Joe Nocera has a mostly perfectly OK column in today’s New York Times on the trading glitch that led Knight Capital to launch a rapid-fire spree of unsought trades that screwed up the stock exchange this past Wednesday. The failure was the third major market technology-mediated muddle in recent times. The most famous of these f**k ups was the 2010 Flash Crash, after which academic researchers introduced the broader public to the delightful phrase, “order flow toxicity,” which Wikipedia handily tells us “can be measured as the probability that informed traders (e.g., hedge funds) adversely select uninformed traders.”
Nocera’s main point that the continuing series of market failures is ruining investor confidence in the market as an institution. He points out that not all the problems are technical — he points to the Facebook IPO as an example of insider treachery that had nothing to do with any computer jiggery-pokery.
But he still goes off the rails in one passage — and the way he does so is illustrative of the larger problem in both the exchanges themselves and in the VSP/elite framing of market society. He writes:
Most rapid-fire trading has nothing to do with the core idea that drew people to the market in the first place — that if you picked good companies, and did your homework, you could make money.
No! No! No!
Or rather — Irrelevant! Move to strike!
Here’s the problem: Nocera may be right in the narrow sense. When I put my 401K (actually a 403B, but that’s a distinction without a difference) into mutual funds, I do hope that I’ve picked good securities, that my homework has extracted more or less accurate information, and that I’ll ultimately be able to retire in comfort. Individual investors do indeed go to the exchanges to make a smaller pile of cash larger.
But Nocera misses the larger issue, and he does so in a very telling way. The classical understanding of what a stock exchange is supposed to do is to allocate capital efficiently, driving investment to what will be, for the economy as a whole, its most productive uses. Obviously, this is a mission often honored in the breach in the current markets in securities of all types (another post on that coming soon), but still, if we’re going to talk about market failures and their consequences, what trading scandals like this one reveal is the way our current pathological form of financial capitalism steals the life blood of a productive economy and transfers it to thieves. (Cough, cough, RMoney)
In that context the real fecklessness of high frequency trading and other tech-driven tactics becomes clear. Trades entered and exited in seconds aren’t about capital allocation. They are just a form of rent-seeking, trying to exploit some momentary imprecision in the markets to take a few bucks out of each transaction…and hence out of productive use, at least for a while.
I’m not an anti-capitalist. I believe, and will argue in the book I’m just starting to write, that the invention of financial capitalism is one of the great goods human society has produced ever. It is also prone to failure in predictable ways and depends acutely on a society’s willingness to enforce norms of public behavior. Absent such a framework, you get what we’ve got: a system that the little guy has damn good reason not to trust — as Nocera says — and one that cannot do the single thing it is supposed to achieve: organize society’s resources to the ends that deliver the most reward not just to given investors or owners, but to the economic life of the country or the world as a whole.
If we’re going to complain about crappy software and cheated investors, we should remember the full tally of what’s at stake in a market system transformed from public utility to rigged casino.
Oh — and one last thought: if you want to talk about the middle class paying to provide the very wealthy a little bit more, Romney’s tax plans are trivial compared to the wealth transfer a vampire-ridden, corrupted financial system can achieve.
[Bonus link. The perfect video for this title/topic]Image: Claude Vignon, Croesus Receiving Tribute from a Lydian Peasant, 1629.
jwb
I’m really looking forward to your book.
WereBear
Ooow! A new book. Looking forward to it.
I like to remind people of all the failures of deregulation; and if they still squeal (likely) I remind them that we need rules because of cheaters.
Ben Franklin
The House of Cards stands ready to fall. All the Handlers need do is breathe too hard.
Linda Featheringill
Okay, guy.
The most useful function of the stock market is to provide capital for companies to invest in machinery etc. in order to increase production.
It looks to me that our stock market is not doing that and hasn’t for a long time. It is now a game of, by, and for stock traders.
There is a shortage of capital for investing in improving/starting companies. Is there anything you can do to the stock market to fix that shortage?
Villago Delenda Est
Unless you worship the ground that pirates like Dubya Mitt Rmoney walk on, you are a fucking Marxist.
Like that Adam Smith guy.
Linda Featheringill
@Villago Delenda Est:
I resemble that remark!
Birthmarker
The transparencies of our institutions were our strengths. That is what I fear the loss of.
dww44
I see the problem as one in which the dismantling of Glass_Stegall and before it, the lifting of usury rates back in the late 70’s resulted in the mass transfer of capital into the financial markets away from manufacturing. In 2009 I was linked to an article, “Is Infinite Debt to Blame” in Harper’s by labor attorney and author Thomas Geoghegan in which he postulated that the crash was the result of the lifting of usury rates which sucked long term investment capital from manufacturing directly to the financial market to get better returns and thereby causing the financial markets to become the only game for investors. Not a healthy situation at all.
Villago Delenda Est
@Birthmarker:
Transparency breeds trust.
Trust gives you more efficient, more functional, more robust markets.
Fortune 500 CEOs hate that. They have to actually compete, they can’t rent seek.
Roger Moore
@Linda Featheringill:
Increase inflation. It acts like a tax on hoarded cash, which is exactly what our economy needs right now. It’s no coincidence that the financial sector took over the economy at exactly the same time central banks were driving inflation down. Bring back 4% inflation, and you’ll see a lot of money moving from financial assets and back into productive assets like profitable businesses.
Linda Featheringill
@Roger Moore:
Increase inflation:
That’s in interesting thought. Let me cogitate on it a bit.
Gin & Tonic
@Linda Featheringill: More “tiers” of timing for capital gains, with higher taxation the shorter the holding period. right now there are two tiers, short-term and long-term. But “holding” a position for a fraction of a second, as was said, isn’t about allocating capital. So maybe ultra-short-term capital gains tax for any position held less than 24 hours or something.
aimai
Isn’t Joe Nocera a sports writer? At any rate, this is so dumb it makes dumb look smart. “The Market” doesn’t want to allocate things fairly, or well, or in any way at all. “The Market” to the extent that it exists as other than a name we assign to the g-do of capitalism, consists of what people do, not what people say they want to do, or hope to do. Traders trade in order to get profits. They don’t trade for anyone’s benefit but their own. There is no “purpose of the stock market” and never has been–that’s a second and third order rationalization of a process that people engage in because money doesn’t grow on trees.
aimai
scav
To a certain extent, the problem rather involves the death of the market as it formerly worked with a market developed from abstracted and simplified theories of how the market v.1 worked. The old market was described, simplified and abstracted to make understanding things going on and then those models were accepted as gospel ideals and implemented by machines that can don everything described very very fast — but they can never implement the unobserved / undescribed behavior of the market v.1. And how there are all the mathematical tricks that exploit the new conditions so, as TL says, the “function” of the new market now longer matches the “function” of the old one. There are other things going on too — we seem increasingly to be producing a brittle economy through over-engineering for optimization profits and skinting on backups. /meandering thoughts.
MikeJake
Will somebody PLEASE think of the liquidity?!
Fluke bucket
I wish I could understand money. I know it does not grow on trees but where in the hell does it come from?
Ben Franklin
@Fluke bucket:
where in the hell does it come from?
And, when it slips through your fingers, where does it go?
Tom Levenson
@Fluke bucket: From hamburgers, of course. As in “I will gladly pay you Tuesday for a hamburger today.”
You’re welcome.
El Cid
I’m an anti-capitalist. No particular point, nor any expectation that some non-capitalist system is likely to soon arrive, but I’m awfully tired of hearing this asserted like being capitalist is the unquestionable natural state of the universe, and the end and highest point of human civilization.
Being pro-capitalist isn’t some sort of more mature or more civilized position.
It would be quite remarkable if the highest form of human civilization in its allocation of material resources and human endeavors just happens to have been developed in the past 150 years.
It could be true, but it’s certainly not silly or immature or naive to think there’s a very high likelihood that like many historical eras, it won’t necessarily last forever.
Of course, each age overwhelmingly seems to convince many living in that time that the status of human life found in that age is, in fact, the natural state of things.
Ben Franklin
@El Cid:
It would be quite remarkable if the highest form of human civilization in its allocation of material resources and human endeavors just happens to have been developed in the past 150 years
I think it was George Carlin who asserted the purpose of Homo Sapiens.
The Earth needed plastic..
jayackroyd
First, I think a lot of this high frequency trading is actually front running–identifying trades that are about to execute, and execute in front of them.
Second, just impose a transaction tax already!
Tom Levenson
El Cid:
As I reckon (and am working on) the financial revolution that marks the emergence of (early) modern financial capitalism begins in the late 17th century and is pretty much in place no later than 1750. That’s a very England/Britain-focused reading, and depending on what you think of Italian and Dutch innovations that came earlier, (among others) YMMV.
But in any event — more like 300 years plus than 150.
#nitpicking
Tom Levenson
@jwb: @WereBear:
Thanks for the enthusiasm about the book. I emphasize the word “beginning.” We’re talking 2-3 years at least before copies hit the store.
scav
@Tom Levenson: You come across Deirdre McCloskey’s Silmarillion, I’m not sure what volume she’s up to yet on Ethics and Commerce etc? I think the first is The Bourgeois Virtues and the second Bourgeois Dignity. I keep trying to get a running start at them and push though a bit further on every attempt but it’s slow going. I’m looking forward to your book even in 3 years as it might be similar but take up less shelf space and it’s usually fun to have slightly different takes on the same subject when plowing.
ETA: and wasn’t it the Nesteen that wanted plastic on Earth?
Omnes Omnibus
@Tom Levenson: But I want it now. Write faster. Damn it.
muddy
@Omnes Omnibus: That’s not very nice, telling him to get the hell out of the blog like that!
mclaren
If you’re not an anti-capitalist, you should be. It’s clear that capitalism cannot be reformed. Like fascism, capitalism is unredeemable: there cannot be a “kinder gentler capitalism” any more than there can be a “kinder gentler Third Reich.”
Either capitalism dies, or America does. Choose.
Omnes Omnibus
@muddy: I am perfectly okay with TL multitasking. He doesn’t have to go.
moops
Tiered transaction taxes. exponential function of hold time Ce^(m/t). Senator Elizabeth Warren could put this on the agenda in her first term.
muddy
@Omnes Omnibus: Well, that’s generous of you, I commend you for your community spirit!
I know from personal experience that once one starts searching the web for artworks that go with a post that this portion can make one oblivious to all else for hours. I had to set up my computer to announce the hour aloud to snap me out of it.
Judas Escargot, Acerbic Prophet of the Mighty Potato God
@mclaren:
I’m not sure you can call our current system ‘Capitalism’, seeing as only 1% of us gets to have any working capital.
While we’re nowhere near a post-scarcity society yet, we are well into an era of ‘forced scarcity’ (due to inefficient allocation/distribution rather than basic scarcity-of-resource). Parasites at the top have gamed the system to capture most of the true, material wealth produced by those beneath.
There are still plenty of Third Ways that we haven’t tried yet.
Omnes Omnibus
@muddy: I find myself going down music related rabbit holes, so I know what you mean. I still want the book now.
muddy
@Omnes Omnibus: Oh, what rabbit holes have you gone down recently? I have a new project coming up that consists of making espresso glasses that look like tiny mugs. It’s hard to get that much handle onto such a small cylinder. I need something to aid in concentration of minutia.
Here is the trial version, it fits some machines but is 1/4″ too tall for others. I need to get them all to the lower height for the order.
http://www.flickr.com/photos/mudpix/7712151688/in/photostream
Aren’t they the cutest little things?
Tom Levenson
@muddy: Yup. I’d love to stop doing that bit, but posts now seem naked to me without the douche’s pretentious art…
muddy
@Tom Levenson: One of my majors was Art History. Don’t you dare stop! I will Occupy your posts with abuse if you do!
mclaren
This is the well known “no true Scotsman” fallacy. It cannot have escaped your notice that this faulty argument is exactly the same one used in the dying days of the collapsing Soviet empire in a futile effort to shore up communism.
“Yes, comrade, it’s quite true that the USSR doesn’t produce enough shoes or bread for the bottom 99% of its people and that we’re losing a hopeless endless war in Afghanistan — but that’s because I’m not sure we can call our system in the USSR `Communism,’ seeing as only the top 1% of us known as the nomenklatura gets to have adequate food or housing.”
Whatever the vast majority of people in a culture call something, is how we define that something. Everyone in America today calls the rotting senile kleptocracy of corrupt crony-run monopolies and debt peonage that rules our society with an iron fist “capitalism,” so that’s how we have to define it.
And as for alternatives, don’t even get me started on Mondragon, Spain.
scav
@muddy: They are fun. I’ll admit that for a while I was making my espresso into the little chicken-shaped egg cups because I couldn’t find anything of the right height. Now they were daft but also fun, especially the frosted pink glass one. But your’s are clay which goes to another nice direction (rather than dementia). And I’m behind you all the way in your Occupation of any artless thread. I’ll bring the tent.
Roger Moore
@Fluke bucket:
Money is basically a promise to do something for somebody in the future. We talk about it as something more than that, but that’s the essence of what it’s about. So you can create money by making an IOU.
muddy
@scav: Better make it a big tent, I’m sure many would join us! When I bought one of Ozeri’s food scales, they sent me these as a thank you:
http://www.amazon.com/Moderna-Artisan-Beverage-Espresso-Glasses/dp/B0041EIFUI/ref=sr_1_42?s=home-garden&ie=UTF8&qid=1344110358&sr=1-42
They’re cute, but I don’t think they hold the temp as well as clay. If you put hot water in one of mine first, or nuke it for 10 sec, mine hold the heat for a long time. I was asked to make these with the temperature holding as a priority.
But if the handle is any smaller, you won’t be able to put a finger through it, and I hate solid handles, they look like ears to me.
Chris T.
@Roger Moore:
Precisely! The difference between an informal IOU (such as me writing on a piece of paper that I’ll do or give you something in the future) and what we usually think of as “money” (typically, some sovereign currency) is that humans share a mass delusion that the green-printed special paper (or other colors and plastic, in the case of many currencies) has some greater intrinsic value than the hand-scribbled IOU.
The especially curious thing is that these government-issue IOUs actually do have greater intrinsic value than hand-scribbled ones. The important question-and-answer is: why? Why are currencies, or in some cases things like cas1no chips, “more valued” than a hand-scribbled IOU? The answer to that lies in the words “trust”, “faith”, and “credit”.
When we lose trust in our shared mass delusions, we lose the intrinsic values. A loss of trust in Wall Street is a loss of some deep intrinsic value. And trust is far more easily destroyed than grown / re-grown. Too many financial types seem to have forgotten this.
elftx
Wired has an article about algo trading as well.
http://www.wired.com/business/2012/08/ff_wallstreet_trading/
AA+ Bonds
I would point out here that Marxists agree 100% that “the invention of financial capitalism is one of the great goods human society has produced ever”
I am not a Marxist but I also believe capitalism sucks and I also agree that “the invention of financial capitalism is one of the great goods human society has produced ever”
The question is whether, agreeing that, say, the Magna Carta was a great achievement, you also agree that no legislation can ever be better (or better suited to current reality) than the Magna Carta
AA+ Bonds
I am not a Marxist but I also believe capitalism sucks and I also agree that “the invention of financial capitalism is one of the great goods human society has produced ever”
The question is whether, agreeing that, say, the Magna Carta was a great achievement, you also agree that no legislation can ever be better (or better suited to current reality) than the Magna Carta
AA+ Bonds
In fact the only anti-capitalists I’ve encountered who consider financial capitalism not to be one of the greatest goods achieved by humanity are all romantics of some sort or another: Catholics, Buddhists, primitivists, etc.
In my experience, anti-capitalism rarely means the belief that Wall Street (or something like it) should never have existed or never had a material reason to exist; it usually means the belief that the time has come to move society past the need for Wall Street
Anoniminous
@mclaren:
You say that as if it’s a Bad Thing.
One of the more illuminating graphs I’ve seen in awhile is this from the Political Compass folks. The major difference between the Dems and Repubs is whether the Iron Fist should be covered in a Velvet Glove.
Omnes Omnibus
@muddy: Well, I came across this the other day.
mainmati
@Linda Featheringill: Moore’s point is not runaway or hyperinflation, which the Rethugs have been yelling about all during our totally flat Depression; it is just enough inflation to induce the Overlords to do something productive with their money instead of just sitting on it or giving it to Treasury at negative interest rates.
jayackroyd
@Chris T.:
David Graeber wrote a pretty good book about this.
jayackroyd
@Chris T.:
Oh, and the short answer to your question as to why government issued IOU tokens have more intrinsic value than privately issued tokens is because only the government issued tokens can be used to pay taxes. And everybody has to pay taxes, while not everyone has to trade with a particular bank, or shop.