a consequence of abnormal volatility (which Flash crashes are) is more likely a professional investor than "Mom and Pop". The guys who are whining the most about HFT continue to be the high touch trading desks who can't keep up and the former "day traders" who have seen spreads narrowed.
ltabb
29 December 2012
Aeron,
I commiserate. The market structure is by no means perfect. It is way too fragmented. There are ways of picking off folks through speed games, dark pools, order types, and just way too much investment in infrastructure. But what is the alternative? Markets certainly were not better in the manual market days. I used to remember as an individual investor getting filled consistently at the worst fills of the day and sometimes above or below the days high/low - and I worked for a brokerage and paid something like $200 a fill for the privilege.
As for the many flash crashes and Nanex et al. Yes there are problems, yes there are computerized patterns that look like the equivalent of saw teeth, or crop circles or whatever, but was the flash crash worse than 1987? That was basically the same thing but it played out over weeks/months not seconds and minutes. No one gets paid to catch a falling knife (be it an official market maker or not) - to use a well overplayed analogy.
Now as I said - the markets are not perfect and I have opined on how screwed up they really are but that said - the NYTimes should get it right. If they want to bitch about market structure - sure there is plenty to bitch about. If they want to complain about derivatives or systemic risk, or the inability of the regulators to get DF through the system - sure there is plenty to bitch and complain about. But don't just take the easy way out and complain about the ICE/NYX or Getco/Knight acquisitions. Especially in such a blatantly wrong way. Talk about poorly financed and equipped regulators, talk about dark pools, talk about trade-at, talk about fragmentation, talk about speed, talk about a hundred things that you can legitimately complain about - but don't present it in a way that is blatantly wrong. And what is more - they actually have folks on staff that know this stuff. And they are the "paper of record" whatever that means.
All I ask is they get it right and if they are going to write a piece about the problems in the market, they should at least wright the stuff that is really wrong with the market and not some poorly researched, babble based upon incorrect common wisdom.
Comments (303)
agrody
31 December 2012
So what’s a guy (or regulator) to do? The industry will constantly game the regulators (not out of Machiavellian intent but rather out of learned culture); the regulators will forever be behind the eight ball (not because they are not smart rather they are simply under resourced); and the public will forever be left holding the bag. That bag can be seen as being perpetually late to the party in the IPO market; in getting the best National Market System best bid or offer but not the best bid or offer; and in being constantly told there is a way to beat markets when all the research for the last two hundred years says otherwise.
So what’s a guy (or a regulator) to do? First, stop making incremental changes to a fundamentally flawed market. For example at its core illiquid (low cap) markets should be separated into institutional markets and retail markets while being kept in synch through real-time technology driven arbitrage; call markets are better for highly liquid (big cap) markets, let’s go do this; and exchanges are very different then in the past, they are profit and shareholder driven businesses that should not be self-regulated.
How do we guys and regulators get from here to there? We need a fourth branch of government, like the press, what I call the Ombudsman Regulators. We have the executive branch, they appoint Chairman and commissioners; we have the legislative branches they approve Chairman and commissioners; and we have regulators that write rules and oversee financial markets through the regulations the write. They do this always in dialogue with “the industry”.
Remember “the industry” is us, and we are not the best to police ourselves or to give advice to regulators on how to do that. We need an Ombudsman Regulator class – former policy people, former industry professionals, former academics, all beyond reproach. People who have served with distinction. A group of distinguished leaders and professionals and, most importantly, people with knowledge, wisdom and judgment that can dialogue with regulators and provide objective advice. Most importantly rather than be picked by a government head or agency they need to self-actuate and organize themselves. Neutral in all respects - looking out for the people’s best interest. For without the people we have no liquid markets, no retirement portfolios to grow and no prices to be discovered.
Let’s start by one or more Philanthropic Foundations putting up funding and calling on members of their own Boards of Trustees, those who have alreday served the financial industry in their past lives, to form the initail core.
Fundamental change. Happy New Year.
Comments (42)
John Harris
02 January 2013
Larry, you appropriately and helpfully held the Times to account for several material, factual errors in its editorial (the link to which, by the way, is broken both in TabbForum and DealBook). But this was actually one of the few Times editorials with which I found myself agreeing in large measure, though I disagreed with its conclusion. And your reply glossed over the larger, more salient points the Times raised.
First, it is certain that these larger entities will be more difficult to regulate. Your reply focused on regulatory processes and tools, but processes and tools aren't the issue. The larger entities will be more difficult to regulate because they will be more complex, incomprehensible, and politically powerful. Your thesis provides no explanation for the failure of central banks and regulators to detect, prevent, or prosecute that massive sales practice and mark-to-market frauds that are at the heart of the ongoing financial crisis. Nothing has changed! Regulators still don't know the market price of complex mortgage derivatives and the like lying stale on bank balance sheets and neither do the banks. Thus their net capital computations are wrong, and overstated. All of our large banks are massive accounting fictions with an implicit taxpayer guarantee, no matter how much they are regulated.
Second, these larger entities and especially the clearing structures they are building do put taxpayers at greater risk. The things to be centrally cleared (and implicitly guaranteed by taxpayers) also have fictional prices and Alice-In-Wonderland mark-to-market processes. FICC has yet to come clean on exactly how it resolved Lehman or the fact that it violated its own rules in doing so. Now we're supposed to believe that netting facilities for CDSs on mortgage derivatives three times removed from pools of impossible--to-value ARMS won't be operated with a wink and a nod?
As you may recall, I support systematic trading and free markets, and oppose government regulation. So I do not wish to have these mergers scuttled. But I do wish to have my children - all of our children - off the financial hook for them. And the Times correctly opined, in effect, "Gee, we're allowing these entities to get even bigger and more powerful, but we still haven't addressed what happened in 2007-2009." In that regard, the Times is right.
thegonch
02 January 2013
I find it challenging to call a market "democratic" or "transparent" that allows certain players the right to superior access to input orders without any regulation that imposes additional responsibility to go along with those rights.
I also believe if you cannot mark a trade, you can't clear it, and that capital rules need to take that into account.
Comments (1)
ltabb
02 January 2013
John,
I am also conflicted. At the end of the day the only thing that will stop too big to fail is to get rid of the larger organizations. However, the combo of Getco / Knight and ICE/NYSE - in no way comes anywhere near as dangerous as a link up and in fact it is much better than what folks did during the crisis - BoA/Merrill, JPMC/Bear, Barcap/Lehman... Getco/knight doesn't take anywhere near the amount of risk than one of these larger banks - they also are not taxpayer guaranteed. Even after the Getco/Knight deal they won't be a bank - and if they do go bust there won't be any taxpayer bailout.
The ICE/NYSE deal - is a bit more problematic in that sense as the ICE has clearing facility that is a SIFI. And yes DF will force the industry to consolidate risk in clearing houses.
And your take about the risk of central clearing is right - I am very much against having clearing houses backed by central banks. But that is another commentary (that I have written about a few times).
But that said - at the end of the day neither exchanges nor clearing houses take market risk. Exchanges take a little credit risk - but only till orders are sent off to clearing. Clearing houses take significant credit and hence market risk (if one of the counterparties go bust) but they are supposed to have appropriate margin (and appropriate is the big question mark).
Yes - I do agree with the Times editorial in that I wish the world was simpler, organizations where smaller, and there wasn't as much risk. But as I said - the world has moved on from that viewpoint and Washington/Brussels don't have the guts/desire to break these organizations up and make the organizations more self reliant, and less risky.
Comments (303)
John Harris
02 January 2013
Agreed as to size differentials, Larry, and otherwise. The big question in my mind - and, I would respectfully submit, what should be the big question in all of our minds - is how does the status quo change? How does the market move beyond Too Big To Fail? When will markets be allowed to clear? Heck, when will markets be allowed to function as markets, will all that implies for the possibilities of success and failure?
It seems pretty obvious by now that change isn't coming through the ballot box. Violent revolution certainly isn't the answer. So are we forever doomed to have a market in which some firms always operate above the law and can't even be prosecuted for wrongdoing out of prosecutorial fear of triggering a systemic collapse.
ltabb
02 January 2013
John,
That my friend is the million dollar question. The one that can answer that deserves a Nobel
Comments (303)
pdaley
04 January 2013
How does the market move beyond too big to fail? We just did.
Knight was allowed to fail if that were to be the consequences of their actions. They were not saved by the government or regulators when it would have been easy for them to do so. All the regulators needed to do was declare the trades that took Knight down as "clearly erroneous" and the $440 million transfer of wealth is undone. Tom Joyce bemoaned this fact publicly at the time (and one guesses privately, and more strongly too). Instead, the trades stood and Knight was forced to find a private solution to their problems.
The market was allowed to clear when they sold the convertible security to private investors that diluted current shareholders and recapitalized the company. They were allowed to fail. And private capital decided to offer them a lifeline at a cost.
Comments (2)
John Harris
04 January 2013
All great points. And nature should have been allowed to take its course with all of the banks that were spared the verdict of the market. No one would have died, the world would not have ended, the sun would still have risen, stronger hands would have taken control of the assets, and the liabilities would have been apportioned according to law, rather than extra-legally. We would know which firms were well-managed and which weren't. But raw political power won the day. And raw political power still rules. Tom Joyce just didn't have enough of it.